In a recent piece, I described the evolution of investment opportunities in the U.S.: real estate, savings accounts, stocks/bonds/mutual funds, pensions, insurance, and on to ETFs, hedge and private equity funds. What will happen in China? Will investment opportunities follow the same pattern or in some other? And are there going to be special vehicles developed in China?
I put these questions to Gregory Wang. Gregory has worked as an investment banker in both the U.S. and China. After going to college in the U.S., he took assignments in both The Philippines and China. He then got an MBA from Columbia and returned to China as an investment banker. He is now the CEO of Newstar Investment, a family office representing Chinese investors that make investments in China and the U.S.
My questions/comments will be identified by EM and Gregory's by GW.
EM: You have seen my characterization of how financial markets evolved in the West. Does it square with your sense of how they have evolved? And do you see the same pattern occurring in China, i.e., real estate, savings accounts, stocks/bonds/ mutual funds, pensions, insurance, ETFs…?
GW: Yes, I think financial markets globally will follow the U.S. pattern, and China is no different in that sense. Stock markets are relatively new in China. Short sales are being contemplated and may soon be permitted, while new investment vehicles, like ETFs, are likely to follow. In real estate, the government is working to implement a property tax similar to what is done in the U.S. All of these new products/policies will be introduced in a manner tailored to China's domestic market conditions and all will take time to implement.
EM: The Chinese household savings rate is very high, but my sense is that most people in China hold on to cash, put some in banks, and speculate primarily in real estate. To date, there has been very little penetration by stock brokers and other salesmen for stocks, bonds, mutual funds, etc. Am I right, and how do you see things developing over the next few years?
GW: The savings rate is very high and people do hold onto cash in the form of bank deposits. There are many reasons for this culturally. But also, what other choice do they have? The U.S. financial markets have a plethora of products for investors. You can buy any sector, any risk profile, any liquidity, any hedge and spend $1 or $1 million. The options are endless. This is not the case in China. You can buy stocks or you can buy real estate. If you are a larger investor, you can buy fixed income products from a trust company or maybe invest in private equity. That's about it. This will change slowly as China liberalizes the financial sector as more product and institutions evolve and more choices are offered as regulations allow. Another aspect to take note of is the evolution of the Chinese investor. As China continues to grow, this investor now has more capital and a greater ability to understand financial investments (risk/reward).
EM: Do Chinese banks do much securitizing and selling off of their loans?
GW: Yes, but not so much to the public markets or to market investors. My understanding is that most of this business is done amongst banks and state companies. Banks are also state companies, so I think you get the picture.
EM: As you know, U.S. banks almost collapsed when the market for mortgage-backed real estate collapsed. European banks ran into the same problem when the market for Greek and other sovereign debt weakened. Certainly the Chinese banks have bad loans. Could something as severe as what happened in the U.S. and Europe happen to Chinese banks or would the government keep it from happening?
GW: I don't think Chinese banks are in any imminent danger of collapsing. Chinese banks are state companies, so China will not allow any of them to become insolvent. The government is already the back-stop on insolvency.
EM: Real estate: I was in Shanghai about 10 years back when the real estate market was going straight up. How have things evolved since then? I can imagine that while growth has cooled in Shanghai, there are a number of other large Chinese cities where real estate is booming. Am I right? And if so, where is the growth most striking. One other question: Real estate cycles have been occurring for centuries and globally they are at or near the bottom. That, coupled with a growing global population should mean real estate should be a good investment for the next decade. Do you agree?
GW: Elliott, I can write a 10 pager on this one. Since my firm's principal business is residential real estate, we are very close to this market. For the last 20 years, residential real estate has been booming. More than two years ago, the government implemented some very restrictive policies to cap real estate growth and price appreciation (i.e. limits on real estate purchases, down payment increases, loan restrictions, etc.). This impacted the market significantly and we saw frequent articles in the press about a real estate bubble burst. While this impact was felt across the country, real estate is a local market business and second and third tier markets were not as impacted as significantly as tier one cities like Shanghai, Beijing and especially Shenzhen. (This is also due to the fact that tier two markets were not as over-built as tier one.) Fast forward to today, those restrictive policies are still in place. However, the market has stabilized in terms of pricing and sales. What we are seeing is that the industry is restructuring itself - that is, the smaller, speculative developers are being forced out of the business while larger developers are investing for the future through land acquisitions. Design and location (residential) are becoming even more important as people buy property to live in rather than as speculative investments.
