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China Gets Real About U.S. Real Estate

Chinese companies have been snapping up trophy properties in the U.S., pushing prices higher. But what will happen if these new buyers ever have to head for the exits?

  • Kaitlin Ugolik

In January 2015 during an event at Harvard Business School, Wu Xiaohui, CEO of Anbang Insurance Group, explained his firm’s expansion plans with an unusual analogy: “Why can a substance like water cover 70 percent of the surface of the earth and exist in perpetuity?” he asked. “A company is a living organization. Could it exist as water does?” The answer to the second question, Wu hopes, is yes. He was in Cambridge, Massachusetts, alongside business partner, friend and HBS alum Stephen Schwarzman, chairman and CEO of alternative-investment giant Blackstone Group, to recruit new employees for Anbang’s growing empire. Wu’s business, which began operations in Beijing in 2004 as a small automobile insurer, has expanded in the past decade to become a $123 billion holding company with assets on four continents. But before Anbang poured nearly $2 billion into the New York City real estate market with its October 2014 purchase of the iconic Waldorf Astoria hotel from Blackstone-controlled Hilton Hotels & Resorts, most U.S. real estate investors had never heard of the company. Now many see Anbang as a harbinger of a tougher competitive environment and shrinking opportunities.

In the months since the Waldorf deal, Wu has embraced the rushing and spreading qualities of water — a core value of Anbang’s internal culture, he says — and jumped into two other major real estate transactions. In March the Chinese insurer agreed to buy Strategic Hotels & Resorts and its 16 luxury hotels from Blackstone for $6.5 billion. At about the same time, Starwood Hotels & Resorts Worldwide announced that Anbang was the leader of a mysterious consortium that had bid $12.8 billion in cash for its portfolio, attempting to squeeze hospitality company Marriott International out of the deal. Marriott ultimately prevailed in the battle for Starwood, but with a bid that included $3 billion more in cash than its original offer. The outcome has some U.S. real estate investors nervous, because Anbang isn’t alone. The recent rush of cash-flush Chinese investors is affecting the tenor of negotiations for deals around the country.

“They may be pushing up prices more aggressively than fundamentals dictate in some cases,” says Kenneth McCarthy, New York–based chief economist at global commercial real estate services firm Cushman & Wakefield. “If you don’t bid aggressively, you don’t get the asset.”

Many of the most recent trophy property deals in the U.S. have involved a Chinese buyer or partner. In 2013, Shanghai investment firm Fosun International bought One Chase Manhattan Plaza; SOHO China, one of China’s largest developers, purchased a more than $700 million stake in Manhattan’s General Motors Building; and state-owned Greenland Holding Group Co. invested $1 billion in a residential and entertainment project in downtown Los Angeles. Last year China’s Sunshine Insurance Group Co. paid a record $2 million per room for New York’s Baccarat Hotel, and Bank of China bought a nearby office tower at 7 Bryant Park for $600 million.

The loudest voice warning about the influx of Chinese investment in U.S. real estate and other parts of the economy may belong to Republican presidential candidate Donald Trump. He has argued that Chinese companies get an unfair advantage in the U.S. and that their country is a currency manipulator. “America fully opened its markets to China, but China has not reciprocated,” Trump contends on his campaign website. As with much of what the Republican front-runner says, this rhetoric has an air of hyperbole. But when it comes to concerns about U.S. investors competing with China in their home market, Trump may have a point. Chinese individuals’ push into the residential real estate market — spending $28.6 billion in the past year alone — has garnered headlines, but less attention has been paid to the influx of Chinese investment in U.S. commercial real estate. The wave of new money, which is coming from a variety of sources, including sovereign funds and private development groups, has provided opportunities for some domestic developers, but many U.S. investors have been forced out, especially in major metropolitan areas.

