Asia Pacific real estate is attractive but its diversity and complexity are daunting. Now help is at hand in the form of the club deal, which provides stability, reliability and flexibility, say Stuart Crow and Glyn Nelson
In times when real estate investment returns are being chased globally and capital flows are not restricted by political borders, investment strategy and structure is of prime importance. Much like water on a pavement, capital finds its way into every crack in regulation and market opportunity. As investors' horizons extend beyond both their home markets and local regions, emerging economies with their comparatively high returns and growth stories have become markets of interest for many.
The emerging markets of Asia Pacific are largely characterised by their ability to help drive regional as well as global growth over the past decade, making them an attractive option for international investors. Typically characterised by a lack of market depth, a comparatively small investment universe, low levels of transparency and a lack of maturity, these riskier markets would seem primed for a new iteration of an opportunistic investment strategy. Opportunistic investment, a phenomenon normally characterised by short-term strategies, is often closely associated with emerging markets and the early stages of property market development. So one might naturally conclude that future capital flows into Asia Pacific's property could be
influenced by this investor type.
The recent trends in opportunistic investment have been overshadowed by a phenomenon called club deals. Though traditionally linked to the more mature markets of western Europe and North America, their prevalence in Asia Pacific real estate is starting to gain ground.
By way of defining this type of investment structure, club deals are a consortium of investors (usually around two to five participants) each bringing a different yet complementary skill set to the table, yet all with an aligned interest. Club deals are similar to joint ventures but can include more investment partners and characteristically are of a larger scale than a typical joint venture.
Club deals, however, are not cast in stone and their composition is as flexible as their potential use. They can be used to invest into large complicated markets, comparatively small but fast-growing markets or very large scale infrastructure projects and either completed asset acquisitions or development projects. This gives club deals a means to explore opportunities in markets such as India where currently greenfield development projects were the primary opportunity available to overseas investors; or China where opportunities exist across the real estate spectrum.
This can be evidenced with UBS's collaboration with Shanghai-listed developer Gemdale Corporation to develop and launch a $1bn (€633m) fund which focuses on residential properties in China. The move follows the likes of Morgan Stanley, RREEF Alternative Investments, and ING Real Estate, which raised a $350m fund for Chinese housing and has partnered Gemdale on individual projects.
If we want to consider the value club deals hold for the emerging world, then we need to look at their influences on both the market players and the markets themselves to determine ‘whether' they are capable of shaping real estate markets, and if so, ‘how'.
By providing a structure where foreign and local parties are able to work together, club deals can potentially add to the depth of the investment market in emerging countries. This can help move them toward both higher levels of market maturity and increased transparency. With ‘stability' and ‘reliability' primary concerns for real estate investors in emerging markets, both of these factors will be highly regarded for their ability to aid in improving market fundamentals and provide a platform from which further investment can be undertaken and confidence instilled.
Risk profiles can often make or break the success of a market or, at the very least, heavily influence the type and number of investors and capital that enter the market. If we stand by our premise that emerging markets are more susceptible to change than mature markets, then we have to be cautious of new investment schemes like club deals and view their influence from all angles.
From a member's point of view, the consortium of large-scale funds working together under the club deal banner should provide greater returns than if the funds competed individually against one another. By working together, the club raises the likelihood of securing a high value asset through their joint bid.
These structures lie somewhere between solo projects and listed or unlisted funds which can have potentially hundreds of investors. By limiting the number of members in a club deal, the group gains several advantages. Set-up and management costs are greatly reduced by side-stepping most public securities issuance regulations and the group can be placed in the most tax-advantageous locality. A small number of parties also means the decision-making structure is more efficient and opportunities are able to be secured faster than some competitors. Thus, strategy and acquisition can be manoeuvred quickly.
By their nature, club deals are typically simple and thus very efficient. They tend to work best on a project-by-project basis as this ensures participant interests are continually aligned (the most important consideration in setting a club deal up) as well as reducing ongoing costs where management of club deal projects and assets that extend beyond one location becomes difficult and costly. They offer large institutions and private equity funds a relatively easy and rapid way to build core real estate portfolios or as a risk-proof way to gain entry into emerging markets without full exposure to the risks associated with opportunistic real estate portfolios.
Getting the right balance from all parties in a club deal is a fine art. Getting it correct could mean a positive contribution to market practice and development - getting it wrong definitely will not. To illustrate, a club with the right mix can enjoy collaborative benefits from a development-focused project.
