Will Australian property markets be affected by China’s slowing economic growth?

We know that China’s economic growth singlehandedly saved Australia from the recession many other countries experienced after the Global Financial Crisis of 2008-9.

China’s requirement for our mineral exports saved our bacon and led to a number of years of prosperity.

Today, even though the mining boom is over, Chinese money is still flowing into Australia in a number of other ways including growing numbers of Chinese tourists, students, settlers and an increased bi-lateral trade relationship.

While there are economic pros and cons to the recently signed  free trade agreement with China, today I’d like to explore how Chinese capital has affected our property markets and it’s likely effect in the future in light of the current Chinese stock market slump.

What happened to the Chinese stock market?

In case you missed it, while many of the headlines were focused on Greece’s economy over the last few weeks, another financial crisis has been competing for the world’s attention – shares on China’s stock markets have nosedived, prompting fears of the biggest financial disaster since the 1929 Wall Street crash.

After a spectacular bubble, at its worst more than $3.2 trillion was wiped out in the value of the Chinese stock market, an amount more than 10 times the size of the entire Greek economy.

Now just to make things clear… China is no longer a communist country. It’s a capitalist country with a totalitarian government and it’s now learning about speculation and market cycles.

By the way: share prices on the Chinese stock market are not as closely linked to fundamentals as they are here.  Unlike other countries, in China, 80% of the stocks are owned by individuals – in reality 90 million retail investors are speculating with their newfound capitalistic freedom.

It’s really the same as all those Chinese individuals and companies who speculated heavily in overseas property.

So to help put things into perspective, let’s first look at how Chinese money has affected the property markets in Australia and then I’ll give some thoughts about the future.

Chinese investment into commercial real estate is rising

We read a lot about foreigners buying all those poorly built, high rise, off-the-plan inner city apartments but there’s much more to it than that.

Chinese capital flows to global real estate surged from $US1 billion in 2010 to $US10 billion in 2014, and Australia has punched over its weight attracting over 15% of this investment in 2014 and over one-quarter of the $US4 billion invested in the first quarter of 2015, with much of that capital flowing into the commercial property sector in Sydney and Melbourne, according to a ViewPoint report from CBRE.

Inner city development sites are a major destination for this Chinese capital.

In the period from January 1, 2014 to March 31, 2015 Chinese direct investors were the second largest purchasers of commercial property in Australia, after Singapore and ahead of the US. Chinese investors accounted for one-third – or $3 billion – of the $9 billion in foreign capital invested in commercial property assets nationally, with that momentum continuing to build.

CBRE’s head of research, Australian, Stephen McNabb commented:

“Flows from China into global markets are expected to remain firm, with potential upside, as regulatory changes over the past three years have allowed a higher investment allocation into real estate for life insurers, rising from 10 per cent to 30 per cent, and offshore investment to a limit of 15 per cent across all asset classes,”

He added that domestic economic and residential market risks in China had led investors and developers to diversify interests offshore into relatively safer markets. Also…

Permanent migration is rising

There are around 450,000 Chinese born residents in Australia, still just 2% of the population, although the number has doubled in the last decade with China now the second largest source of migrants after India.

And those who can’t move here send their children here to study…

Foreign student numbers are growing again

Education is Australia’s third largest export and fourth-largest to China after commodity exports. Chinese higher education students represent close to 35% of higher education students in Australia.

The number grew rapidly until 2009 when the higher Australian dollar saw the rate of growth of international student numbers taper. This has now increased again with the fall of the Australian dollar.

In fact, there are currently over 50,000 visas granted to Chinese students every year.

While Sydney attracts the largest number of Chinese students, Melbourne has significantly closed the gap in the last decade, with 40 to 45% of enrolments in Victoria’s key universities being foreign students, many of them renting in those huge CBD apartment blocks that have been built over the last few years.

China is now our second largest source of tourism.

And we’ve become the playground of the new middle class in China with the number of Chinese tourists having more than doubled since 2006, last year totalling over 700,000.

What’s ahead for China’s economy?

I’ve been following the Chinese economy carefully for a number of years, as it is so closely linked with Australia’s prosperity and our property markets.

For as long as I can remember, commentators have been calling for a Chinese hard landing. And for as long as I remember, they have been wrong.

China’s economy has been growing strongly for the last few decades, with hundreds of millions of people moving from the country to their new big cities, causing an economic and property boom the likes of which we just can’t comprehend here in Australia.

However, in the last few years China’s economic growth has slowed from double digits to 7% or so as it slowly and painfully transitions from a manufacturing-led economy to a consumption-led economy.

The impact of this is likely to affect the world’s markets and of course Australia, whose economy has been so dependent on China buying our exports, will feel the pinch.

China is learning a little about how capitalist markets work – with a property boom leading to a slump last year and then the stock market boom leading to this year’s crash.

In China the property sector directly accounts for 15% of its growth in GDP, and significantly more if raw materials are included. At the same time, property is estimated to be collateral for around half of all banks’ lending.

Overbuilding during its property boom left China’s developers with mounting piles of unsold property, causing the government to cut interest rates to try and stimulate the market.

However, the result was rather than encouraging the locals to invest more in real estate, many speculated in the stock market with borrowed funds.

While the precise nature of China’s future economic structure is uncertain, what is clear is the scope for China to keep growing by investing 25% of its national income in housing and infrastructure is virtually exhausted.

Having said that, China is unlikely to be on the brink of a bust. And while China’s growth has slowed from last decade, it’s still consuming record quantities of Australian commodities.

So what’s ahead for us?

I can foresee a period of uncertainty and lower world and local economic growth in the coming year.

This is likely to translate into a lower dollar, a drop in our experts and even the slight possibility of a recession in Australia.

This all means a longer period of low interest rates in Australia and the likelihood of another rate drop before they eventually rise in 2017.

While in the long term I see a flight to the security of Australian property, in the short term it’s possible that segments of our property markets may stumble.

For example, some of the Chinese investors who bought off-the-plan properties in Australia but are yet to settle may not be able to complete purchases, as it’s reasonable to expect that many of these property investors are also playing the stock markets.

This risk is potentially devastating to those property developers who find themselves in the situation where overseas buyers refuse to or are unable to settle. Imagine trying to chase them overseas for the balance of their money.

Another risk is that those Chinese developers who bought the large CBD development sites may have difficulty obtaining Chinese funding for their projects

However, as I said, in the long term, unless the government restricts overseas buying, I see the lessons the new wave of Chinese investors recently learned will encourage them to move their money to the safe haven of Australian property.

So what sort of property should an investor buy?

Let me start by saying that as an investor you should be looking for properties that are strong (will increase in value at above average capital growth) and stable (should not fluctuate in value much if we hit some economic turbulence.)

This means you should avoid:

• CBD and off the plan apartments
• Regional markets – they’re likely to suffer more than the big smoke.
• Mining towns – but that’s nothing new.
• Blue collar suburbs – unemployment may rise a bit more and these areas could suffer.
• First home buyer areas – these regions are already having affordability issues.
• The prestige end of the market – this end of market suffers when the business sector suffers.

On the other hand there will still be good investment opportunities in the inner and middle ring suburbs of our three big east coast capital cities.

In particular, I’d be looking to buy properties in areas where people’s disposable income is high and increasing above average. In general this will be because people are working in the services industries. Despite what’s happening overseas there will always be people getting married, having babies, divorcing and needing accommodation.

In fact, there is nothing new about me recommending investing in these markets. They are not sexy, nor the latest hotspot, but have stood the test of time through multiple property cycles.

Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property. Subscribe to his Property Update blog.