REAL ESTATE: No entry

Hong-Kong-2Asian property ranged from the best -€“ Hong Kong -€“ to the worst -€“ Japan -€“ performing markets last year. Nick Fitzpatrick talks to two real estate fund houses in Hong Kong that have launched Asian businesses in recent years, and finds solid fundamentals, but restricted access for institutions. With good fundamentals in most Asian property markets, foreign investors from the US and Europe are keen to diversify their real estate exposure to Asia. But there is a problem, particularly in Hong Kong; access.
“Look at all those properties outside the window,” says Thomas Au, director of Asian research at Invesco Real Estate, as he stares out from the 32nd floor of Three Pacific Place, Invesco’s base on Queens Road East, Hong Kong. “They are all owned by developers and developers tend to keep hold of their properties.
“Because the real estate market in Asia is largely dominated by developers, the presence of institutions is not very big.”
There have been some sales to institutions, says Au, but not of premium real estate. “Developers tend to sell second-grade properties through Reits [Real estate investment trusts] listed in Hong Kong and Singapore,” Au says.
At JP Morgan Asset Management, Douglas Sung, managing director for real assets, is also looking out of a window, this time from the 19th floor of JP Morgan’s Exchange Square office in Central. Sung notes another obstacle that lies between investors and Hong Kong real estate.
“Real estate in Hong Kong is difficult to diversify in because the necessary investment is so big. One of these buildings out there could easily cost a multiple of billions of US dollars,” he says.
Despite these factors, both Invesco and JP Morgan have launched Asian real estate businesses in recent years – Invesco in 2006 and JP Morgan in 2007.
Invesco has eight investment professionals spread across Hong Kong, Shanghai and Japan. Au says the team is in the process of assembling a portfolio of residential and commercial property in the region.
Meanwhile Sung says JP Morgan Asset Management was one of the first to manage a closed-ended real estate fund concentrating on Greater China. The fund owns, among other developments, a Shanghai office development and a serviced apartment in Beijing. Vintages and bubbles
Both firms were established by the time Asian real estate witnessed what Sung calls a vintage year between 2007 and 2008.
This ended with the financial crisis in 2008. In China the crisis saw the government launch a series of measures designed to stop markets overheating, which caused a downturn in Chinese real estate, says Au.
“The Chinese government has since launched other measures designed to pick markets up and these have helped real estate,” he says. “In 2009 the market rebounded, particularly in residential.”
It certainly did. Residential prices increased more than 30% in Hong Kong and China, surprising everyone.
The volatility is amplified by the fact that Hong Kong’s currency is pegged to the US dollar. This means that an economy already witnessing growth is importing monetary policy from a country that is struggling to boost its economy with growth measures.
Au says: “In Hong Kong we do not have our own monetary system and, in essence, it is controlled by the US. The economic fundamentals of Hong Kong are largely influenced by growth in China. We are importing Chinese growth, but also US monetary measures designed to support growth. This leads to volatility.”
It has also resulted in cheap lending rates. In Hong Kong, floating-rate residential mortgages can be as low as sub-1%, yet Au tries to diffuse any concern about a residential property bubble.
“We think the residential market will not deliver good returns for the foreseeable future because prices are too high,” he says. “But we do not expect a collapse. A bubble is when prices go beyond affordability and when people become overleveraged. But people here are not overleveraged. The ratio of lending to deposits is in fact very low so people are not putting too much pressure on their balance sheets.
“If US rates go up, then obviously there would be an adverse impact, and US rates will go up one day. But we still do not expect the kind of collapse like during the Asia Crisis when there was a 70% drop in prices from 1997 to 2003. The odds of that occurring appear low.”
Sung, at JP Morgan, adds: “A key difference between Hong Kong, China and Western real estate markets is leverage. Banks in China want a 30% down payment and it is even higher for second homes. In China, a lot of buyers pay cash.
“A lot of home owners have a cushion in equity if there’s a downturn. In 2008 there was a fairly sharp fall in prices, but there was not any panic, no foreclosures and few distressed sellers.”
Sung expects a 5-15% contraction in the market. Limited supply
Price appreciation in commercial real estate has not been so severe, says Au, and this is where Invesco’s main interest lies at present.
“The [Hong Kong] office market still offers quite good opportunities. Vacancy rates are 5-6%, which is very healthy.
“Supply is extremely limited in all sectors. Retail is a positive sector but it is difficult for institutions to tap into because the properties are owned by developers.”
Au expects to see increased interest in Japanese residential and commercial real estate, particularly if there is a correction there.
“The initial yield in Tokyo is around 5.5% to 6.5% and this is attractive. Long-term bond yields in Japan are very low so there is a good spread.”
Sung says that JP Morgan’s Greater China fund is invested one-third in the office sector, around 40% in residential and the rest is split between retail and other sectors.
He says that 90% of JP Morgan’s Greater China real estate focus in Asia is on China. Beyond this, the firm runs an Indian real estate portfolio which is invested 60% in residential with the rest in offices and hotels. An Asian infrastructure fund invests in facilities such as toll roads and a hospital, along with associated commodities such as cement.
JP Morgan’s client base for its real estate investments in Asia are existing clients for portfolios elsewhere, namely US and European pension funds.
“It will be difficult for the Hong Kong market to become institutionalised because of the limited supply, but it will get there. However, there will be more institutional investment in China in future due to the size of the market.”
Au notes that in China there has been a relaxation of regulations concerning investment in real estate by domestic insurance companies. ©2010 funds global

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