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Extremely dicey combo – China and US Property

, July 9, 2013, 0 Comments

The US-China standoff over surveillance and hacking has diverted attention from the steady penetration of Chinese investments in the American real estate industry. Chinese sovereign wealth funds like the China Investment Corporation (CIC) have become one of the largest investors in American property market in recent years. At the same time, state-owned Chinese banks like the Bank of China are lending aggressively for real estate investments in the US market. The Bank of China is now the largest foreign lender in commercial property in the US.

The deluge of Chinese capital into American real estate marks a new route of Chinese acquisition of US assets. Till recently, the Chinese investments in the US were largely focused on the US government debt market. The Chinese have been one of the largest buyers of US Treasury bills. However, these bills have traditionally been low-yielding assets. As a result, Chinese investors are keen on diversifying portfolios by acquiring real estate assets.

China is not the only Asian country plunging deep into the US property market. Singapore and South Korean investors have shown equal, if not more enthusiasm, in acquiring American property. All these investments have been encouraged by the low property prices in the American market and the prospects of American real estate continuing to remain one of the most valuable global assets in long-term yields. The recent rebound in the US housing market reflecting a more than 10 per cent increase in home prices in major cities during April 2012-April 2013 would have convinced the Asian investors about the prospects of high returns even in the near term.

But is the trend likely to continue?

China’s deep forays into the US property market have happened at a time when there have been concerns over the availability of credit in the domestic market. Interbank lending rates in China have risen sharply in recent months creating concerns over whether some major banks are facing cash shortfalls. The prospect of a credit squeeze is a rather unusual phenomenon for the Chinese economy, which has remained flush with liquidity since the monetary expansion effected after the global financial crisis in 2008. It is therefore hardly surprising that the Chinese stock market experienced some turbulence as investors assessed the implications of an impending credit crunch. The People’s Bank of China’s assurances helped in restoring stability in the stock market. However, some doubts remain over whether the aggressive lending policies followed by the Chinese banks are inducing cash shortfalls. One of the areas where the aggression of the banks is most visible, and where a potential credit squeeze might affect investments, is real estate, particularly in overseas markets like the US.

Some analysts following China’s property hunts in the US are quick to refer to the similar aggression displayed by Japanese banks, investment funds and corporates in the 1980s. The collapse of the US property market had created serious financial difficulties for the Japanese banking system. While China would surely not overlook history in this respect, it would, simultaneously, find it difficult to overlook the pulls and pressures exerted by the complexities of its domestic financial system.

Investment in real estate has traditionally been the main option for Chinese banks for earning profits. The surpluses yielded by the domestic real estate sector are likely to reduce as a Chinese government worried over the implications of an overheated property market attempts to manage the ‘bubble’ by reigning in property prices. Banks have to therefore look for alternatives. Funding overseas property investments in markets like the US and Australia have emerged as profitable alternatives.

But aren’t the Chinese banks and sovereign wealth funds worried over property investments becoming ‘bad debts’? Even if the Asian financial crisis might have faded over time, memories of the global financial crisis of 2008 are still fresh and continue to underline the problems of banks taking large exposures in real estate markets.

Well even if the Chinese banks are aware of the pitfalls, they hardly have other choices for reaping surpluses given the otherwise controlled interest rate regime they have to abide with. A freer interest rate policy could have allowed banks to diversify their lending portfolios and price the risks in different lending ventures according to their market prospects. The current controls do not allow the room for maneuver forcing the banks to rely heavily on real estate.

China has viewed the acquisition of financial assets in the US as the means for not only utilizing its large foreign exchange reserves and ample liquidity, but also as a source of securing strategic influence. Real estate is the latest avenue that it is eyeing in this regard. Time will reveal whether the move has been rational or counter-productive.

This article first appeared in the Financial Express.

About author
Dr Amitendu Palit is Head (Partnerships & Programmes) and Visiting Senior Research Fellow at the Institute of South Asian Studies (ISAS) in the National University of Singapore. Dr Palit worked in India’s Ministry of Finance for a decade and handled India’s external sector, industrial and infrastructure policies. ...more