Chinese Investment in U.S. Commercial Real Estate (EB-5 and Capital Controls)

Viewpoints

January 23, 2018

Chinese Focus on Foreign Investment and Post-Crisis Expansion into U.S. Real Estate

At the turn of the century, China introduced a “Going Out” policy that encouraged outward foreign direct investment (ODI) by state-owned enterprises and Chinese businesses. By deploying the country’s significant build-up of foreign reserves, Chinese policymakers aimed to relieve upward pressure on the yuan, establish China as a global economic leader, and endeavor to qualify the yuan for reserve-currency status by the International Monetary Fund (IMF). The focus of Chinese foreign investment shifted over time, starting with energy and natural resource extraction in developing countries (early-to-mid 2000s), then extending into more advanced products and services in developed markets (late 2000s), before expanding into financial instruments and global real estate after the Global Financial Crisis (GFC).1

China’s Outward Foreign Direct Investment (USD Bn)

China’s Outward Foreign Direct Investment to the U.S. (USD Bn)

Source: China Ministry of Commerce, United Nations Conference on Trade and Development (UNCTAD), Morgan Stanley Research

Within the U.S. market, Chinese investment initially focused on purchasing U.S. Treasuries and government agency debt, including Agency Mortgaged-Backed Securities (MBS). However, following the GFC, Chinese investment extended into direct and indirect U.S. commercial real estate (CRE) investments (beyond MBS) – including lending and development projects.

Approximate Chinese Holdings of U.S. Treasuries (USD Bn)

Source: U.S. Treasury, Bloomberg, Morgan Stanley Research

Chinese Holdings of U.S. Agency Securities (USD Bn)

Source: Treasury International Capital (TIC) data, Morgan Stanley Research

Cumulative Chinese Investment in U.S. CRE* (USD Bn)

Chinese Investment (UDS Bn) in U.S. CRE* and Property Count Per Year

*Includes Office, Industrial, Retail, Hotel/Lodging, Multifamily, Manufacture Housing, Self-Storage, and Development Sites
Source: RCA, Morgan Stanley Research

To date, Chinese CRE investments have focused on high-quality properties such as trophy office towers, hotels, and investment sites, located in gateway markets, such as New York, San Francisco, and Los Angeles.2 The level of transparency, strong property rights, and scalability of U.S. dollar-denominated (USD) cash-flowing assets make the U.S. real estate market attractive to a number of Chinese asset allocators, including sovereign wealth funds (SWF), insurance companies, asset managers, lenders and developers.

Top 20 Largest Chinese Investors, July 2015-July 2017

Market Share % by Investor Type

Sources: Morgan Stanley Research, “Why China’s Capital Controls Matter to Global Property Markets”, July 2017; TCW

As the Chinese stock market experienced rather significant volatility in 2015-2016, foreign assets became natural targets for deploying capital and the U.S. saw a surge in investment. In addition to direct CRE purchases, such as Anbang’s acquisition of the Waldorf Astoria in New York City for $2BN (2015) and HNA’s acquisition of 245 Park Avenue in New York City for $2.3BN (2017), Chinese acquisitions included platform investments with significant real estate exposure, such as Dalian Wanda’s acquisition of Legendary Entertainment for $3.5BN (2016) and Anbang’s acquisition of Strategic Resorts and Hotels for $6.5BN (2016).

Capitalizing on the EB-5 Investor Program

One of the largest programs facilitating Chinese investment in the U.S. is EB-5, an immigrant investor program created in 1990 (Immigration Act of 1990) to help stimulate the U.S. economy through job creation financed by foreign investment.3 EB-5 is administered by the U.S. Citizenship and Immigration Services (USCIS) and enables foreign nationals to receive a U.S. visa if they invest in projects that create at least ten permanent jobs, with a minimum investment amount of $500,000 in Targeted Employment Areas (TEA) – characterized by high unemployment and/or rural location – and a minimum investment amount of $1,000,000 in non-TEA areas.4 Upon completion of the project, the foreign national receives a green card for permanent residency status. Approximately 10,000 visas are issued annually through the program – with Chinese investors accounting for over 75% of market share since 2012, largely due to underutilization by other countries. Although each country’s share of EB-5 immigrant visas is limited to 7.1%, a country can claim additional unused visas.5

Following the GFC and resulting contraction in lending, EB-5 financing became a vital funding source for developers. Accessing EB-5 capital became particularly attractive after a 2009-ruling by the USCIS that construction work – the principal occupation created through development – qualified toward a project’s minimum job quota. Furthermore, the primary interest of the EB-5 investor in securing a visa (rather than a high rate of return), makes EB-5 capital a rather efficient and “patient” financing solution, crucial for large multi-phase projects that require horizontal infrastructure improvements before vertical building construction commences (i.e. projects that require financing years before realizing any revenue).6 Multi-phase megaprojects using EB-5 financing include Hudson Yards in New York City, the Shipyard in San Francisco, and Metropolis in Los Angeles.7

Sample Megaprojects Using EB-5 Financing

Hudson Yards (Masterplan) in New York, NY

Source (left): NYU Stern, Center for Real Estate Finance Research, “EB-5 Project Database: 2017 Supplement with Trends and Observations”
Source (right): Designboom.com; https://www.designboom.com/architecture/hudson-yards-new-york-masterplan-shed-vessel-roundup-07-02-2017/

