Lure of the Orient

Developing Asia is complex, diverse and inefficient but it is likely to remain ahead of its rivals for a while. Kristen Paech reports

While the global credit crunch has put the breaks on the established real estate markets of the US and Europe, it is having the opposite effect in emerging Asia. A recent report by KPMG, FTSE and APREA notes the market capitalisation of listed real estate companies and real estate funds in emerging markets have been increasing at an extraordinary rate.

In India, market caps are at an all-time high, far exceeding the expectations of mature markets, and leading some observers to question the sustainability of this growth.
The report, titled "Real Estate Investment in Asia Pacific: Migrating Capital", states the inflow of capital to Asia's real estate market is accelerating off the back of a prolonged period of steady growth powered by a combination of opportunistic and increasingly longer-term investments.

It points to growing interest in the Asia Pacific region by European pension funds in recent months as they hunt for stable returns, and continued interest from Australian funds and even opportunistic US funds in search of distressed assets.
"Alongside huge Asian pension funds from markets such as Singapore, interest hasn't been this high for a long time," the report states.

Strong fundamentals, a better understanding of emerging Asia and the prospects for high returns are behind the growing desire from pension funds to diversify their portfolios outside of their home country.

According to the report, returns in Asia are projected to remain higher than the global average for the coming year, backed by strong market fundamentals and even stronger economic growth.

India
The IMF has retained its growth forecast for India of 8% in 2008 and 2009, a touch behind the 9.3% GDP growth in 2007, but "still not a shabby performance", according to Aniruddha Joshi, executive director of Hirco, one of India's largest real estate investment companies. Hirco invests in the development of multi-use townships outside of major cities including Chennai and Mumbai.

Joshi says India has three key strengths when compared with China - it's a market-led economy as opposed to a government-led economy; it's consumption-based rather than investment-based; and it's domestic-led as opposed to export-led.
"The engine of growth in India is not an American walking into Walmart and buying something, but an Indian walking into a neighbourhood store and buying something," he says.

The KPMG/FTSE/APREA report recognises that the slowdown in the US and European markets is unlikely to cause an immediate negative impact on Asia, although banks will tighten credit policies thus limiting financing options for real estate investments.
As India is a development-oriented market, this is causing problems for developers, says Rashmi Mehrota, business leader for investment consulting, India, at Mercer. "The real estate developers are struggling to get finance," she says.

"The investors are sitting on the sidelines and saying: ‘the property prices have overshot and therefore we should wait until they come down before we buy', but in the meantime, the developers are running out of money and can't get credit very easily, so they are in a credit crunch."

China
In China, however, the cost of credit is less of a problem. According to Roberto Versace, fund manager real estate securities, emerging markets Asia and globally at Melbourne-based MacarthurCook, many of the Chinese developers have no debt at all. "They are net cash, and this is because they have several projects going at once," he says.

"The pre-sales are so strong that they can take that pre-sale money and pour it into another project and, while they are selling off one, they can deploy it to another, so they have this recycling of cash that is quite efficient and a low reliance on debt."
China's growth story continues to offer a compelling investment case for institutional investors making a foray into emerging Asia.

With a population of 1.3bn and a middle class that's expected to increase by 300m to 850m by 2025, according to McKinsey's March 2008 report "Preparing for China's urban billion", the statistics alone speak volumes.

If current trends hold, the report says nearly one billion people will live in urban centres by 2025, and the urban economy will generate over 90% of China's GDP. Like in India, a lot of China's demand, particularly in the second tier cities, is primary, not just speculative demand.

Direct property markets are underpinned by economic growth, and economic growth is the most robust in the Asian region, particularly in the emerging markets relative to the world, says Versace.Emerging market growth overall is expected to reach between 6.5-7% this year, compared to 1.5% for the developed world.

"The residential developers [in India and China] have so much demand for product," says Versace. "People need to be housed, simple as that."

Of the emerging markets, Nicholas Wong, managing director, Asia Pacific region at ING Real Estate Select sees the most opportunity in China on a risk/reward basis.

Vietnam
While Vietnam is starting to come under the radar of funds such as the US$314m (€216m) EII International Property Fund, Wong says it's difficult to get access to good development sites unless you are associated with a local developer.

He also believes there is too much capital chasing too little opportunities. "In places like India and Vietnam, although the market has been going up, [if] funds that have raised billions of dollars are not able to capture the opportunities and deploy the capital, we [don't think] those markets [are] as good as markets like China or Japan, where opportunities are 20% plus internal rate of return yet you can get the capital deployed," he says.

It is hard, however, to ignore the Vietnam growth story. Since the Vietnamese government's open door policy (‘Doi Moi') in 1986, spurred by a change in attitude towards the ownership of real estate and continuing economic reform, the property sector in Vietnam has begun a transition from a controlled state position to a market-led environment.

VinaLand, a closed-end property fund listed on the London Stock Exchange (AIM), has returned 58 per cent on NAV since inception in March 2006. The fund focuses on key growth real estate segments including residential, office, retail, industrial and leisure projects primarily in Ho Chi Minh City but also in Hanoi and key leisure areas.

