Chinese Money and the Great Mortgaging

Uh-oh. Don’t look now, but the amount of Chinese money coming into Australia is set to get even bigger. Direct outbound investment heading out of the Middle Kingdom is on track to overtake the amount of money coming in for the first time. And a whole lot of that’s going to come here.

You only have to look at the figures to see the astonishing rise of this trend worldwide. Outbound investment from China was a lowly US$2.7 billion in 2002. Now it could hit $130 billion by the end of this year.

Of course, $130 billion is not much relative to the size of China’s economy. But the Chinese government is easing off the brakes, making the regulatory process simpler for companies looking to invest offshore. In other words, this trend is just getting started.

The Financial Times sums it up,‘Cash-rich Chinese investors are already snapping up real estate, companies and other assets while growth at home is poised to fall to its slowest annual pace in nearly two and half decades.

China’s biggest commercial property developer, Wanda, shows you this trend in action. Its global expansion plan includes taking its current US$30 billion annual turnover to US$100 billion in five years. The Australian Financial Review reported this week that Wanda has already committed AU$1.7 billion to the Australian real estate market. If you want to know why Australia real estate can go a whole lot higher, Chinese money is a big part of it.

In fact, it appears Wanda’s early plan in places like Australia, the US and the UK is to develop properties and primarily market them to Chinese buyers. I can’t help but wonder what companies and services will spring up around the growing Chinese presence in Australia.

The flipside to this, of course, is the notion that companies like Wanda are not investing in China. If they’re sending their money out of the country, should we be spooked? Not according to Shaun Rein, a market research consultant I’ve followed for a couple of years.

He recently told the China Urban Development Blog, ‘The real estate sector in China obviously has some issues but they are not as serious as many analysts seem to fret. Prices might soften in the residential sector but there is little leverage in the marketplace.

What he’s suggesting — if I have it straight — is to stop expecting some sort of 2008 repeat from happening in China. If property prices come down, the Chinese market can withstand it. The Chinese market simply isn’t geared to the hilt as the US market was in the days before subprime collapsed.

In the context of a recent academic paper, The Great Mortgaging: Housing Finance, Crisis, and Business Cycles, that observation is interesting.

The researchers burrowed into over a hundred years of bank credit data. And it came up with the conclusion that Western banks spend most of their time borrowing short to lend long so we can all buy and speculate in real estate. That’s instead of banks frittering away their time funding, you know, useless endeavours like business and entrepreneurship.

Here’s a snippet from the paper:

We also find that household mortgage debt has risen faster than asset values in many countries resulting in record-high leverage ratios that potentially increase the fragility of household balance sheets and the financial system itself.

It also points out that the recessions are deeper and the recovery longer in the aftermath of these ‘mortgage booms’.

To be honest, the researchers could have saved some trouble and just asked my colleague Phil Anderson, who’s been pointing out these basic facts — and I’m not exaggerating — for twenty years.

For an academic paper, it’s getting closer to the mark of what you need to know, though. The basic message of the paper is that if you want to understand the business cycle, you have to understand how and why banks create credit against real estate collateral and how this has ‘financialised’ Western economies.

-But, like everyone else, it focusses only on the credit side of the equation and ignores the fundamentals you need to know underneath the real estate question.

More importantly, it doesn’t give you any advice on how to time your investments to catch the uplift in property values before the credit contraction comes. If you want help with that, click here.

For what it’s worth, I don’t think the credit contraction is going to hit anytime soon. And indeed, as above, the lower Australian dollar is no doubt making Australian real estate even more attractive to cash rich Chinese buyers. We’re not alone in that regard. Earlier this month, New York’s storied hotel, the Waldorf-Astoria, became the most expensive hotel in the world after it was sold to a Chinese insurance company for nearly $2 billion.

To paraphrase the old Roman Polanski movie, we’re all in Chinatown now.


Callum Newman+
for The Markets and Money Australia

Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect.

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