Asian real estate: after the plunge, the rebound

Institutional Investor, September 2009

Asian real estate has followed up an epic plunge with an equally dramatic rebound. Extraordinarily, deep in a global financial slowdown, there is even talk of a bubble in the residential property markets of China, Hong Kong and Singapore.

It’s quite a difference compared to the mess of 2008 and early 2009. According to CB Richard Ellis, the real estate services group, Asian property investment sales fell 83% to US$3.1 billion in the first quarter of 2009 compared to the same period a year earlier, with Japan, Singapore and Hong Kong suffering the biggest falls; investment turnover for industrial and office property fell 95% and 89% respectively. Many listed property stocks halved in value last year: indeed, the average real estate investment trust (REIT) in Singapore fell 54% in 2008.

While few property stocks have recovered all their losses, they have bounced impressively from their lows, to the point that analysts are already starting to wonder if there is any value left. “Asia Pacific listed property is relatively expensive,” says Matt Nacard at Macquarie Research, who says the sector is now at just a 3% discount to net asset value (NAV), compared to 8% outside Asia, and is now trading at 19 times 2009 earnings. The MSCI Asia Real Estate Index rose 47% in the second quarter alone.

So how has this happened? It depends on the market, but there are some common themes. “This revival in property prices has been mainly driven by the abundance of liquidity in countries such as China and Hong Kong,” says Keith Chan, an analyst at HSBC Global Research. China is probably the clearest example. As our special report on banking in China on page xx explains, the RMB4 trillion government stimulus package there has triggered a vast increase in lending by Chinese banks, with most of the bigger banks showing year on year loan growth of around 30%. Lending like this naturally helps the property market, as well as generating earnings revisions. Says Nacard: “In the absence of cooling measures from the authorities, this leads to a powerful positive combination.”

China also has some unique characteristics. “In China investment alternatives are very limited: it’s either the residential property market or the listed market,” says Kenneth Tsang, head of Asia Pacific research and strategy at LaSalle Investment Management. “And the underlying fundamentals: demand has always been very strong in China because of the growth in income, GDP and productivity. They are long term drivers for the China market.”

Consequently, just months after a period in which the real estate market seemed to be dragging down China’s economy, it is booming again, at least on the residential side. According to data from the National Bureau of Statistics of China, national residential sales were up 54% in volume and 82% in value in June year on year. Eastern seaboard cities, particularly Beijing, led the growth. According to Morgan Stanley, listed property developers in China have achieved an average of 63% of their full year sales targets in the first half of the year, “setting the stage for a potential upward revision of their target during the interim result announcements”. Also, despite the bounce back, Morgan Stanley believes affordability in China “remains at a healthy level, with property prices at six to eight times annual income, or monthly mortgage payments at 40-50% of monthly household income.” This suggests support for further growth. Correspondingly, developers are now actively bidding for new land in China, trying to get prime sites cheaply before the market recovers.

Similarly, in Hong Kong too, liquidity is driving residential prices up, despite the fact that rents are falling. Partly it has to do with government stimulus in Hong Kong itself, but also China is having a big influence. “We are seeing increased inflows from China into Hong Kong,” says Chan. “In the past, buyers from mainland China accounted for less than 5% of the property purchases in Hong Kong. Nowadays 20 to 30% is the norm.” So, when China receives a huge boost to liquidity, it is felt in Hong Kong property too. “I won’t be surprised to see property prices continue on this up trend in Hong Kong,” Chan adds.

Singapore, too, is suddenly filled with talk of price bubbles, which seems remarkable in a recession-hit country that expects its economy to shrink by between four and six per cent this year. Residential rents have halved, and yet the purchase price of the properties themselves is soaring to the point that the government is openly discussing overheating. National Development Minister Mah Bow Tan was quoted in state media in July as saying: “I wouldn’t say there’s excessive speculation at the moment, but there is some element of speculation involved. I think some of the practices that you saw in the last property boom are starting to come back. So I think we’ll have to be careful.” He also said: “I would say that there is more than sufficient supply over the next couple of years and it’s a bit too early to say whether there is a speculative bubble or property bubble building up.”

