Real estate investors could see more distress opportunities – and risks – in the emerging markets, reports Christopher O’Dea
Recent turmoil in emerging markets has been put down to the US Federal Reserve’s untimely removal of the proverbial punch bowl from the festival that emerging markets had become up to 2013.
The taper, says the conventional wisdom, is chasing hot money out of risky emerging markets and back into dollar assets many investors expect to perform well as economic growth accelerates and the dollar appreciates.
One who’s not buying into that story is Richard Barkham, group research director at London-based Grosvenor Fund Management, with $19.9bn (€14.5bn) invested in property around the world.
“The economic environment is profoundly deflationary, and interest rates are under no upward pressure at all,” Barkham says in his latest Global Outlook.
“The reasons for the wind-down of QE are to do with politics and emerging doubts as to the marginal effectiveness of the programme.
“Emerging market turmoil, such as it is, is related to the slowdown in China, and the need for reform in those economies themselves.”
The upshot for real estate investors will be increased distress opportunities – and risks – in emerging markets, with attractive opportunities in US property despite rising rates.
Whether caused by the taper or not, the drop in the emerging markets means investors in the region will face tough sledding for a few years, says Goldman Sachs.
The selloff highlights “the intransigence of the structural fault lines of emerging market countries”, according to Goldman.
“The concern,” it says, “is that these countries showed little appetite for implementing reform during the boom times, and they are far less likely to encourage such transformation now they face slower growth and more deep-seated structural problems.”
Even the economist who coined the term “emerging markets” seems to have thrown in the towel.
Antoine van Agtmael, in an epitaph for the emerging market boom in the US journal Foreign Policy, says: “The US may be doing better than we thought, and China and other rising powers may not be doing quite as well as believed.”
The IMF projects an annual growth rate of 5.4% for emerging markets over the next ﬁve years, compared with a ﬁve-year growth projection of 6.9% in 2008.
This 1.5% reduction is substantially greater than the 0.2% reduction the IMF made in its growth projection for developed economies.
While the drop in equities and the reduced growth rates are obvious, says Agtmael, dimmer prospects result from “several deeper causes, around which the fog is lifting only now” – the most profound being “the lack of institutions that support the smooth functioning of society and the inclusion of larger parts of the population in the increased wellbeing of countries”.
If China’s slowing is the core of the emerging market tumble, property is the main drag on China’s growth.
Yu Yongding, president of the China Society of World Economics, a former member of the Monetary Policy Committee of the People’s Bank of China, and former member of the Advisory Committee of National Planning of the National Development and Reform Commission of China, believes overcapacity is China’s most severe problem.
“China’s economy is being held hostage by real estate investment,” says Yu.
China’s real estate investment accounts for 10-13% of GDP, the world’s highest, which has fuelled a “vicious circle” that has lasted 15 years, he says.
The resulting high prices are fuelling “growing resentment among ordinary people” who cannot afford even a modest apartment, against a surfeit of five-star hotels.
What’s to come?
“China’s banking system is quite heavily protected,” Yu says, so American-style housing crash is unlikely.
But investors should heed the warning signs.
“We recommend a lower strategic allocation” to the region, says Goldman.
“We do not think anyone can tactically avoid probable downdrafts in emerging market assets on a consistent basis over the next decade.”
What’s more, “economic history teaches us that the next crisis usually comes from the region where the applause and self-satisfaction were loudest the previous time around.
“If that holds true, the next economic shock will more likely than not come from the BRICS.”
While there’s plenty of stress right now, and China’s housing bubble may yet bring tears to investors’ eyes, long-term fundamentals augur for more property investment across Asia.
JP Morgan notes that the urban population of Emerging Asia is projected to reach 2.2bn by 2030, fuelling annual infrastructure needs of about $750bn that will drive the need for private equity investments in real estate, infrastructure and transportation.
“Overall,” says Grosvenor’s Markham, “there will be more opportunities, but higher risks in the emerging markets.”
Real estate investors may want to keep their powder dry while those opportunities and risks take shape.
Publicly listed real estate already reflects the looming sense of crisis.
Lotte Shopping, South Korea’s biggest shopping mall owner, may delay its $1bn REIT deal due to the sell-off in emerging markets.
That uncertainty follows poor showings out of the gate for other recent Asian deals.
HK Electric Investments, a trust spun out of Li Ka-shing’s business empire, fell 2% on the first day of trading in January, while Singapore’s latest REIT flotation, OUE Commercial Real Estate Investment Trust, is trading below its IPO price.
“The problem with the emerging markets over the past five years has been the strength of growth and the accompanying high prices,” says Markham.
“In contrast, US real estate will offer good returns at lower risk, despite the tapering.”
As the markets slow down, he adds: “There will be an emergence of distressed opportunities, but they will come with high risks.
“There will be a slowdown in China that will be handled well – but there is the risk it could go wrong, which will have a knock-on effect in the emerging markets and drive distressed opportunities.”