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Accessing the Asia real-estate story Reprinted from AsianInvestor October 2010 alternatives Real Estate Roundtable Accessing the Asia real-estate story Real-estate investors of all stripes debate the opportunities for investing in Asian assets as the region demonstrates continued economic strength after the global financial crisis. Tell us about yourselves and the property investment businesses that you work for. Richard Yue: I run a company called Arch Capital, which is based in Hong Kong. We’re a boutique real-estate privateequity fund management company with specialty in developing and managing residential and retail mixed-use investments. Our footprint is ex-Japan Asia with a focus on Greater China and Southeast Asian countries, including India. We have just made our fund’s first investment in Singapore. Participants Richard Yue CEO, Arch Capital Chris Calvert, CEO, Cambridge Industrial Trust Management Limited Richard David CEO, Treasury China Trust Luke Sullivan Senior vice president, portfolio manager, Cohen & Steers Chris Calvert: I’m responsible for running the Cambridge Industrial Trust which is a Pan-Asian mandated industrial REIT. It is one of five such vehicles listed on the Singapore Stock Exchange (listed July 2006) and has a market capitalization of around S$500 million. It has just under a billion dollars of assets under management. We have a balanced mix of institutional and private investors. All the current assets are in Singapore. We may look to make acquisitions outside Singapore in the future. For our first three years of life we were listed on the UK AIM board. We have S$2 billion in assets. We have a team of 80 people in China, and we handle the whole process from execution through to development management and asset management. Richard David: We listed on the Singapore Stock Exchange this year and we have a focus on commercial real estate in China. Luke Sullivan: Cohen & Steers is a manager of income-oriented equity portfolios specializing primarily in global real-estate Moderator Simon Osborne AsianInvestor securities. Our firm currently manages $26 billion and I’m the Asia Pacific portfolio manager based in Hong Kong. How do you perceive today’s real estate markets and what has been the impact of the global financial crisis? Calvert: The global financial crisis has changed the way investors have looked at Reits. Before 2009 a lot of investors saw Reits as being a capital play, but in our view Reits should always be considered as a defensive asset class and principally an income product that provides a stable and secure income stream. Lately, that perception of it being a defensive play, with the ability to provide some longer term growth, has been accepted more widely again. Sullivan: Asia has withstood a lot of external pressure and has come through the turmoil in a strong position. We’re optimistic that lessons have been learned, especially where some firms used financial engineering to the ultimate detriment of their shareholders. What the crisis highlighted is that investors want assets that can perform through the cycle. We’re now seeing continued resilience and a re-rating of assets with these cashflows. Yue: Banks generally preserved lending lines for their best, existing customers. Aligning ourselves with strong local partners ensures our access to credit. Through the crisis some property investment firms took on too much leverage and risk, and were badly hurt. Has investor risk appetite returned? David: They are looking more at the cashflows that emerge from assets, and that applies not just for Reits, but more broadly. Yue: Developers with large landbanks and moderate leverage were under pressure as they had undergone a cash squeeze. But they are now back out buying land again, and building landbanks. Many were saved by the slush of bank liquidity which came along with the stimulus packages that hit the markets. Sullivan: From a risk perspective, some investors have gone into their shell. We are trying to allocate capital to companies where we believe they have the right capital structure. For example, not simply relying on short-term debt throughout a development cycle. Luke Sullivan: Allocating to companies with the right capital structure David: Although some firms have come under pressure, the banks have been quite patient in Asia, and one explanation of why this may be so is because lessons were learned in the Asian financial crisis in the late nineties. I think that’s partially true, but the bank’s patience was also helped by the fact there was no currency crisis in Asia this time. Yue: In Asia, distress never showed up on the hard asset front. Developers, learning from previous cycles, generally have much lower gearing at present. Banks are better capitalized and have certain limits on their real-estate exposure. Throughout the crisis, we were able to get project level finance in China, Macau, India and Thailand. The banks were lending because there was plenty of liquidity. David: When we were UK listed, most of our lenders were European. We’ve now refinanced 80% of our debt with Asian banks. For good projects and good sponsors, financing is still there. “People are looking for economies of scale from platforms. Where there are a lot of small vehicles, there’s the opportunity for consolidation.” Calvert: I’m hearing different messages. Markets have been choppy for the last couple of months, so it may