Under this scenario, a local developer and foreign investor (typically a fund or an investment institution) collaborate to leverage on each other's expertise. The foreign investor gains access to the developer's land bank, local contacts and local market knowledge while the developer gains access to capital, knowledge of international financial market operations and even potential benefits from a more efficient tax structure.
Together, these strengths can properly balance a club deal to a longer term, risk-averse investment strategy, which brings stability and depth to the market. The financial flexibility and experience associated with investment banks and financial conglomerates can bring best practice to a market, often resulting in significant improvements in a market's maturity and development. Local expertise and know-how can be considered the keystone in this bridge between international capital and local opportunities.
A successfully completed club deal transaction, however should not be automatically regarded as beneficial to a market's development. With private equity flowing into real estate markets in India, China, Korea and Vietnam, one must assume that not all deals are well balanced. More to the point, if we take cues from the more mature markets in North America and western Europe, we see there are indeed some noteworthy concerns associated with club deals, even if they are successfully managed.
Opportunistic investment is sometimes considered as synonymous with emerging markets as they lack of transparency and have low levels of liquidity. We have come to accept this for the early stages of property market development, but it is still in everyone's best interest to lay the foundation for a sustainable investment market. This phase has to be managed in a more responsible way.
Just as club deals offer large institutions and private equity funds a relatively easy and rapid way to build core real estate portfolios, the structure can also provide its members a less risky option of entering emerging markets. But the balance must be right.
In order for a club deal to have a substantive, positive effect on property market maturation, it has to have the right balance of players and goals. However, if this club membership is unbalanced and there is dissimilar interest in parties or inadept club members - for instance a private equity fund with a missing piece (possibly a local developer without a good track record) this could prevent not only the successful completion of a deal, but also negate some or all of the positive effects club deals could bring to the market.
As large scale capital is pooled in the hands of a limited number of investors (club members), its scale and manoeuvrability can price out other bidders on a deal, which in the first instance not only contributes to a less competitive market place, but also directly influences market prices, with vendors being priced down from what they could have achieved under more competitive circumstances.
Despite enormous improvements in cross-border investment transactions, emerging markets remain an attractive option for many investors because of the range of opportunities arising from the lag it maintains behind the mature markets of Europe and North America. This is particularly true for the Asia Pacific region.
Markets ripe with opportunities always fall prey to opportunistic investment. Property markets in Asia Pacific are no exception to this and continue to be subject to an increasingly diverse range of investor types. Real estate market club deals offer a unique opportunity for both investors and investment markets in Asia Pacific.
Investors are now able to seize upon opportunities in a quicker and more efficient way. They are capable of market entry, where previously a lack of local knowledge was an insurmountable barrier. Institutional and private investors have little to criticise about the opportunities club deals bring to the fore.
One of these opportunities is an opportunistic bridging arrangement. In times when equity markets are soft and IPO volumes are down, club deals provide sponsors a structure under which they may release some of their equity while retaining ownership, and prosper from the potential upside of an IPO at a point in the future when the market is more buoyant. By partnering with opportunistic funds in this manner sponsors are able to realise some of their gain immediately and bridge until the equity markets return to a favourable position. The flexible structure of club deals provides for a successful arrangement like this.
Investment markets themselves are a little more discriminating. That is to say, the net effect of any one club deal will not do a market rightly or wrong, but a collective history of deals that can offer greater cross-border investment volumes, local knowledge transfer and sharing of best practice, could very well contribute in a significant way to a market's evolution.
However, the future hangs in the balance for emerging markets. The popularity and significant returns properly managed club deals can bring could result in the type of quick-fix, mismanaged, and classically ‘opportunistic' investor type that pulls market stability and depth apart.
With no clear way to identify the path emerging markets will take in light of club deals, it is difficult to forecast with any certainty the shape of Asia Pacific's future. However, as has been the case for many less developed markets, the contribution private equity is able make to market development can be significant and should not be overlooked.
Today, global capital chases opportunities from one market type to the next, encountering new hurdles and challenges around every turn. An essential quality in successfully navigating these markets continues to be flexibility.
The flexibility that a carefully assembled club deal can offer is not often found in most commercial real estate investment structures and will likely be a core feature in the step toward greater maturity in Asia Pacific real estate.
Stuart Crow, head of Asia Capital Markets Group, Jones Lang LaSalle Asia Pacific
Glyn Nelson, head of Operations, Real Estate Intelligence Service - Asia, Jones Lang LaSalle Asia Pacific