Some analysts have suggested that Anbang’s decision to walk away from the Starwood deal is a sign of a slowdown in Chinese money coming into the U.S. But if recent statistics are any guide, the momentum will be hard to reverse. Chinese companies spent $21.4 billion on commercial real estate outside their home country last year, 41 percent more than in 2014, according to Cushman & Wakefield. These investments were spread between development sites and existing properties around the world, with the U.S. receiving the biggest piece of the pie: $4.4 billion. China is now the second-largest foreign investor in the U.S., after Canada. Although its share of the market is still tiny — a total of $530 billion changed hands for commercial real estate in the U.S. in 2015 — China is drawing attention for purchasing iconic properties at eye-popping prices.

After buying the Waldorf, Anbang acquired the office tower at Manhattan’s 717 Fifth Avenue from Blackstone in 2015, paying $415 million. Sunshine Insurance made its own headlines last year when it bought the Baccarat from Greenwich, Connecticut–based Starwood Capital Group (which founded Starwood Hotels) for more than $230 million.

These deals have happened against a backdrop of slowing growth and increasing volatility in the Chinese economy. After averaging double-­digit annual GDP growth from 2001 to 2011, China is expected to see only a 6 to 7 percent increase in 2016. This slowdown, and the government’s opaqueness when it comes to explaining what’s behind the economic numbers, have made some market observers nervous. Many predict further currency devaluation. Meanwhile, China’s equity markets are still feeling the effects of last August’s devaluation and the subsequent stock slump. This has led to capital flight by wealthy individuals, state-owned enterprises and large private companies alike. For its part, the Chinese government has encouraged some state-connected investors to put money in outside markets. Insurance companies are allowed to invest as much as 15 percent of total assets under management overseas. Currently, they invest only about 1.4 percent. According to Chicago-­based property consulting firm JLL, if every Chinese insurer reached that 15 percent maximum, the total investment would be $240 billion.

Historically low U.S. interest rates have sent Chinese investors that previously flocked to Treasuries looking for better yields. The jump to real estate is not a big one. Investors of all stripes have long seen owning U.S. real estate as a great way to diversify and ensure long-term returns. In December, President Barack Obama signed a law that made it easier for certain foreign parties to invest in publicly traded real estate investment trusts — one indirect way that many Chinese investors are entering the market.

Properties and portfolios in gateway markets such as New York, Los Angeles and San Francisco typically offer solid capitalization rates (expected rates of return based on property value and net operating income from leases), especially in the office, multifamily and hospitality sectors. Owning a property in one of these locations also provides access to high-caliber tenants, good infrastructure and often a bit of a buffer from economic downturns. It takes a city like New York a few years to bounce back from a financial crisis, but it can take years longer in less developed markets.

Ying Geneve DuBois, a partner at law firm Holland & Knight who represented Sunshine Insurance in the Baccarat deal, says pent-up demand and the desire of many Chinese investors to set down roots in gateway markets will likely outlast any potential slowdown caused by economic uncertainty at home or yield compression in the U.S. “I think this is only the beginning,” DuBois says.

For high-net-worth individuals buying U.S. homes, a major impetus is access to an American education for their children. Large companies have a different educational goal as they prepare to face a growing consumer economy back home. “They invest here and want to help certain brands or businesses to expand here, but it’s a global world and the long-term plan is not to isolate development in China and development in the U.S.,” says DuBois. “It’s only natural that if a brand and business is doing well in the U.S., it’s something they can bring to China as well.”

Some experts worry that the current market presents a muddled set of motivations on the part of Chinese investors and raises questions about their intentions for the buildings and companies they purchase. Others are concerned about the potential for catastrophe in the U.S. should China’s economy falter. For U.S. investors, though, the primary problem is the shrinking pool of opportunities as cash-rich Chinese buyers push prices ever higher.

The phenomenon is worrisome for another reason: The last time a major Asian nation focused this many resources on U.S. real estate, it didn’t end well. In the 1980s, Japanese investors snapped up trophy properties at sky-high prices only to run for the exits a few years later as their home economy slumped and the U.S. real estate market began to crash.

