Overcoming Investment Challenges in Asian Real EstateAn interview with Principal and Head of the Asia Real Estate Boutique at Mercer
Investing in Asian real estate is an inviting proposition, but it isn’t without its challenges, particularly given Asia’s great diversity across various parameters, namely maturity of the market, regulatory landscape and the scale and subsets of opportunity.
Henry Ching, the head of Asia real estate at Mercer Investments, speaks to BRINK Asia about some of these investment challenges, how a local presence can go a long way in mitigating some of the challenges, and what some opportunities in this space are.
BRINK Asia: In your view, what are the major investment hurdles in an Asian context when it comes to real estate investing?
Henry Ching: The first one that pops in my mind is that what you’re dealing with, while it may be called a “region,” it is actually a collection of many countries, each of which has its own regulations, market conditions, customs, languages, way of doing business, tax structures, and many other facets. We have large and small countries and countries that lie all along the economic maturity spectrum.
Then you’ve got currency risks, wherein small movements in exchange rates can adversely impact investment returns—so investors need to be properly hedged. This problem can sometimes be compounded, because in many markets in Asia, it may not be as easy to hedge or take money out of the country as it is to invest.
And third, from a global investor perspective, in this context of heterogeneity, finding and getting to know the right partners is challenging. This is particularly true of non-Asian investors because of the need to understand these markets at an individual level. So, investors need to spend time with their partners and understand them and determine who they can and cannot trust. In the recent past, we have seen even very established managers lose trust with investors because the local partners that the managers worked with locally didn’t do their job right or because there were compliance breaches.
BRINK Asia: How important is it to invest with fund managers that have a local presence on the ground? With the evolution of communication and the flow of information, is this less of a concern today?
Mr. Ching: The reality is, if you look at the track record over the past two cycles, we see that locally run or regionally run asset managers have become more competitive, and they have tended to have stronger track records than their global peers, because they have grown bigger in size. Today, some of the largest Asia-focused real estate funds originate from within the region. We have also seen the larger, global managers come back to the market, because they have seen the fundraising success of the regional/local managers. However, if you just look at things empirically, it is clear that locally owned and managed fund managers that have local decision-making and strong local networks are the ones that have done well and attracted a lot of capital recently. This, to me, demonstrates that a local presence on the ground remains as important as ever.
BRINK Asia: Is there a major difference in real estate valuations between developed Asian economies and developing markets such as China, India and Indonesia?
Mr. Ching: I think the simple answer is that it’s not so much about developed versus emerging economies. The differences are more dependent on the amount of liquidity in these individual markets—markets with stronger liquidity generally have higher valuations. Another important factor is the ease (or difficulty) with which investors can exit a market. Owing to this factor, some of the markets that have seen valuations increase are in cities in developed markets, because it is easy to buy and sell property, and there’s a lot of history. Even when someone goes to the investment committee, it is easier to push through investments in these cities because people have a higher comfort level investing in them.
That said, liquidity is also high in China, with local as well as global liquidity. So, we see that even in emerging markets, valuations are quite high, especially in China. That’s why I think, in the current cycle, it’s more a liquidity story, coupled with what people have felt more comfortable with traditionally.
Those looking to invest in China must get comfortable with how Chinese decision-makers act: decisions are based on what is good for the country.
BRINK Asia: One of the complaints investors in alternative assets in Asia have is that of a high turnover rate at firms. Would you agree?
Mr. Ching: Yes, in my view this is a major challenge, because the high rate of turnover does not allow investors enough time to get comfortable with their local partners. A lot of the non-Asian investors haven’t spent much time in Asia because it is a small part of their portfolio in terms of allocation. As a result, they are not necessarily willing to spend enough time with managers in cultivating relationships and becoming comfortable with them. Moreover, in Asia, a lot of the times, managers you see in one cycle may not be around in the next cycle. Owing to this high rate of turnover, a lot of the time, people just think it is too much effort—I don’t know the market and I don’t know the people. There is a lot of anecdotal evidence that reinforces this idea of management difficulties. While things are more stable in a market like Japan, this is a big challenge in markets such as China and particularly India.
BRINK Asia: Where do you see some of the biggest opportunities in the next year or two, from a private real estate investment perspective?
Mr Ching: If the liquidity situation remains the same, then my top pick for the next year or two would be some niche strategies in China because of its depth and certain manufacture-core strategies in Japan, which is benefitting from both an improving underlying economy as well as low interest rates and the upcoming 2020 Tokyo Olympics. The thirst for yield as well as the availability of debt are other positive factors that Japan has going for it, but valuations have also increased significantly, especially on the income-producing property side. So, if you can create properties that produce stable income, then there will be investors who are willing to pay a fairly handsome price, and that seems like a good strategy.
And in China, of course, there is a lot of liquidity, both domestically and from overseas. Economic growth is a very strong factor for China, which remains one of the world’s fastest growing economies, and there is a lot that can be done in China. If investors can find good managers focused on, say, the logistics space or on some other niche areas, then they can take advantage of the strong liquidity to create something and then get a high valuation.
BRINK Asia: Speaking about China, what are some of the things investors must be mindful of when they invest in Chinese real estate?
Mr. Ching: Those looking to invest in China must get comfortable with how Chinese decision-makers make their decisions. Most of the time, decisions are based on what is good for the country and not necessarily for the investors. As you know, whenever there is a crisis unfolding that puts investors’ interests in conflict with those of the general public, then—as with most governments elsewhere—Chinese decision-makers will make sure that people are taken care of first.
When you think about it though, over the long term, that is only going to benefit investors. I do think that at times there will be interruptions, and there will be times when investors want to get out and they cannot because of capital controls; or there may be times when restrictions are imposed on buyers when the government wants to control the market somewhat. I will add, however, that while this brings an element of uncertainty, this is no different from what we are seeing in many other countries, including the U.S.
I think investors must make sure that their local partners—whether they are fund managers or developers, or both—are not caught off guard when there are changes, because there will be changes. I also think that over time, these concerns will ease.