By Jason Murphy.

The stream of capital flowing out of China to the west is growing and becoming more influential. Chinese capital has helped boost property markets from Auckland and Sydney to Vancouver in recent years, but new regulations raise the question of whether the effect will subside. Will developments be left unfinished? Will deposits for off-the-plan sales be abandoned? Will a weaker flow of Chinese capital leave western economies limp? Or will the beat go on?

Record prices

The effect of Chinese money is impossible to wholly separate from other dynamics of certain highly desirable property markets, but in the favoured destinations, housing prices are on a major hot streak.

Sydney house prices are up 75%, Vancouver prices up 74%, Auckland prices up 80% in the past five years. This far outstrips wages, which grew by 12% in Australia, 10% in Canada and 20% in New Zealand.

In 2017, PwC published a report arguing the inflationary effect of Chinese demand is widespread.

“Bidding by Chinese developers – who are often willing to pay more for development plots than local rivals – has caused land prices to soar in many Asia Pacific cities, and particularly in Hong Kong, Singapore and Australia.”

Meanwhile, the volume of property development is growing rapidly. More than $72 billion of foreign investment in residential real estate was approved by Australia’s Foreign Investment Review Board (FIRB) in 2015–16 (the most recent data available). About $65 billion of that was for new properties, and China was the biggest single source of buyers. This is a six-fold increase on the 2012–13 figure of $11 billion. 

The influx of Chinese property investment in western markets has not gone unnoticed. As the markets have risen to fever pitch, so regulations have changed.

Fencing things off, somewhat

Several destinations most favoured by Chinese investors have new rules targeting foreign capital:

• In 2016, the Canadian province of British Columbia levied a 15% tax on foreign buyers to try to cool prices in Vancouver. Toronto followed suit in 2017.
• In New Zealand, new Prime Minister Jacinta Ardern has implemented an election pledge to ban foreigners buying homes.
• In Australia, New South Wales doubled a surcharge on foreign investors to 8% in 2017, while increasing land tax from 0.75% to 2%. 
• Victoria added extra stamp duty charges of 1.4–5.5%, as well as a vacant property tax of 1%.

So has this worked? Have property markets collapsed? The answers are: perhaps slightly, and no. 

In a recent note to clients, Credit Suisse analysts Hasan Tevfik and Peter Liu argued property demand held up in New South Wales over 2017 at between $1.4 billion and $1.6 billion a quarter. Their analysis shows a new or higher tax on foreign buyers can make property price growth slow, but does not cause price falls.

“Based on the experience of other cities around the world, we do not believe the recent increase in taxes by NSW will cause property prices to contract,” Tevfik and Liu wrote.

The evidence largely bears out their claim:

• Vancouver’s property prices rose 14% in the year to November 2017. That’s below the circa 30% annual appreciation seen in 2015, but scarcely a sign of a cooling market.
• Sydney property prices also rose in the year to November 2017. Price growth was 5%, according to data from property firm CoreLogic. Prices fell in November 2017 by 0.7%, but that may be partly explained by a rise in some interest rates offered by local banks.
• New Zealand house prices grew 3.9% in the year to October 2017, according to the QV House price index, but prices fell 0.6% in Auckland, where foreign buyer activity has been strongest.
• In Melbourne, where foreign demand is the highest in the nation, house prices rose 1.9% in the three months to November 2017, according to CoreLogic. 

Is this limited effect because the curbs are too weak? Or is it because foreign capital is not a major driver of property markets? An analysis of Australia’s housing market by ANZ senior economist Daniel Gradwell suggests caution. Gradwell argues that foreign buyers own 2.5–4% of Australian housing stock and their overall impact on prices is not clear.

“The purchase of 7% to 13% of total sales each year is not as significant as the share of new construction,” he said in an ANZ report in November. “The impact on overall prices is likely to be less.”

China's slice of Australian property

(Source: FIRB, ANZ The total value of foreign property investment approvals by Australia’s FIRB by source country, in A$ billion. Includes approvals for commercial and residential real estate investment. No country breakdown provided for 2008–09.)

