First, its sovereign-wealth fund, China Investment Corp., invested $3 billion in Blackstone Group before the private-equity firm went public in June 2007. Since then, Blackstone's shares have fallen 66%.
China's $5 billion investment in Morgan Stanley in December 2007 was has also a loser. Morgan Stanley shares are down 45%.
Now fast forward to 2009. Many economists and investors say commercial real estate is cracking but has yet to fully crumble. But today we read in the WSJ that China has seen the cracks and is getting ready to invest in commercial mortgages and related securities. Holders of $100 billion of commercial mortgages, which will face difficulty getting their loans refinanced in the next few years, must be salivating.
So before China's investment foray into commerical real estate becomes this decade's equivalent of investors buying Florida swampland in the 1950s, there are some notes of caution CIC might want to consider:
1) The commercial real estate market still has a long way to fall. Even as the economy shows signs of improving, that isn't likely to lead to quick improvement in vacancies in the office market, where much of the distress is being felt, because hiring will tend to lag behind other economic indicators in the early stages of an economic recovery.
2) Beware of false bottoms. Some investors with savvy track records learned this the hard way during the housing bust. Morgan Stanley thought it was buying land cheaply when its real-estate fund bought 11,000 house lots from home builder Lennar in November 2007 for $525 million. At the time, the Morgan Stanley fund purchased the property at a 50% discount from its book value, but land values sank another 40% after the deal. Commercial real estate, unlike land, will throw off cash, even in a downturn. But China should be wary of buying highly leveraged properties that are likely to tumble in value. That would mean China could inherit the difficulties of refinancing.
3) Follow that old real-estate adage: location, location, location. China is most likely to invest in distressed debt and securities backed by commercial real estate, rather than the buildings themselves. Still, it is important to know what properties are backing those pools of securities. Investors got burned on residential mortgage securities because they weren't aware (or blithely ignored) the fact that these investments were backed by subprime mortgage loans in overheated housing markets such Las Vegas and Phoenix. Not all commercial real estate is created equal. Some areas that could take additional hits include offices in New York City, which tend to be highly levered and are suffering high vacancies because of the contraction in the financial-services industry. Another trouble spot: suburban strip malls located in troubled, suburban housing markets that were built for consumers that are suffering a double whammy of high foreclosures and job losses.
Michael Corkery
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