Australia has seen a recent influx of Chinese investors in the past few years into the property market. Whether it be buying properties locally or investing in developments, there has been a surge of Chinese capital that has flooded the Australian market. One particular space that has seen an increase in investment is within the commercial property market. There are many reasons for the growth in this sector, starting with the types of investors.
Two types of Chinese investors
There are two main types of investors who are interested in Australian commercial property – corporate and institutional investors, or high net worth individuals. Each of these investors has different motivations for choosing to invest in Australia, as well as a varied perspective on what they hope to achieve from their investment.
Corporate or institutional investors choose to invest offshore for two main reasons. The first is the mandate to deploy large funds, and with the domestic market slowing, this has driven them to look overseas. The second is to keep their investment assets diverse and spread out over markets and cities that are seen to be well supported by demand, with survival possible even in the event of a global downturn. These markets mainly include Australia, the USA and the UK. Further to that, the top tier cities are seen as the lowest risk and best understood and therefore are the main focal point of investment. These cities include San Francisco, New York, London, Sydney and Melbourne.
While the above are the two main reasons that corporate investors are turning their attention to Australia, return on investment is not necessarily the primary factor – for some it’s the perceived risk mitigation profile it brings to a company’s portfolio. However, the Chinese are still savvy investors and will structure their investment in such a way to maximize their after-tax returns.
The second type of investors – those with a high net worth – are commonly seen to be motivated to invest for migration purposes. As with corporate investors, the places high net worth investors choose to invest are within the tier one cities. The reason for this is mainly due to the cycle of popularity of these cities. Investors with a high net worth choose to migrate to these regions, driving corporate investors to strategically target these cities as their buyers are planning on moving there.
Return on investment
For these two investors, the minimum return can differ substantially as they have different motivations for investing in Australia. For corporate and institutional investors, they typically invest in one of two ways: with debt investment or equity.
Debt investment is a preferable method of investment for corporate and institutional investors first into the market, for the simple reason that it is a lower risk product with protection against losing principal, as there is an obligation for the loan to be repaid. Equity however, only guarantees a share within the development.
There are also preferable tax treatments for debt products. Debt investment incurs a 10 per cent withholding tax rate, as opposed to equity, which incurs a much larger tax rate of 30 per cent.
Investment returns tend to differ quite substantially between corporate and high net worth investors. For corporate and institutional investors, they expect returns from a range of 10 to 20 per cent, dictated by their own cost of capital and the reason for their investment.
If their reason for investing is capital allocation, deployment of surplus capital, and risk mitigation against exposure to the Chinese market, a high return isn’t necessarily the primary concern. However, the opportunistic corporate investors looking at Australia with a view to enhance their returns in line with investor expectations will expect returns in the upper end of the range. Australia is generally viewed as a stable market with a lot of growth and demand, so for those corporate investors that require returns of no less than 15 to 20 per cent, Australia is a prime market for them with upside opportunity.
High net worth investors, especially those with migration as their key agenda, are more willing to sacrifice return on their investment to gain the value of migration. Their returns can be as low as high single digits.
Five year outlook
The last five years has seen real estate as a sector become more prevalent growing from 14 per cent of total foreign investment into Australia to 45 per cent in 2013 to 2014. This is because as an asset class, it is well understood, is low risk and has large allocations by superannuation and insurance funds.
Going forward, a key trend will be China’s middle class growing wealthier, which will result in the expansion of Chinese superannuation and life insurance funds. In turn, Chinese fund managers with their swelling balance sheets look to countries where there is a steady growth and stable economy to invest in, such as Australia.
Australia can expect to see a continued positive outlook within demand in property market from Chinese investors. In particular, the greatest demand will be for prime commercial assets, typically within Central Business Districts. This again is due to risk mitigation and their understanding of tier one cities. Chinese investors are willing to pay premium for ‘trophy’ assets and assets with depth of demand; so we can expect yields to firm for prime assets.
Matt Khoo is the Director of Finance & Development Manager at ICD Property. He has a background in finance through Macquarie and ANZ and his current role involves executing the company's expansion strategy, overseeing the finance and investment team, managing project and company cash flows as well as capital structuring.
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