Emerging opportunities

Parts of Asia, particularly at the more developed end, have been hit hard by the downturn. Elsewhere, the economic turmoil is throwing up new possibilities, as Kristen Paech reports

Today's global economic turmoil is a financial tsunami from which there is no such thing as a safe haven. All countries, and all asset classes, are feeling the impact of a liquidity crisis that, while sparked initially by sub-prime mortgage issues in the US, may have thrown the entire world into recession by the time this article is published.

However, some countries have been hit harder than others and, perhaps ironically, when it comes to the real estate markets it is the emerging economies that are best at weathering the storm.

The US and UK residential property markets have suffered huge falls in both pricing and sales, and while emerging Asia has not been spared, the situation is far less pronounced. Limited supply is buoying the real estate markets of India and China, while underlying fundamentals, such as manufacturing, urbanisation and a growing middle class population, are expected to keep the emerging economies on course to deliver solid long-term returns to investors.

Small economies with high external dependency, such as Singapore, are even more exposed to the slowdown in international trade and foreign direct investment flows. Singapore's economy recorded growth of only 2.1% in the second quarter of 2008, down from the 6.9% increase in the preceding quarter. The bleaker global economic outlook has also affected sentiments in the Singapore residential market, with a notable reduction in prices evident in the first half of 2008.

According to a September research report by Citigroup Global Markets, the volatile stock market and potential job losses in the financial industries could result in a further 25% decline in the high-end residential segment in Singapore, while prices in the mid-market could fall another 15%. Both markets have already fallen some 20% and 10%, respectively, according to Citi.

"Asia has not been hit as badly as the US and Europe so far but, going forward, we believe the impact will play out more gradually," says John Su, director of Asian research and strategy at Aberdeen Property Investors. "The more mature the market economies, like Japan, Singapore and Hong Kong, the more they seem to be tied to the problems in the West, and that's probably reflecting that the financial systems are more mature and more exposed to risks in the western world.

"I would expect certainly from Q4 that we'll see residential market prices start coming down in Hong Kong as well. In terms of sales and transactions, not just for residential but also commercial, you've seen volumes in August down by 50 to 60%… so we have already seen volumes come down quite significantly."

Citi is equally bearish on the Hong Kong property market due to recent hikes in mortgage interest rates and declines in property rentals. "Today's slowing economic growth, falling stock markets, rising job insecurity and higher borrowing costs are all reminiscent of the Asian financial crisis in 1998," the report notes.

"The downward spiral in the property market will continue, in our view, and corrections will likely overshoot on the downside." In Japan, the investment market peaked at the end of 2006, yet Toshiro Nishioka, managing director of IPD Japan, says residential returns have remained relatively stable.

The IPD Japan Monthly Databank, however, reveals a decline in both capital growth and total returns on a six-month annualised basis (to June 2008).
In Tokyo's five wards of Chiyoda, Minato Ku, Chuo, Shibuya and Shinjuku, capital growth fell to -0.4, down from 2.9 in the six months to June 2007, while the total return dropped to 4.2, down from 7.9 in the same quarter last year.

In Osaka, capital growth declined to -4.3, and the total return was just 0.7%. Nishioka says the announcement in early October by residential J-REIT New City that it will be privatised shortly could put further pressure on pricing. "We have seen a lot of differential between the performance of underlying assets and the performance of J-REIT equities, so it's not really a property market problem, but a big impact from the financial side," he says.

"At the end of the day, if one of the biggest residential J-REIT funds has collapsed, they will start selling assets to the market so, in the short-term, that is one of the triggers that will impact the pricing in the market, not just for residential but in the commercial market as well."

There is no doubt that even the hot Indian residential market is feeling the effects of the global slowdown, yet positive demographics are expected to drive continuing long-term demand for real estate. Anshuman Magazine, chairman and managing director of CBRE South Asia, says new development sales have dropped significantly across India in the last six months.

"Last year, before a developer put the shovel to the ground, he would have pre-sold most of the development," he says. "Today, pre-sales have come down, but sales have come down significantly. What is ironic is, although the sales have dropped big time, the prices have not dropped correspondingly.

We are not facing sub-prime issues that the US or England is facing so far; people are still holding on." Magazine says there has been a decline in prices in some micro-markets across India. However, there is no stress in the residential market yet from a pricing point of view.

"The mortgages have gone up so they are 12% plus now, which is the highest it's been in several years, and the sentiment in the market is low like everywhere else, however we are not seeing distressed sales or prices going down," Magazine says. "In the next few months I expect the prices to start declining to some extent, but very marginally in prime areas because supply is limited."

