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On an aircraft between Beijing and the central Chinese city of Wuhan, Frank Xu shuttles to another investment opportunity created in the construction boom that is fuelling the Chinese economy.
With his laptop armed with spreadsheets, the goal of the overseas-educated mainland Chinese fund manager who oversees an international China real estate opportunities fund, is to find safe havens for the billion-odd dollars of committed capital his fund has recently raised. It is often difficult work.
Finding good assets and reliable local partners, negotiating deals and asset management all pose challenges. He is the man who seeks to reconcile the demands of a mercurial seller with those of an investment committee and compliance team in New York. It is classic “Mr China” stuff, and it’s not getting any easier.
In his back pocket, Frank has a clutch of recent Chinese legislation, known here as circulars. The names roll off the tongue like motorways. Circular 50, Circular 171 and Circular 192 all seem to lead in different directions, but away from his goal of the next closed deal.
For three years, China has been trying to damp its property market so that housing remains affordable. Initially the target was local governments, developers and banks, but recently the focus has shifted to foreign investment.
It started last year with rules raising the capital requirements for foreign- invested enterprises (FIEs) involved in real estate and restrictions on currency conversion in and out of China. Concern about currency and investment speculation is paramount in the minds of authorities.
The latest restrictions require all real estate FIEs to file with the central government. This filing has always been mandatory but local governments routinely ignored the requirement in the quest to fill their local foreign investment targets. Now, however, a foreign investor cannot register its company unless the filing is made. In effect, foreign investors have become policemen enforcing rules the centre requires the localities to abide by.
The filing requirement is not strictly an approval but it gives the centre an obvious lever of control, and that lever is now becoming clear. The government has decided as a matter of policy to slow down approvals generally and withhold approvals for foreign-invested property projects that incur overseas lending, including any overseas shareholder loan.
Not that revolutionary, you may think, given China’s functioning banking system. Think again, Frank says. The shareholder loan was a particularly efficient means of repatriating cash out of China, since the ability to declare dividends is often constrained by China’s traditionally strict accounting rules requiring the deprecation of buildings, which in turn suppresses accounting profits. Payments on shareholder loans and foreign bank loans were not subject to such restrictions. For Frank, trapping surplus cash in China eats into his returns and constrains his ability to raise debt.
With ever-increasing regulatory barriers, can Frank still make the figures work? He thinks so, viewing the market like a high jump competition. As the bar gets raised, the fitter, more experienced and better- prepared investors believe they can still “clear the bar”. So doomsday predictions are premature.
Focus is likely to shift to cities where local approvals are still relatively easy to come by, to projects that combine real estate and wider business activities (eg infrastructure and logistics) that are encouraged by the authorities, to probable changes to accounting rules that may reduce the cash trap issue, and to quasi equity finance structures.
Frank also has his eye on the day when he invests funds raised within China in his deals without the same complications affecting foreign money. For the moment, he focuses on his next jump.
The author is managing partner of the Shanghai office of Allen & Overy