There are no perfect correlations in economics, of course. The China of 2016 is different in many ways from 1980s Japan, and the U.S. real estate market is thought to have a few years of upside left. But cycles can provide a historical guide, and some experts point to the fact that asset bubbles tend to correlate with credit expansion; China is experiencing rapid expansion at this time.

For foreigners part of the point of investing in the U.S. is to hedge risks incurred elsewhere by planting one foot firmly in a so-called safe haven. But if the Chinese economy turns sour or if political pressure changes the U.S. regulatory environment, a sell-off may not be out of the question. Kyle Bass, founder of Dallas-based hedge fund firm Hayman Capital Management, predicts a credit crisis in China within the next two years. As for the situation in the U.S., he says, “This is eerily reminiscent of the 1980s.”

Though Chinese investors have made periodic plays in U.S. real estate for years, the roots of the current influx can be traced to the 2008–’09 financial crisis. For those who had been looking for a way to get into the U.S. commercial property market, the crisis provided a prime opening to buy cheap and ride the returns up as prices recovered.

“The 2008 meltdown in the real estate market was a good opportunity for companies like Xinyuan to enter the States,” says George Huaiyu Liu, chief financial officer at Beijing-based developer and property manager Xinyuan Real Estate Co. Xinyuan was the first Chinese real estate company to list on the New York Stock Exchange, in 2007, just in time to take advantage of the coming collapse. “We saw the opportunities and seized them, and so far we are happy with what we have done,” Liu says. Xinyuan’s investments include a $270 million stake in a 216-unit luxury condominium building in Brooklyn.

Over the following several years, as the market recovered in the gateway cities and China relaxed some rules on outbound investment, the wave accelerated. Nearly $6 billion of the $8.5 billion that Chinese investors put in U.S. real estate in the decade ended March 2014 was invested between January 2013 and March 2014, according to professional services firm Deloitte Touche Tohmatsu. In 2015 the strategy broke records, and though there was a slight retrenchment in January and February of this year as investors watched the currency and equity roller coaster back in China, the pause appears to have been temporary. “What looked like a pullback in February does not seem to be the case today,” says Darcy Stacom, vice chairman of investment properties at Manhattan-based brokerage CBRE Group. “I don’t think we’re off the peak.”

In 2014, Xinyuan’s Brooklyn condo project, which has already sold more than half of its units and is expected to open later this year, received a $165 million construction loan from New York–based Fortress Investment Group. Today, Chinese firms commonly work with domestic players like Fortress on new developments. The arrangement can have important benefits for Chinese investors, which typically are new to some U.S. cultural customs related to deal making. At the same time, Chinese investors have helped keep many U.S. developers in the game despite postcrisis banking regulations that have made financing harder to come by.

In Brooklyn’s Fort Greene neighborhood, New York developer Forest City Ratner Cos. had been working since before the recession to create a large commercial and residential development on the site of a former Metropolitan Transportation Authority rail yard. Finding financing for the development, now known as Pacific Park, became difficult after the crisis, as the company “searched far and wide” for an investment partner, says Christopher Clayton, executive vice president of Capital Markets at Forest City Ratner. With few domestic options, the firm’s sights landed on Chinese state-owned developer Greenland, which had recently invested $1 billion in a mixed-use development on land purchased from the California State Teachers’ Retirement System in Los Angeles. In 2013, Forest City Ratner entered into a deal to hand over a 70 percent stake in the $4.9 billion Brooklyn development to Greenland.

Greenland wasn’t the only Chinese investor in Pacific Park. Forest City Ratner has also made liberal use of the EB-5 immigrant investor program to help fund the development. Administered by U.S. Citizenship and Immigration Services, the EB-5 program provides green cards to foreign investors in U.S. projects in qualified economic centers that create or preserve at least ten permanent jobs. “After the economy collapsed in 2008, it became very challenging to raise large amounts of capital,” Clayton says. “Ultimately, the EB-5 program provided a viable solution for us to borrow capital for Pacific Park’s infrastructure and predevelopment work.”