But analysts seem less enthused about the prospects in Singapore’s real estate markets than Greater China’s. Macquarie expects a 20% fall in residential prices this year.  Morgan Stanley analyst Melissa Bon calls the valuations of Singapore’s listed property developers “fundamentally unjustifiable” and has an underweight recommendation on big developers like CapitaLand, Keppel Land and City Developments.

The office market in Singapore has been particularly badly hit: CB Richard Ellis said it hosted the worst office rental contraction in Asia in the first quarter, down 34% on the previous year, and Macquarie expects a 38% fall in office rents in total this year. Indeed, across the region the office market has not enjoyed anything like the ardor that residential has. “Office is a different picture,” says Chan. “In top tier cities in China office values have dropped 15 to 20% from the peak of last year.” In Hong Kong the office market suffered in the first quarter – the 25% drop in office rents compared to the previous quarter was the worst Macquarie had seen since it started keeping records in the 1980s – but Chan says the limited supply in places like Central (Hong Kong’s CBD) help to maintain stability.

Tsang agrees. “Supply for commercial real estate in Hong Kong is not an issue: not much is coming and we are not anticipating very high vacancies.” This is in contrast to Singapore where a lot more supply is still due to come on to the market, “which may delay the recovery process.”

Nevertheless, things have clearly improved, but analysts and fund managers are mindful of how quickly things can change. Morgan Stanley’s Derek Kwong, in a recent report on Hong Kong, notes: “While we are upbeat about the benefit of escalating asset prices on the back of ample liquidity, there is always the risk of its exit.” He adds: “We are certainly mindful that the bull case is not dissimilar to a bubble situation.” In China, where momentum and mood have such an impact, there are a number of things that could reverse sentiment: the authorities may seek to rein in lending or implement a round of tightening by raising rates and reducing the attraction of debt; or a round of corporate earnings downgrades could also reduce confidence.

The global financial crisis put a serious dent in the REIT market, which had otherwise been flourishing up to 2007. Asian REITs suffered their deepest ever fall in the second half of 2008, with their market capitalization falling by almost one third to US$48 billion, according to CB Richard Ellis. Only one new REIT has been launched in Asia in the last 12 months – Centra Hotels & Resorts Leasehold Property Fund, in Thailand in October – and many existing ones struggled to raise funds to meet short term debt obligations. New City Residence, listed in Tokyo, was the first to be wiped out, filing for bankruptcy in October 2008 (see Japan box). In other cases REITs were offloaded in order to help shareholders improve their own positions: Allco Finance Group sold its stake in AllcoCommercial REIT to Frasers Centrepoint; Malaysia’s YTL bought a 26% stake in Macquarie Prime REIT from Macquarie, and renamed it Starhill Global REIT.

At its worst, there was real concern about the very viability of the REIT model, although that moment appears to have passed. “The model was under a lot of pressure when yields were 8, 9, 10%,” says Arjun Khullar, managing director and head of equity capital markets for south and southeast Asia at JP Morgan. “It’s difficult to make an accretive acquisition then. Now some are at 5, 6%, it is much easier to do.” Many of the bigger REITs that needed to recapitalize were able to do so, notably Ascendas REIT, Singapore’s biggest industrial property trust, which raised S$300 million in January in the first successful recapitalization, and CapitaMall Trust, part of the CapitaLand family, which managed to raise S$1.23 billion in a rights issue in February. “S-REITs have not disappointed in terms of refinancing their debt,” says Bon. “Indeed, they recapitalized ahead of our expectations.”

Singapore is ex-Japan Asia’s biggest market for REITs, with 21; Hong Kong, which started trying to attract REITs later, has only seven. Other, smaller markets exist in South Korea, Taiwan, Thailand and Malaysia. The Philippines and China have both spoken about launching REIT markets, with legislation already underway in Manila. Since the Philippines boasts three of the region’s blue chip developers in Ayala Land, SM Prime and Megaworld, it is a natural home for REIT structures.

While it’s clearly going to be some time before any new REITs are launched, existing ones may return to the markets. “We’re likely to see more REITs raising money again,” says Khullar. “A-REIT and CMT [Ascendas and CapitaMall], earlier this year, were defensive plays: they were raising money so that if the world did end, they would still be able to stay standing. Now valuations have come down, I think REITs will look to raise money for more aggressive reasons: for acquisition.”

