How ‘hot’ Chinese money is fuelling our property bubble
Lately, we’ve seen an increasing number of media articles about how Chinese ‘investors’ are snapping up our real estate assets – and, in so doing, pushing prices beyond the reach of many Australians. How do they do it? Here’s the answer, direct from the South China Morning Post…
You can read the complete article here.
Here’s an excerpt.
Let us use the numbers of HNA’s HK$8.8 billion winning bid for its first Kai Tak land plot as a hypothetical illustration of the leverage game.
Step one: Pledge a mainland asset with a mainland bank for a standby letter of credit (SBLC) which is a promise by the bank to pay. Use the SBLC to get a HK$8.8 billion loan in Hong Kong. Since it’s a deal to pay off a piece of land publicly auctioned by the Hong Kong government, approval from the mainland regulators will be easy.
Step two: Pledge the Kai Tak land with the banks in Hong Kong. Many may find the bid – 70 per cent above market estimate – rather risky. Yet, it won’t be too difficult to find banks to provide a HK$3 billion loan which is only 40 per cent of the land cost.
Step three: Pledge the HK$3 billion cash with a bank in Hong Kong for a SBLC.
Step four: Use the second SBLC as security at a mainland financial institution to purchase debentures and bonds with annual returns of over 6 per cent or above.
Step five: Pledge the HK$3 billion worth of debentures with mainland banks for another SBLC. Given a routine discount of 30 per cent for financial products, the bank will issue a promise to pay HK$2 billion.
Step six: Use the third SBLC as collateral and get a HK$2 billion loan in Hong Kong. Repeat step three to five and so on so forth.
These steps may sound a bit complicated. But in many cases, these steps are all done among the mainland and Hong Kong branches of the same bank, though occasionally several banks are involved to dodge regulatory hurdles.
The result is swift creation of capital. In the first round the result is HK$8 billion, which is comprised of HK$3 billion land loan, HK$3 billion worth debentures and a HK$2 billion loan. The second round result is HK$6.4 billion, while the third round leads to an additional HK$3.8 billion. Ultimately, the tally can be as high as HK$25 billion.
This collaboration of the capital markets on the mainland and in Hong Kong also satisfy another wish of many mainland companies nowadays – moving money out from the country. In our hypothetical case, the outflows amount to HK$14 billion.
It may sound outrageous. Yet the formula illustrated makes use of conservative ratios only. The money “created” can be poured on hotel chains in Europe, office towers in the United States, golf courses in Japan or to acquire controlling stakes in listed companies. Therefore, it won’t hurt to overpay as long as the new assets will keep the ball rolling.
Neither does it really matter that a plot of land next to you is sold cheaper than what you paid. Since the land loan is only 40 per cent of the valuation, there is sufficient cushion to keep the banks happy. You also have lots of money to pay off the unhappy ones.
The only thing that matters here is whether you have the connections and know how to get the money in and out of China.
Despite Beijing’s pledge to tighten its grip on currency outflows, things remain fairly relaxed for HNA and many others so far. The companies regularly transfer multiple billions of dollars worth of yuan across the border. We are talking about daily, not weekly or monthly here.”
And that’s why Chinese property ‘investors’ can seemingly pay any price for that house in your street.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Victor
:
Hi Roger, was listening to some of your comments on Nightlife the other night. I’m the so -called average first home buyer (2+ br, small backyard/courtyard, 5-10kms from the city) and what particularly resonated with me were 2 points. Firstly, your point on financial stress and that being the catalyst for discounting, be it from an oversupply of apartments or due to ppl who are too highly leveraged with rates going up. The other relating to the question of whether or not ppl are willing to switch to buying to a discounted apartment instead of a detached dwelling, inevitably creating a cascading ‘discounting’ effect that would affect the market as a whole. If either 1 of the above does not happen and people plain and simply do not choose the ‘apartment life’ how do you see this scenario affecting market dynamics?
Roger Montgomery
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Buyer willingness to drive prices higher is still impacted when (if) one part of the market is collapsing.
Chris
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With all this money entering not only our, but other property markets around the world (and thus, bumping up prices), it is only a matter of time before it precipitates a crash.
Not because of the sheer weight of money entering it – markets don’t necessarily crash because they’re expensive, but because of some other event that causes the exuberance in it to shatter.
What do I think ? Obviously the Mainland Government are not that fussed about money being repatriated, otherwise they would try harder to stop it (most likely the ones who are moving money are those who in the position to do so, are high up and/or well-connected enough, hence, they have a conflict of interest).
I already own property (not apartments) and not in the Eastern States, so I don’t particularly care if it booms or busts, but my thinking is that there will be a crisis of confidence somewhere; with several European elections coming up this year, that is fertile ground for it if the Far Right gain traction (or if there is an ill-conceived directive from President Trump)…or there will be some sort of repeat of the sub-prime crisis but this time, it will involve the questionable credit worthiness of overseas buyers.
When it comes to settlement, they somehow won’t be able to make it due to falling property values against which their deposit was backed (because of currency fluctuations or some other event) or Government limitations on what they can repatriate. People won’t be able to settle and there will be a lot of pain involved.
All in all, I can’t see how it will happen, I just see that it is not going to end well.
And good luck trying to chase these people for monies owed. Once they leave Australia, it is very difficult, particularly in a place such as China (which probably would not share that information too readily if it meant penalties against one of their own citizens…as far as they would be concerned, the offence did not take place on Chinese soil, therefore, likely to be no case to answer).
There’s a lot of land and a lot of people to hide amongst over there.
Steven
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Thanks Roger, my only question would be, is this sustainable ?
Roger Montgomery
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Clearly not. and as the Herb Stein once observed “if something can’t go on forever, it must stop.”
Joe Rich
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Amazing article Roger, thanks for sharing.
A few quick questions:
I’ve only heard of SLBCs being used in commercial transactions – never as a promise to pay off a property loan. I would imagine that for an SBLC to cover a liability of $8.8b, the initial value of the land first pledged in Step 1 would need to be significantly higher, is that right?
Secondly, and I guess more importantly, how is all the debt created serviced from a cash flow point of view? I’m guessing that developers are using the additional ‘capital’ created –> i.e. new debt to service the old, all the while betting that land values will increase and they can profitably exit/wind down their positions in the future.
Sounds very pyramid schemey to me…
Roger Montgomery
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House of Cards is exactly what I had in mind when I read it.
Fred
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Is this type of process being used to procure funds to purchase typical residential home purchases in, say, Sydney, or only for larger developments?
Roger Montgomery
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I’d haxxard a guess we are talking much larger development sites…nevertheless…
jimbo james
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Yet Australian authorities keep turning a blind eye to it as many of these purchases of established properties are illegal. A Government review spearheaded by Kelly O’Dwyer fizzled and failed to reach it’s stated objective of quantifying the scale of the purchases being made. Joe Hockey offered her a promotion presumably to placate her concerns. We still don’t have any actual data on the number of properties purchased, particularly by the Chinese using loopholes as such.
The number of Chinese registered private jets arriving in Tasmania these days suggests Bass Strait will need to be renamed the South China Sea within a decade.
Roger Montgomery
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I have read Kelly O’Dwyer’s squeaking on the issue may have been teh reason for her ‘promotion’/redirection.
jimbo james
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Yes Roger and to think these guys are our supposed leaders. Is this Australia or some corrupt third world African or Asian country we’re talking about?