not be over quite yet. In Singapore we saw a tremendous recovery in the first half of this year. With the emergence of the European sovereign debt issues, and the slowdown in China’s growth cycle, there’s still a fair bit of caution out there and this may present a challenging second half of 2010. Our investors are saying that capital and risk management should remain a top priority, and we agree. That said, some unit-holders have said to me that they’d be happy to see the trust’s gearing increase. That surprised me given how recent the crisis was. There are mixed views, but ‘keep it steady’ is the main message, and err on the side of caution. Sullivan: I’d also say that people are looking for economies of scale from platforms. Where there are a lot of small vehicles, there’s the opportunity for consolidation and reduce expense ratios for unit-holders. Sensible M&A is one aspect I’d like to see eventuate in many Asian markets. alternatives Real Estate Roundtable conservatively suggesting the Manager reduce gearing. China property: a bubble? David: I’m in the ‘non hot’ camp. I’ve been involved in that market for 11 years, and this is about the fifth set of austerity measures I’ve witnessed. They’re trying to dampen down demand, but this is not a typical boom/bust cycle. Demand there does endure. The only way to stop this on/off austerity cycle every two years is to tackle social housing countrywide. That will only resolve itself if income from auctions for land sales isn’t such an important component of local government revenue. Yue: Demand is there for housing. Market drivers are still strong: urbanization,the growing middle class, rising incomes, growing consumption. Inventories of developers are dwindling, affordability is still reasonable. David: The government’s influence is so overarching. Take hotels for example. In 2001, the central government said “No more 5-star hotels in Shanghai”, then the World Expo came along and they didn’t have enough premier hotels. Richard David: Chinese demand for real estate is structural To what extent is activity back to precrisis form? Are people attempting the same sort of deal structures? Sullivan: Slightly concerning, we are observing some undesirable features in recent IPO deals. Companies wanting to raise a significant amount of money are finding that investors are somewhat more discerning. There have been some IPOs, some successful and some not, with deferred management fees over paying dividends, with management fees paid out of shares, and sales/leasebacks that don’t reflect underlying economics in the properties. In our discussions at pre-IPO stages, we are doing our best to encourage cleaner structures. David: Given our experiences, I can definitely endorse that the cleaner and neater the structure is, the better reception it receives from investors. Yue: Moving away from IPOs, I would say that land prices are one particular issue that is returning to pre-crisis levels. In China and Hong Kong there are record prices being paid. That means they see sentiment and property prices going higher. What about gearing? Are investors comfortable with it? Calvert: Some investors are currently comfortable for Cambridge Industrial Trust to be leveraging up. Although, just a year ago (post the aftermath of the global financial crisis), they were Yue: Our China strategy is to focus on 2nd and 3rd tier cities in housing, retail and mixed-use, and to be beneficiaries of the new major infrastructure that enhances transport links. We think there may be some overheating in tier-1 cities but for the longer term, we are still bullish on them. Sullivan: We do get concerned by some of the commercial developments where there is a strata sales as part of the project. These normally lead to disjointed property management, especially in shopping centres, and less future capital appreciation. David: The Shanghai government has imposed restrictions on precisely “The cleaner and neater the structure is, the better reception it receives from investors.” alternatives Real Estate Roundtable this. We’re in commercial rather than residential because the entry point for the latter is tricky. The developers are good at their job, ‘build and sell, build and sell’, all a bit of a sausage factory. What we do is more tenant-led where there isn’t too much competition, rather than building a shopping centre and trying to sell a hundred lots from it. Yue: Chinese developers are very good at building and selling residential. But on the commercial and mixed-use front, foreign partners can still add value and there are still plenty of opportunities. What other Asian markets are attractive? Calvert: The Trust will maintain its focus on Singapore. While it’s a relatively small market, it’s a closely controlled market from a demand and supply perspective, and that keeps things in balance. There aren’t too many surprises for investors looking for income streams from Singapore industrial properties. But if competition makes Singapore too expensive and we cannot identify value, we may look further afield, and consider markets like Malaysia, and potentially Indonesia. We are seeing some attractive ‘value’ opportunities presenting themselves in these two markets. Yue: We like Macau. We are not into gaming, but we bought a large tract of residential land years ago. The economy in Macau is driven mainly by the growth in its gaming sector with annual gaming revenue now reaching $20 billion a year, up tenfold