While Asia's debt and equity markets are becoming more active, foreign investors are still focusing on domestic opportunities, says Chris Reilly
So far in 2009 nearly $24.8bn (€37.4bn) of equity capital has been raised in the construction and real estate sectors in Asia Pacific ex Japan, a long way ahead of the $15bn raised in 2008 but still significantly behind the sums raised in 2007.
The bulk of the activity has been in the Australian listed property sector where equity issuance of over $7bn was influenced by large offerings from Westfield, Stockland and General Property Trust. The Chinese residential sector has also been extremely active and broad based. Chinese IPOs, such as Glorious Property Holdings and BBMG Corp, as well as follow-on offerings from such issuers as China Resources Land, SOHO China, and Shimao Property Holdings, among others, have together amounted to well over $6bn.
Singapore has not been far behind Australia and China,with follow-on offerings from both property companies and SREITs together amounting to more than $5bn year to date. While the IPO flurry in China has been driven by the ongoing need to acquire residential landbanks, the refinancing in Singapore and Australia has been more about retiring debt for REITs and rebuilding balance sheets for opportunities ahead. Hong Kong has been quiet, with few property companies coming forward to tap the market, reflecting a conservative degree of debt on their balance sheets.
The public real estate markets found themselves in a difficult position towards the end of 2008 as the combined effects of the global financial crises and Lehman's failure reverberated through markets. In addition to falling asset prices and volumes, the sector needed to refinance a significant amount of debt in 2009/10, while credit markets were closed and equity markets were falling. The prospect of selling assets to pay down debt was not really an option given falling valuations and a lack of credit for would-be buyers. As a consequence public companies sought to preserve capital by cutting dividends, and a number of initiatives were introduced to circumvent the funding shortage. In Singapore, for example, the central bank offered to facilitate the refinancing of debt for SREITs, while in Japan a new public/private sector fund was introduced to supply capital to JREITs.
The wave of distressed selling feared by many has not materialised for a variety of reasons. But the main reason was because other avenues for funding have gradually appeared. The massive monetary and fiscal stimulus packages launched by governments around the region increased public spending, injected liquidity into the banking system and kept interest rates low. Strength in Asian economies has fuelled an equity market recovery and granted a much needed ‘window' for equity funding. Real estate companies and REITs have been quick to issue equity to repair their balance sheets, even though this has tended to dilute earnings.
Public debt markets have also been reasonably active in Asia in 2009. So far this year $3.6bn has been raised via a combination of mortgage-backed securities, corporate bonds and medium-term notes. Spreads on corporate bonds have moved down sharply over the past six months. The JP Morgan Asian Credit Index (JACI), which measures credit risk premiums, tightened to 300bps at the end of September, down almost 100bps from three months ago, bringing the JACI back to June 2008's level.
Asian residential property markets have proved surprisingly robust in 2009 and this has generated better cash flow for listed developers than expected and has also helped alleviate funding concerns. The weighted average leverage for public real estate companies now stands at around 30% in Asia, down from a peak of 45% at February end.
For private real estate, the funding options are less complex, although no less challenging. The typical sources of capital include private equity raised from the international investment community, alongside various types of loans. Most unlisted investment vehicles offer some form of (limited) liquidity mechanism. Capital pressures and challenging liquidity conditions have caused some unlisted funds in the region to be suspended, although the sector has arguably fared better than the listed sector, particularly in Australia and Japan.
Compared with the public markets, new sources of funding have been slower to rebound in the unlisted market, although there are now some positive signs. Private investors in real estate have faced similar problems to those of their listed peers, namely that these loans ultimately need repaying or refinancing, while selling assets has been challenging, particularly where values are falling.
In 2007 and 2008 significant amounts of third-party equity were raised for Asian real estate investments. Fund raising was assisted by a global surfeit of capital and some truly giant funds were created in the process. During this time, global funds came to dominate activity in the Asian region. Activity has slowed down significantly in 2009, with first-half transactions at around $60bn compared with $106bn during the same period in 2008 and around $200bn in the first half of 2007, according to Real Capital Analytics. The nature of the activity has also changed, with local funds now more active in the region than global funds. Many funds still have capital to commit to the region but those that invested fully are also likely to be dealing with legacy valuation issues.
As risk appetite begins to improve, unlisted real estate investors are to returning to the table. Compared with the West, Asia stands out with better economic fundamentals and momentum, and investors recognise that the region is likely to deliver stronger bottom-line returns over the medium term. In the meantime, however, investors also need to take stock of opportunities in their home markets, which have fallen sharply in some cases, and reassess their allocation to real estate alongside other asset classes.
At Henderson Global Investors we are conscious that our investor's needs are evolving. As conservative managers we are well positioned to continue to serve our investors in Asia. Generally, a preference for simpler, core-type structures with lower leverage and risk has emerged. Investors want more focused country/sector strategies where execution capability is greater, rather than broader pan-regional proposals.
Banks in Asia are naturally more circumspect about granting loans on real estate following the cyclical downturn and have resorted to stricter loan criteria in many cases. The defining issue, as always, is the value of the underlying real estate. Where values have fallen sharply - in parts of Europe and the US - the pressure on banks over their loan book is that much more intense. Even under these circumstances banks have tended to prefer to negotiate extensions to loans to avoid crystallising losses and taking these assets onto their books.
In Asia, the picture is mixed. Non-performing loans are a concern in markets such as Japan where leverage is high and asset prices have deteriorated. In markets such as China, where asset prices are stable or rising, the problem is naturally less severe.