In a case of seeking silver linings around clouds, the fund manager of this article sees benefits from a supposed retreat from US commercial property by Chinese investors.

Apparently Chinese high net worth and other investors from that country are falling out of love with US commercial real estate. But whether that spells bad news for parts of the market is an open question, and may even carry some positives, according to Jonathan Lewis, founder and chief executive of JLJ Capital. The editors of this news service are pleased to share these views and invite responses; they do not necessarily endorse all views of guest writers. Email tom.burroughes@wealthbriefing.com

Over the summer, The Wall Street Journal published an article discussing how Chinese investors were beginning to exit the US commercial real estate market. 

The article, Chinese Investors Have Been Selling Properties, But Not at Any Price, published on 24 July, notes: “These investors, who were among the most aggressive in the US market, have become net sellers to repay debt, to offset losses or [are] under pressure from the Chinese government to curtail overseas investment.” 

This is part of an ongoing trend where Chinese investors are concerned. According to Cushman & Wakefield data, $7.3 billion from China and Hong Kong was used to complete commercial real estate acquisitions in the US in 2017 - a year-over-year decrease of 55 per cent from 2016. Furthermore, deal volume for US commercial real estate acquisitions of more than $1 billion by Chinese investors was down by 75 per cent year-over-year in 2017.  

This is a positive development for the US commercial real estate market. Chinese and other foreign investors who have bought into US commercial real estate have generally done so to make relatively safe investments which are protected from currency risk. These investments have pushed market prices to unhealthy, and ultimately unsustainable, levels.

Now that Chinese investors have been directed by their government to reduce their US investments and remove their capital from the market, commercial real estate prices can decrease to more sustainable levels and valuations can improve. 

Opportunities from debt
Regardless of how much Chinese investment flows out of the US commercial real estate market, bank lending remains relatively tight in the space. According to Federal Deposit Insurance Corp (FDIC) call report data compiled by BankRegData, while commercial real estate loans in bank portfolios climbed to a record $1.4 trillion in the first quarter of 2018, the rate of growth slowed to the lowest level in three years. BankRegData noted in its June 2018 report that lending increased from $1.2 trillion in the third quarter of 2015 to $1.3 trillion in the third quarter of 2016 (a rise of $100 billion in four quarters), but it has taken six quarters since then to reach $1.4 trillion.

There are a number of factors contributing to the commercial real estate lending slowdown, including more competition from non-bank lenders and higher loan delinquencies. 

However, this development - along with the exodus of Chinese investors - potentially offers promising investment opportunities for high net worth investors. Banks can lend capital for commercial real estate projects, but they are not actually commercial real estate operators - and therefore, too often, they may not know what to look for in a prospective borrower. For example, a bank may view the son of a successful real estate developer favourably as a borrower, but what if this is the son’s first project on his own, without his father, or his father’s team, to guide him? 

A non-bank lender whose team has extensive experience in commercial real estate, and also understands banking infrastructure, has a better chance of identifying a borrower that will be able to not only pay back their loan, but also accomplish all the objectives for the project for which they requested capital. If this type of non-bank lender also structures loans with as many protections as possible for investors, and/or creates investment products tied to those loans, then high net worth families and individuals could consider investing capital with the goal of obtaining healthy, risk-adjusted returns which are not correlated to other asset classes. 

Furthermore, fewer Chinese investors in the US commercial real estate market means that more loans can be granted to owners/operators who are genuinely interested in the long-term quality of their real estate projects, as opposed to owners/operators who are using real estate as a hedge against currency risk. 

As long as high net worth investors know where to look, there are always opportunities to obtain uncorrelated returns across multiple market conditions. Commercial real estate debt is one such avenue they can explore.