Now, several years into a slow but steady recovery, U.S. firms are still choosing Chinese development partners and Chinese buyers over domestic players for commercial real estate. In early April, New York real estate publication theReal Deal reported that a luxury condominium development at 100 Varick Street in Manhattan looked to be on track to become the first New York City development funded almost entirely by Chinese entities. The development group for the project, which includes Aronov Development, Bizzi & Partners Development and Halpern Real Estate Ventures, reportedly has received $320 million in construction financing from Bank of China and $130 million from the U.S. subsidiary of investment firm China Cinda Asset Management, and is raising EB-5 funds as well.

“What some of these properties are selling for is making it difficult for some domestic investors to rationalize,” says Roger Power, an audit partner and Chinese investment expert at KPMG. Institutional investors in particular are having a harder time finding deals that fit their parameters, in part because many have funds that require a seven-or ten-year return. “A Chinese life insurance company may have a much longer time horizon,” Power says.

Sellers in many markets have begun to capitalize more aggressively on this situation. Joel Shackelford, a partner at law firm Kaufman Dolowich & Voluck in Los Angeles — after New York the most popular target city for Chinese investors — says he has seen an uptick in litigation and arbitration as opportunistic sellers of properties in the $10 million to $50 million range break deals at the first sign of a Chinese investor with a thick wallet.

“It’s harder and harder to find deals, and harder and harder to close,” Shackelford says. “Now with prices going up, up, up, sellers are looking for any reason whatsoever to break a deal.”

Three years ago Ying Geneve DuBois was working on real estate and hospitality deals for Holland & Knight in the law firm’s Fort Lauderdale, Florida, office. DuBois was born in China, grew up in Hong Kong, studied in the U.S. and speaks both Mandarin and Cantonese — all of which has put her in a unique position to facilitate many Chinese investors’ forays into the U.S. real estate market. So when Sunshine Insurance chairman Zhang Weigong came to Florida looking for potential investment targets, it was natural that the two would meet. Zhang was hoping to deploy some of the millions that Sunshine had amassed in recent years and was being encouraged by China to spend outside its borders. He soon also met Barry Sternlicht, founder, chairman and CEO of private equity firm Starwood Capital. Starwood, which has more than $45 billion in assets under management and owns thousands of hotels around the world, was in the process of creating a new flagship hotel brand, Baccarat.

Zhang “was really impressed with [Sternlicht] and where he wants to go with his company and the new brand he was establishing, so they decided to make a very bold move,” DuBois says.

Sunshine agreed in early 2015 to purchase the world’s first Baccarat hotel, at 28 West 53rd Street. The $2 million price per room and the fact that Sunshine had scooped up the property before it even opened raised some eyebrows. DuBois admits the transaction was somewhat risky given the newness of the brand. But Sunshine didn’t just want a piece of a new high-end hotel on Manhattan’s West Side — it wanted a piece of Baccarat, of Starwood and of the U.S. hospitality ethos. “They were looking at it not just as buying a property but really buying the fact that the property has a brand, Baccarat Hotels, and it was a long-term partnership between the two companies,” says DuBois.

Sunshine is hoping to capitalize on the China tourism boom both within the country and abroad. In 2015, 2.5 million Chinese travelers visited the U.S., and nearly 3 million are expected this year. Only 6 percent of mainland Chinese citizens currently have a passport, but that number is expected to rise as the economy shifts. This is one reason so much of the Chinese capital chasing U.S. real estate deals in the past several years has focused on hotels.

Chinese investors are concentrated on the coasts, but they are also finding opportunities in the American heartland. Dalian, China–based property developer Wanda Group — known for its 2012 purchase of AMC Entertainment Holdings for $2.6 billion, at the time the largest acquisition of a U.S. company by a Chinese one — has put down roots in Chicago. Working with the city’s Magellan Development Group, Wanda is building a $1 billion hotel and condominium tower known as the Wanda Vista Tower. The building, which will be the third tallest in the Windy City, is the “crown jewel” of a bigger, mixed-use development currently under construction, and its 240-room luxury hotel will be under the Wanda brand, according to Sean Linnane, senior vice president of development at Magellan. Wanda already owns about 70 hotels in China; the timing of the latest project is aligned with its global expansion plans.

