Heavy weather: Investing in emerging markets is not for the faint-hearted
October 28, 2015
By 2030, the purchasing power of the E7 group of countries will overtake that of the G7, and Asia Pacific’s middle class will be larger than Europe’s and North America’s combined this year, according to PwC.
That continuing search for yield may lead some property investors to latch on to cities that promise the potential for significant growth from fast emerging real estate markets, with Asia, India and Africa already firmly on investors’ watch lists. But the uncertainty over the long-term performance of these markets has threatened to undermine their credentials as credible alternative investment options when compared to more developed and stable markets.
In that regard it is, perhaps, unsurprising that the time horizon for investing for most respondents to ULI’s recent Emerging Trends Asia Pacific survey is three to 10 years, with only 13.4 percent looking beyond that timeframe.
Volatility impacts on long-term path
“We like the growth story in emerging markets,” says Ian Gleeson, CIO of CBRE Global Investment Partners. “We have been active in China, Malaysia and Brazil and have been focused on both stabilised, dominant assets in those markets as well as developing core real estate where there is an obvious undersupply. We have yet to venture into Africa but may do so in the future.
“The challenge for us is being able to take a long-term view and withstand the short-term volatility that often accompanies the market conditions,” Gleeson explains. “We are also conscious that over the longer term the fundamentals are positive and, if an institution or pension fund can see a way to invest in an acceptable way in these markets, there could be a very positive socially responsible dimension that could be also transformational for the market and country in question.”
With the successful growth of cities dependent on infrastructure investment and dedicated government efforts to increase the resilience of urban areas from climate change, the future of emerging markets is not always positive or easy to predict.
For this reason, Europe still appeals to global investors despite how exciting Asia’s property markets seem. TH Real Estate has reported that by 2030 there will be 141 cities in Asia with 5 million people or more (versus just five in Europe), accounting for half the world’s occupied office space. But investors should proceed on the basis of these headlines with caution, warns Alice Breheny, global co-head of research at TH Real Estate.
“Yes, growth rates in Asia and Africa are exciting but most of the cities there are coming from a low base — only some will get it right. Europe may look uninspiring by comparison but it will still have winning cities, like London, which need to absorb a lot of people,” says Breheny.
Long-term outperformance still likely
Economic growth globally has declined for all the major nations and the emerging markets are no exception. The question on investors’ lips, according to David Steinbach, CIO of Hines Global REIT, is — looking beyond the current slowdown and the repricing that is taking place — whether the emerging markets growth will outpace that of other G7 nations?
“We still think that the answer is ‘yes,’ due to a still rising middle class and a younger workforce relative to their more developed neighbours,” says Steinbach. “We don’t necessarily see growth returning to levels seen in 2001–2011 but we do think that the growth of emerging markets will outpace the G7. As to the question on what it will take to reverse the current trend, we see different issues facing each of the BRIC nations. Therefore, the recovery to each will look different and likely occur at different times.”
This is echoed by Jon Zehner, global head of the Client Capital Group at LaSalle Investment Management, who contends that certain emerging markets are falling back into favour again.
“Three years ago, investors were backing away from Brazil, but a favourable currency exchange and attractive real estate prices means that it is back in the spotlight again,” he says.
“Of all the emerging market economies, the country that is most likely to struggle is Turkey in light of the political uncertainty in the country. Slovakia, Hungary and Romania, which had largely moved off of the list of emerging market economies attracting real estate capital, are now starting to get attention again. The improvement is primarily capital flow–driven. You can expect greater returns in these countries than in the past and liquidity is increasing.”
Asia Pacific takes the spotlight
Investment volumes in China have slumped 16.9 percent year-on-year, according to Knight Frank, as the yuan has weakened against the US dollar, despite allegations of undervaluation by the United States. Concerns have been raised as the country is still battling its overcapacity problems, as a result of which producer prices have experienced outright year-on-year deflation for three years.
Even domestic Chinese investors are increasingly going overseas, with deregulation in recent years permitting the large Chinese insurers and life funds to invest in international real estate markets.
Zehner says: “We are long term in our perspective and unlikely to dive in and out of markets just because we see a short-term opportunity. China and the Czech Republic/Poland are examples of emerging markets in which we have been involved and expect to continue to be involved in the future. It is conceivable that our focus on China may evolve from a primarily logistics-oriented focus. The volatility in China may result in us tinkering with that strategy going forward.
“I’m still a believer in emerging markets in the medium term as the demographics are convincing,” Zehner continues, “particularly if we see them investing heavily in their infrastructure and in reducing government red tape.”
India has seen investment activity pick up dramatically since the second half of 2014, with volumes increasing by more than five times when compared to the same period in the previous year. Demand came from both local and foreign investors who are seeking exposure to the anticipated acceleration in India’s economic growth.