This is an exciting time to be in the real estate business and we believe it remains one of the best investments in China. It is what I call a "backbone industry" in China supported by two key trends which no policies can contain. The first is a real natural demand for housing as China's industrialization and urbanization continue (It is worthy to note that none of those restrictive policies implemented by the government target first time home buyers). The second is a significant reliance on real estate to generate revenues for local governments through land sales. We don't see this economic structure changing any time soon despite the currently contemplated real estate tax. If you consider these two simple social and economic factors alone, you can see that real estate in China will continue to be supported by the government and grow in the foreseeable future.
EM: Two questions:
- Will your firm develop investment vehicles for Westerners to invest in Chinese real estate?
- Will your firm develop investment vehicles for Chinese clients to invest in U.S. real estate?
GW: We are trying to do both. It is harder for us to develop vehicles for Western investors to invest in Chinese real estate due to Chinese regulations. The real estate restrictions mentioned above now make it very difficult for foreigners to invest in residential or commercial real estate without approval from the government and these approvals are difficult to obtain. Furthermore, foreign exchange and remittance of capital is another hurdle that must be cleared. Any conversion of RMB into a foreign currency must be approved by the State Administration of Foreign Exchange (SAFE). Many foreign private equity real estate funds are now considering forming RMB funds for Chinese real estate investments. Some are targeting industrial real estate such as logistics. Probably the best way for individual investors to get into Chinese real estate companies is via public real estate companies listed on the Hong Kong exchange.
For Chinese clients to invest in U.S. real estate, the primary obstacle is currency conversion, also regulated in China (i.e. no more than $50,000 per individual per year). However, for clients who already have funds outside of China, my family office provides investment opportunities in the U.S. market. For example, we are currently investing in a boutique condo development in Boston, which will generate some strong yields for our clients.
EM: I recently did a piece looking at U.S. and China futures. So I want to ask you a few questions about your view of China 10 years from now. Here is what I see: China is a resource-poor country. Its rapid growth in the last 30 years was generated by exporting goods (with significant import content) to the West. Looking ahead, I see an emerging middle class that wants the goods that Western middle classes already have. And this includes autos. At the same time, China, unlike Russia and the US, is running out of coal. Putting this all together, I see China going from a huge trade surplus to a deficit.
GW: I am not an economist. But from what I have experienced on the ground, I don't believe China will trend into a trade deficit scenario. Furthermore, I do not believe there will be a doomsday scenario of sharply lower growth followed by major implosions within China. I do think that China's growth will slow over the next decade to less than 7%. And China does indeed have many structural problems. There are significant deficiencies in the financial system and a huge underground economy that is difficult to control. I also see a serious future problem caused by the country's unsustainable pension and healthcare programs. However, I am confident the Chinese government will be able to manage the micro and macro challenges it will face in the future.
I believe that over the next ten years, China will be able to live with lower growth as it seeks greater stability. Policies will be fine tuned to achieve this balance all with the intent of buying enough time to work out structural reforms and introduce market mechanisms.
EM: Gregory believes there are great real estate investment opportunities in the second/third tier cities of China, and I see a meaningful recovery finally occurring in the U.S. What should a Western investor do?
China: Gregory suggests investing in publicly traded Honk Kong real estate companies. Another alternative is to invest in Guggenheim China Real Estate (TAO). 80+% of this ETF "indexes" on Hong Kong real estate companies. And at least some of their investments will be in second and third tier Chinese cities.
U.S.: When Peter Lynch was running the Magellan Fund at Fidelity, he would buy "an industry." Individual investors must be more selective. I favor high-yield U.S. real estate investments (the dysfunctional U.S. government could still imperil the U.S. recovery so I at least want a good yield). ETFs worth considering include: KBW Premium Yield Equity REIT Portfolio (KBWY), Market Vector Mortgage REIT Income ETF (MORT), FTSE NAREIT Mortgage REITs Index Fund (REM), and IQ US Real Estate Small Cap ETF (ROOF).
For some time, I have been holding Fidelity Real Estate Income (FRIFX) and Brookfield Asset Management (BAM) as real estate plays.
I am not an investment adviser and nothing I say should be taken as a recommendation to buy or sell an asset.