These are exciting times for real estate markets in emerging countries around the world.
For the first time, the world’s emerging nations are leading the sustained economic surge in the global economy.
As a result, there are rapidly growing middle classes in countries such as China and India, and increasing interest in western-style shopping experiences.
A growing middle class, higher incomes and rising rates of urbanisation present numerous opportunities to develop the retail sector as well as fast-growing office and industrial property sectors.
The robust global economy continues to drive stronger real estate fundamentals, partly from high levels of liquidity, as investors are attracted to real estate’s growing income streams.
At Macquarie, we predict a fifth consecutive year of solid growth, the strongest global economic cycle since the early 1970s.
With global conditions providing plenty of momentum for real estate markets, invested funds are reaching record marks.
There are particularly interesting opportunities for property investors in Asia and Eastern Europe.
The bloc known as BRIC (Brazil, Russia, India and China) has increased its combined percentage share of global output considerably from 20 per cent in 1995 to 27 per cent in 2007.
China is expected to become the world’s second largest economy after the US by 2025.
According to the recent IMF World Economic Outlook (April 2007), growth in emerging Europe has accelerated to 6 per cent in 2006.
A key driver of the region’s sustained success over the past 10 years has been the process of integration with the European Union.
Over the past decade, gross domestic product (GDP) growth in this region has averaged around 5 per cent, supported by rapid increases in total factor productivity and raising per capita income levels closer to the EU average.
In particular, strong economic growth in the Baltic States, including Latvia and Estonia, has been comparable to the recent economic growth rates evident in China.
India’s economy is also booming, with economic growth well and truly outpacing its developed nation counterparts.
India’s real GDP growth in 2006 was 9.6 per cent, the strongest since at least 2000, and Macquarie Research Economics is forecasting growth to remain around 9 per cent for at least the next few years.
This compares to US real GDP growth of 3.3 per cent for 2006 and weaker growth expectations this year.
Strong drivers
The sheer scale of the world’s emerging markets (in terms of population) and potential to add real estate stock to the investable universe is unprecedented.
As already seen in China, providing retail infrastructure to satisfy growing demand for goods over the coming years will present investors with new opportunities.
With rapid rates of urbanisation, the rise of a consuming middle class and strong retail sales growth, China presents significant opportunities, particularly in second-tier cities as the path of economic growth shifts inland.
First-tier cities, such as Shanghai and Beijing, have already enjoyed significantly growing retail capital values and rents.
In India too, there is a rapidly growing middle class (driven in particular by the growing IT and IT support service industry) and keen interest in investing.
Increasing urbanisation in emerging countries such as China, India and Indonesia provides retail sector development opportunities.
And expansion of the retail sector has the flow-on effect of increased demand for logistics and warehousing space.
This evolution has already begun in China, with rising retail sales resulting in the expansion of the logistics sector.
Export growth together with growing domestic demand is expected to increasingly contribute to the development of China’s logistics and, therefore, a sizeable logistics real estate sector.
China’s World Trade Organisation (WTO) trade agreement opened up markets and services that were previously shielded from foreign competition.
Conversely, regulations on foreign investment into Chinese real estate have been changing, with new regulations making foreign investment increasingly difficult.
Yield spreads in China are also favourable, with further compression likely from shifting demographics and the impact of WTO changes. Any future relaxation in investment restrictions for domestic institutional investors will result in a significant contraction of yields.
Another trend for emerging real estate markets is the introduction of real estate investment trust (REIT) legislation (akin to our listed property trusts in Australia).
Since 2000, REIT legislation has been introduced in 11 markets, and another 11 countries have REIT legislation under consideration, including India, Brazil and the Philippines. REIT legislation provides investors with easier access to real estate opportunities and helps increase market transparency for all investors.
What this means for investors
The global economy is showing us that these times are different.
Never before have we seen such strength in the global economy at a time when the US economy is moderating.
There are a number of factors that are driving this, including improved strength in the Japanese and European economies.
But part of the real driving force behind the global economy is the rising power of Asia, as highlighted in the chart. The strong global economy, particularly with Asia as its driving force, is supporting healthy real estate fundamentals and opening up opportunities in new markets.
Of course, the global real estate carnival must end at some stage. And, inevitably, when the global economy slows and liquidity declines, it could be the emerging markets that suffer the most, particularly as these markets often lack depth and transparency.
Some of the most significant risks of investing in real estate in emerging markets include lack of transparency and management, plus regulatory issues such as government measures designed to slow foreign investment.
Macquarie typically uses local partners in emerging markets, which provides greater local market knowledge and helps mitigate many of the risks associated with investing in emerging markets.
Also, some of these emerging markets have already seen rapid yield compression and, therefore, there is limited further yield compression to drive returns in this stage of the real estate cycle. Investors in emerging markets will need to focus increasingly on rental yields to achieve target returns. The chase for yield will persist in those markets where there still remains a sizeable yield spread (measured as the spread of the real estate yield over the domestic 10-year government bond yield).
Today, Australian planners and individual investors are seeing a fast-expanding array of listed and direct property vehicles that offer increasingly efficient access to diversified global property opportunities.
As developed and emerging property markets open up, new funds now offer retail access to exciting property investments in established property markets such as Europe and Japan, as well as emerging sectors in China and many others that were previously only accessible to large institutions.
Rod Cornish is head of research at Macquarie Real Estate.
