china’s impact on australian real estate · lasalle investment management | research &...

China’s impact onAustralian Real Estate

Contacts:

Leigh WarnerNational Director, Research & [email protected]

LaSalle Research & StrategyAugust 2015

THE

• China has become enormously important to the Australianeconomy as its largest export destination, a rapid source ofgrowth in inbound international tourism and migration, plusa strong source of foreign investment.

• The impact of China on Australian property has been bothindirect through the impact on the broader economy anddirect through capital flows and Chinese developers buildingAustralian businesses.

• LaSalle’s house view is that China’s debt boom willundoubtedly cause turbulence in credit markets. However,only a full blown financial crisis would have a significantadverse impact on Australia and we see the likelihood ofthis outcome as low.

• The size of any impact would depend on the extentsentiment of global investors swings against Australia (withfew remaining AAA alternatives) and how sustainable thedomestic economic recovery in Australia proves to be.

• Uncertainty surrounding the Chinese economy is alreadydriving strong capital flows into Australia and we expect thisto continue over the medium-term.

• Longer-term, a recent free trade agreement (FTA) will likelyfurther deepen the trade and capital flows between the twocountries and Australia remains well positioned to capitaliseon China’s continued economic growth and expandingmiddle class.

• While occasional reversals in capital flows could provedisruptive to local property pricing at times, it is likely that theoverall impact will be to boost property demand, particularlyin the residential market. The hotel/resort market and themarket for rural land are also likely to be impacted long-term.

Apartment Blocks, Gold Coast

Key Points

LASALLE INVESTMENT MANAGEMENT | RESEARCH & STRATEGY CHINA’S IMPACT ON AUSTRALIAN REAL ESTATE | 3

The economic impact ofChina on Australia’s economy

Bulk Commodity ExportsQuarterly

Source: ABS, RBA

2005 2010 2015 2005 2010 201530

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190

Met

ric T

onne

Iron Ore

40

50

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Metric Tonne

Coal

Australian Exports by DestinationAnnual Share of Total Values

Source: ABS, RBA

2001 2005 2009 20130

5

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35

Per

cent

age

(%)

IndiaChinaS KoreaUSEU-27Japan

The Australian economy has quiteremarkably experienced twenty one yearsof continuous expansion. The saying usedto be that ‘when the US sneezed,Australia would catch a cold’, but certainlyover recent years it has been the strengthof the Chinese economy that has boostedAustralia’s economic prospects wellbeyond those of most other majordeveloped economies, including the US.While Australia’s fiscal stimulus followingthe global financial crisis (GFC) wasswifter and more significant than mostother developed economies, undoubtedlya greater boost came indirectly from thefiscal stimulus and building programinstituted in China, which fuelled strongdemand for Australian commodities andre-ignited the mining investment boom thatwas starting to gain momentum pre-GFC.China is Australian’s largest export market and now

takes over a third of Australia’s exports by value.

Bulk exports, particularly iron ore and coal have driven the trend.


Some of the clear impacts of China on the Australian economy can be seen in the following areas:

Exports

China overtook Japan as Australia’slargest export destination in 2008 andover that time has risen from less than15% of Australia’s total exports to over a third of Australian exports (Figure 1).Exports to other major trading partnershave also increased over the period involume terms, but this growth has beenmore than overshadowed by the growth in Chinese exports and all other majortrading partner’s shares of Australia’sexports have declined in recent years. The growth in Australia’s exports to China largely reflects the bulk commoditydemand emanating from China’s strongeconomic growth and construction-ledinvestment boom. Australia’s main twocommodity exports have been iron ore,which have more than doubled in volumeterms in the past five years, and coal,which has almost doubled (Figure 2).

Tourism

Australian tourism has been through alean period over recent years, with thestrong Australian dollar (AUD) dampeninginbound international tourism and boostingoutbound international travel (and in theprocess dampening domestic tourism).Despite this generally subdued environment,inbound Chinese tourism has been onearea of strong growth over the past fiveyears. This growth has seen Chinabecome the largest inbound internationalmarket for Australia by value, with Chinesevisitors spending AUD 5.26 billion over theyear to June 2014 (Table 1). With theweakening of the AUD in 2014, tourismfrom other countries has also improved inthe latest 12 months. But, the Chinesemarket still dominates, as it has grown16% off an already large base.

