Influence of Chinese investors set to grow

Guest Observation

Paul Craig, Managing Director of International Investments at Savills, looks at what’s driving the weight of foreign capital in the Australian market, particularly in relation to prime commercial stock, and what lies ahead for major players.

I have just completed a trip to China, visiting our clients and presenting to institutions and investors.

On the flight back to Australia, I made some notes on what we learnt. What struck me most is that the Chinese investment we’ve seen in Australia to date is really just the first wave.

Across the mainland, and on the island of Taiwan, there is real impetus for major institutions like insurance companies and private investors to look abroad for high-quality assets with good returns. That search has led them to Australia at the same time as major institutions here have been pursuing a deleveraging strategy with their portfolios.

With local institutions like super funds returning to the market, a likely increase in Chinese investment means competition for highly rated commercial property is set to intensify.

Why are these investors interested in Australia?

Prime office and retail property in Australia has seen offshore investment for years, but until recently, most interest came from German funds, REITs and private investors from Singapore and Malaysia, and Korean pension funds.

In 2013, we started to see the emergence of what I call the second generation of capital, led by Chinese and Taiwanese insurance groups. These groups spearheaded a worldwide trend of institutions de-risking their portfolios and spreading their assets across the globe. What they are looking for is prime assets with good levels of return, and that is what exactly they’ve been finding in Australia.

Our market ticks all their other boxes too – a highly transparent market, good-quality information, an easy to understand tax system, accessible consultants and no sovereign risk

During the course of 2013, many of these groups flew staff in to get to know the market, and once they felt comfortable, they were quick to take advantage of opportunities in office and retail assets in Sydney and Melbourne in particular.

But now, the easier pickings have gone and local super funds and REITs are returning to the market, thanks to the lowest cost of debt in forty years and a reallocation of funds to property.

The return of local institutional buyers has increased competition for prime assets, which is seeing many Asia-based investors priced out of major sales, so now they are turning their attention to other areas.

A shift to residential

Residential development is part of the landscape in Asian markets and these investors understand it well, particularly the recycling of buildings to residential or mixed use. 

With local institutions deleveraging and transitioning their portfolios, China-based groups have been finding opportunities to convert older office buildings to residential – particularly in Sydney’s CBD and in precincts like Hyde Park.

For the most part, I think they will employ long-term strategies rather than immediate conversion, as they have an interest in retaining the building’s income and transitioning these assets over time. They are also buying land parcels for development in inner suburbs near transport in Sydney and Melbourne.

The other key target for foreign capital is old industrial infill sites for future residential development. I think this is a significant growth area and is becoming keenly sort after by foreign developers.

The resource states

The focus on better returns will see more Asian-based investors venturing into the resource states.

In Perth, they will find opportunities in a market with a little more volatility. Good-quality CBD stock is recording higher vacancies than in Sydney or Melbourne, but also better rates of return given slightly higher risk and less aggressive competition.

Perth is currently absorbing supply, but this market often experiences a quick uplift after a lagging period. It is a natural resource hub, and its exposure and proximity to, and same time zone as Asia, combined with the lower profile of the financial sector and greater resource exposure, offers a balance to investments on the east coast.

Investors in Western Australia should buy without a specific exit date, but as a long-term holder who sells when the time is right for their strategy.

I think we will also see interest spread to Brisbane, with an emphasis on residential. There is an increase in tenants moving from older properties to more prime CBD offices as the rental market eases, which means we should see an increased opportunity for the repositioning of older stock.

Interest in residential development should also find its way to other major centres as the stock in the sought-after cities depletes. We are already seeing a strong move by foreign capital to sites in the east and inner metropolitan areas of Melbourne, and the Sydney metropolitan market has been in full swing for a while now.

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Partnerships

Another change we are likely to see is more investment through partnerships.

Many of the core office assets with good covenants and long lease profiles are owned through equity arrangements, and this should prove an attractive avenue for these institutions.

Many Chinese groups will be inclined towards indirect pathways such as joint ventures with Australian developers and partners. It makes sense for their strategy, gaining better returns in Australia with management issues left to a local partner.

‘Second city’ investors

To date, most investment interest has come from Beijing and Shanghai, but on our trip we fielded significant enquiries out of second-tier centres like Dalian, Shenzhen, Guangzhou and Chengdu.

Like their ‘first city’ cousins, these investors are attracted by the returns and transparency of arrangements here and they will be keen to understand the dynamics that drive the market. These players are likely to be interested in smaller scale, private equity type arrangements.

What picture does that paint?

A growing Chinese investment wave makes for some upbeat prospects for the Australian market.

With low interest rates and a significant weight of capital wanting to find a home here, I think we will continue to see Asian-based investment in residential development and prime properties held through shares and joint ventures with local partners.

Many Chinese groups have done their homework on Australia, and with the weakening of the Australian dollar having commenced its run, we expect to see these groups make quick decisions to secure assets ahead of a potential new wave, particularly of private equity, that will find its way here off the back of a weak Australian dollar.

That paints a bright picture for asset holders and market players alike.