In financial markets, sentiment has taken a knock over the past couple of months. While global stocks are still trading near record highs, investors have become much more concerned about the outlook for the global economy.
Although a number of factors are contributing to the more cautious mood, an increasingly important one is mounting anxiety over China. Over the past few months, the economic, regulatory and financial environment in the country has become much less predictable, and is now viewed as one of the main threats to markets.
A slowdown that was evident earlier this year is gathering momentum. Growth in retail sales last month fell far short of expectations, while construction investment contracted in the first eight months of this year due to more forceful measures to cool the housing market.
Beijing’s rapidly widening regulatory crackdown has caught even the most seasoned of China-watchers off guard, fanning fears about which sector will provoke the government’s ire next following heavy-handed interventions in the technology, education and gaming industries.
Moreover, there are growing concerns about systemic risk due to the liquidity crisis gripping China Evergrande Group, the world’s most indebted real estate developer and Asia’s largest issuer of high-yield, or “junk”, bonds. The yield on a gauge of Chinese dollar-denominated junk bonds has shot up to 14 per cent, a decade high, data from Bloomberg shows.
While a restructuring of Evergrande’s staggering US$300 billion debt pile remains the most likely scenario, uncertainty over how far Beijing is willing to go to reduce moral hazard, and take the heat out of the housing market, is undermining sentiment towards China.
The threat of a sharper property-induced slowdown and an increasingly uncertain policy environment poses a particular challenge to China’s commercial real estate sector, notably cross-border investment, which accounted for 30 per cent of transaction volumes between 2015 and 2019, according to property consultant RCA.
Earlier this month, US private equity fund Blackstone announced it had been forced to abandon its US$3 billion takeover of Soho China, a leading office developer, due to the failure to win regulatory approval within the agreed time frame.
Yet, the fact that Blackstone – a high-conviction, thematic investor that takes big bets on secular trends in the global economy – announced the acquisition in mid-June, when Beijing had already stepped up regulatory scrutiny of the tech sector and China’s slowdown was becoming more pronounced, is telling.
Not only is it indicative of the appeal of China’s commercial property investment market – which over the past several years has vied with Japan’s for the top spot in Asia-Pacific transaction volumes – it attests to the strength and resilience of leasing activity.
A woman rides a bike past the Wangjing Soho commercial complex in Beijing in October 2014. Husband-and-wife team Pan Shiyi and Zhang Xin built Soho China into a major mixed-use residential and commercial property developer. Photo: Simon Song
While Beijing’s regulatory clampdowns have dominated the headlines, key drivers of growth in the commercial property sector – structural changes to global investors’ asset allocations that increase demand for higher-yielding and resilient assets, the vast potential of China’s consumer market and the shift to technology-enabled real estate – continue to underpin demand.
A report published by Colliers on September 1 noted that, in the first half of this year, transaction volumes in China were the third-highest among the top 10 countries with the highest levels of investment activity relative to their first-half cyclical averages.
Indeed, China’s commercial property market is benefiting from increased transparency and liquidity. The launch in June of publicly traded real estate investment trusts – several focused on industrial and logistics properties – provides a new vehicle to help investors deploy and recycle capital.
Foreign investors are also showing “a confident underlying conviction in well-located retail assets”, said Tim Graham, head of capital strategies for Asia-Pacific at JLL. While shopping centres in Western economies remain out of favour with investors, Canadian asset manager Brookfield bought a portfolio of malls in five Chinese cities in June for US$1.4 billion.
Unlike the residential sector, commercial real estate does not fall foul of Beijing’s policy priorities, and is set to benefit from the government’s desire to boost domestic consumption and advanced technologies. The logistics sector is particularly well placed to capitalise on the growing importance of high-end manufacturing.
Employees work in the warehouse of Cainiao Smart Logistics Network, the logistics affiliate of e-commerce giant Alibaba, in Wuxi, China’s eastern Jiangsu province, on November 6, 2020, ahead of Singles’ Day on November 11. The logistics sector is well placed to capitalise on the importance of high-end manufacturing in China. Photo: AFP
The disconnect between the bleak headlines about China in the Western financial media and the strong growth prospects of the nation’s commercial property market is most apparent in the office market.
In the second quarter of this year, net absorption of office space was close to the all-time quarterly high, powered by strong demand from tech companies. According to CBRE, China accounted for over half of leasing activity in Asia last quarter.
For large cross-border investors, China’s crucial role in the global economy, the sheer size of its consumer market and the necessity of having exposure to the country to build scale in Asian commercial real estate outweigh the increasing unpredictability of the policy environment.
“Capital is looking for scale, which is difficult to achieve in most other markets in Asia,” said Chris Pilgrim, global capital markets director at Colliers in London.
A sharper slowdown in China, and a deepening crisis at Evergrande, increase the scope for more monetary stimulus, strengthening the case for focusing on the strong fundamentals of the occupier market.
China’s residential property sector is under severe strain. The commercial real estate market, however, is performing remarkably well.
Nicholas Spiro is a partner at Lauressa AdvisoryInternet Explorer Channel Network