Chinese Investment Capital – 3 Macro Trends to Look Out For | Pete Wargent

Chinese Funds Seeking a Home

commercialEarlier in the year we were contacted by a rep from a group of overseas investors from Asia with a punchy nine-figure sum to invest in Australian commercial real estate, seeking an office property investment in the harbour city.

Upon meeting at our office, we tactfully pointed out that, even as visible from our very office window, Sydney is busily in the process of constructing an impressive oversupply of office space.

With some of the biggest developments in Australian history well underway (the LendLease Barangaroo “T1” tower will be Australia’s largest ever commercial tower, for example) better office investments must surely exist in other cities well away from Sydney’s oversupplied Central Business District (CBD).

There will be far more Sydney office space than demand for it, and rents must inevitably fall, yet the message conveyed back to us was that Chinese investors are familiar with and like Sydney, and therefore they be would progressing to seek out a Sydney office investment anyway.

Dollar Declines

When I wrote my first book back in 2011, the Aussie dollar was trading way above parity. I put forward the viewpoint that as and when the dollar declined materially we would see an inflow of foreign capital to Australia, although the impacts could be somewhat different to what we might expect, and may be felt most acutely in the respective CBDs of Sydney and Melbourne, and the immediate fringes thereof.

With commodity prices now getting whacked across the board, finally it does not seem unreasonable to expect that we might see an Aussie dollar with a “70 handle” some time in the not-too-distant future, which would provide some welcome respite for our exporting economy.

Australia and China have this week signed a Free Trade Agreement, and so with China news and views all the rage at this time, let’s take a look at three macro trends which we might expect to see that could impact investors in Australia.

Macro Trend 1 – Land Prices

As noted here earlier in the week, under the terms of the ChAFTA, the threshold of Foreign Investment Review Board (FIRB) screening for Chinese investors wishing to buy commercial real estate has been lifted from a comparatively trifling $54 million to a massive $1,078 million, in line with limits on private business investments.

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Meaning? To all intents and purposes, Chinese investment groups wanting to mop up Australian commercial property, can target anything they want.

In theory this could ultimately add to the housing supply in Australia as prime location commercial sites are acquired and residential developments are instead brought to the market.

In reality what is happening is that Chinese investors are paying way above market price to gain access to prime sites in our two largest cities, and then are proceeding to landbank them.

As also noted by Business Spectator, almost exactly mirroring my own anecdote above, this is only really happening in inner Sydney and inner Melbourne (“mainly around the CBD and their fringes”), where Chinese investors pay “at least 25 percent more” for sought after areas pushing development site prices “35 to 40 percent higher”.

It’s something we can see first hand in Sydney’s inner west where I personally have long owned investment properties, including in Erskineville where former warehouses and printing shops are seen as ripe for new development, sending land prices are soaring. Back to Business Spectator:

“Goodman sold an industrial park in Erskinville [sic] in South Sydney [technically it’s in the inner west region], a large potential residential site, for $350 million to Hong Kong’s Golden Horse Holdings — reportedly the highest price yet paid for a residential site in Australia. Mr Williams believes that those entering the market at the current point in the price cycle will have to build the higher land cost into the price of the end product.”

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When folk see diggers and cranes they instinctively associate the machinery with an oversupply of dwellings, but while there is plenty of construction happening, vacancy rates in Erskineville have been under 1 percent (effectively nil for any half-way decent property) for the past decade, while across the inner west region the vacancy rate is closer to the city’s average at 1.8 percent.

It is important not to underestimate the potentially limitless scale of Chinese investment. Take the example of Greenland, constructors of the 600 unit Greenland Centre tower in Sydney’s CBD, a behemoth group which has generated an astonishing $78 billion in revenue in the last 12 months. To put that in perspective even the mighty Commonwealth Bank could only muster $44,312 million.

Reports the AFR:

“Chinese state-owned property developer Greenland sees “no ceiling” on the amount of funds it is prepared to invest here, declaring it will expand into agriculture, a day after the free trade agreement with China was signed.”

The merits of foreign investment in development sites are forever mixed, and land prices around the centre of Sydney and Melbourne are undoubtedly now being pushed higher by Chinese investment.

As the investor group suggested to me, however, Chinese developer interest in most other parts of Australia is considerably lower, and probably immaterial in the majority of cases.

Part 2 – Share Price Indices

China’s construction boom has already distorted Australian share indices, although a good deal of the impact is now to be seen in the rear view mirror.

The huge explosion in Australian mining investment was threatening to make a nonsense of my contention that industrials and financials make for a better long term play than Australia’s resources companies.

However, as our updated chart packs will confirm next Thursday, mining and engineering construction is now set to drop like a stone over the years ahead, and the resources index is at long last following commodity prices down to earth with a thud as supply ramps up.