It is far from clear that rules introduced so far will change the housing markets in Australia, New Zealand and Canada. But new rules on inbound foreign investment have been matched by tight new controls on outbound investment in China, too. 

Building a dam

In China, capital that leaves the country does so under scrutiny.

This has little to do with the state of western property markets. Rather, China manages the value of its currency, and that often means the People’s Bank of China must sell large amounts of foreign currency to buy excess renminbi in the system. An estimated US$800 billion worth of Chinese currency flowed offshore in 2016. Capital outflows increase the volume of Chinese currency in global markets and deplete those foreign exchange holdings further.

So at the end of 2016, China began cracking down on outbound capital flows, causing concern in global property markets about possible effects.

China’s general desire to prevent capital outflows coalesced into something far more concerning for foreign property markets during 2017. In August, the National Development and Reform Commission (NDRC), declared some Chinese investment overseas as “irrational”.

Forbidden cities

The NDRC, an economic decision-making body, may have had its eye on a developer operating in Australia when it used the word “irrational”. 

Amid a global buying spree, developer Dalian Wanda bought a site between the Sydney Opera House and Sydney Harbour Bridge and began to pre-sell a $1 billion 59-storey luxury development. Building has not yet begun, but the development has been sold, and a large portfolio of other Dalian Wanda developments worldwide are also being sold. Dalian Wanda had its debt downgraded to junk status by rating agency S&P Global in September.

The rapid retreat of Dalian Wanda is a sign of things to come for investors depending on China for capital.

In the second half of 2017, China’s central government promulgated a document entitled Guidance on Further Guiding and Regulating the Direction of Overseas Investment, installing a new three-tier system of banned, restricted and encouraged investments. Gambling investment was banned, along with selling military technology. Meanwhile, investment in agriculture and infrastructure was encouraged, a move intended to support China’s ambitious belt and road initiative to build infrastructure around the world.

Real estate fell into a middle category of investment – restricted. Other types of restricted investment include investments in countries that do not have diplomatic relations with China or are at war. Lending for such purposes will likely be tightly controlled. 

PwC’s Sue Ann Khoo has argued that Chinese groups with investments in Australia would likely continue to pursue investment strategies but they may have to pay more. “Some Chinese investors may need to seek more expensive funding, such as mezzanine debt, due to the tightening of lending by the Chinese banks,” she says. Some investors may shift their focus to industries the Chinese government is encouraging, such as agriculture, she adds.

The extent of the impact of the capital controls remains to be seen. Much depends on how tightly they are implemented. But questions are already being raised about how long China will keep them in place.

How long can China control capital?

Chinese capital controls and rules on investment might not cause western property markets much of a headache. They can often be circumvented. Whether it is smuggling cash out of the country or using the extensive shadow banking system, money frequently finds a way. 

At any rate, not all Chinese money need be expatriated; much is already outside China. It will now be kept offshore, explains James Quigley, head of capital markets at real estate firm Cushman and Wakefield.  

“Following the government guidance, we are starting to see established Chinese groups recycling capital in offshore markets rather than repatriating the proceeds of asset sales,” Quigley says.

But as China comes to depend more on markets, its ability to control capital flows will recede. Chinese capital crackdowns are ultimately just a blip on a path to normalisation, according to researcher Guonan Ma from the Bank for International Settlements and Professor Rodney Maddock of Monash Business School.

In a 2017 paper, Ma and Maddock argue China’s long-term success depends on it adopting the norms of wealthy countries. Among those is a floating currency that can move freely across markets.

“The process will be gradual,” Ma and Maddock write. “The current tightening of regulations, processes and oversight of offshore investment should be seen as a pause, not more.”

The implications for Australia are clear, they argue. 

“We can expect a lot more foreign direct investment from China into Australia, a lot more portfolio investment, and probably a lot more private investment including into property.”

If they are right, the effect of Chinese capital on western property markets may be just beginning.

In an Acuity podcast Bob Carr discusses how Australian business can benefit from the predicted explosion of China’s middle class.

Jason Murphy is an economics writer and former policy analyst for the Australian Treasury. 

Photographs: Fairfax