since the handover and now multiples of Las Vegas and with only a fraction of the hotel rooms. GDP growth is approaching 30%, yet property prices have hardly moved compared to its neighbors. As a Special Administrative Region influenced by the Chinese economy and with a currency linked to the US dollar, property prices have a lot of upside in the current low interest and inflationary environment. The Hong Kong-Zhuhai Macau bridge will promote the fuller integration of the Pearl River Delta region. We think the Pearl River Delta will become a super economic bloc integrating Hong Kong, Guangzhou, Macau, Shenzhen, Dongguan, and Zhuhai. In five years time, Macau will be a totally different place. David: We’re limited by our Greater China mandate, but we’re also into the Zhuhai area, predominantly around logistics and retail opportunities. I buy into the ‘super region’ idea for the Pearl River Delta, because whilst people have always drawn rings around groups of cities in China, now with infrastructure being built between those cities, such as the fast train networks, those links can really come into being. Infrastructure is making these ideas real today. Sullivan: Hong Kong landlords look like winners over the next few years. There is a shortage of supply and the landlords that have the upper hand will be extracting higher rents. Eventually rents may become prohibitive and firms may relocate elsewhere, but in the current environment, tenant demand will continue to grow. What are the developments in the Reit sector? Are there any important reforms taking place? Sulllivan: In the last 18 months, there has been the most activity in Reit reform in Japan. A lot of that has been driven by necessity, with smaller players merging with stronger firms. Its still an insular market insofar as international equity investors and more accessibility of foreign capital would be a welcome next step. Calvert: The Singapore market has been more proactive with regulation. Authorities have worked closely with Reits to see how this sector can become Chris Calvert: Singapore Reit trusts will look to other markets with greater value alternatives Real Estate Roundtable more efficient. For example, with the introduction of dividend reinvestment plans, the authorities have recognized that this is a positive means for Reits to retain cash on their balance sheets, while allowing unit-holders the opportunity to subscribe for units at a discount and not incur brokerage fees. Now investors are far more focused on manager’s expertise and track record, and how they can add value rather than focusing entirely on growth strategies. Sullivan: Regulators need to look at alignment of interests. Sponsors with a strong platform can create a lot of value for their Reit, although personally I’d like to see more thoughtful regulator scrutiny on future transactions involving related-party transactions to ensure that minority shareholders aren’t prejudiced. In other developments, our research has indicated that US-listed property securities have outperformed core and core-plus products in the last decade. As institutional investors reflect on these historical trends and think about the structural shift to stronger economic climates, we believe there will be a greater shift to listed Asian real-estate products over time. How would you recommend that investors who are keen to increase their property portfolios express their view? Yue: My investors are mainly institutional and many from Europe. Increasingly they want to diversify out of the euro and into economies that are growing and to currencies which are strengthening. The bookends of growth in Asia are China and India. Investors are seeking funds with a specific focus, specialized in certain areas, and experience in managing the asset class, be it residential or commercial. Overall, there has been a sea change in the real-estate private-equity landscape. A number of financial institutions have moved out of the unlisted real-estate market and we have seen platforms being sold. We still see strong demand for capital from private equity, especially in markets where capital markets are still Richard Yue: Some private-equity providers have exited despite demand for capital developing. It will be interesting for the remaining players in this space. In the unlisted world, small is beautiful. Calvert: I agree. Shareholders have to push Reit managers to demonstrate their ability to manage their asset class and demonstrate track record and prove their understanding of the fundamentals. From our own perspective, shareholders should ask Reits if, for example, properties are close to major arterials, or if there is flexibility in the use of the property, so that they can be rented for multiple uses if necessary. “In the unlisted world, small is beautiful.” David: The last three to four years have shown the beginnings of the China consumer boom, and that still has years to go. So investors should align themselves to that Chinese consumer theme. That could be accomplished by building out a retailoriented portfolio. Sullivan: On a longer term view, we’d suggest exposure to consumer trends in emerging markets, primarily through shopping centres in Thailand, Philippines, India and Indonesia, for example. While there is limited listed means to achieve this now, especially in a concentrated portfolio, we’d expect over the next four to five years there will emerge more listed companies through which to invest. n