China Capital Controls.  Will settlement risks now start to bite?  Alternative facts, FIRB crackdown.

Limitations on transferring money out of China escalated sharply on 30 December 2016 when new rules impacting individuals and corporations were issued by the Chinese government.   Like water flowing downstream, some will trickle out but these big new dams are holding back a lot of capital.

A director of China’s State Administration of Foreign Exchange (SAFE) told China Business News recently that the regulator will fight against illicit practices including “fraudulent corporate outbound investments, false profit remittances, obtaining foreign currency under forged trade pretenses, pooling quotas of others to purchase or sell foreign money, illegal buying or selling of foreign exchange, and moving assets overseas through fake trade or investment deals.”

Effectively, Chinese individuals will find it harder to pool their US$50,000 annual quota for money transfers offshore, they have to specify (to the banks facilitating the transfers) their reasons for taking money out and they cannot buy offshore residential property for investment.  Chinese companies can only take money out if they are to buy an offshore asset related to their business. Eg  A Chinese mining company can no longer buy residential property development sites because the asset is unrelated to mining.

These new controls will increase settlement risk.  In early 2016, we said settlement risks for the year were overblown, and numbers from large developers such as Mirvac later confirmed it.

However, we are now not so confident.   Feedback from our networks suggest the number one concern among their property developer clients is helping FIRB buyers find mortgages.    We are also seeing an uptick in both developers quietly selling out of incomplete projects and off the plan buyers selling their units on the secondary market at a loss immediately after settlement.

The problem is that for many Chinese buyers, they would keep their units, even with a decline in the market, if they could…because its a safe haven investment.  But they simply can’t do it.  They are struggling to get money from China and are struggling to find mortgages in Australia.  Which is where our non-bank lending networks come into play — please contact us or attend the Australia-China Property Finance Conference in Sydney to discuss settlement risk, the impact of China’s currency restrictions, and financing solutions for Australian property developers, organised by our alliance partner, Cross Border Management.

We remain convinced (A) that Chinese individual investors have a tremendous appetite for Australian real estate and (B) that the Chinese government cannot sequester the world’s second largest economy without causing tremendous damage to that economy.   But those things are longer-term factors, and in the short run Beijing is worried about a weakening yuan and falling currency reserves.

It is now a balancing act –will there be enough non-bank-lenders to fill the gap?  And how long will Chinese buyers be willing to pay the higher-than-bank interest rates, with their assumption being that they will eventually get funds out of China.

Meanwhile higher stamp duties, FIRB fees, & land taxes charged in the East coast Australian states have had some impact on Chinese demand, but as the experience in Singapore, Canada and Hong Kong shows, these extra charges are absorbed and need to be higher before becoming a material factor.  e.g. it took a 15% tax on foreign buyers in Vancouver, introduced last year, to now cause a slump in the number of sales (down 39% in Dec 2016 vs Dec 2015 in sales volume) but not yet prices.

 

Alternative facts

One of the problems both Australian  and Chinese investors face is getting an accurate picture of what is really happening in the Australian market.  There is a huge range of pundits, forecasters, broker reports…partly because any dramatic drop in property conditions or developer defaults will impact on Australian bank shares, and in turn impact on the broader S&P/ASX 200 index.

However, there is even a more basic problem;  being the handful of property price index providers who show very different returns on the same asset pool.   They range from Corelogic’s 15.5% return for Sydney prices for 2016 to Australian Bureau of Statistics 7.%* (*ABS will release the 2016 number around 22 March 2017 but we are estimating 7.0% –based on the first three quarters of 2016 and our estimates for the December quarter). –see table below

These variations makes the property market ripe for the cherry-picking of information by vested interests to present a particular outlook.  E.g. annualising quarterly results to make it look higher if that quarter was significantly higher, or reporting of returns based on capital price plus gross rental yields while others report on capital price only.

Clouding the outlook further are the ‘personal stories’ shared via ‘word-of-mouth’ among investors in China. Take for example the rezoning of land close to railway stations in metro Sydney for higher density dwellings.  This has resulted in affected landed properties booming in value. However, property just outside the rezoning will not have risen to the same extent, but the story has spread in the meantime.  (and skewed property price index movements)

Media reports have also played a part in the ‘alternative facts’ being presented.   For example, in 2016 there were headlines of citing dramatic price falls in many off-the-plan apartments in Melbourne as reported by some property valuers.  However, in one major story that was later ‘picked’ up’ by other news outlets or recited in later property reports,  it failed to mention that the main reason for a significant drop in value for a particular set of apartments was because the apartment building was fire damaged!

 

Forced property divestments reach 61. Case closed?

61 properties worth $107m have been ordered for divestment after breaching FIRB rules, according to a media release from the Federal government last week.

The government launched a crackdown on illegal purchases in May 2015, and some 2,200 cases were referred for investigation by the ATO.  The cases came via the public who ‘dobbed in’ suspect deals, as well as the ATO’s own enquiries.

We believe all these 2,200 cases have now been investigated.  Late last year, the government had announced 400 cases remained under investigation and had ordered 46 forced sales on the 1800 cases they had investigated.   If a similar ratio is used (1,800 cases investigated, 46 forced divestments), then another 10 divestments would have been expected.  Instead the latest was 15 divestments, taking the total to 61. Not all culprits were from China as illegal buyers came also from India, Indonesia, Iran, Malaysia, UK, & Germany.

However, the government noted that a total of 570 foreign nationals did breach FIRB rules in some capacity, which resulted in 61 forced sales, as well as self-disposals, variations to previously approved FIRB applications and retrospective approvals with strict conditions. Breaches of these conditions will result in civil penalties or criminal prosecution.

In comparison, there have been 57,800 FIRB real estate approvals worth $53.3b from Chinese nationals alone in the 6 years to June 2015.  (June 2015 is the latest FIRB stats available)  Other main source countries of real estate investors include the US, Singapore, Malaysia, Korea & the UK.

So why is there a ‘disconnect’ between the public perception of a large number of suspected illegal purchases and the reality?  We addressed this question in our 2016 newsletters but repeat them here. Explanations include:

Chinese permanent residents in Australia are buyers not foreigners. (there are around 16,000 skilled migrants from China each year and in recent years gaining Australian PR…and many are likely to have the funds to buy and to invest)

Chinese temporary residents (students, 457 holders) can buy to live in (and not rent out) but must sell when they leave.

 

ABS statistics

Below are the ABS (Australian Bureau of Statistics) numbers for property price change for Australian capital cities. To calculate the annual growth rate, add the past 4 quarters.

e.g. the annual growth rate for Sydney to Sep 2016 is 3.1%.  We forecast a Dec quarter growth rate of 2.3%, taking the annual growth rate to 7% for calendar year 2016.