Tempting the investor 'Cross Border investments to Asia' |
| By Marinus Dijkman, Editor in Chief Europe Real Estate |
2005 and 2006 saw cross border investments to Asia taking off. In fact, according to DTZ, approximately US $6.2 billion was invested in Asia from other parts of the world in 2005 alone. But looking at worldwide investment this is not really a huge amount. Perhaps investors are still not that confident about Asia, or perhaps they do not know enough about the opportunities available. However, the situation is complicated further by the size of this vast region, where different countries and cultures – both rich and poor – rub shoulders. This article looks at some of the general issues surrounding investment in Asia, with of course the main focus on China – a country currently seen as the favored destination for foreign investment.
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The Great Wall: a real symbol of the past now that China has opened its doors to the world. |
| The size of the region can make investing difficult according to C.Y. Leung, Chairman of DTZ North East. “Seen from Beijing, Sydney is as far away as London. Building up and managing a portfolio scattered around Asia is not a time and cost effective approach and does not provide the necessary critical mass of experience and network. Some kind of geographic focus would be preferred.” However, it is in fact the size and variety of |
Chart 1. Source: DTZ. (click on the chart to enlarge) |
Asia which offers investors such scope. China alone has 661 cities, giving investors a whole range of opportunities in Chinese 2nd and 3rd tier cities, such as Wuhan, Xian, Chengdu, Shenzhen, to earn the kind of IRR that was available in Beijing, Shanghai and Guangzhou five years ago.
Private equity
The same circumstances also somewhat apply to India and Australia. As a result, some funds concentrate on |
Chart 2. Source: DTZ. (click on the chart to enlarge) |
one country only, in particular those dealing with Japan or China, due to the size of opportunity. The Asian market began to really attract the world’s attention in 2005 and 2006. According to DTZ, total investment purchases in Asia in 2006 totaled US $83 bln., a 30% increase on the same period in 2005, and double that of 2004. This is compared to an increase of 20% in the US, and 3% in Europe. However these figures need to be seen in comparison, and investment in Asia remains marginal when viewed on a worldwide level, with US $448 bln. of investment transactions worldwide, and only US $83 bln. in Asia. Private equity makes up approximately 80% of these capital flows, with 40% of all activity involving lot sizes of US $250 mln.+.
Cross border
As seen in the charts 1,2 and 3, money is increasingly sourced from multinational companies headquartered in the US, Western Europe and Australia. The majority of capital flowing into Asia is still going to Japan, which is something that may surprise the many observers who still think that China is the biggest market. According to the World Bank, Japan’s nominal GDP was worth US $4,622 bln. in 2006,compared to China’s US $1,931 bln. A huge difference. But on the other hand, China consistently scores the highest growth figures of approximately 10% a year compared to Japan’s 2%+ (Source: Atchison consultants). Because of continually increasing product prices, higher leverage is something that is becoming more prevalent across the region.
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Investment out of Asia
According to chart 2 (above), about US $6.2 bln. was invested by European and American companies into Asia. However, there was also a substantial fl ow of capital moving in the other direction. “The main exporter out of Asia Pacific is Australia, via property trusts which are investing in the US and Europe. In 2005 they sent over US $11 bln. to the US, and in 2006 they switched focus to Europe. We are now seeing Korean and Japanese money as well as some Singaporean going to the Middle East, the US and Europe. Some Chinese money is finding its way to Russia,” says Guy Hollis, International Director, International Capital Group of Jones Lang LaSalle – Asia Pacific.
Australian view
The Australian contribution is unique among Asian countries. The Australian government’s national pension scheme has made it compulsory for employers to contribute 9% of worker’s funds to retirement funds. Many of these are then repackaged into REITs or listed property trusts (LPTs), as they are known in Australia. Consequently these funds have now grown quite large and represent approximately |
Chart 3 Source: DTZ. (click on the chart to enlarge) |
10% of the total capitalization of Australian stock markets. As a result, they are running out of local assets to buy.