VinaCapital Investment Management, which manages the fund, says the country's burgeoning urban middle class, increased international exposure including an influx of international tourists and multinational companies, are the drivers behind the increased demand for real estate in all sectors.

But not all managers are convinced. Although AEW Capital Management includes Vietnam in the investment universe for its US$558m AEW Value Investors Asia Fund, to date the fund has invested US$200m solely in Singapore.
Peter Wittendorp, managing director of Asia-Pacific, says AEW is actively pursuing opportunities in Malaysia, Thailand, Hong Kong and Shanghai, but has concerns about the economic climate in Vietnam.

"If you look at the office market in Ho Chi Minh city, there's only a handful of decent office buildings around with rents going crazy because of a lack of supply, but the market is getting a bit too far ahead of itself at the moment," he says.

"The hyperinflation is about 20%, there's a big trade deficit, so we're a bit worried about that market, especially if you have an emerging market where land registry offices are being built up so you don't know yet if you do a development deal whether you will become the owner of a piece of land."

AEW's approach is to identify underappreciated properties in insular locations, such as old Shanghai, and enhance their value through better management.
"In Asia in general (ex-Japan), real estate per capita is very low, so a lot of real estate fund managers focus on development deals, and historically a lot of people don't take very good care of the assets they own," Wittendorp says.

"Residential is self-liquidating to a certain degree or, if you develop a mall or an office building, you sell it onwards to the next person, but a lot of stock, especially stock conceived in the 1990s before the financial crisis, is in the hands of corporates [and] wealthy individuals, people that aren't necessarily the natural owners, managers or landlords of these assets. So there's a lot of dilapidation going on - deferred maintenance - and you see that too in places like Shanghai because there's already an enormous amount of stock available."

Macao
Macao has also emerged as a new hub for opportunistic real estate investment, with enormous hype generated by the construction boom and development of US-style casinos.

According to Wong, gaming revenue has surpassed the American state of Nevada, with tourists from China and Japan viewing the island as Asia's Las Vegas. "You've got expatriates there building and running the casinos, so they need a place to live, and on the back of that Macao residents are getting rich and are trading up," he says.
"But at the same time, it's extremely small, so, unless you are associated with some of these Casino groups, finding opportunities is difficult."

The political risks in emerging Asia have reduced significantly, especially in South East Asia, with ASEAN gaining prominence as seen in the border dispute between Thailand and Cambodia.

Jones Lang LaSalle's latest Global Real Estate Transparency Index found emerging markets generally have "significantly improved" their levels of real estate transparency.
China's tier one cities' transparency score improved by 0.33 between 2006 and 2008, while Vietnam upped its game by 0.29.

"Many cross-border investors focus on more mature, open and transparent real estate markets such as the UK, Canada, Netherlands and Hong Kong. However, opportunistic investors will consider the emerging, less mature, less open and semi-transparent markets, but will require higher returns to compensate for the higher risks associated with lower transparency," says Lee Elliot, a director in JLL's research team.
"Only the most opportunistic investors will consider semi-transparent markets found in Eastern Europe, Latin America and South East Asia."

Indonesia
In places like Indonesia, terrorism remains a threat to those institutional investors brave enough to invest in what is still a relatively opaque market.

Indonesia was named by JLL as a country that has "consistently scored in the low transparency range over the last few years despite an increase in cross-border trade, finance and commerce over the same time period".

"We're a little bit apprehensive about the political environment in Indonesia, so we'd probably like to see that consolidate before we went forward and [deployed] money," Versace says.

"Political stability is very important; we like to see governments who have as much control as they need to govern, and that there's not a constant threat of a political coup. Terrorism is also something we don't like to see, and that's the biggest problem in Indonesia. We're cognisant of those aspects and they do shake equity markets seriously as we saw with September 11 [terrorist attacks in the US]."

While China is politically stable, the government's heavy influence - as evidenced in the austerity measures introduced early this year to try to cool off the market - makes government risk a noteworthy challenge.  And Wong says the length of time it takes to close a deal in the emerging markets means pension funds must take a long term approach to the investment. "In places like India and China, a deal takes on average one year to close," he says.

"Most of the funds are opportunistic in nature, and most have a large development component, but these projects take years to complete, so it's tough to say what type of return you're going to get. You can't see the performance until the tenants move in and the project stabilises."

This makes choosing an investment partner even more important, according to Joshi. He says the biggest risk for institutional investors when investing in development projects in India is execution risk.

"In most emerging markets, many more projects are announced than actually get done, so that's one thing that foreign investors need to be aware of," he says. Choose a partner, invest with someone in India or invest in a project where you can be sure of the execution capability of the person or company responsible for delivering that project."

Jennifer Kaiser, head of property research Asia-Pacific at Mercer, agrees manager selection is crucial. "[It's about] finding the manager that's considered to be best of breed and highly capable of executing in these markets that are relatively inefficient but still have the ability to provide opportunities," she says. "You need to look for highly skilled, stable managers with local teams on the ground, who speak the language, and have the right alignment of structures."