In recent years, following the influence of real estate control policies in first-tier cities, reduced domestic investment channels, renminbi appreciation and the rebound of real estate markets in Europe and the US, an increasing number of Chinese investors are going abroad for real estate investment. This article is a brief analysis of the potential legal risks such investments may be exposed to.
Features to note
The following features are evident in overseas real estate investments by Chinese investors:
- Gradual increase of institutional investors. Domestic institutional investors have accelerated their overseas real estate investment following the gradual relaxation of relevant policies. For example, several Chinese insurers have carried out overseas acquisitions of landmark commercial properties in response to the China Insurance Regulatory Commission’s (CIRC) relaxation of restrictions on overseas real estate investment with insurance funds in March this year.
- Gradual increase of developers. In recent years an increasing number of domestic real estate developers are going abroad for the development of various types of real estate projects. Generally speaking, these projects target Chinese investors as their main clients in order to maximize brand benefits.
- Expanding investment areas. The areas of overseas real estate investment by Chinese investors are expanding, from the US, UK, Australia and Hong Kong during the early years of investment to less familiar territory in Southeast Asia, Japan, Korea, the Middle East and the Caribbean. These emerging investment destinations are all focusing on attracting investors from foreign countries, including China.
Regulatory approval and legal risks
Amid the rapid development of overseas real estate investment, the associated legal risks have gained increasing attention. Some common legal risks are listed below.
Until now, overseas property investment by individual investors is not restriction-free under PRC law. That means individuals investing in overseas property are still subject to cross-border financing, fund transfer and other restrictions, which are pending relaxation after the promulgation of the Qualified Domestic Individual Investor programme (QDII2) and other new policies. On the other hand, overseas property investment by enterprises may not be carried out unless they are filed with or approved by the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOFCOM), the State Administration of Foreign Exchange (SAFE) or their local divisions, in accordance with relevant laws and regulations.
While investing in overseas property projects, many Chinese investors are not aware of the importance of a complete offshore company structure in avoiding risks, reducing taxes and facilitating exit, and therefore tend to adopt simple investment structures; for example, a structure under which a domestic company invests directly in a project in the destination country as shareholder. We believe that as investment experience increases, mainstream investors will accept the practice of establishing complete investment structures based on specific projects.
Restrictions in destination countries
As the number of real estate projects invested in by Chinese investors increases, the number rejected by foreign investment review authorities is also rising. Latest cases include the rejection by the Australian government of a Chinese enterprise’s acquisition of S. Kidman & Co, a company controlling 100,000 square kilometres of land in inland Australia. “State-owned enterprise background”, “national defence and security” and “national interests” are among the most common hurdles for Chinese investors. Resolving unfavourable factors and avoiding unnecessary policy risks have become important issues that Chinese investors should consider.
Project legal risks
Sufficient and in-depth due diligence of the relevant overseas property project is pivotal to the success of an investment. During the legal due diligence, in addition to standard investigations on project title, property management and on the project company, in-depth investigations should be conducted with respect to planning files, environmental evaluation, transaction records, neighbouring properties and roads, restrictions on property utilization and reconstruction, and other matters in connection with the project concerned in an effort to make the best of public and available information resources in accordance with the legislation of the relevant jurisdiction, and to provide a solid basis for deciding to invest.
Investors normally need to undergo complicated negotiations regarding transaction details in order to purchase and sell overseas properties. In this respect, investors are advised to focus on key terms that are likely to be exposed to risks during the transaction process, including transaction price, delivery, method of capital escrow, representations and warranties, conditions precedent, post-closing indemnification, liquidated damages and dispute resolution.
Risks during holding period
In overseas property markets, and in mature property markets of developed countries in particular, the holding period upon acquiring a property asset is normally as long as 10 years. Investors are advised to pay proper attention to the legal risks during the holding period. For example, many countries have specific restrictions on the increase of annual rent and expulsion of defaulting tenants. Investors should have a sufficient understanding of the relevant provisions during the holding period to avoid unnecessary losses.
Under the backdrop of renminbi internationalization and global distribution of assets by Chinese investors, overseas property investments will certainly become an area of particular attention for Chinese investors. However, given the numerous potential legal risks, we recommend that Chinese investors seek professional legal assistance and evaluate relevant project risks in a prudent manner to ensure the smooth implementation of relevant projects.