About Us
International Real Estate situation
Thai Real Estate Situation
Costs of Constructions
Contact Us

The Growing Signs of Recovery And the Future Of Asian
Real Estate From a Global Economic Perspective

VAT News Vol.1/2001

Gordon Davis
Director, International Affairs
National Association of Realtors (NAR)

        This paper discusses the signs of recovery in Asia after the 1997 crisis. What the future holds for the regional real estate market in a borderless world is also focussed on.
        To steal an allusion from a famous British statesman, we may not have seen the beginning of the end of Asian economic troubles, but surely we are well past --- well past indeed --- the end of the beginning. The outlook is one of guarded optimism, and there is a growing array of investment opportunities as the market firms here.
        We are going to look at elements of the Asia real estate market, not from a local perspective but from a global perspective. Why? Asia is now more than ever a part of the global real estate market --- rather than isolating Asia, the 1997-98 meltdown accelerated the process of world market consolidation. The recovery is accompanied by the arrival of investors from the U.S., Europe and elsewhere who are comparing opportunities here with others around the world. This presentation will suggest to you some of the factors international investors will be weighing as they look over the opportunities here in Asia. Others at this conference will go into detail on the opportunities in various markets; but my presentation will remain somewhat general. I will first review some of the relevant history.
        Before I get into the body of my discussion, I would first like to provide a preview of the topics that I will be addressing today:
1. How Asia fits into the global economy.
2. Asia economic overview
3. Causes of the Asian flue and its impact on the world economy.
4. Growing transparency or availability of real estate market information.
5. Some brief comments on the major Asian markets.
6. How institutional investors are pricing country related investment risk.

ASIA in the World
        With a population of nearly 3.4 billion, Asia dominates the world. According to Standards and Poor's/DRI World Economic Outlook, 56.3 percent of the world's population resides in Asia. Looking toward the future, population growth in Asia is projected to be on par with the world average. The slowdown in population growth in China has harmonized the region's population growth with world statistics. The Middle East and Africa have growth rates well above the worldwide totals over 2.0 percent per year respectively. Meanwhile, Eastern and Western Europe are projected to grow at rate far below the world average, less than 0.5 percent per year respectively.
        However, Asia's domination of the world population has not been carried over into the economic arena. In terms of GDP, both North America and Western Europe lead Asia. With a world economy estimated at 30.9 billion in 2000 by Standard & Poor's/DRI, North America and Western Europe have GDP's that when combined account for 63.0 percent of the world's population, but only 14.3 percent of the world's population. Meanwhile, Asia accounts for 56.3 percent of the world's population but only 25.1 percent of the world's GDP. By 2005, this number is projected to increased to 25.9 percent. Nonetheless, in the near-term, Asia is not projected to challenge North America and Eastern Europe for economic supremacy. However, in the long-term, North America and Western Europe will not go unchallenged by Asia.

Asia Economic Overview
        With a combined population of nearly 2.3 billion, China and India account for 67.9 percent of the region's population. In 2000, Standard & Poor's/DRI population estimate for China's was nearly 1.3 billion and just over 1.0 billion for India. With a stronger population growth rate, India's population is expected to rival China's population this decade. At 210.7 million, 150.8 million, 127.4 million, and 126.9 million the respective combined populations of Indonesia, Pakistan, Bangladesh, and Japan approach neither China nor India in population.
        Similar to the worldwide GDP statistics statistics, population dominance does not translate into economic dominance. With a population comprising only 3.8 percent of Asia, Japan's GDP accounts for stunning 50.6 percent of the region's GDP. With a per capita GDP of $30,897 in 2000, Japan is far ahead of the $874 and $442 per capita GDP of China and India respectively. Given the emergence of India as a major technology center, large gains in GDP are project during the decade.
        With a per capita GDP of $31,969, Singapore is the only Country in the region with a higher per capita GDP than Japan. The per capita GDP of $23,459 and $23,919 for Australia and Hong Kong respectively represent the next closest countries to Japan.

Asian Currencies appear to have stabilized throughout the region. Moody's has signaled its intent to upgrade credit ratings of Malaysia and Hong Kong. Standard & Poor's credit ratings for China and Malaysia are holding steady, and Hong Kong's and the Philippines' downward slide has apparently been arrested. Thailand's credit rating slide was steeper, and the jury is still out there.