“There’s been tremendous growth in China, but [Wanda] can’t sustain that sort of growth by only building in China,” says Linnane, who evaluates development opportunities for Magellan in Chicago and its surrounding suburbs.

Anbang’s recent deals also are part of a broader expansion effort. In addition to its U.S. property acquisitions, the company is actively buying up insurance assets around the world. After walking away from its eventual $14 billion bid for Starwood, Anbang wasted no time in reaching a deal to purchase the South Korea operations of German financial services firm Allianz for about $3 million. At last year’s Harvard recruitment event, CEO Wu said that Anbang plans to expand into peer-to-peer lending and health care, and that an IPO is in the cards. But the real estate deals have captured the market’s attention.

At last summer’s Institutional Investor and CNBC Delivering Alpha conference, Blackstone’s global head of real estate, Jonathan Gray, said the Waldorf sale was not just another wildly overpriced foreign transaction. “When you look five, ten, 15 years from now, it’ll look like a smart investment,” Gray told CNBC’s David Faber. “I think it’s easy sometimes to dismiss when the headlines [say], ‘The foreign buyers bought something, therefore it doesn’t make a lot of sense.’ I don’t think that’s really the case.”

Gray noted that two things signal trouble in the real estate world: “capital and cranes.” The former, he clarified, is really an issue of leverage. When a great deal of money floods a market and much of it is leveraged, as is currently the case in China’s real estate sector, the odds of a correction are strong. There is a lot of capital chasing deals in the U.S., but lenders are being cautious about esoteric financing. The question of cranes, or excessive construction and development, however, may depend on the observer’s view. At the beginning of the year, New York City had 13,000-plus hotel rooms under construction — more than any city in the U.S. — and occupancy was already nearly 85 percent, according to hotel research firm STR. Some wonder what might be next.

“We’ve seen this before,” says Scott Crowe, chief investment strategist at Plymouth Meeting, Pennsylvania–based CenterSquare Investment Management, which oversees $6.8 billion of real estate and infrastructure securities. “There was a lot of money in hotels just before the financial crisis. Everyone is brand-aware about them, so people tend to be attracted to them. The problem is that over a cycle it’s often challenging to make money on them, particularly if you’re buying later in the cycle.”

There is some disagreement among economists about just how late we are in the current cycle, but Crowe points to the recent underperformance of hotel-focused REIT stocks as a potential red flag. The shares of lodging REITs were down about 20 percent in 2015, according to the Urban Land Institute. But many real estate experts and investors brush aside worries about any impending downturn, confident that the U.S. commercial real estate cycle still has a significant amount of upside.

Sitting in a white armchair in his office on the 44th floor of 28 Liberty Street, in Manhattan’s financial district, one afternoon in March, Fosun International’s U.S. representative, Bo Wei, spoke animatedly through a translator about Cirque du Soleil. The theater company was set to launch its first-ever Broadway show in April, and thanks to what Bo called one of the company’s globalization deals, in which it had acquired a stake in Cirque du Soleil, he had access to pretty good seats. The space Bo occupies at 28 Liberty — formerly known as One Chase Manhattan Plaza — also came through a deal he credits to globalization.

In 2013, JPMorgan Chase & Co. chairman Jamie Dimon decided that his bank, which had about 4,000 employees occupying only half of the landmark building, was ready to downsize. JPMorgan Chase would keep “a strong presence” downtown and throughout the city, the bank said in a statement at the time, but it would no longer occupy the 2.2 million-square-foot building. In stepped Fosun, which had become known in the previous two decades for its global investing prowess, putting more than $10 billion to work overseas since 2010 alone, about half of that in the U.S. Although Fosun invests in everything from retail brands like Folli Follie to luxury resorts like Club Med, when the company decided it was time to move into New York, it seemed clear that its target should be a piece of trophy real estate.

