Real estate survey 2010: It’s all about Asia

CHINESE BUYERS ARE driving global commercial real estate turnover, albeit in their local markets. Chinese funds make up more than 90% of the top 10 most active buyers by global deal volume, with $48.3 billion of reported acquisitions, according to Real Capital Analytics, a US-based data provider. Blackstone is the only western fund to feature in the Real Capital Analytics Most Active Buyers table, with $4.1 billion invested this year. Despite growing fears that fiscal stimulus has inflated the property market to unsustainable levels, Chinese rents and valuations have recovered after a brief dip following the 2009 Olympics construction boom. Jason Kern, managing director and head of real estate advisory, Asia-Pacific, at HBSC, says that residential demand in such markets as China, Hong Kong, Singapore and India has clearly been keeping up with supply, as evidenced by escalating home prices across the region and the consequent policy tightening by various governments to “let some air out of the bubble”. Even the huge new supply of office and retail space in such cities as Beijing and Shanghai is being quickly absorbed, and rents are on the rise.

Chinese funds have also flowed into the US, including commitments to US real estate fund managers Brookfield Asset Managers and Cornerstone Real Estate Advisors, reports say. Most recently the Chinese Investment Corporation (CIC) is said to have been in advanced negotiations with the Harvard Endowment Fund to acquire its $500 million real estate portfolio. However, given the lack of disclosure from the $300 billion sovereign wealth fund, it is difficult to calculate how big its allocation to global real estate will be.

The rise of the very large, well-capitalized Asian institutional buyer is accelerating across the region as other countries follow China’s example, notably Korea, Malaysia and Singapore. The Malaysian Employee Provident Fund, for example, is preparing a €1 billion war chest to be deployed in the prime London office market, according to market sources.

Dragons and tigers grow bold

Asian property markets have avoided the worst effects of the global financial crisis. While office rents took a hit as domestic and multinational tenants suffered reduced demand, assets in the supply-constrained centres such as Hong Kong and Singapore generally performed well, with low vacancies and strong rental incomes. In some cases, such as Hong Kong, rents and property values have recovered to almost peak levels.

“If you’re a big developer, you are probably moving a lot of your shop to Asia,” says Ray Torto, global chief economist at CB Richard Ellis in New York. If the US and European CRE property and finance markets are in intensive care, then Asian markets are almost fully recovered and some, such as Hong Kong, Singapore and China, are already in expansion mode. “The weight of migration within China and from rural to urban areas, and from China to Hong Kong, means that developers are building small countries. If you can get in front of that wave, you will make money,” he says.

With the exception of Japan, which is suffering from similar issues to the west’s, the Asian property finance market is very different to its western counterpart, with investors preferring self-funded direct ownership over borrowing. Kern at HBSC estimates that there are as many as 900 publicly traded property companies in the region and that more than 30 of them have equity market capitalizations of more than $5 billion, which is more than the US and Europe combined. “Public property companies in the west are predominantly Reits owning stabilized commercial properties, whereas in Asia Pacific they are more typically developers,” he says. “Most of the large developers have strong financial backing and conservative balance sheets and many are self-funding from pre-sales of residential units and cashflow from rental properties and therefore generally don’t have the same problems with debt redemptions that some in the west have faced in the recent past.”

That said, Asian banks and other investors did suffer losses when the economy slowed down, albeit relatively modest ones compared with the west. A combination of financial and cultural factors means that Asian real estate restructurings can have widely divergent outcomes to those seen in the west.

Nick Crockett, head of corporate finance at JLL Asia in Singapore, explains that like their European and US counterparts, Asian banks have split CRE portfolios into core and non-core assets and have also employed “extend and pretend” modifications to keep economically attractive borrowers in loans. However, there is a lower probability of default, foreclosure and liquidation in Asia than there is in the west. Crockett says: “Generally speaking Asian banks do not like foreclosing. If the sponsor is not under distress themselves they will encourage them to deleverage the asset by amortizing the loan, provide additional capital or collateral security and in turn the banks will restructure the loan. If this is not achievable the banks will seek a new sponsor for the asset off-market. Only as a last resort will they appoint a receiver.” He adds: “In the event that a loan has passed its maturity date, banks are open to looking for alternative ways to amortize the amount outstanding, for example by employing cash sweeps from the asset’s operating income and converting some portion of their debt into equity but allow the sponsor to continuing managing the property until it is stabilized.”

Buoyed up by healthy cash surpluses, and well-capitalized local financial institutions, Asia Pacific property investors continue to be active buyers at home and, increasingly, abroad. As international banks and private equity funds have divested in Asia, local players have been there to take attractively priced assets off their hands. Buyers including publicly traded property companies, Reits, insurance companies and other institutional investors have all grown real estate exposure in the main markets in the past two years. Crockett says: “Last year’s big growth story was China, and it continues to grow despite government attempts to cool things down. This year, we also see strong performances from the emerging markets, namely India and Vietnam, and an increasing trend of core investors seeking opportunities in gateway markets such as Sydney, Melbourne, Singapore, Hong Kong and Seoul.”

Although their preferred investment instrument is direct equity for the full amount, Asian investors do continue to present senior lending opportunities for international banks with the balance sheet and risk appetite to compete, particularly in transactions where local lenders don’t have the appetite for leverage. Indeed, after a wave of forced retreats, some of the larger German and French banks and US insurance companies are beginning to return to Asia hoping to fill funding gaps.

Prolonged pain

Given the extent of the problems in the worst-affected parts of Europe, only a solution that combines debt, equity, asset management and restructuring approaches will have a chance at clearing the trillion dollar bottleneck in the US and Europe. Nationalized UK banks have already adopted parts of this approach by carving out non-core or troubled CRE assets into bad banks. As a signal of the hand-to-hand combat they expect over the short to medium term, some of the banks have assembled workout teams with headcounts in the hundreds. “The solution needs to combine capital markets funding with a workout process that can reset things for a recovery over the medium term. Some will come in the form of equity recapitalizations for sponsors that can be listed or undertake IPOs later on, some will come in the form of CMBS 2.0 and others will be joint-venture deals with other investors to share the upside,” Barry Osilaja, a director in Jones Lang LaSalle’s European corporate finance group, says. Even if it is possible to pull together this patchwork of vested interests, there will still be widespread defaults and bankruptcies among all but the strongest sponsors. “The majority of loans in an average CRE loan book are likely to be secured against 50% secondary assets, which will eventually have to be sold, and banks will have to bankrupt some organizations to do that. As the capacity to absorb losses improves we will see more loans sold and default called,” he concludes.

see also:

Real estate: The dragon and the stagnant pond
Awaiting resurrection: CMBS
It’s all about Asia
Real Estate Poll 2010: Results
Real Estate Poll 2010: Methodology