Australian Tourism Expenditure by Country of Origin

Market Yr-EndJun 13($ m)

Yr-EndJun 14($ m)

%Change

China 4,518 5,255 16%

UK 3,144 3,548 13%

USA 2,467 2,641 7%

NZ 2,288 2,361 3%

Japan 1,460 1,355 -7%

Korea 1,225 1,107 -10%

Singapore 1,012 1,081 7%

Germany 917 1,023 11%

Malaysia 925 1,018 10%

Hong Kong 822 938 14%

Source: Tourism Research Australia

Chinese tourists spent over $5.2 billion in Australia lastfinancial year, which is more than any other countryand was up 16% y-o-y.

Chinese Investment in Australia by Industry, 2012/13

Industry China($m)*

% ofTotal

Agriculture, forestry and Fishing 328 14%

Finance & Insurance 23 1%

Manufacturing 957 15%

Mineral Exploration 8,273 19%

Real Estate 5,932 16%

Resource Processing - 0%

Services 291 1%

Tourism - 0%

Total 15,803 13%

Total Approvals (number) 6,102 48%

Source: Foreign Investment Review Board

Chinese investment in Australian real estate has increasedsignificantly over recent years.


Foreign Investment

Chinese foreign investment in Australia,particularly in agriculture, resources andresidential housing has gained somepublic attention over recent years. Totalforeign investment is lumpy and can jumparound due to particular large corporate orcommercial real estate deals, but Chinahas consistently been one of the largersources of foreign investment intoAustralia over recent years (with the USthe largest). Figures from the ForeignInvestment Review Board (FIRB) suggestthat in 2012/13, Chinese interests invested$15.8 billion into Australia, or 13% of allmoney invested. The proportion ofinvestment in some sectors was high,such as mineral exploration (19%), realestate (15%), agriculture (14%) andmanufacturing (15%). However, investmentin many other sectors such as finance andinsurance, services, tourism and mineralprocessing was low or zero.

Comparing these results to 2008-09, boththe level and share of Chinese investmentis slightly lower now than it was four yearsearlier. Nevertheless, there have beensome big changes in the composition oninvestment. What stands out is thenumber of approvals and particularlyChina’s share of approvals by number(48%). This supports anecdotal evidencethat Chinese investment is having a bigimpact on residential housing markets,particularly in Sydney and Melbourne.Evidence suggests that this activity hasincreased over the past 18 months andalso that some of this impact has beenindirect through Chinese-born Australianresidents and not picked up in the FIRBnumbers. A parliamentary enquiry intooverseas investment in the Australianresidential market released in November2014 concluded that current regulationsthat push investment into new rather thanexisting stock are an overall positive forthe Australian market and dampen pricingover the medium-term by stimulatingsupply in the apartment market. However,the recommendations focused strongly on boosting enforcement of the FIRBregulations, noting they were easy to by-pass due to limited resourcesdedicated to policing the regulations.

Queen Street Mall, Brisbane

Inbound Chinesetourism has been onearea of strong growthover the past five years


Slower recent Chinese economic growthand recent sharp falls in commodity prices(particularly iron ore, see Chart 3) and theAUD have put a sharper focus on the risksthatlarger than forecast Chinese economicslowdown would have on the Australianeconomy and property markets. It shouldbe recognise that the pace of Australianresource exports to China was alwaysgoing to slow at some point becauseChina’s post-GFC building boom could notbe sustained forever and it was alwaysintended that growth be shifted moretowards consumption. The issue hasalways been whether this transition is slowand gradual, or if the imbalances ofgrowth in the past cause a more rapidadjustment period. This would likely betriggered by a rapid decline in Chineseproperty prices, increased bad debts(many outside the regulated bankingsector) and an ensuing financial crisis.

To date, China has been able tosuccessfully tighten credit conditions andengineer a slowdown in property markets,with only isolated developer/investorbankruptcies and without tipping intofinancial crisis. Economic growth hasslowed, perhaps slightly more thanintended, but with plenty of reserve capitalto tip into the financial sector and thingsseemingly stabilising, the risk appears toremain low. Oxford Economics rate thelikelihood of Chinese financial crisis to beonly around 10%. However, while theprobability is low, the impact would belarge and Oxford estimate that ChineseGDP would fall to below 2% in 2015 and2016 in the event of a full blown financialcrisis. This magnitude event wouldcertainly have a large impact on Australiangrowth prospects and likely tip theeconomy into its first recession in nearly aquarter of a century.