Asian Flue
        According to a report by Prudential, property values in Hong Kong, Singapore and South Korea bottomed out in 1998. Other countries' property markets seem to have more or less stabilized in 1999. We will doubtless hear more about specific country markets later today. But as an approximate regional prognosis, I quote you this statement from Prudential: "Overall, the current conditions of the Asian real estate markets can be best described as stabilizing with signs of recovery.
        Buoying the Asian recover has been the brevity of the economic cycles. The Asian flue swept through Asia in months and swiftly plummeted the Asian economies into a deep recession. It would have taken years for a similar incident to have fully reverberated through the U.S. economy. In terms of the economic recovery, the sharpness of economic cycle is turning into a benefit. What goes down rapidly has the ability rise nearly as fast - which has been the recent experience of many Asian economies. However, Asian governments and central banks are attempting to manage their economies in a manner that will reduce the amplitude of future economic cycles.
        Tom Friedman, the foreign affairs columnist for the New York Times, has written a terrific book that I encourage you to read called "The Lexus and the Olive Tree." It is an excellent discussion of what we're all calling globalization. Friedman is not an economist, but he has produced the most readable explanation I have found of the happenings here in Asia, and subsequent events around the world, that began in 1997.
        Friedman begins with a riveting description of the Thai currency crisis. You are all painfully familiar with this, but indulge me. The Thai finance houses had borrowed dollars, and re-lent them locally for the building of hotels, offices, luxury apartments and factories. Many Thai real estate developers had also borrowed dollars and other hard currencies directly from foreign lenders. Most of the debt service was supported by Baht-denominated business activities. But --- thousands of currency speculators around the world, operating independently, had sniffed out that there were underlying problems in the Thai economy. They sold Bahts, vast amounts of them, requiring the Thai government to defend its currency by depleting its dollar reserves. When the government strategy failed, the Baht sank 30% against the dollar.
        Now those responsible for servicing all these dollar loans had to come up with 30% more Bahts, and many could not, bankrupting the borrowers. Complicating the situation was that many of the Thai finance houses' loans and also many of the direct loans to developers had been short term or demand obligations, and the lenders now demanded repayment. In December of 1997, as most of you will remember, the Thai government closed most of the finance houses in Thailand. They were bankrupt. The Thai economy very nearly collapsed.
        Provoked by these attention-grabbing developments, investors around the world began to look closely at their investments in all of the Asian emerging markets --- Indonesia, the Philippines, Malaysia, Taiwan, China, even those Southeast Asian paragons, Singapore and Hong Kong. As many of the same factors found in Thailand were spotted in these economies --- inflated prices, overbuilt sectors, off-books obligations, unacknowledged bad debts being carried by banks, cronyism, etc., there was a rapid and across-the-board flight of capital from these markets, sparking a general rise in interest rates. The Asian meltdown didn't end in Asia, of course.
        Let's continue with Friedman. Because of the resulting Asian recession, commodity demand in the region dried up, hence commodity prices dropped. This devastated Russia. The Russian government depended on oil and other commodity prices to finance its government operations. When their prices plummeted, Russia had to sell bonds with stratospheric interest rates to cover its cash shortfall. Hedge funds and foreign banks bought them, confident that a sovereign nation would never default on its bonds. But in August of 1998, Russia did the unthinkable --- it defaulted. The hedge funds had actually borrowed money in order to buy Russian bonds. To cover their loans they were now forced to cash out their assets in Brazil, Korea, Egypt, Israel, and Mexico, which drove interest rates through the roof as these countries tried to stem capital flight. A general flight to US Treasuries occurred, driving down yields, which wiped out other major players including the huge US hedge fund Long Term Capital Management that had bet Treasury yields would go in the opposite direction. We were very near a global meltdown. Friedman quotes USA Today: "The trouble spread to one continent after another like a virus. U.S. markets reacted instantaneously. People in barbershops actually talked about the Thai Baht."
        Some people disagree with Friedman that the problem started with currency speculation. Paul Krugman, another New York Times columnist (who in his day job happens to be an international economist) thinks that the currency crisis was not the cause, but one of the effects of an Asian asset bubble that saw real estate prices rise rapidly, then decline prior to the run on the Baht. He points out that none of the conditions of the classic currency crisis were present in the affected Asian economies: large government deficits, rapid monetary growth, and rapid inflation. They did not have high unemployment, leading to expansionist monetary policies. In all cases, financial institutions seemed to have played a part. And, most significant in terms of our professional interests, they had all experienced stratospheric increases in real estate prices. Krugman put it this way: "In all of the afflicted countries there was a boom-bust cycle in the asset markets that preceded the currency crisis: stock and land prices soared, then plunged (although after the crisis they plunged even more)."
        I would hate to leave you with the impression that economists are unanimous on the causes of the Asian crisis, or, indeed, the solutions. Professors Jeffrey Sachs and Woo Wing Thye, of Harvard and the University of California, Davis, respectively, argue persuasively that the mechanism was not astronomic asset prices, though that did not help, nor structural and policy problems endemic to all the Asian economies, but the ill advised defense by Thailand of its currency, doomed to fail, and the ensuing full blown financial panic that resulted when the Thai government had to give up on July 2, 1997. They also take the IMF to task for administering the wrong fiscal and monetary remedies in the short term, which they say made matters worse.
        Regarding the appropriate medicine for the Asian flu, there is probably more of a consensus among the world's investors than among governments, or economists, maybe even of IMF officials. Let me quote to you from a recent Ernst and Young publication titled "Asian Real Estate Report" that advocated a continuation of Asian financial system reform. "U.S. firms continue to advise Asian governments and banks in instituting financial system reforms including merging or closing insolvent financial institutions, writing down shareholder capital, recapitalizing banks and finance companies, increasing supervision of weak institutions, and promoting foreign participation in domestic financial systems."
        Friedman says that international investors --- the "Electronic Herd," he calls them, because of their use of the internet and other instantaneous communications techniques--- are generally encouraging countries striving for an investor friendly environment to embrace these goals: "Maintaining a low rate of inflation and price stability, shrinking the size of its state bureaucracy, maintaining as close to a balanced budget as possible, if not a surplus, eliminating and lowering tariffs on imported goods, removing restrictions on foreign investment, getting rid of quotas and domestic monopolies, increasing exports, privatizing state-owned industries and utilities, deregulating capital markets, making its currency convertible, opening its industries, stock and bond markets to direct foreign ownership and investment, deregulating its economy to promote as much domestic competition as possible, eliminating government corruption, subsidies and kickbacks as much as possible, opening its banking and telecommunications systems to private ownership and competition, and allowing its citizens to choose from an array of competing pension options and foreign-run pension and mutual funds."
        More important than the prescription for change, though, is this point: the Asian meltdown, which rapidly became a financial panic and a crisis threatening the global economy, has left an indelible mark on international investors --- those individuals and firms that even now are evaluating possible investments in your Asian economies. The dramatic transformation of world capital markets that occurred prior to the Asian meltdown gave investors around the world access to investment opportunities in every corner of the globe. In the aftermath, as these thousands of investors lick their wounds, dust themselves off and pull up their socks, they perceive this lesson: market access without fully available market information --- I refer to that as transparency --- is a prescription for disaster. In the aftermath of the Asian meltdown investors are acknowledging that they cannot adequately evaluate risk without information. Investors, more than anything else, are demanding transparency.

