New research has delivered a step change in transparency in a region that has been crying out for it, as Kevin Swaddle reports

With the release of the second annual IPD Pan Asia Return Research in June, there is just that little bit less mystery surrounding the Asian market for the commercial property investor. While we are not yet calling it an index, our work in the region is steadily taking shape, and increasing in both breadth and depth - simply put, it is getting there.

It is not just for romantic effect that the East has traditionally been shrouded in mystery to those with an Occidental disposition; the eastern markets have often been a closed book to foreign investors, where a different style of business, often driven by relationships, predominates.

The difficulty, and strength, for the traditional IPD model is the source of our numbers. By collecting information directly from building owners, our data is of unrivalled accuracy and quality. At the same time, this can make the creation of our databank incredibly difficult, particularly where fund managers are still wary of sharing their information. There is just not the same degree of transparency as there is in Europe or the US. Thus, it is not only a case of finding clients and making an index, it becomes increasingly a question of trust. Domestic Asian investors have to trust us with their information, as well as see the end benefit of providing it. In Asia, we have had to depart from the traditional model somewhat, and have blended data from IPD contributors with other asset-level data taken from the reports of REITs and property companies.

Our ongoing challenge with domestic investors is to build a rapport and to gain their trust. This is something we have had with UK investors for more than 25 years and in Europe for more than 15. In Korea they have the notion of Chong, an emotional connection that exists between business partners, in China there is Jung, and in Japan there is Shinrai. We have been building these relationships slowly, along with our databank, and now, for a second year, we are able to publish demonstrable results on a pan-Asian basis for the region.

It has been a similar story for investors of all types across Asia: the Asian markets are opaque. This was not such an issue before the downturn when high growth and impressive returns more than made up for the lack of transparency. But we are in a new world since the financial crisis: managers are held more accountable to investors, shareholders, trustees and regulators, and thus they need increasing levels of information.

While there are enormous challenges in the Asian market, the work IPD is doing, along with initiatives of industry bodies such as ANREV and APREA, has been incredibly important in establishing Asia as a more open, investable region. Domestic and regional managers are waking up to the need for accurate reporting as well, but there are still many hurdles to overcome.

The numbers
This year the research incorporated two new markets into the composite, Indonesia and Taiwan, in addition to the seven markets included in last year's research, those of Hong Kong, China, Japan, South Korea, Malaysia, Thailand and Singapore.

The combined total return for 2010 was 6.4% on a weighted local-currency basis, a strong improvement on the -0.2% delivered in 2009, driven by an increase in the capital return, at 0.9%. In line with the general trends in the Asian economy, Asian commercial property values are increasing off the back of strong investor sentiment and increasing demand from occupiers.

The office sector, which in 2009 posted returns of -2.2%, rebounded in 2010. As the largest sector in the databank, comprising 47%, it contributed heavily to the overall performance of the composite. The sector - traditionally more volatile and vulnerable to economic stimuli, such as reduced tenant demand, falling rents and oversupply - delivered returns of 4.7% for the year, indicating the overall recovery in occupier demand in most Asian markets.

This was, however, still well behind the performance of retail, whose returns increased to 8.6%, off the back of strong capital growth. Industrial/logistics returns lagged the other two sectors, having been ahead of offices in 2009.

The research this year also includes returns going back four years for most of the markets covered, which gives us an increasingly long-term perspective of the performance of Asian real estate, and enables us to start spotting trends. Over the four-year period Asian real estate returned 5.6% per annum, with capital returns of 0.5%. Crucially, the data we now have includes the market downturn and its subsequent recovery, which starts to enable investors to take a view on the volatility of the Asian markets vis-à-vis other regions.

And the variation in performance between the markets is large. The presence of a pan-Asian composite is crucial in helping investors allocate their investment pots, allowing a suitable degree of hedging in markets that see a high degree of volatility. The spread in performance between the markets this year was 21%, similar to 2009, with Hong Kong delivering the highest return, and Japan the lowest.

The variation in national market returns depends on that country's position in the current cycle, with Japan's low returns a result of prolonged downturn in the general economy, which was out of step with the rest of Asia well before the triple disasters of 11 March. And the healthy Hong Kong return indicates a market that is benefiting in the post-financial crisis recovery, not least because as the centre of Asian finance it is attracting huge corporate demand for limited space, and unprecedented demand from China.