Preferred investment vehicles
In terms of structured financial markets, China and the previous ‘Asian tiger’ countries are still relatively young; funds and REITs have not yet made a large impact. The first REIT in Singapore was launched in 2001. They are now becoming increasingly important in the region. “There is an appetite for investment in China assets at an institutional and retail level,” says Paul Hart, Executive Director of Knight Frank Hong Kong. “The recent listing in Singapore of CapitaRetail China Trust (CRCT) REIT is a good example of the extent of pent-up investor interest. These seven retail malls now trade a premium to NAV of +183% with an estimated dividend yield of around 2.2%. |
| In contrast Hong Kong listed, GZI REIT,comprising four commercial complexes in Guangzhou, are trading with an NAV at close to par giving an estimated dividend yield of over 6%. “Why is CRCT out performing GZI? Well there are a number of reasons. CapitaRetail is part of CapitaMall group, Singapore’s most respected retail operator and is a darling of the Singapore exchange. |
Chart 4 Source: Bloomberg as of 10-31-06, UBS research.(click on the chart to enlarge) |
| CapitaMall has worked hard at establishing relationships in China and their pipeline of future products is reflected in current pricing. The retail sector is also one that investors understand and like.” |
Strong retail sales China’s strong economic growth has resulted in the emergence of a growing middle class, which translates into a growth of consumerism and an increase in retail sales. But direct investment is still the most widespread investment vehicle. “There are not many inter-regional REITs apart from the Australian property trusts,” remarks Hollis. “There are a number of global funds fronted by investment banks such as Macquarie and Goldman Sachs, and a lot of private equity. In all, there is a rich diversification of investment methods, and increasingly direct |
Hong Kong Bay with its high-quality Conference and Exhibtion Center in front. |
| investment from the Middle East.” Equity capital is the most usual form of direct investment. C.Y. Leung reports that “If 5 represents no change in the amount of equity available for investment, and 9 a very large increase, the amount of equity available for investment from ‘all sources’ in Asia in 2006 and 2007 respectively will be 6.81 and 6.89. |
Emerging trends The Urban Land Institute, which published their second brief on Asia in 2007 entitled ‘Emerging Trends in Real Estate Asia Pacific 2007 survey’, showed that the largest increase of equity capital available in Asia countries was in Japan and China. It is difficult to generalize on returns in a region as large as Asia. Guy Hollis only commented on office returns as being anywhere from “between 3% to 8% for offices. Pick your market.” According to the ULI report, office and hotel/resort real estate appears to be the most popular for buy opportunities across Asia, however there is a problem of prime office availability in China. Owners of interests in retail, industrial, distribution and residential are advised to hold. There is considerable divergence between the way the markets are performing in various Asian countries and capitals. Singapore, Mumbai, Ho Chi Minh City, Tokyo and Osaka were rated as the top five office ratings. In the hotel and resort market, New Delhi, Mumbai and Ho Chi Minh form the top echelon, and in the retail market, Mumbai, Tokyo, Shanghai and Bangalore rank in the top five. |
Ho Chi Minh City is the prime real estate development center of Vietnam. |
Development the preferred way to invest capital The Urban Land Institute report states that development has become more and more popular in Asia: “Development is now a preferred way to invest capital in the Asia Pacific region, and many investors believe that it offers better risk-adjusted returns than core; it also allows investors to acquire new, high-quality assets on their own terms, albeit with higher risks.”
Market watchers, however, note that more government intervention is the downside to the political stability and openness which seems to be an irreversible trend in many Asian countries. “Even in Mainland China, where economic development tends to override other considerations, local governments there are seen to be favoring local residents on matters such as compensation for redevelopment,” remarks C.Y. Leung.