        Jacques Gordon, Managing Director of LaSalle Investment Management in Chicago, recently published a thoughtful paper entitled "International Transparency in Real Estate Markets." His thesis is that access to information on the investment characteristics of commercial real estate markets varies greatly from country to country but, in general, is improving globally in response to investor demand. As a result, market efficiency will increase, and investors as well as occupiers will greatly benefit. But the improvements are not across the board. Some markets get it, and are doing better than others.
        How is transparency improved? Gordon believes that International Accounting Standards (IAS) and Generally Accepted Accounting Principles (GAAP) will increasingly be applied internationally. Indicators such as Net Asset Value (NAV) as used in Europe and Australia, and Funds from Operations (FFO) as used by U.S. REITS are useful when standing alone, but it is even better when both measures are used simultaneously.
        According to Gordon, in some countries, investor access to senior management of property companies is now easier to achieve than in the past. Independent, outside directors are now becoming the norm in key countries where in the past boards were packed with family members, the company's bankers, lawyers and accountants, and other cronies. The need for regular communication with investors is becoming generally recognized. Performance statistics are now being published in a number of markets where information heretofore was not available. Institutions patterned on NAREIT in the United States are pooling industry information in some countries. Again, though, many of these changes are country specific, and a country may have cultural biases that leads it to favor or resist particular reforms.
        These developments are producing greater transparency, according to Gordon, which makes for more intelligent and accurate risk assessment in those markets. The clear import is that international real estate investors will opt to do business in the transparent, not the opaque, markets whenever they can, other things being equal.
        How transparent are Asian markets? Generalizations have limited value, of course, since Asian markets share a few characteristics, but they are also unique. China with its nearly 1.3 billion people has little in common with Singapore that has 3.2 million. GDP per capita in Japan is $34,400 and in Indonesia only $747. Yet it seems fair to say that in general there have been improvements in the economic fundamentals, the structural characteristics and --- yes, the transparency --- of most Asian markets since the meltdown. Jacques Gordon says that the higher financial reporting standards characteristic of Hong Kong and Singapore are gradually being adopted in Japan, Korea, Taiwan and Thailand. The Korean Chaebol have now apparently acknowledged the full extent of their indebtedness --- $100 billion instead of the originally reported $50 billion. Some Japanese companies are acknowledging off-books loan guarantees. Several countries, in varying degrees, are getting serious about non-performing bank loans. Japan, Korea, Malaysia and others have created national asset management companies patterned on the U.S. Resolution Trust Corporation, and some, particularly Korea, have begun aggressively disposing of NPL's.
        There is some hard evidence, moreover, of progress in other areas that indirectly relate to transparency. Indonesia has promised extensive reforms in exchange for new IMF backing. The Philippines has made some progress in dealing with its deficit problem. Thailand and Korea have both adopted new bankruptcy laws. Japan is about to launch the Japanese version of the REIT, which will be governed by rigorous financial reporting rules.
        Surely in part as a result of the various reforms underway, confidence is up and markets throughout the area are showing signs of life. Here are some indicators:

