Ambitious players seek guidance

Asian investors are mopping up assets coveted by European pension funds - and blazing a trail in markets some would consider uninvestable. And they're keen to learn, as Shayla Walmsley reports

With few exceptions, Asian property markets have been dominated by global investment. That's beginning to change - a change accelerated by the US-led global downturn.  One reason is that Asian investors are flush. Unlike overseas private equity investors, they don't go for gearing: they don't need to.

According to Watson Wyatt's most recent ranking, two of the world's top five pension funds are Asian: Japan's Government Pension Investment Fund, with $936bn (€593bn) and Korea's National Pension fund, with $203bn.

Sovereign wealth funds are somewhat different - even more liquid but geographically more adventurous and in many cases focused on trophy assets. In some cases, as with Singapore sovereign wealth fund GIC's acquisition of Tokyo Weston hotel, this involves assets typically traded at a premium. Returns they're looking for; a bargain they aren't, necessarily.

Ryo Kuwasaki, real estate director at Ernst & Young Transaction Advisory Services, claims the number and volume of acquisitions in commercial real estate properties made by sovereign wealth funds in Japan will increase considerably in the coming months. "Their ability to fund the significant portion or the entire acquisition cost in a timely manner will be viewed as a significant advantage in the market," he says.

Across the region, it is as though governments had deliberately doled out the innovation to SWFs and restricted pension schemes to bonds with an equities rider. Compare GIC - an aggressive investor in assets from London landmarks to Russian residential - with the Central Provident Fund, the government's pension scheme, which is invested solely in Special Singapore Government Bonds and advance deposits placed with the Monetary Authority of Singapore (MAS).

Regulatory constraints on overseas investors, for instance those in China, offer only a partial explanation of the mooted rise of regional investors. Asia has plenty of regionally biased constraints of its own.

The recent Comprehensive Economic Cooperation Agreement - effectively, an Indo-Singapore trade treaty - avoids double-taxation on cross-border property deals. Under the terms of the agreement, Temasek and GIC, Singapore's two sovereign wealth funds, may hold 20% of the shares in Indian companies, despite an otherwise statutory 10% cap.

In other cases, there is local bias by default. In the absence of Indonesian REITs regulation - draft rules were introduced last August, but with no timetable for formalisation - REITs-enabling markets, such as Singapore, adopt cross-border investment strategies that include Indonesian real estate assets in their portfolios.

Hence, First REIT, which floated as a hospitality operation on the Singapore bourse (SGX) in 2006, invests in Indonesian real estate.

With market-specific caveats, Asian investors have some investor characteristics in common. The first is institutionalised caution.

To some extent, the caution is externally imposed. Taiwan only recently relaxed direct investment rules in overseas real estate for domestic pension companies; Korea likewise.

"The level of acceptance of, and sophistication in, real estate investing can differ widely between investors in Asia," says Eduard Wehry, head of institutional clients, Asia, at ING Real Estate Investment Management. "Some of the few larger more developed institutions usually already have well established real estate investment programmes in place, whereas others are just starting. Usually, these programmes start with domestic investments, or internationally via listed real estate securities, before moving into international private equity real estate funds."

Hence Korean pension funds, up to now focused on their domestic market, are growing and diversifying their real estate allocations. "The assets under management of domestic institutions are growing rapidly, and with the broader acceptance of real estate as an attractive asset class, allocation to real estate is rising," says Wehry.

The irony is that, given the opportunity, Asian pension funds tend to be as aggressive as their western counterparts in search of returns. The Korean National Pension Service, for instance, plans to allocate 10% of its portfolio - around US$43bn (€28bn) - to alternative investments by 2012. Overseas investments currently make up around 2.8% of its assets, against a target of 6.8%.

Even China's Social Security Fund (SSF) has diversified into alternative assets - but only to date into private equity. Keping Li, vice-chairman of the National Council for SSF, tells IPE Real Estate: "Current government regulations mean SSF cannot invest in property till now. Maybe in future, SSF should consider entering property in the region to pursue more diversification."

Second, Asian pension and sovereign wealth funds invest with an eye to liquidity. Wehry points out that Japanese investors are "very conservative by nature", marked by negative experiences of direct investment in the 1980s, with larger allocations to fixed income. When investing in real estate, their preference in general is for listed real estate securities, especially when investing in overseas markets. In any case, "things can move slowly in Japan".

In the meantime, Japanese banks aren't lending - or at least not as they have been. Lehman Brothers recently pulled out of a Tokyo office acquisition because of a lack of willing lenders and loan conditions it wasn't prepared to meet.

The third notable characteristic of Asian pension fund investors is that they invest increasingly like European and US pension funds. Larger ones are taking their strategic cues not from some mythical model of Asian investment but from the PGGMs and CalPERSs - and that includes their expectations of fund managers.

Watson Wyatt claims both pension funds and sovereign wealth funds are looking to global practice to inform their funds' development in terms of returns and diversification into alternatives, including real estate. But the trend doesn't apply exclusively to real estate. Korea's National Pension Service has taken to activist shareholding on governance, for instance hiring consultants RiskMetrics and opposing on grounds of graft the re-election of Chung Mong-koo as chairman of Hyundai, one of its holdings. 
"Investors in Asia are typically eager to learn how the more established and sophisticated institutional investors in the US and Europe structure their real estate investment programmes," says Wehry.