 

Industrials and financials as an index tend to be more self-sustaining and can pay stronger dividends through the cycle than the resources explorers and producers which exhaust their reserves and incur heavy reinvestment costs in the form of exploration and construction spend.

Remember too that yield and income are not the same thing (aka. beware the “yield trap”) and thus the listed property trusts (today known as “A-REITs”) which have often paid the highest yields may be better suited to those in the income phase of their lives such as retirees, with high payout ratios stunting growth.

The best long term bet for both growth and dividend income has generally been a diversified share portfolio weighted to industrials and financials, and by next month’s chart pack we may see that the financials index has finally eclipsed the resources index (which since 1999 in particular has been performing way stronger than long term history suggests is normal).

It is feasible that lower interest rates and a lower dollar could make share indices more attractive to foreign investors, who already own a sizeable chunk of Australian shareholdings, but forecasting monthly index movements is essentially a fool’s errand. so I’ll pass on that for today.

3 – Residential Property

One way or another Chinese investors will inevitably have an impact on Australian residential property. Consider the inexorable rise in the number of Chinese visitors to our shores.

And, indeed, Chinese permanent settlers.

Funds might flow into Australian residential property either legally or illegally as is debated ad infinitum. My contention has always been that inner Sydney, inner Melbourne, and to some extent inner Brisbane, will be the locations impacted by the trend towards the globalisation of capital city property markets.

Reports the AFR, offshore interest from Chinese buyers is very heavily focussed on a few inner Sydney, Melbourne and Brisbane areas, with $1.35 million the average price bracket of interest and average purchase budgets ranging from $3.36 million to $3.7 million.

Unsurprisingly the most popular suburbs include Mosman and Bondi Beach, prime location Sydney suburbs with access to beaches, as well as other locations in the eastern suburbs and lower north shore from Coogee to Cremorne. Melbourne and Brisbane suburbs also feature prominently.

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The “blue chip versus blue sky” suburb debate was discussed over at Property Update earlier this week. As an investor in Bondi myself, I always tend towards the blue chip choices.

While it’s not everyone’s cup of tea, we have seen median apartment price growth in Bondi Beach of 45 percent in the past five years or $231,000, while median unit prices in Bondi Junction, where I’m an investor (generally, I like train lines), are up by 50.4 percent or $234,000.

Granted this is not the fastest rate of growth in Sydney. As previously cited, another example I’m familiar with as an investor is the inner west suburb of Erskineville, where we’ve seen median unit prices rise by 56.7 percent in the past five years, or $243,000.

Quality investments have done better than median price growth. Whatever your view on Bondi, and there are no doubt a fair few detractors, I’ll take a bet that there are plenty of investors around Australia who would chew your arm off for results of $250,000+ in capital growth over the last five years.

Beware the Yield Trap in Real Estate

It may seem counter-intuitive that prime location suburbs are the long term outperformers, since there is ever a tendency to feel that the best of the growth must always lie in the past. However, in common with all commodities, it is demand outstripping supply that moves prices as capital city real estate becomes a more global product.gold house

We have seen this play in London over the decades, with house prices in Kensington & Chelsea easily outperforming all other property types in Britain, and continuing to do so throughout the financial crisis and beyond. Despite a thousand crash predictions over the years, the average asking price today is more than £2.2 million…and we are talking an entire London borough here, not only Egerton Crescent.

Buying cheap property in outer areas (where there is more land available for release) because prices seemingly “can’t get cheaper” can often be a more risky approach. My bookshelves at home are strewn with UK “Buy-to-Let Bibles” written a decade ago before the financial crisis, many of which stressed the importance of seeking 8 percent yields since capital growth was apparently impossible to predict.

Yet the high-yielding 8 percenter suburbs listed therein now read like a retrospective list of where to find property which has crashed in value, from the north-east of England to the Potteries. Yield in itself is rarely a reliable indicator of the quality of an investment, and higher yield can often represent higher risk.

With Australian household debt nudging up against its likely effective ceiling from around 2006 onwards, one wonders whether the chat forums will begin to be filled with yield-focused property investors from around Australia who are beginning to question whether property is even a worthwhile investment at all as the current property cycle eventually reaches its peak.

Capital growth has been very weak and even negative for years in many areas, since spiralling household debt can no longer lift all boats as it once did.

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If income was your goal then for the past 5 years, you need have looked no further than Australian bank stocks.

Investing in residential property predominantly for its yield is akin to attending an AC/DC concert in order to appreciate Phil Rudd’s drumming prowess. It’s important – integral to the overall result even – but it’s not the main event. Capital growth is.



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Pete Wargent

About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


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