Country Comments
Between the Internet and major institutional real estate players such as Jones Lang LaSalle, Lend Lease, CB/Richard Ellis, and Colliers International and accounting firms such as EY/Kenneth Leventhal there is an abundance of real estate information on the Asian markets. Drawing from these sources an overview of the real estate market conditions for some Asian markets will be addressed briefly. However, other programs in this conference will present more current and perhaps accurate information - you be the judge.
• Office market conditions vary from extremely strong in the central business districts of Sydney and Melbourne to stagnant in Adelaid and Perth.
• The lack of available Class A office space in Sydney has pushed up lease rates and has reduced yields as institutional investor via for the limited amount of available properties. Sydney is no place for bargain hunters.
• The robust economy has strengthened retail and industrial/warehouse markets.
Hong Kong
• Institutional quality product rarely comes on the market and is expensive. Investment opportunities are in smaller scale retail projects and multi owner office buildings.
• Large additions to the office supply coincided with a general downturn the economy resulted in higher vacancy rates and reduced lease rates.
• The retail market is undergoing a major restructuring with the introduction of larger scale shopping centers. Because of the lackluster economy, retailers have had to work hard to maintain market share.
• The industrial market has been on a long-term downturn. Many older industrial buildings are being targeted for redevelopment.
• It appears that the commercial real estate market bottomed-out in 1999. However, years remain for the commercial market to be fully recovered.
• The recovery of the stock market set the stage for the recovery economy in 1999 and further improvement in 2000 and beyond.
• A much milder strain of the Asian flu struck Singapore and did little to reduce the high real estate values, which are unattractive to foreign investors.
• Since the early 1990s, The governing Liberal Democratic Party nearly doubled the national debt while unsuccessfully attempting to spend Japan out of recession.
• Japanese banks have been slow to liquidate bad loans from their books. By year-end 1999, only about 10 percent of the $800 to $1,200 billion in bad real estate loans have been liquidated, representing a potential buying opportunity for investors. Loans have been liquidated at 15 to 20 percent of book value.
• Few property sales have occurred to foreign companies because of relatively high asking prices.
• The pending J-REIT legislation will provide the opportunity to invest in Japanese real estate. However, the low anticipated dividends will not make J-REITs attractive to foreign investors. The lack of an UPREIT structure, which allows companies to contribute properties without creating a taxable event, may slow the contribution of properties to REITs.
• In Tokyo, office lease rates should decline due to the addition of new supply over the next several years.
• As Japanese companies restructure there has been a significant movement to reduce the size of their balance sheets by selling corporate headquarters buildings. The steady supply of these buildings should prevent the rapid escalation in building prices. Nonetheless, unleveraged capitalization rates in the 5 percent range will not bring out the bargain hunters.
• Massive civil unrest has slowed Indonesia's recovery and investor interest.
• The government passed strong measures to compel debtors to work aggressively with financial institutions to restructure bad debts.
• Opportunities for foreign investment exists as some of the government owned banks look to dispose of high quality commercial real estate assets that include luxury hotels, Class A office buildings, and quality apartments.
• Unlike Japan, Korea has aggressively marketed non-performing real estate assets from failed financial institutions, which has sped up the real estate recovery.
• When the Asian Flu struck Malaysia, Prime Minister Mahathir Mohamad went his own way by turning away from the International Monetary Fund for a bailout. Instead he initiated currency exchange controls to prevent speculators from driving down currency value and hunkered down to wait-out the economic maelstrom.
• The large inventory of non-performing loans has not been reduced due to the reluctance of Danaharta, Malaysia's Asset Management Corporation, to dispose of foreclosed properties through bulk sales.
• Investors in office property will have to accept slow leasing or reduced rental rates due to overbuilt market conditions.
• The government is attempting to slash large deficits through fiscal reform measures that are intended to buoy business and consumer confidence in the economy.
• Strong economic growth is projected for 2000.
• Taiwan's real estate markets were traumatized by the Asian Flu and then by a massive earthquake in 1999 that caused an estimated $9 billion in property damage, precipitating bank write-offs of $300 million to $1 billion in mortgage loans.
• The dramatic devaluation of its currency and stock market collapse has reverberated into the real estate sector.
• Banks have shown little flexibility in restructuring debt and commercial real estate markets are significantly overbuilt.
• Poorly underwritten real estate loans by state owned banks could result in losses as much as $105 billion.
• Vacancy for commercial real estate in major cities is estimated to be between 50 percent and 80 percent.
• China is expected to start liquidating non-performing loans in 2000. However, because property is owned on a lease basis foreign investors are skeptical that there property right will be protected.
• Construction of telecommunication infrastructure represents a significant business opportunity for real estate developers.
• The small size of the Vietnam economy, $25.8 billion GDP in 1999, Indicated that it is one of the smallest emerging markets with significant risk due to lack of infrastructure.
• Non-performing loans are estimated to be in the 40 percent range and government agency has displayed little fervor in the liquidation of the failed loans.