In terms of liquidity and financing, the Indian commercial property investment market has been a consistent underperformer. However, hope is on the horizon, not only with the ongoing improving economic fortunes of the world’s largest democracy, but also with the REIT framework, investment vehicles that invest in rent-yielding completed real estate properties.
REITs certainly have the potential to transform the Indian real estate sector, helping to attract long-term financing from domestic as well as foreign sources. For investors, REITs can provide a new investment vehicle with ongoing returns, elevated transparency and governance standards, while offering an exit opportunity to developers, enabling them to monetise their real estate. According to Knight Frank, Blackstone has already invested $1.7 billion (€1.5 billion) in Indian real estate; followed by GIC, with $850 million (€759 million) committed; Canada Pension Plan Investment Board, with $750 million (€670 million); and Brookfield and ADIA both having spent more than $500 million (€446 million).
However, uncertainty over other parts of Asia Pacific persist, with the impending US rate hike posing the greatest risk to Indonesia where weak commodity prices have hurt exports and slowed down economic expansion. Elsewhere, South Korea, Thailand and Malaysia share the same problem of high household debt of more than 80 percent of GDP weighing on consumption.
“Emerging markets have generally been falling out of favour as their economies have faced headwinds while the economies of developed markets continue to improve and so we have been focusing most of our investment activity in developed markets,” says Gleeson.
“Particularly at the moment, there seems to be almost a perfect storm facing emerging markets, with commodity-driven problems, uncertainty over US interest rate rises, which has exacerbated an already volatile situation, as well as some political instability in certain markets.”
Africa: catching up fast
The rapidly-growing economies of Africa are catching the attention of increased numbers of property investors and corporate occupiers. A recent Knight Frank report claimed that Africa is no longer viewed as a region of long-term economic distress, but is increasingly seen as a continent of opportunity.
Since 2000, Africa has averaged growth of more than 5 percent per year, with the sub-Saharan region averaging growth of close to 6 percent per year. The larger emerging economies of this region, such as Nigeria, Kenya, Angola and Ethiopia, have increasingly been the key drivers of the continent’s growth.
Nonetheless, the economic outlook for many African economies has been clouded by the steep fall in oil prices that started in the middle of 2014 and has continued into 2015. The IMF has revised downward its GDP growth forecasts for Africa and now expects sub-Saharan growth to be below 5 percent in 2015. The short-term outlook for Nigeria, in particular, has weakened. Sub-Saharan GDP growth is forecast to move back above 5 percent in 2016, and to strengthen in subsequent years.
This suggests that, as many African economies have diversified and reduced their dependency on commodities, the recent collapse in oil prices may have a less severe impact on Africa than historical commodity price downturns.
The growth of Africa’s cities is creating a need for increased volumes of good-quality commercial and residential real estate of all types. Retail property development has been encouraged by the rise of the urban middle class, as well as the expansion of South African retailers such as Shoprite and Pick n Pay into the rest of Africa. Modern shopping malls are a relatively new phenomenon in much of Africa; Accra Mall, for example, the first to be built in Ghana, opened in 2008.
Increased numbers of multinational companies are seeking offices in African cities, generating demand for high-quality space, particularly in key regional hubs such as Nairobi and Lagos.
The oil and energy sector is an important driver of activity in many of Africa’s most dynamic office markets. Demand from this sector, combined with an extreme lack of supply, has made Luanda in Angola one of the most expensive office markets in the world, with prime rents at $150 per square metre per month (€1,620 per square metre per year). Likewise, recent offshore gas discoveries have driven construction activity and rental growth in Mozambique’s capital, Maputo.
Sub-Saharan markets are now attracting increased interest from international investors, but the most noteworthy flow of capital in recent years has been from South Africa into the rest of the sub-Saharan region, as a growing number of funds have been established by South African developer/investors targeting the rest of the continent.
Compelling, yes; compelled, no
Despite their increasing lure to investors, some emerging markets have a long way to go before they form major components of investor portfolios. As Gleeson puts it: “Real estate in emerging markets has, to date, only ever made up a small part of our overall portfolio, and I don’t see this changing significantly in the very near future.”
Steinbach concludes: “The emerging markets are not all in the same place in their correction and recovery so it depends on which country we are specifically talking about. But in general we are seeing the real estate markets reprice as the general economy has slowed down. Once the market has repriced, we think it represents an attractive opportunity, giving long-term growth prospects.”
This article was contributed by Real Assets Adviser, the first publication dedicated to providing actionable information on the real assets class and facilitating important business connections for registered investment advisers (RIAs), wealth managers, family offices and independent broker/dealers. Coverage includes real estate, infrastructure, energy, commodities/precious metals, agriculture and timberland.
Author James Buckley is a freelance writer based in London.