“New York City is not only the U.S.’s city, it’s also a global city,” Bo says. Fosun was certain that the health of the local and national real estate markets would guarantee that the price it paid would accurately reflect the property’s value. That price — $725 million, agreed upon in October 2013 — became the most expensive purchase of a New York building by a Chinese buyer at that time. Chase customers can still visit an ATM on the building’s sidewalk level, and the bank still operates vaults on several floors, but a Google search of the name “One Chase Manhattan Plaza” brings up “28 Liberty Street.” Inside, Fosun occupies one and a half floors, prepared for its arrival by a feng shui master and sparsely decorated apart from an ornate marble wall near reception.

Deals like this one — which saw an icon of New York City’s status as the U.S.’s financial engine change hands to a foreign firm with big expansion plans — remind some investors of Mitsubishi Estate Co.’s nearly $2 billion investment in Rockefeller Center. That deal became the cautionary tale of the late 1980s Japanese frenzy for U.S. real estate and other assets. The spree was fueled in part by a 1985 currency agreement that devalued the dollar, encouraging Japanese trade with the U.S. Shortly after Mitsubishi acquired its 80 percent stake in the 14 buildings that make up Rockefeller Center, Japanese inflation led to an interest rate spike, Tokyo’s equity markets plunged, and a harsh correction followed, pulling much of the recent Japanese investment in the U.S. down with it. Mitsu­bishi ultimately sold its stake through a bankruptcy proceeding.

At the time, Japanese investors, like Chinese investors today, contended that the high prices they paid, and the subsequently even higher prices the market demanded, were justified. “Their theme was that they’re long-term holders, so they can afford to pay a little more up front, but that didn’t turn out so well because the fundamentals of the markets changed,” says Ray Cirz, head of valuations at New York–based property valuation and consulting firm Integra Realty Resources.

China’s current economic status is different from the story of Japan in the ’80s, but quickly changing fundamentals could play a role in some investors’ decision making. Hayman Capital’s Bass has been publicly warning about an impending credit crisis in China since 2014, and he sees the current U.S. spending spree as part of a broader set of troubling signs. “It’s so obvious to see what’s going to happen in the next year or two, and yet investors look at China with reverence and believe it can do no wrong,” Bass says.

Even some Chinese investors who have participated in deals that helped push up prices now believe the market is getting overheated. In 2013, Zhang Xin, CEO of SOHO China, purchased a stake in the General Motors Building, valuing the property at $3.4 billion. She recently said current prices are far too expensive for her to consider another such deal. “I wouldn’t be making that investment today, full stop,” she said at the September opening of a SOHO China office building in Shanghai.

When Anbang bought the Waldorf, few analysts could resist making the comparison to Japan. It was an ambitious deal for a high-profile New York property with a price tag that screamed overpayment. But at Harvard in January 2015, Wu told the room of potential recruits that he had done the math and the hotel had actually been a steal — especially considering that his company planned to keep it for more than 100 years, with Hilton handling the management. The total investment of $1.95 billion worked out to about $11,700 per square meter (about $1,086 per square foot) of space at the time, Wu said. “Such a lifetime ownership of this trophy hotel is very cheap in my eyes compared to properties auctioned at 100,000 RMB [then about $16,000] per square meter on China’s Beijing Financial Street with 40-year land use rights,” he said.

“As an icon of America, the Waldorf Astoria represents the glorious history and spirit of the United States,” Wu said at Harvard. “The China dream shares many of the similarities with the American dream, but great dreams need to be realized through actual strength. We must succeed in each investment, and Anbang’s strategy is to treat every victory as a new starting point.”

Anbang’s corporate focus on embodying the qualities of water includes embracing change. Like water, real estate markets tend to ebb and flow. The shifts of the 1980s caught many Japanese investors in U.S. assets off guard. If people like hedge fund manager Bass, who saw early-warning signs of the 2008 financial crisis, turn out to be right about a credit crunch or currency devaluation in China, the often-hypothetical comparison to Japan will be something to take more seriously. •

Follow Kaitlin Ugolik on Twitter at @kaitlinugolik.