Longer term, emulating sophisticated western investors could mean Asia becomes an increasingly intermediated market. "Larger pension funds in Asia increasingly work with consultants to help them formulate real estate investment strategies and undertake manager selection," he says. "The experience in investing in unlisted real estate funds is relatively limited and there's a need for independent advice. I don't see that part of the market growing rapidly in the short term, but it will grow over time."

Given their emulation of mature markets' pension funds' investment strategies, it isn't clear that Asian pension funds will radically alter Asian markets in terms of yields. You could argue that the drive for liquidity and the retreat from debt is as much observable in Europe as in Asia, for instance.

An investable market is, after all, an investable market. The Ho Chi Minh City Real Estate Association (HOREA), for instance, claims to be seeing interest from investors in South Korea and China, as well as the US, in Vietnamese projects after bank loans effectively dried up.

"The fundamentals of the real estate market and the Vietnamese economy make for a good investment story both for regional and international investors," says Alastair Orr Ewing, executive chairman of Savills Vietnam.

It isn't just markets with a clear proposition such as Vietnam, the regional logistics hub, for Korean investors. What Asian investors might represent to their overseas counterparts is a beacon (or coal mine canary) in high-risk markets. They're willing to go where few institutions have gone before, notably to Cambodia. A Korean firm, for instance, is investing $2bn in an urban complex, Camko City, outside capital Phnom Penh, that will be the largest single investment to date in that market. 

Orr Ewing also points obliquely to another characteristic of Asian real estate investors that perhaps reflects the appetite of cash-rich European and US pension funds in their regional markets a few years ago. Given the opportunity, they invest vigorously- but that doesn't necessarily mean they invest optimally, despite the advantage of local knowledge. Orr Ewing says Savills is seeing an "appetite for all sectors, although we don't necessarily agree that all sectors have similar potential".

Even within one sector, hospitality, the lack of prime assets mean investors have little choice - but still invest. "Investment activities are driven by the supply of available assets for acquisition, not necessarily what the investors prefer to acquire," says Kuwasaki.

Continued competition, whether between international or regional investors, will likely result in no immediate softening of (in this case) Japanese yields. In any case, says Kuwasaki, well-funded investors will simply increase the equity component, "albeit at the cost of achieving lower but still acceptable yield".

REITs are a barometer of the contours of individual Asian property markets. An industry poll on REITs conducted in March this year by Trust Company and Allens Arthur Robinson, a law firm, found that property market growth forecasts were highest for emerging Asian markets: China, India and Vietnam. Yet all three appear at the bottom of the list in terms of regulatory support for REITs.

The second annual Asia Pacific REIT Survey found low yields - for almost half the respondents - and poor regulatory processes ranked among the strongest threats to Asian REITs. Of those polled, 40% were local property institutional investors, with 98% currently or previously located in Asia. Sources involved with the fund forecast that China will move faster than India to improve its regulatory position on REITs.

Regulation is variable - but lip-service is universal. "Where the legal and regulatory framework is either unclear or not supportive there is a smaller REIT market in that country," says the report, citing Indonesia.

Yet even regulators in the fractious Indian market are getting in on the act. REIT-style real estate mutual funds (REMFs) are currently being drafted by the Securities Exchange Board of India (SEBI), the regulator, but they will require changes to the legal and tax regimes and industry maturation to increase transparency to attract greater core-oriented international investment. As a result, sources involved with the survey forecast that China will move faster than India to improve its regulatory position on REITs.

All forecasts for the Asian real estate market depend on continued regional growth. Yet this is always to some extent at risk - including political risk. Even in Japan, a mature economy, the failure of the bicameral parliament to ratify a new central bank governor could weaken confidence among investors. The main opposition party, which controls the upper house, has so far opposed two candidates in succession as "too political" for the job.

Lombard Street Research (LSR), an economics consultancy, offers a cautious economic prognosis: a "looming" Japanese recession that policy tweaks won't fix in time; a Chinese positive output gap, albeit mitigated by "policy-induced slowdown"; an overheated India with pending above-forecast inflation. Only Korea, with its strong tax revenues and fiscal surplus, "seems well placed" to weather the global slowdown.
In the meantime, local investors could be left a clear run at local markets. APREA, among others, claims opportunistic international investors are pulling out of Asian property - partly to focus on distressed assets closer to home and partly because credit is harder to come by in their preferred Japanese market.

Will the rise of Asian investors change the regional real estate market? Perhaps not fundamentally, except to squeeze out highly leveraged investors in a trend we're already seeing in Europe. European pension funds planning to stay and (given nous and an appetite for competition) expand will create specific Asian beneficiaries.

It has become all but axiomatic that going it alone is not an option for smart investors in the region's emerging economies, notably China and India, but the result has been to give potential local partners considerable clout. In other words, the real market winners could well be the fixers. European partners, beware.

"Asia is incredibly opaque," says Calum Mackenzie, senior investment analyst at AON Consulting. "There's intense competition for assets and local partners. Fund managers are desperately trying to acquire in Hong Kong. You're seeing more joint ventures. In theory, it's a good idea to have a local partner but fund managers will also want to see strong alignment of interests, with both partners investing capital. They'll want exclusivity agreements."