Asia is still attracting property investors - but they are not necessarily European pension funds, as Shayla Walmsley reports

Money is pouring into Asian property - $104bn (€72bn) of it so far in 2011. What's different now from a year ago is that it isn't European money. According to a DTZ report, ‘Great Wall of Money', published in March, both European and Asian investors are focusing on their own regions - one group to retreat and retrench, the other to take advantage of their home region's economic growth.

"Before 2007 we were seeing more cross-border activity. But investors, in the wake of a financial crisis, with weaker economic growth, retreated to their home markets," says Nigel Almond, associate director of forecasting and strategy at DTZ. "It isn't surprising. Judged by a fair value index, it's relatively more attractive, even if the US is more attractive overall."

So where's the money coming from? When the researchers analysed the regional domicile of investors, they found domestic or intra-regional investment accounted for 92% of it.

The switch from European to Asian capital might affect the regional real estate market in a number of ways. One potential implication, for example, could be repricing as a result of increased competition.

Asian investors have the cash and, according to last autumn's PricewaterhouseCoopers (PwC) report on the regional shift of the asset management industry from Europe to Asia,the region's fund managers have the nous. So a more significant implication over the next three decades could be a geographical shift of asset management clusters from the West to Asia.

According to PwC, even more important than regulatory and tax disincentives, including AIFMD, will be the potential for organic growth as a result of the increase in public and private capital available in Asia. Hong Kong and Singapore, existing clusters with relatively light tax regimes, will grow rapidly.

Would European pension schemes invest in Asia-domiciled funds? Peter Martin of consultancy JLT, which has advised the £4.7bn (€5.3bn) Merseyside local authority pension fund on investing in Asian real estate, says he would "rule nothing out".

"As a consultant coming in open-minded on the types of fund manager you're looking for and their relationship with local property companies, for example, it depends what's going to be best to the mandate. A UK-based fund manager might make investors feel comfortable and be accessible for reporting purposes, but they would need a presence in Asian markets."

There has been a trend over recent years for funds of funds investing in Asian real estate to include REIT exposure. That suggests scope for investment in S-REITs, which offer one of the few routes for cross-border real estate investment in the Singapore market.

Moody's analyst Alvin Tan has given a ‘stable' rating to S-REITs for the next 12-18 months. The rating, based on macro growth increasing rental and lowering vacancy rates, would be threatened only by a combination of slower growth combined with significant new supply.

"As an investor, you have to be aware that some Asian markets might be accessible only through REITs," says Martin.

The regional market could also see Asian investors providing capital to beleaguered construction firms as bank lending all but dries up. A market update published in May by Hong Kong-based property fund manager Tan-EU Capital reported anecdotal evidence that SME developers were scouting alternative sources as a result of a sharp drop in available funding from existing channels.

Chinese banks are undoubtedly facing rising credit risks. The loan balance grew 11.3% to US$6.98trn in the first half of 2010 following 33% growth in 2009. There's a high delinquency rate on loans to property developers - although that exposure is mitigated by developers' sensitivity to their liquidity position. Chinese banks' non-performing loan (NPL) ratio, which S&P forecasts will remain at 3-4% until the end of 2011, will increase in the short term but stay below 10% until the end of 2012.

But new lending is slowing, and the National Statistics Bureau claimed to identify in Q1 the first deterioration in business conditions in two years. Both in terms of current conditions and outlook, the big losers were real estate and construction businesses.

China still in the frame
Meanwhile, there is still an appetite for single-country investment, which accounts for 50% of the funds raised for investment in Asian property - most of it for China or Australia. In other words, the Chinese market, even if it's bubbly, is still pulling in the investors.

Transactions are undoubtedly trending downwards, not least because of a government campaign started a year ago to end property market speculation, and especially in Beijing, where tightening policies were most strictly applied. A central government thinktank recently claimed the cooling measures hadn't done enough to control speculation and urged the introduction of a nationwide real estate tax.

Other policies specifically target foreign investors, including the introduction announced in January of a stricter approval process for foreign investors in residential projects.
Yet according to Mark Konyn, CEO of RCM Asia Pacific, a subsidiary of Allianz, the volume of specialist mandates for China from pension schemes and sovereign wealth funds indicates that it could become a quasi-asset class. His point is that, while large institutional investors saw Asia as a source of beta, China also offered liability-matching alpha exposure.

"Most international investors come to Asia for both the beta and alpha," he says. "Currently Chinese assets are under-owned by global investors due to the currency restrictions. These will be gradually liberalised over several years suggesting that international investors will own more assets denominated in RMB and the RMB itself."

His optimism about currency liberalisation may well be overstated. Despite the success of Hong Kong's RMB-denominated so-called ‘dim sum' bonds, Mark Williams, senior China economist at Capital Economics, has pointed to a contradiction between government aims to internationalise the currency and control its value, pointing out that one of those policy goals has to give. Other analysts, such as Li-Gang Liu, head of China economics at ANZ, claim internationalisation will only happen gradually, and that it will depend on whether China is able to manage capital inflows.

Even so, last year's 2010 triennial central bank report estimated trading in RMB outside its home market at US$22bn. China is now also the largest market in terms of transactional activity, having overtaken Japan.

"The issue is that all this money is trying to find the right products," says Almond. "Investors are more likely to go down the development route because there are fewer prime assets than there is capital looking for them."

Europeans will return, he adds, "but how they invest and where those funds will be located is the question".

The result will be more funds emerging within the region, he adds - but not necessarily raised from exclusively, or even mainly, Asian capital. "Most funds will be set up with investors from that region but capital will come from various jurisdictions," he says. "We can expect to see some investors looking already and there are still opportunities in Asian markets. I wouldn't be surprised to see more cross-border activity - but in the long term. It won't happen overnight."