As the world’s second largest economy, China’s influence on the global economy is expanding at a furious pace, thanks in part to the surge in outward foreign investment. In the United States, China is now a major source of foreign investment with capital flowing into virtually every industry and market. For many Chinese firms and individuals, the United States is a prime destination for their investments because the prospects for stable returns are high.
Policy makers, business leaders, and the general public in the United States still do not have a comprehensive understanding of the patterns and implications of Chinese investment in the United States. While foreign investment has been a critical piece of this country’s economic success, the recent boom of Chinese capital flowing into the United States has stoked fears of job loss and disruptions to local and regional economies and markets, and even threats to national security.
Chinese investment into U.S. real estate, in both the commercial and residential sectors, stirs up these misgivings and sparks debate about the domestic costs of these investments. Concerns range from anxieties over the potential inflationary effects of deep-pocketed firms and investors in the residential real estate market to more pronounced anxieties over property acquisitions that can endanger national security. The reality, as this landmark study makes clear, is much more complex.
Chinese investment around the world surged in the past decade, expanding from an early focus on natural resource extraction and energy in developing countries to broader industries and advanced products and services in developed markets. In 2014, Chinese outward FDI flows totaled $116 billion, and approximately $18.1 billion flowed into the United States. In 2015, Chinese outward FDI flows totaled $118 billion, and Chinese foreign direct investment flows into the United States increased to $22.3 billion. Still, China accounts for less than 10% of all foreign direct investment in the United States.
Chinese direct investment in U.S. real estate was negligible until 2010 but has since grown dramatically and visibly. In 2015, China ranked third in U.S. commercial real estate acquisition volume, trailing only Canada and Singapore and tied with Norway. Chinese developers are building multi-billion-dollar projects in several major cities. A Chinese insurance firm bought the prized Waldorf Astoria hotel in New York City in 2015 and struck a $6.5 billion deal for Strategic Hotels & Resorts in early 2016. Chinese investors dominate an immigrant investor program known as EB-5, and in 2015, China overtook Canada as the biggest foreign buyer of U.S. homes.
This anecdotal portrait reveals the rapid and widespread entry of Chinese investors, both firms and individuals, into the U.S. real estate market, but it also underscores how real estate differs from other investment sectors. It defies the traditional definition of foreign direct investment – ownership of at least a 10% stake in a U.S. company – with a broad range of entry points. Buying a home, for example, does not have an analogue in the technology industry but is critical in painting a full picture of Chinese capital flows into the U.S. real estate market. Furthermore, in addition to the unique channels of real estate development and EB-5 capital, Chinese investors are also increasing investment in portfolios of U.S. assets through real estate investment trusts and private equity funds.
These real estate investments come on top of China’s position as the biggest holder of mortgage-backed securities issued by U.S. government-sponsored enterprises such as Fannie Mae and Freddie Mac. Like U.S. Treasuries, these bonds are important investments for Chinese government finances, because they allow for recirculation of dollars gained by the trade imbalance, and for the U.S. housing market, because they help ensure liquidity and mortgage rate stability. Chinese banks have also become major sources of debt capital in the U.S. real estate market, primarily for U.S. firms. To fully understand the role of Chinese capital in the U.S. real estate market, it is vital to look beyond direct investment. More than any foreign investor other than Canada, China stands out for the breadth, depth, and speed of its participation in the U.S. real estate market.
Our findings are that from a modest base in 2010, China was the source in aggregate of at least $350 billion in U.S. real estate holdings and investments by the end of 2015. This figure includes the direct purchase of real property and indirect investment through the purchase of agency mortgage backed securities and provision of debt financing, among other channels. In addition, we estimate that Chinese entities managing U.S. real estate operations and individual investment through vehicles including the EB-5 program may have created or sustained 200,000 jobs. For commercial and residential real estate, China has been an important source of capital as the U.S. economy recovered from the recent financial crisis and Great Recession.