Country Risk Analysis
        The real harbinger of Asian recovery is the return, in moderate strength, of international investors. This is critical, according to Ernst and Young, because Asian banks will not be able to play their traditional role in helping to finance the region's growth until they are able to clear the vast aggregation of NPL's still on their books.
        For this reason, I want to use the remainder of my time to discuss one approach --- which I would argue is typical --- to real estate risk assessment now being employed by international investors, as they tiptoe back to Asia. Every potential investor in Asia now has an array of options in other parts of the world that compete with the potential deals he could do here. It is important to understand the approach investors are taking as they compare European apples, say, to Asian oranges.
        I commend to you two papers available on the Prudential website. The first, by Conner, Liang and McIntosh, is entitled "Myths and Realities of International Real Estate Investing." They classify risk into three levels: country, market and deal, which to a certain extent are additive. The country level of risk reflects the stability of the country, the degree to which the economy is developed and financial markets are integrated into the global capital market, and to some degree the legal system. Country risk denotes long term risk. Market risk refers to property and economic cycles and, therefore, is more short term. Deal level risk is specific to individual investment opportunities.
        In general, country risk can be classified core, core plus or emerging market. The U.S., Japan and most European countries are core; Hong Kong, Singapore, South Korea, and Taiwan are core plus; and China, Thailand, Indonesia, Malaysia, and the Philippines are emerging market countries for country risk assessment purposes. Under this classification system, about 80% of the universe of higher grade commercial real estate is in core countries, 12% core plus, and 8% emerging markets.
        A U.S. based investor or an investor in another core country will naturally expect a progressively higher absolute return if he invests in a core plus, or an emerging market country. This reflects the obvious assumption that investing in a core plus country entails greater risk than in a core country, and investing in an emerging market country is riskier than in a core plus country. The risk premium an investor expects rises with risk, of course, and would be greatest when investing in an emerging market country.
        Actually calculating the three components of risk assessment --- country, market, and deal --- can be very complicated, with judgment calls aplenty, and two intelligent investors would not necessarily arrive at the same result. For example, in calculating market risk, it is generally agreed that opportunities are greater at the beginning of a market cycle, but accurately identifying the beginning of the cycle is not always easy, and quantification is always guesswork. Deal level risk is sometimes more quantifiable, for example, where there are tenants with reliable credit ratings and track records.
        Country risk is typically the largest, and hence most important component of overall risk assessment. The second Prudential website paper I mentioned earlier is helpful in connection with country risk. It is titled "Country Risk Premiums for International Investing," and is attributed to Liang and McIntosh. It points out that the historical approach to quantifying country risk has been to subdivide it into its components, such as political risk, economic risk, legal risk, currency risk, etc., to estimate a risk factor for each, and to add them together.
        Liang and McIntosh suggest another approach, which I find to be ingenious and extremely useful. They have developed country risk premiums based upon two publically available sets of figures. The first is the country credit rating numbers published twice yearly by Institutional Investor, and the second is the stock market returns of 53 countries tracked by Morgan Stanley Capital Market International. Without going into the regression analysis, I offer you this table, which contains the calculated risk premiums for the Asian countries plus a few others around the world. Actually, what you see on the right is the Expected Return, assuming that a competing investment in the US would be expected to return 12%.

