Aug092016

Home sales weaken as Chinese investors sour on US real estate

A rising US dollar makes Irvine homes much more expensive for Chinese buyers, and capital controls makes it much more difficult to move money out of China for those inclined to do so.

Chinese_freedom_support_California_real_estate1Chinese investors buy a significant number of homes in Irvine. Anecdotally, 80% of sales in some new home communities are sold to Chinese Nationals. In fact, Irvine homebuilders depend on Chinese buyers to purchase their overpriced houses, which becomes a problem when this flow of money dries up.

The only realistic scenario where aggressive sellers enter the market and push house prices lower is if Chinese Nationals reverse the flow of money by liquidating their US holdings to cover financial obligations back home. To really precipitate a crash, many Chinese Nationals would need to be compelled to sell at the same time, requiring either an economic catastrophe in China (a possibility given their real estate bubble) or a change in government policy.

Chinese Nationals who own real estate often pay all-cash because they lack the credit history or proof of income to obtain a loan — and because many of them have the money, and they need a safe place to store that money. Cash buyers like Chinese Nationals are typically the most stable homeowners because they can never be compelled to sell at auction because they failed to pay a mortgage. However, that doesn’t mean cash buyers may not need to sell for other reasons, and if the Chinese government demands repatriation of the money that technically left the country illegally (they knew it was going on but ignored it), that one policy change could flatten the US housing market with special devastation laid upon Coastal California.

For years, Chinese could export cash by setting up dummy foreign corporations that import goods into China. The dummy corporation sends a bill to the Chinese mainland for goods that are never shipped (or grossly overpriced), and the money is used by this dummy corporation to buy real estate, often in the US, and often in Irvine, California. The money leaves China through an export sham, but it leaves all the same.

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China has experienced sub-par growth of late, and the Chinese leadership may identify the outflow of Chinese capital as one of the culprits. If they decide capital outflows are an enemy of the State, they will do everything in their power to stop it. Think about that: the Coastal California housing market could be radically altered by decisions made by Chinese government officials.

A policy change that cracked down on this flow of capital wouldn’t be a minor headwind, it would be a hurricane force blast that would flatten house prices here — and don’t think for a moment that the Chinese government would be patient with sellers who want to get top dollar. If they say “bring the money home (or else)”, those houses would flood the market, prices would crater, and nobody in our government or the banking cartel could do anything about it.

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There is a middle path the Chinese government will likely follow. Allowing unrestricted expatriation of money is one extreme, and demanding repatriation of money is the other. In the middle, the Chinese Government and Central bank can slowly allow the Yuan to depreciate versus the dollar, making US real estate more expensive and slowly choking off the flow of capital. This is less shocking to both financial systems, so it’s the course of action the Chinese are mostly likely to follow.

End of an era as China’s love affair with U.S. real estate fades

Lillian Chen, Jacob Gu, Updated 9:28 am, Friday, August 5, 2016nouveau-riche-university

(Bloomberg) — For David Wong, the business of selling homes isn’t as good this year as it was in 2015, and he’s blaming that on a decline in customers from China.

The residential-property market here, especially for those priced between $2.5 million to $3 million, has been affected by China’s measures to control capital flight,” said the New York City-based Keller Williams Realty Landmark broker. “You need to cut the price, or it may take a real long time.” …

Total sales to Chinese buyers in the 12 months through March fell for the first time since 2011, to $27.3 billion from $28.6 billion a year earlier, according to an annual research report released by the National Association of Realtors. The number of properties purchased by Chinese also declined to 29,195 units from 34,327 units.

While the total international sales saw its first decline in three years, the 1.25 percent pace is slower than 4.5 percent recorded for Chinese buying. In terms of U.S. dollar value, the total share of Chinese buying of international sales dropped from 27.5% to 26.7%.

Why is the flow of international capital slowing down? US real estate is pricey, and when you factor in an appreciating US dollar, foreign nationals are slowly but surely getting priced out of the market.