Chinese investment in U.S. real estate is a recent development with considerable growth potential. While it is not as politically sensitive and does not directly impact national security as does Chinese investment in U.S. technology or telecommunications, real estate affects more people and communities and involves policy makers at multiple levels.
This report aims to objectively present the following:
- Sources of Chinese capital flowing into U.S. real estate;
- Motivations and drivers for various Chinese investors;
- Benefits and impediments posed by this wave of investment;
- Analysis and projections of the sustainability of Chinese investment in commercial and residential property;
- Recommendations for U.S. and Chinese investors, policy makers, and stakeholders to keep investment channels open.
Combining information from public records, reports, and trade groups – based in part on gathering of data and interviews with industry sources – this report assembles a unique information set, providing the first comprehensive analysis and understanding of Chinese inbound investment into all facets of U.S. real estate.
This reported investment data are not perfect, a result of the combination of the particulars of real estate investment avenues and the ability of government and third-party sources to accurately measure capital flows. Furthermore, a significant portion of investment from offshore locations, including China, comes in the form of minority interests in projects sponsored by U.S. entities and is not directly traceable to the capital country of origin.
Our study is focused on investment from mainland China, but the flow of capital through intermediary destinations sometimes necessitates the inclusion of capital from Hong Kong, Macau, or Taiwan. Moreover, the task is complicated by the multiple channels for investment, ranging from purchases of homes and apartments to business investment in commercial assets to development and construction, as well as through provision of debt to both residential and commercial property investors. The myriad ways in which to record real estate ownership can also obscure the true country of origin of the buyer. With this in mind, this report presents the data as minimum investment volumes. While acknowledging these data limitations, we have made every effort to compile data and insight that provide a more complete reflection of actual Chinese investment activity across the entire spectrum of the U.S. real estate market than previously published. This includes enhancing investment volumes reported publicly as well as confirming the reported data via industry participants.
The investment flow has come into the United States through several channels:
- Residential property: Between 2010 and 2015, Chinese buyers spent at least $93 billion on homes, including condominiums, for occupancy and investment. Spending rose at an annual rate of 20% and provided important demand in many local markets hit hard by the housing crisis. Chinese buyers paid substantially more, on average, per home than other international buyers because of their concentration in prime neighborhoods in California and New York.
- Commercial property: Between 2010 and 2015, Chinese investors acquired at least $17.1 billion of existing office towers, hotels, and other commercial buildings, representing an annual growth rate of 70%. Half of that investment came in 2015 alone. The buyers were mainly large Chinese companies, including real estate firms and institutional investors.
- Development: By the end of 2015, Chinese-funded projects under construction or planned totaled at least $15 billion. These range from multi-billion-dollar mixed-use projects in Los Angeles and the San Francisco Bay Area to smaller-scale developments in secondary markets. These investors include Chinese developers, builders, and construction companies, some of which have set up U.S. offices, creating local jobs for ongoing operations beyond the construction phase.
- EB-5 visa program: Since 2010, Chinese nationals have been the most numerous investors in the EB-5 U.S. visa program. The program enables a foreign national who invests at least $500,000 in projects that create a minimum of 10 jobs to receive a U.S. visa and, on completion of the project, a green card for permanent residency status. Detailed data on these investments and the actual number of jobs created are not generally available. But based on the minimum investment and job creation requirements, and assuming all investments are successful, Rosen Consulting Group estimates that since 2010, nearly 20,000 Chinese EB-5 investors have generated at least $9.5 billion of investment capital and contributed to the creation of 200,000 jobs.
- Residential mortgage-backed securities (RMBS): Chinese government entities began purchasing U.S. government agency-backed RMBS in the early 2000s to diversify beyond U.S. Treasuries. As of June 30, 2015, China held $207.9 billion in agency-backed mortgage bonds, more than any other country, according to preliminary U.S. Department of the Treasury data. These holdings contribute to enhanced liquidity in the U.S. housing finance market.
