As most developed real estate markets continue on the path of recovery after the financial crisis, are once dynamic emerging real estate markets being left behind? Eric Rosedale of international law firm Greenberg Traurig investigates.
As most developed real estate markets continue on the path of recovery after the financial crisis, are once dynamic emerging real estate markets being left behind? Eric Rosedale of international law firm Greenberg Traurig investigates.
Financial markets in emerging countries have been on edge due to a number of factors, most notably low oil and other commodity prices, a strong dollar and the prospect of the end of quantitative easing in the US. These macro-economic trends have been exacerbated by unprecedented waves of political turmoil, acts of terrorism, corruption scandals and health and safety concerns in emerging markets across Eastern Europe, Africa, Asia and Latin America.
Danger zones
Once favoured emerging markets with vibrant real estate sectors have become investment danger zones – Russia being a prime example of a dynamic market that has virtually fallen off the cliff with institutional real estate investors. Russia presents one of the starkest examples of what can go wrong in the real estate sector when the international politics of an emerging market go off the rails.
Just a few years ago, Russia was known for its high levels of growth, booming energy market and growing middle class that fed a spate of international capital funding a slew of office, retail, logistics and hotel projects. In less than a year, the Russian economy has dramatically reversed and borders on recession. Retail sales are down, the local currency has collapsed, office vacancy rates are up and foreign real estate investors have largely vanished.
Tide of capital
The troubles in emerging economies are happening at a time when historic amounts of capital are washing over real estate markets. This capital has been concentrated in gateway cities across the world’s developed markets but is slowly seeping into secondary cities and alternative real estate sectors as demand outstrips asset supply.
Ironically, at a time when investors would normally be looking to move up the risk curve and rotate more capital into emerging real estate market opportunities, they are now questioning both sides of the risk-reward equation. Compounding the problem is the absence of significant price adjustments that would make emerging market yields more attractive compared to developed market opportunities. This can be attributed to growing local investor capital being redeployed into real estate which is supporting price levels that are hard to swallow compared to opportunities in developed markets.
While every emerging market has its own dynamics, institutional investors are not likely to jump back into markets such as Russia any time soon. This is partly because investors are getting used to decent returns in second and tertiary markets on the peripheries of developed countries.
However, not all is lost for emerging real estate companies, as behind every crisis lies an investment opportunity. Emerging market specialists with reliable, well-connected JV partners can benefit from the vacuum created by flights of foreign investment capital, tightening debt conditions and distressed situations.
Beyond gateway cities
Cash-rich/yield-starved institutional investors with record levels of cash allocated to real estate eventually need to move beyond overheated global gateway cities in developed markets. As they move higher up the risk curve, will they stay closer to home or be drawn to the potential of higher returns in those emerging real estate markets that have not suffered as much macroeconomic turmoil and as many external shocks as others? With half of the BRICS nearing recession and the other half entering a new, more complex growth phase, which emerging markets will still have their ‘mojo’ in 2015?
The future seems to indicate that smaller emerging markets with relatively stable governments and no regional conflicts may provide a niche for committed and knowledgeable investors. Markets such as Mexico, Chile, Morocco, Panama, Turkey, and Vietnam might offer opportunities in most real estate sectors, though pricing and availability of institutional quality product will remain a challenge. For the foreseeable future at least, the amount of cross-border real estate capital flowing into emerging real estate markets will likely be dwarfed by the amount of capital fleeing them and finding a home in real estate safe havens.
Eric Rosedale is Chair of International Real Estate at international law firm Greenberg Traurig