_How are Chinese capital controls impacting London?

In 2017, Greater China accounted for 43% of total Central London turnover by price with total acquisitions reaching £7.12 bn, significantly boosted by two transactions over £1 bn; LKK Health Products Group’s purchase of 20 Fenchurch Street, EC3, and CC Land’s purchase of The Leadenhall Building, 122 Leadenhall Street, EC3.

So far this year, London has witnessed investment from Greater China retreat somewhat, but it is still over the long-term annual average of £1.78 bn. Despite tapering deal flows, there is still interest from Greater China, as can be seen from the year-to-date results which are the second highest on record.

On balance, London offers the same strong property market fundamentals that other gateway cities offer, such as market stability and transparency, as well as the language advantage. For investors from Greater China, exchange rate arbitrage over the pre-Brexit period still exists even though the RMB has weakened somewhat recently.

But for investors who seek long-term yield growth, London does offer a comparative advantage. Property owners in Hong Kong, where capital values have reached new highs and yields historic lows, in some cases below 2%, are now being attracted to invest in London where yields are substantially higher.

Consequences of Chinese capital outflow controls

We have already seen signs of tighter and wider controls emerging. For example, in a directive issued at the beginning of the year, the National Development and Reform Commission (NDRC) expanded the coverage of a stringent approval process from firms on the Chinese Mainland to the Mainland firms operating out of Hong Kong, reaffirming its stance against firms investing outside of their core business and classifying real estate as a “sensitive” sector.

Although the market should not over read the latest policy movements, a seasoned market watcher will recognise the top-down approach the Chinese corporate system operates under. The prevailing view is to contain and correct the over expansion in the past. So unless this view changes because of a major event like a geopolitical shift, the investment in real estate by heavyweights, such as insurance giants and conglomerates, will remain subdued.

Outbound controls may also lead investors to look more for domestic opportunities. Nevertheless, the market this year has seen some owner occupier purchases and purchases with funds raised overseas. Some developers with offshore experience and mandates are still actively looking for opportunities.

In the long run, Chinese investors will develop more sophisticated global strategies so that they can easily refocus to capture growth opportunities globally. However, the top-down, policy-driven behaviour we have observed will take time to evolve.

Conclusion

As a result of China’s capital outflow restrictions, the current cycle, which has seen a buying spree by Mainland Chinese investors over the past five years, is drawing to a close. As demand from China reduces the market has returned to a sense of normality from the perspective of many long-term players including sovereign wealth funds with long-term national mandates, investors, and developers with offshore fundraising capability, whose core business is real estate.

While capital controls persist, Chinese investors will remain cautious. This could have an impact on short-term transaction volumes but in the long-term, they cannot ignore the many opportunities presented in the gateway real estate markets.

As the Sino-US trade dispute rages on, its ramifications will spread beyond trade to the general investment environment in gateway cities. So in the short-term, New York’s loss is London’s and Hong Kong’s gain. Meanwhile, investors from outside Mainland China, in particular from Hong Kong, are picking up deal flows, as we witnessed from their recent acquisitions in London.

Other Asian investors, specifically from Singapore and Korea, are also stepping up their activity. This has resulted in healthier competition and a more balanced market, reducing the policy induced market disruption. This actually bodes well for mature Chinese investors who seek long-term return for their investments.

Read more in the latest Central London Quarterly Report Q3 2018