Despite EB-5’s popularity amongst Chinese visa-seekers and U.S. real estate developers, the program faces a number of criticisms, including but not limited to: a lack of transparency with information, significant gerrymandering of TEA designations, numerous cases of investment fraud and misappropriation of funds, as well as broader uncertainty with respect to program reform and/or extension efforts.8 Additionally, demand for EB-5 visas exceeds the annual cap, resulting in a backlog for approval (more recent reports suggest 6-10 years) that diminishes the attractiveness of EB-5 investments as an efficient path to permanent U.S. residency.9

Recent Chinese Capital Controls and the Medium-to-Long-Term Outlook:

After decades of accelerating foreign investment, starting with the 2000 “Going Out” policy, Chinese policymakers reversed course in 2017 with the implementation of strict capital controls.10 The 2017 pullback of Chinese capital is evidenced by a 65% decline in Chinese investment in U.S. CRE year-over-year (from $16.1BN in 2016 to $5.5BN in 2017).11

Certainly, the significant acceleration of Chinese investment in U.S. CRE from 2010 to 2016, followed by the dramatic slowdown in 2017 (projected through at least 2018-2019), can be considered a cautionary tale. However, it is worth keeping in mind that Chinese investment in U.S. CRE was de minimus before 2010 – with Chinese insurance companies only active since 2015.12

Importantly, the elements that attract Chinese asset allocators to U.S. CRE – market transparency, clearly established property rights, scalable cash-flowing assets denominated in a reserve currency (with potential upside from rent and valuation growth), and expanded business opportunities – are likely to remain in place in the medium to long term, irrespective of shifting domestic capital control regimes and/or U.S. EB-5 reform efforts.

Sources:

1. Asia Society, “Breaking Ground: Chinese Investment in U.S. Real Estate”, May 2016; link:
https://asiasociety.org/files/uploads/66files/Asia%20Society%20Breaking%20Ground%20Complete%20Final.pdf

2. Asia Society, “Breaking Ground: Chinese Investment in U.S. Real Estate”, May 2016; link:
https://asiasociety.org/files/uploads/66files/Asia%20Society%20Breaking%20Ground%20Complete%20Final.pdf

3. Asia Society, “Breaking Ground: Chinese Investment in U.S. Real Estate”, May 2016; link:
https://asiasociety.org/files/uploads/66files/Asia%20Society%20Breaking%20Ground%20Complete%20Final.pdf

4. NYU Stern, Center for Real Estate Finance Research, “EB-5 Project Database: 2017 Supplement with Trends and Observations”, August 2017;
link: http://ilw.com/articles/20170816.pdf

5. Asia Society, “Breaking Ground: Chinese Investment in U.S. Real Estate”, May 2016; link:
https://asiasociety.org/files/uploads/66files/Asia%20Society%20Breaking%20Ground%20Complete%20Final.pdf

6. Asia Society, “Breaking Ground: Chinese Investment in U.S. Real Estate”, May 2016; link:
https://asiasociety.org/files/uploads/66files/Asia%20Society%20Breaking%20Ground%20Complete%20Final.pdf and U.S. Citizenship
and Immigration Services (USCIS) Website for EB-5 Investors; link: https://www.uscis.gov/working-united-states/permanent-workers/
employment-based-immigration-fifth-preference-eb-5/ eb-5-investors

7. NYU Stern, Center for Real Estate Finance Research, “EB-5 Project Database: 2017 Supplement with Trends and Observations”, August 2017;
link: http://ilw.com/articles/20170816.pdf

8. NYU Stern, Center for Real Estate Finance Research, “Understanding EB-5 Securities – NYU Stern Database of SEC EB-5 Securities
Enforcement Actions”, December 2017; link:
http://www.stern.nyu.edu/sites/default/files/assets/documents/Understanding%20EB-5%20 Securities%20-%20NYU%20Stern%20
Database%20of%20SEC%20EB-5%20Securities%20Enforcement%20Actions.pdf

9. CNN Money, “America’s ‘golden visa’ is losing its luster in China”; link:
http://money.cnn.com/2017/09/29/news/economy/china-us-eb5- visa-immigration/index.html

10. Morgan Stanley Research, “Why China’s Capital Controls Matter to Global Property Markets”, July 2017

11. J.P. Morgan Research, “CMBS Weekly, January 19, 2018: Starting off strong”, January 2018

12. Morgan Stanley Research, “Why China’s Capital Controls Matter to Global Property Markets” July 2017, Asia Society, “Breaking Ground:
Chinese Investment in U.S. Real Estate”, May 2016; link:
https://asiasociety.org/files/uploads/66files/Asia%20Society%20Breaking%20Ground%20Complete%20Final.pdf, and Cushman &
Wakefield, “Chinese Insurance Outbound Capital”, November 2015; and WSJ, “China’s CIC Gearing Up Investment in Overseas Assets”,
May 2015; link: https://www.wsj.com/articles/chinas-cic-gearing-up-investment-in-overseas-assets-1427456722


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