Everyone was talking about REITs; you'd think it was the only game in town, even though only 10% of Asian real estate is listed. But the hype is to some extent understandable because REITs have been an Asian phenomenon in the last three years.
The Japanese J-REIT market is already worth $30bn (e23.9bn) and is expected to grow to $40bn in the next couple of years. Singapore has established itself as the second most important REITs market while Hong Kong is still getting its act together.
Mark Ebbinghaus of UBS in Singapore expects $2bn of REIT product to come to the market in the next six months. The challenge now for all IPO sponsors is to ensure a level of quality for their REIT
portfolios. Investors are being much more discerning and have not taken to some of the more financially engineered product that have appeared. Ebbinghaus says: "Asia is a ‘show me' market, it is not a ‘trust me' market. People buy into REITs as an acceptable
substitute for direct property, not as an alternative equity holding. We need to keep that distinction or
the asset becomes more closely correlated with broad equities."
The balance is certainly shifting towards REITs for a variety of reasons. In Singapore, because of the government's encouragement of the REIT market, it is actually tax inefficient to hold real estate investments in any other form.
The nature of the listed property proposition in Asia is quite different. Although June was a bad month for prices, the overall trend has been for REIT issues to be heavily oversubscribed. There has been some spectacular share price growth which has compressed yields, but as Michael Smith of Goldman Sachs points out, investors are attracted to REITs on the total return ticket of yield plus capital growth. He suggests REIT managers need to consider the style of products they are creating, particularly in the light of the adverse reaction to recent financial structurings that have used swaps to boost yield. "Total return is what the smart money wants," says Smith.
"It is important to articulate your objectives. As institutional investment grows, it concentrates into smarter money pools, and their objective is growth rather than income." A good quality REIT product will continue to find a home, say the bankers. The problem is in finding the quality.
Private equity including pension and insurance funds, represented 29% of the global total of $780bn flowing into real estate last year. RREEF's Peter Hobbs made the point that Asia's markets, while showing great potential and with a huge pool of investible assets still to be tapped, remain emergent and therefore higher risk. Over 70% of Asia's market is ‘maturing' compared to 15% in Europe and 1% in the US.
The pace of the maturing is encouraging though. Asia now has a much broader investible universe of real estate and the marketplace is growing all the time. You only have to look at the underweight allocation of pension funds around the world and the virtually nil allocation in Asia. To surmise there will be significantly increasing capital flows that will have the effect of keeping yields down. Allied to this will be an ongoing substitution from private institutional ownership to REITs. So the ability to package investments suitable for the pension fund community presents a great opportunity over the next 20 years.
Mark Gabbay of Lehman Brothers in Asia suggests investors who are used to an IRR investment structure may be encouraged to use more leverage. "The important thing to consider is when capital does move out, who will be the lender of last resort?" Gabby says. He adds: "We can expect to see a greater amount of volatility."
Share price hiccups will be dictated by capital flows and I would expect flows will continue to be volatile (certainly until the market is deeper, broader and the excesses have been worked out).
European investors are now as focused on Asia as they are on the US. China, Hong Kong and Japan are the most attractive markets. China is the market that has really captivated European investors while US investors are the biggest investors in Japan.
US investors will continue to invest internationally and increasing wealth in Asia will strengthen cross-border investment. The activity of hedge funds has been increasing in the real estate space. David Moritz at Credit Suisse in Singapore says they have been a key component in a number of recent deals handled by the bank. "They have toyed with the idea of getting into direct property, but most of them don't consider this their area of expertise."
According to Kiran Patel at Axa Real Estate IM, Asia's share of the total real estate transactions has increased from 8% in 2003 to 14% in 2005. While the US and Europe saw a net disinvestment by global funds in 2005, there was a $4.2bn net inflow into Asia.
Once you take Japan out of the picture, nearly all of the flow is cross-border. So who is doing the investing? It is largely US funds, Middle East investors, Europeans and Australians. They are using opportunity funds, core and value added, and participating in the REIT space.
Asia's share of cross-border activity represents 30% of the total transactional Asian activity, $20bn out of an Asian direct property investment total of $67bn. Cross-border growth has doubled in the last two years. Patel suggests Asia is following the same trend in Europe where cross-border activity has gradually overtaken the amount of direct domestic investment in real estate.
China is expected to continue leading global economic growth, which will drive development opportunities. According to Citigroup Property Investors' managing director Jim Green, China opportunities will remain focused on the eastern regions, particularly the Pearl River Delta and along the Yangtse River. China opportunities are apparent in the Shanghai office market, residential development in secondary cities, retail across the board and industrial near ports and manufacturing centres. He adds that distressed debt could later create opportunities in China. For China, he says, the well-capitalised developers are really the ones who will benefit.
Dr Leonard Mayer zu Brickwedde, chief executive of Hypo Real Estate in Asia, sees plenty of potential pitfalls in China: "The risks in China are that growth slows down to unacceptable levels, leading to unrest. We also face the issue of how does it work in practice? If a particular strategy works in one area of China, it doesn't follow that it will be acceptable in another. The same applies to India."
India is the next hot destination. Its $12bn real estate market is expanding fast, with projections that it will grow to around $50bn in the next five years. In order to promote foreign ownership, the government will now consider easing FDI rules for companies willing to invest over $10m on specific projects and in larger general projects over 545,000ft2.
TSI Ventures in Bangalore, a joint venture between Tishman Speyer and India's largest privately-owned bank ICICI, has earmarked $1bn for Indian real estate ventures.
Whether the risks are real or perceived, an investment in an emerging real estate market has to have some added benefit. So what sort of risk premium do investors expect from maturing markets? In a market such as India, it could be 200-300bps.
Mark Gabbay suggests that retail in Asia is a good place to be right now. "And residential in the vicinity of casino and gaming developments, or sea view opportunities."
Shortage of supply in the Singapore office market could be seen as holding back its development as a financial centre to rival Hong Kong. The consensus at the conference was that Singapore will nonetheless develop as a sound office investment market. With $5bn of land sales in Singapore in the last year, the government has taken a pragmatic view by saying it will collect fewer taxes to attract foreign capital, but as money needs to be redeployed the government encourages these investors to buy more land in Singapore.
Asian investing poses many challenges and risks of course. RREEF's managing director in Hong Kong, Brian Chinappi, comments: "It is impossible to mitigate the government or regulator policy risk in Asia and we don't expect that risk to go away. So the challenge is to find areas that have a low level of political or regulatory risk."
Chinappi added that "a potential lack of discipline" in the market is also a risk: "It is important to emphasise the need to be very local in your attitude and to avoid those markets prone to blow-outs." Staffing is also an issue, with the banks finding it difficult to hire staff with experience in real estate.
Moritz at Credit Suisse says another risk is in over-estimating the ability of these countries to change in the next five to 10 years. It might take much longer than that.Meanwhile, yields are expected to remain steady, guided by the combined forces of rising interest rates and rising capital values.