- Real estate loans: In recent years, Chinese banks increased activity in lending for real estate acquisitions, recapitalizations, and construction and development. The banks have amassed at least $8 billion in loans and have become a major source of funding for large commercial real estate projects. This loan portfolio extends beyond Chinese investors and projects with Chinese partners, as leading Chinese banks are active competitors with U.S. and international banks and private sources of capital in the commercial property market. Residential mortgage lending by Chinese banks in the United States is more limited, but growing.
We believe China’s economic turbulence will create a short-term speed bump for real estate investment overseas, including in the United States. In the near term, a 6- to 24-month temporary period of increased capital controls is likely – either formally via policy announcements or informally through administrative processing – until the Chinese currency can be re-aligned with that of global partners. However, this does not mean investment will cease during this period. Furthermore, the long-term investment drivers remain: strong U.S. demand for capital; a widening and deepening pool of Chinese investors, many of whom have not ventured into U.S. real estate; increasing global appetite by Chinese developers and construction companies; a $1.6-trillion insurance industry that has become active overseas but invested just a fraction of funds available for real estate projects; and new Chinese investment vehicles, such as private equity funds, which have only recently become a factor in the U.S. market.
We project that Chinese direct investment across existing U.S. commercial real estate assets and residential purchases, excluding new development projects, could total at least $218 billion, cumulatively, from 2016 through 2020. In the short term, capital controls will likely slow individual purchases of U.S. homes, the biggest component of Chinese real estate investment, and slow the growth rate of commercial property acquisitions. Chinese-backed development projects are likely to remain a substantial component of the commercial real estate market even as the economic cycle in the United States slows the overall pace of new development announcements. Beyond 2020, Chinese investment in U.S. real estate could accelerate further.
These large capital flows, accelerating substantially in a short period of time, do not come without challenges in both countries.
In the United States, several policy areas will need attention in the next several years:
- Rationalization of taxes affecting foreign investment: The Foreign Investment in Real Property Tax Act (FIRPTA), while perhaps well intentioned at inception, is an onerous structure that creates an impediment to international investors in real estate. Every effort should be made so that there is a level field for taxes on foreign investors regardless of their domicile.
- Continuation of the EB-5 program: While the program was extended through the summer of 2016, renewal is by no means a certainty. It has been a successful bridge builder, bringing capital into the marketplace, growing or retaining jobs in the United States, and allowing Chinese citizens and families access to visas and residency. The EB-5 program will likely undergo reform, but it should not be altered so dramatically as to cut off access to international capital and immigration, including those from China.
- Continued implementation of existing security policy: Offshore investors are understandably screened for security risks and legitimacy of capital sources. So far, such concerns have not been an impediment to investment in U.S. property, as it has been in technology platforms, manufacturing firms, or natural resources extraction and processing. Any proposal to restrict U.S. government occupancy, including those of certain government contractors, in foreign-owned buildings – as is being discussed in congressional circles – should be carefully monitored.
On the Chinese side, the issues that deserve attention include the following:
- Continued development of legal and financial rules to encourage private sector investment in overseas property: Chinese companies and individuals can benefit themselves and the Chinese economy by diversifying assets globally. It is critical that China develop a robust domestic legal framework for foreign investment, as many countries expect reciprocal treatment of foreign investors. Likewise, reforms that reduce bureaucratic bottlenecks and expedite outward investment should continue.
- Enhanced transparency in capital ownership: The United States and other global financial centers are increasingly monitoring the identities of foreign investors and business operations. While China is not the only country that raises concerns, Chinese businesses historically have been less open regarding origination of capital and ties to government or military officials. Continuing progress toward the transparency required by international agencies – many of which are welcoming China as a significant participant – will be an important step.
- Avoidance of capital controls: China’s economic growth rate has slowed, and its currency is re-aligning with that of other major economies. Chinese concern over capital outflows is understandable, but a hard capital-control regime could negatively impact the financial institutions the government nurtured over the past two decades.
China is a powerhouse the US cannot discount. Prosperity and free flow of capital between the 2 nations is the only way to go.