Gordon Davis
Director, International Affairs
National Association of Realtors (NAR)
Introduction
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.
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.
Australia
• 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.
Singapore
• 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.
Japan
• 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.
Indonesia
• 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.
Korea
• Unlike Japan, Korea has aggressively marketed non-performing real estate
assets from failed financial institutions, which has sped up the real estate
recovery.
Malaysia
• 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.
Philippines
• 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
• 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.
Thailand
• 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.
China
• 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.
Vietnam
• 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%. |