Capital Controls

The yuan began plummeting in August, driving the Chinese currency to a five-year low versus the U.S. dollar. The Chinese authorities have been compelled to increasingly tighten the noose on cross-border capital flows to defend the yuan and to slow down the burnout of the nation’s foreign-exchange reserves since then. This includes increasing scrutiny of transfers overseas, to closely check whether individuals send money abroad by breaking up foreign-currency purchases into smaller transactions.

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New measures were also introduced in December to crack down on illegal China UnionPay Co. card machines, which were suspected of being used to channel funds offshore via fake transactions. Meanwhile, illegal foreign-exchange transactions from underground banking were brought to regulators’ attention, as China busted the nation’s biggest underground bank, which handled $62 billion, according to a November report by the official People’s Daily.

China’s efforts, coupled with restrictions on companies’ foreign exchange business as well as curbing the offshore yuan liquidity to make currency shorting costlier, finally managed to work: China’s foreign reserve outflow has been mostly contained after climbing to a peak of $108 billion in December. The reserve resumed an increase in March and April.

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“Many Chinese buyers are paying all cash in the U.S. because they neither have a credit history nor income proof here, making it impossible for them to obtain mortgages from banks,” Wong said.

Seventy-one percent of Chinese buyers in the U.S. real estate market paid completely with cash, the Realtors group said in its report. One-fifth secured mortgages from banks operating in the U.S. In comparison, only 7 percent of Indians paid all in cash, while 90 percent had financing from U.S. banks.

The returns on US real estate have never been very good, and with prices so high relative to rent, capitalization rates are as low as they’ve ever been. Yet Chinese investors increased their holdings in the US substantially over the last 20 years. The devaluation makes those investments perform better for a Chinese National than a US citizen. When the US dollar increases in buying power relative to the Yuan, those that own US real estate benefit from the currency move.

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I exchanged emails recently with a reader who sent me an article on a huge sale of blue-chip commercial properties to a Chinese company for an insane valuation. For the US company selling the properties, it was a no-brainer because they obtained a 20%-30% premium on the deal, but I couldn’t understand why the Chinese company would pay so much until I considered the impact of devaluation.

Devaluation

A slowing economy and the weaker yuan also played significant roles in suppressing the Chinese demand, said Yun.

The median price of existing-home sales in the United States increased by 6 percent in March 2016 from one year ago, but when measured in the Chinese currency, they were 10% more expensive, Yun estimated. They were costlier when it comes to California and New York, major destinations favored by the Chinese buyers, he said.

The Chinese currency depreciated 4 percent during the reporting period of the Realtor group’s research. The onshore yuan fell 2.92 percent against the U.S. dollar in the three months ended June 30, the biggest quarterly drop since 1994. The CFETS RMB Index fell to an all-time low of 94.25 on July 8, before rebounding slightly.

China’s economy expanded 6.9 percent in 2015, with 22 of the mainland’s 31 provinces decelerating from a year earlier as the nation’s growth slowed to the weakest pace in 25 years.

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Earlier this year I asked Will the slowdown in China hurt Irvine real estate? While the indices show no measurable effect, the conditions are in place for the slowdown of foreign money to accelerate.

“The increase of average price and median price indicate that those really wealthy people are still able to get their money out in some way,” Yun said. “Maybe they can bypass the capital control measures.”

Please note Lawrence Yun encouraging Chinese Nationals to break the law.

“The Chinese buying profile is very unique and different from many other international buyers,” Yun said. “For example, the buying activities from Europe are more related to their financial capabilities — if the dollar strengthens, then fewer European buyers are expected. But the Chinese view is that U.S. property buying is more than investment, but some kind of safe-haven– it is a much safer diversification than just keeping everything in China.”

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The people who deny a real estate bubble in China are wrong, and the deflating Chinese property bubble could destabilize the world economy, but of greater interest to owners of Coastal California real estate, the deflating Chinese housing bubble could turn local real estate buyers into desperate sellers.

Both homebuilders and real estate agents delude themselves with notions about the desirability of Coastal California to convince themselves the influx of Chinese money is based on sustainable fundamental factors. In reality, this is hot money escaping a collapsing market, subject to the policy whims of an unpredictable totalitarian government. Chinese capital is an unstable source of investment, and it could reverse course in a moment based on policy changes in China.

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