A vacation from inflation
Last month, two prominent firms introduced real estate reports — one for the Mumbai Metropolitan region and the other real estate trends in Asia Pacific 2015. ASK Property Investment Advisors (ASKPIA), the real-estate private equity arm of ASK Group, launched the first-ever detailed report on Mumbai residential real estate. During the launch of this report, Sunil Rohokale, CEO & managing director, ASK Group, said, “Mumbai’s growth continues to be driven by finance, media, telecom, entertainment, IT/ ITeS, gems and jewellery and trading industry and posted 15% annual growth in last seven years. The imminent economic growth would result in rising incomes, higher addition of jobs, and need for housing. The expectations of softening interest rates, standardisation in approvals and various policy initiatives will provide boost to the real estate sector. At the same time providing housing that meets the end-user budget would be the real challenge.”
The second report jointly published by the Urban Land Institute (ULI) and PricewaterhouseCoopers (PwC), says that sentiment around Indian real estate among both domestic and international investors has improved in recent times, following the election of a new government and also on account of an upturn in consumer demand.
If investor sentiment in last year’s Emerging Trends in Real Estate Asia Pacific report reflected a degree of bemusement at how regional markets had remained so resilient in an environment of weakening economic fundamentals and apparently ever-compressing cap rates, the tone this year is more one of resignation. With asset prices across the region now setting new highs, cap rates plumbing new lows, and economic conditions as weak or weaker than in 2013, real estate buyers appear to have embraced a new normal, where, investment markets are now well ahead of fundamentals—they’re pricing in a recovery that just isn’t there.
The main reason behind this now-longstanding tension between economics and pricing is clear enough: Asian real estate is struggling to absorb a seemingly endless stream of new money arriving from a variety of sources, both outside Asia and (for the most part) within. They include sovereign wealth capital, regional pension funds, real estate investment trusts (REITs), and accumulated high-net-worth money from across the region.
In addition, and perhaps of greatest importance, Asian asset prices have been boosted by the trickle-down impact of almost six years of global central bank easing. While the U.S. Federal Reserve has now ended its most recent bond-repurchase program, rising aggregate stimulus from other global central banks has more than filled the resultant gap. The European Central Bank (ECB) announced new programs in September 2014 that will expand the ECB balance sheet by Rs 500 billion (approx. $625 billion) per year. After a new round of stimulus in late October 2014, Japanese central bank easing will now contribute another US$720 billion per year. And with Chinese central bank purchases of US Treasury bonds estimated to come in at $560 billion in 2014, current increases in global central bank easing now exceed the Rs 1 trillion rise in government-sponsored stimulus seen annually since 2010. As a result, according to a recent J P Morgan analysis, excess liquidity throughout the global economy is now “the most extreme ever in terms of its magnitude”.
Amit Bhagat, CEO and MD, ASK Property Investment Advisors Ltd, says, “The growing suburbanisation of the Mumbai region and demographic growth indicates a housing need of 120,000-125,000 units annually over next three years. We expect prices to not go up due to balanced demand-supply, while growth corridors are expected to witness rise in demand from end-user.”
The one alternative investment category that has undoubtedly enjoyed success in Asia is logistics. The sector now represents about 10% of total commercial real estate transactions in the region, according to Deutsche Bank, although the supply of new product in 2014 was down about 30% on the previous year. Although logistics yields remain higher than in other sectors, they continue to compress and are now as low as 4.5% to 6% in Singapore and Japan. The acute shortage of modern distribution facilities will last for years, especially given the rocketing popularity of internet shopping across Asia.
Raising new capital has been a major issue for most Asian fund managers since the onset of the global financial crisis. Not only have limited partners (LPs) in general been reluctant to commit new capital to investment funds, but when they have, it often came with various strings attached, providing them with greater control over decision making. This year, however, while no investor was willing to say that capital raising was easy, a marked improvement in sentiment seems evident.
The banking sector continues to dominate real estate lending in the region. The very low cost of debt in Asia has contributed to the downward march of cap rates because investors still get positive yield spreads even with tightly compressed yields. That would change, of course, if interest rates were to rise significantly, which is one reason many investors are avoiding markets such as Hong Kong, where prime cap rates commonly stand at 3% or less.
Still, there is one market where real estate finance remains firmly rooted in the world of debt. Banks in India remain reluctant to lend to developers for most projects, and charge high rates when they do. At the same time, an opaque regulatory environment has led to legal problems for investors—especially foreigners—when they have tried to deploy equity.
The result has been a focus for the last several years on debt as the main medium for investments. With returns on debt falling firmly into opportunistic territory, choosing it over equity is a “no-brainer.” As one foreign fund manager commented: “In the past, we were doing straight-up equity deals when the market was super-hot and losing everything. Then we did structured equity and ended up in arbitration in London. Then we end up doing debt using an NBFC (nonbank financial company), where suddenly it works—so that’s where a lot of capital has gravitated.”
The few pure-equity deals that occur in India are happening at around 25%, mezzanine fetches 21-23%, while pure debt—which is still popular—is now in the sub-20% bracket. Mezzanine deals are currently favoured because while improving sentiment means that developers are eager to restock land banks, there is no way to project when the rebound will actually arrive. As a result, investors are hesitating to commit to fixed returns for debt on a long-term basis.
However long the market takes to turn, the change in sentiment toward India from both domestic and international investors is evident. One reason for this is the election of a new government, for which investors have high hopes. Another is that growing economic confidence is creating an upturn in demand. According to one interviewee, “Clearly there is now a demand/supply mismatch in commercial property, because over the past four to five years not many developers embarked on new developments or added to the new stock of supply. And that means that with the recovery on the demand side you have a situation where rentals are firming, for the first time in years.”