Australia 13.4%
China 19.0%
Hong Kong 15.2%
Indonesia 26.4%
Japan 12.6%
Malaysia 18.6%
New Zealand 13.9%
Philippines 20.0%
Singapore 13.2%
South Korea 17.5%
Taiwan 14.2%
Thailand 19.4%
Belgium 12.8%
France 11.9%
Germany 11.9%
Netherlands 12.0%
Poland 17.3%
Russia 34.9%
Argentina 20.4%
Brazil 22.5%
Chile 16.7%
Canada 13.0%
Mexico 19.4%
South Africa 20.1%
United States 12.0%

        Bear in mind that these figures are the country risk only, and would have to be modified by market risk and deal risk. I think you see the point, though: to be competitive, deals in Asian countries would have to show risk premiums over comparable deals in the US or Europe of anywhere from .6 to over 14 percent. A deal in South Korea would have to show a risk premium in excess of a comparable deal in Chile. A deal in Malaysia would need to show a risk premium higher than a comparable deal in Poland.

        Let me try to sum up. On balance, there is no doubt in my mind, nor apparently in the minds of the financial commentators I have read, that Asia is on the way back. Colliers Jardine has posted on its website a ringing commendation that I would like to quote: "Asia's continual economic recovery has revitalized the region's property sector since the forth quarter of 1999, with a significant growth in tenancy demand, take-up rates and office rentals recorded for key markets including Singapore, Hong Kong, Seoul, Taipei, Bangkok, Beijing and Shanghai." They go on to say, "Although the pace of recovery may differ for the various markets, the overall outlook is positive. Most of the fundamentals are in place for a property market rebound in the region, with investor confidence returning, a growing tide of corporate expansions, and the boom of telecommunications and dot-com companies."
        The message here in Asia is of restructuring, rebuilding, rethinking the Asian relationship to the rest of the world and, if all of the national economies are not yet infused with great underlying strength, there is nevertheless discernible determination to meet international standards in ways that will guarantee new access to international capital. As I said at the outset of this talk, Asia is now more than ever a part of the global real estate market --- rather than isolating Asia the 1997-98 meltdown accelerated the process of world market consolidation. Your recovery is heralded by arrival of international investors --- from the U.S., Europe and elsewhere --- who are carefully comparing opportunities here with others around the world. I feel certain that the prognosis is good for you, and for investors across the globe.

@area 5/15, Nonsi Road, Chongnonsi, Yannawa, Bangkok 10120
Tel: 66-2295-3171 Fax: 66-2295-1154 Email: info@thaiappraisal.org  VISIT US: Location Map