Government intervention in China aimed at cooling the economy has meant that it is more difficult for foreign investors to enter the market. A good example of this is Document 171, which outlines a series of restrictions pertaining to Chinese real estate. “These rules eliminate offshore holding structures for purchasing real estate assets and required paid in capital to 50% of the value of a project, reducing the amount of leverage foreign firms can use for their property investments,” states Michael Hart, head of research for Jones Lang LaSalle mentioned. “They also suggest that all future residential real estate developments, should on average have 70% of units that are 90 m2 or less in size. Many details of the announced rules were vague in this initial document and a wide range of interpretations ensued.” |
Special project vehicle Investment figures into China since the new regulations were announced indicate that they have had little effect on foreign involvement in the market, as most large players have already established themselves in China, and are large enough to deflect recent changes. According to Paul Hart, if anything, interest has increased: “There is significant new interest in the Chinese real estate market despite the measures introduced by the government to both cool the market and to limit foreign investment. Much of this investment has come from Australian funds but we are also seeing the large US industrial investors such as ProLogis and AMB increase their exposure.” As far as the elimination of offshore holding structures go, Paul Hart states: “Many investors today establish a special purpose offshore project vehicle which in turn holds the special purpose onshore project vehicle which then holds the asset(s).” |
Central Business District of Seoul, South Korea. |
Lack of product A major problem affecting crossborder investment into Asia is lack of product. C.Y. Leung mentioned that for every US $1 worth of investment grade real estate entering Asia, there are US $5 chasing. Others have placed the coefficient closer to 10 to 1. The cost of money in Asia, either from local or overseas sources is on the rise, forcing buyers to target higher growth expectations and exposing themselves to a higher risk. Market prices have risen in most Asian countries; cap rates have compressed so |
Singapore, one of Asia’s first ‘Economic Tigers’. |
much that further price hikes by cap rate compression is unlikely. The most likely solution seems to be the creation of more investment grade product, in China and India especially. However, given China’s huge foreign currency reserves, which now stand at US $1,000 bln., and the unwelcome upward pressure on the Renminbi, China can be picky about who it accepts as investor. This can be seen by the introduction of regulations over the last year. “There is no doubt that there is a lack of investment grade product in China,” says Paul Hart. “This has much to do with the lack of investment focus that many local developers have as well as a previous lack of quality standards.
Unfortunately, many developers in China still believe that predevelopment research is unnecessary. Often little thought is given to end-user’s requirements sometimes resulting in inappropriate column spacing, low ceiling heights, poor accessibility, under provided building services and poor servicing arrangements. Many of these problems cannot be rectified once the building is completed. That said, as the market matures we are seeing an appropriate discount being applied to these poorer buildings and this is presenting investment opportunities for the more adventurous investor.”
In further regard to this topic C.Y. Leung mentioned, “Increase in capacity will not come quickly. Despite the projected increase in 2006 and 2007 in the amount of capital for investment, because of the shortage of products, I would venture to suggest that the total amount of transaction in Asia pacific in the next 18 months will actually come down from the 2005 levels.” |
Human Resources Not unsurprisingly, the next biggest problem in Asia has to do with human resources. Asia is a big place, and many more manhours are needed to penetrate the emerging and not-so-transparent markets of mainland China, India and Vietnam, than those of Singapore or Hong Kong for example, leading to staff being very stretched on the ground – in China in particular. “Finding the right people is the most pressing issue. This is a hugely expanding industry, and it is very difficult to find people with the right skills and experience,” says Timothy Bellman. “There are two concerns. Firstly, how to retain talent, and secondly, is there enough of it to make all of your investments sensibly?”
Transparency
As a whole, transparency is on the rise throughout Asia, as it is in the rest of the world, with India now competing with China to become ‘semi-transparent’. The foreign |
Commercial Center in Beijing, China. |
| funds, developers and banks operating in China have not matched the volume in terms of building output as developers from Asia, but they have managed to increase standards with respect to conducting due diligence and maintaining transparency. Furthermore, this is a trend that is set to continue in future, which is positive news in a country known for major liability to third parties, not to mention a somewhat vague interpretation of the laws. In general, we find that pressure on cap rates throughout Asia are forcing investors to look further in order to find higher yields and a compromise on risk. |
Old and new Shanghai (China). Across the Bund (boulevard left) Shanghai has developed itself into a 21st century megapolis, with new landmarks such as the 468 meters high Oriental Pearl TV Tower which has a famous rotating restaurant at the top. |
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