BOX: Japan

Japan’s property markets have slumped with the rest of that economy. According to Mizuho Trust and Banking, real estate transactions more than halved in value and volume in 2008, particularly because J-REITs, Japanese real estate investment trusts, have not been buying. “The J-REIT market is still stagnant in terms of property acquisitions, given that most of the J-REITs’ balance sheets are geared up to their respective self-imposed maximum levels, and concerns about financing and potential bankruptcies had brought down most JREIT share prices substantially below their book values, essentially closing the door for equity raising,” says Macquarie in a recent report.

Japan was where REITs first started to come unstuck, with New City Residence being the first in the region to go under in October 2008. Things have picked up in the second quarter, though. The government has brought in measures to try to temper concerns about bankruptcies, including the provision of loans through the Development Bank of Japan, and eased tax transparency requirements around M&A (making it easier for one J-REIT to acquire another at a discount to its NAV). Also, new sponsors are being found for those J-REITs whose existing sponsors have already applied for bankruptcy. Most recently Daiwa Securities announced in June it would become the new sponsor of DA Office; other JREITs including Nippon Residential, Nippon Commercial and Joint REIT, were expected to appoint new sponsors at the time of writing.

Despite the trials of the markets, Tokyo is not officially the most expensive place in the world for office space, according to CB Richard Ellis: US$183.62 per square foot per annum, edging out London’s West End and Moscow. Despite that, vacancy rates have continued to rise in Tokyo; Macquarie expects a 9% peak within the next two to three quarters.

BOX: Asia’s blue chips

Asia’s blue chip companies are emerging from financial crisis, sometimes scarred but generally intact, and ready to take on opportunities as they arise.

The Dow Jones Country Titans indices, which measure the performance of the biggest and best known companies in each country, tell the story. Its China 88 index is up 92.5% year to date, while Singapore’s is up 48.4%, Hong Kong’s 43.7% and South Korea’s 41.1%. Compare this to the world’s old guard: the UK’s blue chips have gained just 5.4%, Germany’s 6.4% and France’s 8%.

Partly, this is because Asian markets fell irrationally far in the first place, particularly given that their banking systems were largely immune from the problems that blighted those in the US and Europe. The fall was a consequence of capital behavior: as times turned difficult for US and European fund managers, they tended to bring money home in the belief that it was safer to do so. This exit of foreign institutional capital more than anything else hit Asian markets so hard.

Now, though, some common sense is returning. Economically Asia has the best prospects, given the scale of its population steadily growing in wealth, bringing with it demand for goods and services that can’t be matched elsewhere in the world. As it is, GDP numbers in many Asian markets remain highly impressive despite their decline – China may well log 8% GDP growth this year. Generally, Asia’s populations are characterized by high savings, and those in weaker Anglo countries by higher debt. On top of that, Asian banks and companies, have learned lessons the hard way from the Asian financial crisis in 1997-8, have tended not to be highly leveraged; the banks in particular have been run with greater conservatism than many US houses in particular, and it could also be argued they were protected by a lack of sophistication from owning things like collateralized debt obligations which caused such trouble elsewhere.

Those fundamentals are coming back into focus for analysts and investors. “Expect Asian markets to outperform in the next five to 10 years,” says Shane Oliver, chief economist and head of investment strategy at AMP Capital Investors. And the biggest companies, since they have the easiest access to capital when bond and stock markets regain their liquidity, are also in the best position to acquire other businesses.

From the investor perspective, much of the easy gains may already have passed: Oliver, speaking to Institutional Investor in July, points out that most Asian markets are already trading around their long-term price/earnings ratio averages despite the fact that most of the world is still technically in recession. Nevertheless, he thinks that five to 10 year projected equity returns are higher in ex-Japan Asia (11.6% per year, 3.6% of it coming in dividend yields) than anywhere else in the world – he projects just 6.4% for Europe, for example. Besides, very few stocks have recovered so far as to be higher today than they were 12 months ago: while a handful have done so, such as China Life, Posco, CNOOC and Sun Hung Kai Properties [NOTE to EDITOR: this is based on August 6 closing prices], even some of the most resilient portfolio stalwarts are still under water over the last 12 months, among them PetroChina, Hutchison Whampoa, Taiwan Semiconductor Manufacturing, Industrial & Commercial Bank of China, China Mobile and Shinhan Financial. This suggests there is still value available.