How big is the risk of slowdown?

Bulk Commodity PricesFree On Board Basis

2011 2013 2015

US

$ P

er T

on

Iron Ore (LHS)

2011 2013 2015

Thermal Coal (LHS)

US

$ Per Ton

2011 2013 2015

Coking Coal (RHS)

35

75

115

155

195

50

150

250

350

450

Average Australian Export Price Spot Price* *Iron Ore Fines, Newcastle thermal coal and premium hard coking coal

Source: ABS, Bloomberg, IHS, RBA

Recent price fall has been significant and raises the need for Australian domestic drivers to take up the slack.


Slower Chinese growth has certainly beena factor in recent declines in bulkcommodity prices, most notably in ironore. This has affected investor sentimenttowards Australia to some degree andbeen a major factor driving a recentdepreciation of the AUD (Chart 5).However, this depreciation is not anunwanted event and the Reserve Bank ofAustralia (RBA) has been arguing forsome time that a lower AUD would helpother sectors of the Australian economyand help balance out growth.

In the short-term, Australian commodityexports will not fall away sharply becauserising export volumes (as more resourceprojects undertaken over recent yearscomplete) and a lag between spot prices

and contract prices mean recent price fallswill take a while to reach their full impact.This lag buys more time for Australiandomestic drivers to pick up. On this frontthere are still mixed signs– businesssentiment remained positive through 2014, which is supported by an apparentstabilisation in the labour market and byincrease leasing activity in office market in Sydney and Melbourne. While consumersentiment remains fragile, housingconstruction activity has been stronger of the past 12 months and contributing to GDP growth. Stronger housing marketactivity, continued low interest rates andlower petrol prices should all supportstronger consumption activity over the next12 months (particularly if employmentgrowth increases as expected).

While not the central forecast, a Chinese financial impact would have a large impact on both the local andAustralian economies.

Chinese GDP Outlook

Source: Oxford Economics/Haver Analytics

2006 2008 2010 2012 2014 2016 2018

Per

cent

age

(%)

Year

Baseline

Forecast

ChinaFinancial

Crisis

0

2

4

6

8

10

12

14

16

AUD Exchange Rates

Source: Thomson Reuters, WM/Reuters

1985 1990 2000 2005 2010 2015

Yen

(¥)

US

$, Euro

Euro per A$*(RHS)

Yen per A$(LHS)

US$ per A$(RHS)

50

100

150

200

250

0.40

0.80

1.20

1.60

2.00

*ECU per A$ until 31 December 1998

A slow steady fall in the AUD will be good for Australia’s economic rebalancing


Australia and China signed an FTA inNovember 2014 in the wake of the G20meeting in Brisbane. The negotiation onthe long-awaited FTA commenced almosta decade ago and the agreement is in its18th iteration. Some of the key aspects ofthe agreement are as follows:

• Over time, as much as 95% of Australianexports will enter China without attractinga tariff

• Tariffs on most Australian agriculturalgoods will be phased out over the nextfour to nine years

• For mining, tariffs on alumina, zinc,nickel, copper, coking coal and uraniumare to be eliminated, while tariffs onthermal coal will be removed in twoyears;general economic boost toAustralia

• Service exporters are big winners, gettingpreferential access in a number of sectors.Australian business will gain access toChinese private hospitals and nursinghomes, tourism operators will be able topurchases restaurants and hotels, whileAustralian insurance companies will getaccess to the third-party insurance market

• The threshold for FIRB review ofinvestment by a private Chinesecompany will be lifted from $A248million to $A1.087 billion. Chinese state-owned enterprises still need FIRBapproval for all investments

• The Australian government has agreedto a case-by-case application process for Chinese investors to bring Chineseworkers for Australian projects.

A recent FTA will createsome opportunities

The recent FTA shouldprovide a general economicboost to Australia, increasecapital flows from Chinafurther and create somespecific opportunities in theagricultural and serviceexport sectors.


A Chinese financial crisis would havelarge economic ripple effects on theAustralian economy and on propertymarkets, but we believe this to be a “highimpact/low probability” situation. If suchan event were to occur, the impact oncapital flows and values is also notentirely clear. In the immediate aftermathof a Chinese financial crisis, Chineseinvestors are likely to look for safe havento place money and Australian assetscould potentially increase in demand.However, eventual deleveraging couldresult in existing Australian assets beingsold off to repatriate capital back toChina. The impact of these fire-sales onasset prices would depend on the strengthof Australian domestic property demandand the extent to which such an eventaffects local sentiment.

