A New Daisy Chain? U.S., Europe, China

Includes: FXE, UDN, UUP
by: Marc Chandler


Chinese firms investing in US commercial real estate.

US private equity and hedge funds buying distressed European assets.

The US continues to recycle global savings.

In many discussions about capital flows, mutual fund and ETF activity is emphasized. Sometimes, the speculative positioning in the futures markets is discussed. Occasionally, Japan's weekly portfolio flow data is incorporated into analyses.

There are, of course, other flows, many of which are harder to track. They are what we want to discuss here. In particular, what has captured our attention are reports of Chinese investors buying US commercial real estate and US investors buying distressed assets in Europe.

According to Real Capital Analytics, Chinese businesses invested $3 bln in US commercial real estate last year, a 10-fold increase from the 2012. This does not include the Atlantic Yards project in Brooklyn, New York. It is reportedly a $5 bln development project, for which a Chinese company (Greenland Holding Group) has a 70% stake.

Another Chinese developer, China Vanke, is working with a NY-based developer building a 61-storey luxury condo in midtown. New York City appears to be the favorite destination for Chinese developers, but it is not the only city that has drawn their interest. San Francisco and Los Angeles are also seeing stronger Chinese interest.

There are both supply and demand considerations. As part of its reforms, China has eased rules on foreign direct investment. US developers seem happy, if not eager to share the risk or cash-out. Greenland Holdings, for example, has reportedly become one of the largest investors in US real estate. The Metropolis project, acquired from the California State Teachers' Retirement System, is a 275, 450 square foot development that is expected to be completed in five years.

The other, arguably under-reported flow is the US-based hedge funds and private equity funds buying distressed assets in Europe. We had noted that the turn in the euro area PMIs last summer and the reduced risk that Spain would lose its investment-grade status when Moody's raised its outlook to stable from negative marked an important turn in investor sentiment.

At the turn of the cycle, a few large hedge funds publicized their purchases of what were perceived to be among the most distressed assets, Greek property, banks and bonds. Many real (as in not leveraged) asset managers could not do this, as they were limited to the investment-grade universe. Their choice, apparently, was Spanish and Italian bonds and stocks.

There has been a shift in the supply too, as European banks, under the increased scrutiny of regulators (see Asset Quality Review and Stress Tests), have become more willing to part with the "toxic assets." In addition, the recovery of some prices of the assets may also encourage some selling. At the same time, the decline in US bankruptcies (commercial failures fell by roughly a quarter last year) reduces the supply of domestic distressed assets.

A recent report by PwC estimated that last year, European banks had about 1 trillion euros of nonperforming loans on their balance sheets. This is roughly twice the amount that they had before the crisis. Last year, PwC said European banks sold about 64 bln euros of the nonperforming loans to investors This was roughly a 40% increase over 2011.

In some ways, these two narratives--Chinese buying US commercial real estate and US private equity firms and hedge funds buying distressed assets in Europe--illustrate the US role in international finance. It absorbs some of the world's surplus savings, and recycles it by purchasing foreign assets. The US consistently earns more on its foreign assets than it pays to foreign investors for their US holdings. This is tracked by the consistent surplus the US records on the investment income balance (part of the current account), even though foreign investors own about $4.5 trillion more US assets than US investors own of foreign assets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.