China's $300 billion sovereign-wealth fund is eyeing big investments in distressed U.S. real estate, according to people familiar with the matter. To finance some of the deals, China may rely on an old trading partner: the U.S. government.
In recent weeks, officials from China Investment Corp. have held talks with U.S. private-equity fund managers, including BlackRock Inc., Invesco Ltd. and Lone Star Funds, about potential investments in beaten-down property assets, namely mortgage securities backed by office buildings, hotels, strip malls and other commercial property. CIC also is considering buying ownership interests in buildings, according to the people with knowledge of the matter.
In addition, CIC is weighing investing through one of the U.S. government's bailout programs, the Treasury's Public-Private Investment Program, known as PPIP. The program is designed to rid banks of toxic mortgage securities by enticing investors to buy these assets with financing from the U.S. government.
Representatives for CIC, BlackRock, Invesco and Lone Star declined to comment.
The discussions come at a time when CIC, which had nearly $300 billion in assets at the end of last year, is moving to deploy its capital after a relatively idle 2008. Property markets world-wide have plunged since the credit-market crisis that started in mid-2007, creating opportunities for cash-rich buyers. In the U.S., commercial property values already have dropped 35% from the peak.
Last year, CIC deployed just $4.8 billion in global financial markets. This year it invested that much in a single month, CIC Chairman Lou Jiwei said last month. He said that if CIC's future returns are good enough, it might ask the government to let it invest more of China's foreign-exchange reserves, which now total $2.132 trillion.
It is unclear how much CIC intends to allocate to U.S. real estate. But in order to achieve any meaningful diversification in its portfolio, the fund would need to set aside between $4 billion and $10 billion to global property investments in the next year and a half, estimates Michael McCormack, an executive director at Z-Ben Advisors, a consulting firm in Shanghai. By 2014, he projects that CIC's U.S. property investments alone could amount to more than $20 billion.
The U.S. property market is appealing to the Chinese partly because of the financing being offered through the PPIP program.
Under the program, the Treasury will co-invest with funds that buy toxic mortgages that have been clogging banks' balance sheets. The U.S. government, through the Treasury and the Federal Reserve, also will make financing available to the ventures. In other words, CIC and the Treasury would be partners in borrowing money from the U.S. government to buy troubled mortgages.
The Treasury, which plans to allocate as much as $30 billion to PPIP, has designated nine fund managers, including BlackRock and Invesco, to raise at least $500 million of private capital each by the end of September. The Treasury then will provide equity capital up to 100% of the private capital raised by the fund managers. The fund-raising efforts are off to a relatively slow start, as many investors remain wary of the red tape associated with investing in a government-sponsored program.
The possibility of a sovereign-wealth fund investing through PPIP was envisioned in the program's design. It limits investments by any single investor to no more than 9.9% of each PPIP fund. The cap was intended to assuage any concerns that any one investor, like China, could control too much, according to government officials. A Treasury spokeswoman declined to comment.
To be sure, CIC and other sovereign-wealth funds face some obstacles to investing in U.S. real estate. Economic distress has raised the ire on Capitol Hill, with some lawmakers pointing the finger at China. They claim that heavy purchases of U.S. government bonds by the Chinese helped inflate the credit bubble by keeping interest rates low.
Elected officials have for decades been concerned about foreign investment in U.S. real estate. In the early 1980s, Congress approved a tax on capital gains from foreign sales of U.S. property. That tax, however, didn't stop Japanese investors in the 1980s from investing about $77 billion in the U.S. property markets, buying such assets as Rockefeller Center in New York and the Pebble Beach golf course in California.
CIC is unlikely to replicate those investments. It has consistently taken minority stakes, often below 10%, in part to defuse political risk. CIC's "debut in the U.S. property market likely will be double arm's-length investments," meaning through U.S. fund managers, with a minority stake in the fund, as opposed to direct stakes in actual properties, Mr. McCormack said.
And the woes in the U.S. marketplace might work in the favor of foreign investors like CIC. U.S. real-estate executives are lobbying to amend tax law to encourage overseas capital to flow into U.S. real estate, thus helping prevent a further decline in commercial-property values.
"Simple reforms could be made that would help address the equity shortfall our markets need to recover," said Jeffrey Deboer, president of Real Estate Roundtable, a trade group that is spearheading the lobbying efforts.
CIC's foray into international markets, including its stakes in Blackstone Group LP and Morgan Stanley, has been marked with big losses, at least on paper. But it recently has signaled a willingness to reopen the purse, selecting both firms to help oversee new investments in hedge funds. Also this year, it bought stakes in China-focused alternative asset-management firm Citic Capital Holdings Ltd. and U.S. asset manager BlackRock and has been in discussions about allocating billions more to hedge funds.
It recently made an investment in Goodman Group, a real-estate trust in Australia, and bought a stake in Songbird Estates PLC, the majority shareholder of Canary Wharf Group, an owner and developer of office towers and retail stores in London.
In addition, CIC has committed about $800 million to a Morgan Stanley global property fund, which intends to raise more than $5 billion and invests in real estate world-wide, according to a person familiar with the matter. A Morgan Stanley spokeswoman declined to comment.