In the absence of such an event, theoutlook for the Australian economy is stillsolid, with stronger domestic economicgrowth expected to improve prospects for property leasing demand in all sectors.Sentiment toward commodity markets and the prospect of rising interest rates in other major developed countries1 couldwell cause further depreciation of the AUD,but this is likely to be a growth-positiveoutcome by assisting exportcompetingindustries. Capital markets are likely toremain very strong, due to comparativelyattractive asset pricing in Australia, andproperty yields have the scope for furthercompression over the next few years.

Regardless of what happens in the shortto medium-term, a financial crisis wouldbe cyclical and China (along with the restof emerging Asia) will have a further bigimpact on Australian property marketslonger-term. The indirect impact on theAustralian economy through resourcedemand will return – the amount ofpeople globally moving from low-income to middle class lifestyles over the next fewdecades will be unprecedented and willresult in unprecedented resource demand.The nature of demand will change –particularly energy demand as dirty fossilfuels like coal subside in favour of cleanerfuels – but few places in the world haveas many different resource reserves asAustralia and such a small domesticmarket to service. This surge in the size of the middle class globally will also putgreat pressure on global food suppliesand demand for services (includingtourism and educational services).Australia’s opportunity to capitalise on thisis further enhanced by the recent FTA.

What does it all mean for Australianproperty markets?

1. A narrowing of interest rate spreads between Australiaand other major countries would reduce the ability ofinvestors to do ‘carry trades’ (borrow at lower interestrates elsewhere and get higher return in Australia) andjust the anticipation of these gaps narrowing is enough tocause a depreciation.

Australian International Students by Country, 2013

Industry Number % ofTotal

China 150,116 28.5%

India 49,265 9.3%

Republic of Korea 27,580 5.2%

Vietnam 26,015 4.9%

Thailand 21,762 4.1%

Other Nationalities 252,194 47.9%

Total 526,932 100%

Source: Foreign Investment Review Board


The impact of Chinese and other Asianinvestment has already been discernable in the residential property market,particularly in Sydney. While risk of a short-term reversal of capital flow is present (asdiscussed above), the longer-term impacton demand is likely to be strong. Being aparticularly sparsely populated continentAustralia is likely to face greater externalglobal pressure to receive greater migrantintake in the coming decades.

In our view this will also be tempting forfuture governments to counteract a shrinkingnatural tax base as the population ages. Assuch, greater migration potential than mostother developed nations will good forAustralian housing construction prospectslongterm. China is already the fastestgrowing component of Australian migration,and the second largest source after NewZealand. This trend not only will have animpact on the volume of construction, butalso further impact the mix of product asEuropean and North American migrationfalls and Asian migration dominates.

From a supply perspective, Chinesedevelopers (and developers from otherAsian countries, particularly Singapore)have recently been active in acquiring sitesand commencing major apartmentdevelopments across the Eastern seaboardof Australia. The recent parliamentaryenquiry into foreign investment in theAustralian residential market concluded thatthis stimulus to apartment supply willeventually outweigh the impact of strongoffshore demand and dampen Australiandwelling prices. Many of the sitespurchased by offshore developers are alsocurrently occupied by office uses and sothe eventual conversion or demolition ofthese premises will ultimately have theimpact of removing some stock fromAustralia’s major office markets.

While the impact on housing is alreadyevident, the impact on many other sectorsof the property market is still to come. Ourview is that the direct impact on commercial(office, retail and industrial) property ofChinese investors and developers is likely tobe more limited in the medium-termbecause domestic players already dominatethe relatively small market and it is hard toenter for external parties. There could bemore significant impacts in smaller non-coreproperty sectors where Chinese enddemand is likely to have a bigger impact onmarket dynamics and barriers to entry arelower. In particular:

Aside from opportunities in theresidential sector, some smallerniche sectors are likely to benefitfrom the impact from China,including tourism, studenthousing and rural land. Residential Development


• Tourism – growth in Chineseinternational visitors is likely to continueto grow at a strong rate as Australia iscurrently only has a very low marketshare. Also, as wealth grows the marketwill grow. Strong Chinese migration addsimmensely to the growth of tourism aswell, as it adds to the ‘visiting, friendsand relatives’ travel category. This is astrong opportunity for Chinese hotel andresort operators to develop product thatsuits and can be marketed back intotheir home country

