Hooks and Hurdles for Chinese Investors in the U.S.
Hooks and Hurdles for Chinese Investors in the U.S.
This past November, the first Chinese company to be listed on the New York Stock Exchange, Xinyuan Real Estate Co. Ltd., began construction on a 400,000-square-foot luxury condominium development in Williamsburg, Brooklyn. Although Xinyuan is one of the largest Chinese companies operating in the United States, it is just one of many Chinese real estate entities drawn to the American commercial real estate market in recent years.
There are many reasons for the influx of Chinese investors into the U.S. market. According to Malcolm Riddell, a U.S.-based investment banker and lawyer who lived in China for many years, “The Chinese have gotten rich, but China is an unpleasant place to live today in many ways.”
Riddell says that pollution, food safety, traffic, and other issues have caused Chinese people to look outside their own country for opportunities, but that the situation is especially acute for real estate investors and developers. Chinese commercial real estate markets are generally considered to be in a bubble. To try to deflate that bubble, Riddell says the Chinese government has recently made real estate development much harder. One of the ways Riddell says they’re doing that is by squeezing financing sources, making real estate development less profitable than it was a few years ago.
Recently, China’s largest real estate growth has been seen in multifamily developments in the outskirts of big cities like Shanghai and Beijing, according to Ted Dang, principal at the Commonwealth Cos. in Oakland, Calif.
“A lot of these units are vacant, even though all of them are sold to middle or upper-middle class people who buy them not for their income but their appreciation,” he says. But, he notes that because of the rampant speculation, the government has cracked down in some cities and made it illegal for a family to own more than two properties.
In other Chinese cities, they’re limited to only one residential unit per family, says John Liang, executive vice president for investment strategies and international operations in the New York office of Xinyuan Real Estate Co. Furthermore, he says non-real estate investment options are also very limited. According to Xinyuan’s research, which examined 10-year returns in 2013, the Chinese domestic stock market performance was dead last in the world in terms of rates of return.
“China’s stock market is under-regulated and corporate governance is very weak,” Liang says. As for putting money into Chinese banks, says Liang, that is a losing proposition, because a bank deposit is tantamount to “a deposit account for the government,” which could take that money at any time.
Teaming Up with U.S. Partners
It’s no secret that Chinese developers and investors are turning to the U.S. market. Alongside Canada, China has been the fastest-growing source of international clients for members of the National Association of REALTORS®, according to the group’s latest Profile of International Buying Activity.
When Chinese nationals invest in commercial real estate here, they most often team up with American counterparts because the latter have the land, the expertise, or both, says Eric Anton, managing partner at Brookfield Financial in New York. Chinese investors contribute capital to their American partners in order to learn the American development business, he says.
“Because Chinese investors want to get into the [American] market,” says Anton, “they will suffer lower returns.” At the same time, Americans seek out foreign investors, including the Chinese, because they provide them with “cheap money,” he says.
In Manhattan, commercial real estate returns are roughly 3.5 percent a year, compared to 15 percent to 20 percent in Chinese cities, says Shang Dai, a Chinese real estate attorney based in New York. But Chinese investors still prefer to buy in New York, because they see the U.S. market as more transparent and mature than the Chinese market, he says.
Unlike many American investors, Dang says, “a lot of Chinese real estate investors aren’t that concerned with cap rates, tax shelters, or cash flow.” Just as they do in their home country, they concentrate on the potential for appreciation, which makes them more gamblers than investors, he says.
Relationships between Chinese investors and developers and their American partners are not without tension, says Darlene Chiu Bryant, executive director of ChinaSF in San Francisco, an organization that encourages business investment in Northern California by Chinese investors and works closely with the San Francisco Association of REALTORS®.
“In China, the system doesn’t protect [junior] partners the way it does in the United States, where everything is spelled out in black and white,” says Chiu Bryant. Because of these legal protections, Chinese developers often want to have complete control of the project, she says.
Chinese developers are also used to significantly shorter timelines in their own country, says Chiu Bryant. A Chinese developer may be able to finish a master development in China in five or ten years, whereas an American developer might do the same project in San Francisco in roughly 30 years, she says.
Also, it’s important to note that the Chinese system of doing business is very different from the American one, says Riddell. “You count more on relationships there than in the United States. Most commercial transactions in China are off-market; there are no brokers involved. If you trust somebody, you buy the building without a middleman,” he says.
While differences between the way business is done here and how investment is handled in China is an important consideration for all parties looking to make inter-country connections in commercial real estate, there are more concrete considerations.
“The difference between cultures is not the only impediment to American and Chinese partnerships. As much as Chinese investors hanker after American and other western countries’ real estate, there is a hitch,” says Riddell. “According to Chinese law, Chinese nationals are not allowed to take more than $50,000 out of China each year.”
Chinese investors who want to take more money out of the country can always apply for approvals from the government, but they don’t always get them, says Riddell. So they have to find other—sometimes illegal—ways to get the money out, he says. Some Chinese nationals even fill suitcases with cash in order to ferry the money out of the country, but it’s very risky.
“There is lots of [Chinese] money sloshing around out there that is not supposed to be, maybe coming from the corrupt official or the businessman who’s mis-invoiced his exports for 20 years and now wants to invest the money that is outside China,” says Riddell.
But for those who prefer to legally take money out of China, there is good news: “The general trend [within the Chinese government] is to relax the rules governing foreign exchange outflow,” says Xiaolin Zhou, a New York–based partner with Jun He, a Chinese law firm. Businesses and individuals still need approval to take more than $50,000 per year out of the country, but the approval processes are getting easier and are taking less time, he says.
Stephen Cowan, managing partner in the San Francisco office of global law firm DLA Piper, agrees. He represents Chinese investors who are executing million- and billion-dollar deals in the United States that require approvals for taking out sums over $50,000 at the provincial and national levels in China.
“While these approvals sometimes take months, I haven’t seen any of them being declined in the last six months,” says Cowan, which leads him to believe that they are easier to get today than a couple of years ago.
For those Chinese investors who are able to successfully transfer large sums of money out of the country, the U.S. government will often help them put their money to work. The EB-5 investor visa program enables foreign investors to obtain green cards by investing in American businesses and creating jobs. Though the program has been around since the 1990s, transactions using the program have grown exponentially in the last five to seven years, according to Ankur Gupta, real estate partner with the corporate advisory group at McDermott, Will and Emery LLP in Chicago. He notes that in the hotel sector specifically, “You can create more direct, permanent jobs than you can with other sectors, such as multifamily, industrial, or office.”
Gupta’s colleague at McDermott, Will & Emery, immigration partner Joan-Elisse Carpentier says this increase in EB-5 use has been driven largely by China. “Chinese investors in the EB-5 investor visa program are using roughly 80 percent of the available visas in this category per year,” she says.