Posted on February 10, 2017

China’s Global Homebuyers Could Be Suddenly Cash Poor

Property prices around the world have benefited from the demand of foreign buyers, a.k.a. China’s capital outflows. China has issued unexpected rules on exchanging yuan for international currency. This could impact real estate around the world. Some argue it already has.

China’s Clamp Down on Outflows

As capital flight intensified, China’s reserves have plunged, causing the country to sell US treasury bonds. In response, China has introduced new rules, which now require disclosure of the intended use of the yuan being converted. In addition, they must pledge the money won’t be used for the purchase of property, securities, or insurance products. Borrowing or lending on behalf of others is now prohibited, and requires a legal declaration saying you have not done so. Anyone caught breaking the rules will be denied the conversion and lose exchange rights for two years. They can also be subject to an anti-money laundering investigation.

China’s currency is not freely convertible on the open market. In order for yuan to be used internationally, the People’s Bank of China purchases foreign currency and provides liquidity for yuan holders. The government restrictions already exist–each Chinese citizen can trade up to US$50,000 per year, and only that much can leave the country. This rule has not forestalled huge outflows.

Despite the rule, one measure of capital outflow from the State Administration of Foreign Exchange (SAFE) shows approximately US$1 trillion dollars worth of yuan were removed from the foreign exchange reserves from the 2014 peak to November 2016. To put that in perspective, this outflow is larger than the entire gross national product of Canada in 2016.

Much of this money found its way into global real estate markets causing prices to boom. Property prices surged in some parts of Canada, the US, the UK, New Zealand and Australia, all countries that had relatively low barriers to importing large volumes of capital and liquid currencies.

Some analysts believe that the party might be over. However, China has a massive underground banking market that operates in the shadows. In August 2016, the Chinese government shut down one operation in Shenzhen, but no one knows just how many more such shadow banks there are.

Also, some Chinese people purchased homes via a process called smurfing–where large amounts of money are broken down into small undetectable amounts. Homes are an easy way to reassemble the money into a single house-shaped bank account. However, you need to sell the home to retrieve the money.

Many people that do this are just looking for a way to hedge against any devaluation their hard-earned money might experience as a result of a major currency change. It does present a problem for domestic investors though. If a large number of people smurfing require their money soon, they’ll have to sell. This will provide downward pressure on house prices.

There is anecdotal evidence that tighter restrictions on capital outflows from China is having an impact. According to Bloomberg News, “China’s escalating crackdown on capital outflows is sending shudders through property markets around the world. … In Silicon Valley, Keller Williams Realty says inquiries from China have slumped since the start of the year. And in Sydney, developers are facing “big problems” as Chinese buyers pull back, according to consultancy firm Basis Point.”

“Everything changed’’ as it became more difficult to send money offshore,” said Coco Tan, a broker associate at Keller Williams in Cupertino, California. Bloomberg further reports that “In London, Chinese citizens who clamored to purchase flats at the city’s tallest apartment tower three months ago are now struggling to transfer their down payments.”

We have seen a slowdown in high-end purchases in Vancouver since the August imposition of a 15% land transfer tax on nonresident foreigners. While home sales were slowing even before the tax, it might just be that some of that slowdown was the result of China’s efforts to stem the outflow of capital.

“While no one expects Chinese demand to disappear anytime soon, the clampdown is deterring first-time buyers who lack offshore assets and the expertise to skirt tighter capital controls.”
Dr. Sherry Cooper