A softening of prices in the Asian real estate markets and desire for portfolio diversification could increase the attraction of residential property for pension funds and fund managers alike.

Mark Khoo, director of research, Asia, at AEW, says the AEW Value Investors Asia Fund has avoided the residential sector to date, although the pricing is becoming more favourable given the current global economic environment. "A lot of the markets we believe were overpriced even when we started our fund one year ago," he says. "We are mainly focusing on serviced apartments, and they are quite limited in the sense that not many were being offered for sale at that time.

If you ask us in four years from now whether we've bought residential, we probably will have but right now we don't have any in the portfolio." Su agrees investors will probably seek out buying opportunities in 2009, but warns that, after a price correction, it's important to go back to basics and focus on fundamentals.

"I would focus more over the long term on the second tier locations in China, where gradually you will see these locations continue to develop and see more demand for residential housing," he says. "From a mature market point of view [investors] should wait for prices to come down and then enter the market; for the emerging markets, returns expectations have to cut back slightly.

The good thing about the emerging markets is that the long term story is still there in terms of the middle class… [but] the first tier cities are at this point overpriced so in terms of returns they are probably not as attractive over the longer term compared with second tier cities."

The emerging markets of Malaysia and Thailand likewise remain somewhat insulated from the global slowdown due to favourable demographics. While Japan has an ageing population and a residential sector dominated by retirement homes, Malaysia offers an entirely different investment proposition.

David Jarnell, head of research, Malaysia, at Jones Lang LaSalle, wrote in the firm's Asia Pacific Property Digest for the second quarter of this year that the Malaysian high end residential property market had witnessed strong activity in recent years for various reasons: "These include strong economic growth and relaxation of investment policies and guidelines (for example, Real Property Gains Tax was exempted on April 1 2007), which resulted in increasing wealth, high liquidity, greater affordability, particularly from foreigners, in the Malaysian high end residential market.

" Although he expects "a general slowing demand trend" in the short term, condominiums in the vicinity of Kuala Lumpur City Centre, a mixed use development which is home to the Petronas Twin Towers, are expected to remain popular. Khoo says Malaysia's young population - with a median age of around 25 - has also contributed to the Malaysian growth story. "You're seeing strong household formation over the next few years, the main issue for Malaysia right now is political problems," he says.

"Longer term, if you get the story right, and there's a pick-up in political stability, residential will have good long-term prospects. Thailand is a lesser story, but we like places like Bangkok, which has good mass transport systems like the rail system. Increasingly, people will be using public transportation, and if you pick the right product over the long term you will see fairly good returns."

The investment landscape in China has changed significantly over the last year, largely as a result of relaxed monetary policy. In 2007, in response to concerns about the economy overheating, the Chinese government introduced a handful of authoritative measures to reduce foreign investment in China.

This year, the government has taken a different tack. "In 2008 as the credit crisis worsened, in August you saw [the government] increase the lending ceilings of banks, allowing them to lend more, and cut interest rates," Su says. "It's an indication that the Chinese government can see that the global economy is softening to a point that it will impact on China's economic growth, and they feel there's a need to relax the monetary controls through a cut in interest rates to generate growth.

"I don't think the impact will be significant but what we should take from that is in 2009 we should expect a slightly more relaxed investment environment than we saw in 2007, which is easier for investors." Vietnam has proved another favourite with investors over the last two years, although inflation remains out of control and some managers believe prices are too high to justify.

While often likened to China when it comes to the underlying fundamentals, there are some distinct differences between the two markets, not least the fact that Vietnam has proved less able to absorb external shocks than China. In Jones Lang LaSalle's Asia Pacific Property Digest for Q2, 2008, Jane Murray, head of research, Asia-Pacific, noted that inflation presents a more serious threat to the region than the economic slowdown.

"The most alarming growth in consumer prices has been in Vietnam, where the CPI [Consumer Price Index] soared 27% year-on-year in July," she wrote. However inflation is not the only risk facing parts of the emerging markets. In India, much of the current supply is sitting on paper, or is currently under construction.

Magazine believes the true picture will play out next year, when the planned projects are completed. "Most of the developers now are facing capital credit crunch but deals are still happening and the picture will get clearer in the next two to three months because that's when we'll see where the market is really heading," he says.

"Also next year, one of the threats is a massive supply expected and a lot of the projects will get completed towards the latter part of 2009/10. The real market test will be when the physical buildings are ready for occupation; then we'll get a clearer picture of how the market is withstanding the supply."