Its market is known for being responsive to the economic environment, and therefore generally more volatile as a result. Hong Kong experienced the worst returns of all the markets covered in 2008, but has now been the best-performing market two years in a row.

Conversely, the Korean market has recorded the second-lowest return in the composite, of 5.8%, because of its stable performance during the downturn. Lacking the dramatic negative value readjustments the more volatile markets experienced, the Korean market has thus had lower returns in 2010 because of the lack of a bounce-back in values during the recovery.

The spread in sector performance was also impressive, 16% between the best and worst performing retail markets and a 27% spread in offices. Hong Kong and Japan occupied top and bottom slots in both sectors.

Global comparisons, and the exclusion of Japan
On a local-currency basis the pan-Asian return lagged behind those of the US and Europe, which delivered 14.2% and 8% respectively. This might seem somewhat low to investors, as generally, the advantage for investing in Asia is the lower cost and greater returns, offset by the increased risk.

But, put simply, Japanese returns drove down those of the Asian composite, which, excluding Japan, delivered 13%. Because of its relatively large weighting in the index, and more mature market conditions, the Japanese effect on returns was considerable, almost entirely because of its continuing capital depreciation. Of course, Japan cannot just be excluded, because it does represent a considerable part of most investors' exposure to the region. However, without Japan acting as a drag, the performance of the Asian real estate sector was much more competitive.

It is important to understand that no actual investors would ever receive the 6.4% pan-Asia return, even if they had a portfolio that perfectly mirrored the weighting of the composite. This is because of the effect of converting the local-currency returns back into their home currency. In the case of a US dollar investor, returns go up to 16.7%, while an investor in yen will get returns of only 1.5%. Thus investment in Asia can give significantly higher returns, but with the added risk of currency exchange.

Where next?
It is important for the Asian investment market that this research grows and eventually passes all the tests for a full IPD index. Transparency is essential for the efficiency and reputation of real estate markets. At all stages of the cycle, an index is essential for telling investors where they are, and giving analysts and forecasters a record to work from. Until the publication of this research, there was no credible source to enable asset allocators to compare real estate with the bonds and equities markets, and, essentially, investors have had no idea how their performance compares with the wider market.

The importance of an index in attracting investment cannot be overlooked. Without reliable market information, there is no way for the global strategists to weigh returns against volatility, and play the risk game to their advantage, allocating across the more volatile and stable markets to balance returns. The markets of Asia, as I have already said, have an enormous variation in performance, and have experienced the slowdown and subsequent recovery at vastly different rates. The structure of an investor's portfolio across the region will have a huge impact on returns.

For the moment, we will continue with the dual strategy we have been employing for the past two years. We will continue to target the international investors who have not yet contributed their assets to the databank, and we will build up the size and strength of each national sample. This approach has the advantage of using existing relationships already built with investors in the US and Europe.

At the same time, we will continue to target domestic investors, and this, of course, is where it becomes more difficult. While the growth of the listed REITs sector has helped matters, getting some used to the idea of greater openness, there is a significant disparity in the quality and openness of the funds and their data. Thus, we are still working from an incomplete picture, and working with domestic investors requires new relationships to be made, and trust to be earned. However, it should be noted that this is not a one-sided struggle; many Asian managers are also keen to promote their reputation and security, and are taking an interest in promoting and benchmarking their markets.

Both Japan and Korea now have established indices, and we hope to be able to break out more full indices from the composite before too long. In the meantime, the new dataset is sufficiently robust to start providing indicative benchmarks and return attribution. Another intriguing possibility is that the new dataset might answer the conundrum of how to benchmark funds in Asia. The diversity of funds in Asia (investment styles, gearing levels, sector and geographical specialisations) means they each find it very difficult to define a relevant peer group. The existence of returns for the underlying real estate means that it is possible to build up a hypothetical return based on different sector/country weights and an assumed level of debt.

The IPD Pan Asia Return Research has come a long way in a few short years, and slowly but surely we are making progress.

There is a little less mystery surrounding the markets, and next year there will be even less. National and international investors are waking up to the idea of the importance of openness, transparency and independent measurement in their markets.

Kevin Swaddle is head of Asia Pacific at IPD