• Student accommodation – Australia is popular study destination for Chineseand student numbers have been growing strongly the past few years, in spite of the strong AUD making it acomparatively expensive study market. A somewhat lower AUD over timeshould improve the affordability side andboost the attractiveness of the marketfurther. Australia has a relativelyundeveloped student housing market,with most students accommodated oncampus or in the private rental market

• Institutionally owned studentaccommodation is an emerging assetclass in Australia, but relatively lowyielding one which has constrained itsgrowth. Nevertheless, with strong end-demand more groups are starting to findbusiness models that work in thestudent housing space

• Rural land – agriculture in Australia hashad relatively challenging times over thepast decade, with drought affectingproduction and the GFC denting demand.Both production conditions and landvalues have increased in recent times,but the Asian growth story makes thelong-term demand picture appear verystrong. As Asian wealth grows, diets areevolving and shifting more towardsWestern diets. Longer-term this createsenormous potential for Australianindustries like the beef industry, the wineindustry and many other agriculturalproducts traditionally produced for a smalldomestic market. Foreign investment inagricultural land is always more politicallycharged than many other sectors,prospects for Australian agricultural landappear on a longterm upswing.

Growing Hotels and Hospitality

Student Accommodation

Agricultural Importance

LASALLE

Conclusion

• Twenty two years of continuous economicgrowth runs the risk of investors puttingtoo much faith in the idea that theAustralian economy is bullet proof.

• While this run could well continue, the domestic economy remains veryvulnerable to external shocks atpresent, and particularly any significantfurther slowdown in China.

• While a full blown Chinese credit crunchis not our central forecasts, concernedinvestors can position themselvesdefensively for such an outcome bylimiting exposure to vulnerable sectors,for example inner urban residentialdevelopment on the Eastern seaboardand offices in the resource-heavymarkets (Perth and Brisbane).

• However, in the short to medium-term,the risk of such an outcome is likely to push more money into Australia realestate cause further upward pricingpressure on all assets.

• To protect themselves further, investorsshould now become much more discerningabout paying too much for core Australianreal estate as the capital markets entersthe latter parts of the cycle. In particular,this includes Sydney and Melbourne CBDoffice assets, trophy regional and CBDretail assets in all major metropolitan areasand prime industrial assets across theEastern seaboard.

• Value-add investments with a shorterinvestment timeframe certainly appear to offer much cushion against widermacroeconomic uncertainty, leadingLaSalle to favour strategies in all sectorswhere active management can add value.

• Prime assets in some metropolitan officemarkets now appear attractive, with arelatively wide yield premium to CBDinvestments, moderate supply pipelinesand expected improvement in demandover the next 12 months.

• Some new residential developments will certainly still make sense in 2015,particularly in Sydney and Brisbane.However, supply competition hasincreased sharply over the past 12months and investors will have to beconsiderably more discerning about localmarket demand and supply conditionsbefore commencing new projects in 2015.

• Longer-term, we think China will continueto have a very large direct and indirectimpact on the Australian economy andreal estate markets. While this willprovide a broad boost to residentialmarkets generally, we believe the bestopportunites to capitalise longer-termmay be in niche sectors where thisimpact could be very large, such astourism, student accommodation andrural land.

Sydney Central Business District

Important NoticeThis information is intended to assist professional investors in deciding whether they wish to consider the investment further. Thispublication does not constitute an offer to sell, or the solicitation of an offer to buy, any securities or any interests in investment fundssponsored by, or the advisory services of, LaSalle Investment Management and is subject to correction, completion and amendmentwithout notice. Any such offer, if made, will only be made by means of a confidential prospectus. The prospectus will include informationregarding investment risk and investors should have the financial ability and willingness to accept these risks. All information obtainedfrom third party sources is believed to be reliable and current, but accuracy cannot be guaranteed and we do not undertake to update anyinformation contained in this document. All assumptions, figures and calculations contained in the information must be independentlyverified by the professional investor. This publication has been prepared without regard to the specific investment objectives, financialsituation or particular needs of recipients. No legal or tax advice is provided. Recipients should independently evaluate specificinvestments and trading strategies. By accepting receipt of this publication, the recipient acknowledges that this publication is confidentialand agrees not to distribute, offer or sell this publication or copies of it and agrees not to make use of the publication other than for itsown general information purposes.

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