Given the potential impact of higher interest rates on U.S. real estate, many high net worth investors are increasingly looking for opportunities in other countries. According to Wharton’s Peter Linneman, sophisticated investors began looking more seriously at offshore real estate opportunities five years ago. In a 2001 research paper titled, “International Real Estate Investing,” he noted that real estate was occupied by a rapidly globalizing tenant base and financed by capital sources that were increasingly international and integrated. “The attractions of international real estate investing are both obvious and alluring,” he wrote. “Perhaps as much as 60% of investment-quality real estate lies outside the U.S.”


Cut to the present, and there is evidence all around that the current real estate boom has gripped investors from Sao Paulo to Shanghai. Clark Winter, chief global investment strategist at Citigroup Global Wealth Management, says it’s getting easier to secure legally enforceable titles to property in many countries in Latin America, Eastern Europe and Asia — something that didn’t exist in earlier years. That has coincided with easier access to credit and equity flows fueled by robust economic growth. Winter recalls how London was one of the first recipients of global investors’ real estate capital after it opened up in the post-Thatcher years. To identify similar opportunities, experts from Wharton and Citigroup note, investors need to develop a real, local understanding.


Global Real Estate Isn’t So Global


In the fall 2004 edition of the Wharton Real Estate Review, Jacques Gordon, global strategist at Chicago-based LaSalle Investment Management, cautioned against using the word “global” too broadly for real estate. “There is little that is ‘global’ about the world of international real estate,” he says. “This is not a world that treats all 197 countries tracked by economists at the United Nations, the World Bank, the OECD and the IMF as equally eligible investment targets.” Gordon says the capital willing to flow into real estate comes mostly from eight to 10 countries and is headed for no more than 20 or 25 countries. Research by LaSalle Investment Management’s parent, Jones Lang LaSalle, identified the principal origin countries for real estate capital in 2002 to 2004 as Australia, Canada, Germany, countries in the Middle East (including Israel and oil-exporting Arab states), the Netherlands, Singapore, the U.K. and the U.S. The target countries, however, represented 80% of the world’s gross domestic product.


What are the obstacles? First, the trend toward legally enforceable titles has only just begun. Indeed, lack of transparency and the inability to secure property rights still get in the way of real estate capital going to many emerging markets, Gordon says. Also, many local real estate practices show relatively few signs of “convergence” despite the pressures of globalization. “Lease contracts, mortgage instruments, and regulatory and tax regimes remain deeply rooted in country-specific traditions, notwithstanding the growing trend of cross-border investing and the advent of multi-country trade blocs,” he says.


Gordon acknowledges that transparency regarding the nature of these differences is rising, but country-specific real estate practices remain closely tied to long-held institutional frameworks. Gordon lists some of these: the Civil Law versus Common Law approach to property rights; tenant-friendly versus landlord-friendly approaches to lease contracts; and local standards applied to building and zoning regulations.


Wharton real estate professor Grace Wong, who has studied the housing market in Hong Kong, particularly the bubble during the mid-1990s, emphasizes the difficulty of unraveling the elements that affect real estate pricing in the global market. Wong’s analysis of the Hong Kong bubble — which saw a 50% increase in housing prices between 1995 and 1997, and then a 57% decrease between 1997 and 2002 — shows that even the usual suspect — interest rates — had little to do with the initial rise in home prices. It also wasn’t a simple supply-side story, according to her analysis. “The literature of speculation has been limited by the difficulty of measuring fundamental values of assets,” she writes in a working paper titled, “The Anatomy of a Housing Bubble.” “This difficulty is exacerbated in housing studies

because of the structural heterogeneity of the housing stock, low transaction frequency, and the importance of geographical location and local institutions (e.g., zoning laws) in determining housing values.” 


Sweet Spots amid Uncertainty


Stephen Coyle, chief investment strategist at Citigroup Property Investors, sees some “sweet spots” amid all this uncertainty. For instance, he finds the western German residential market to be “interesting” and says Citigroup is active there. “Properties are being sold for 80 cents on the dollar at today’s values, which is up from 70 cents on the dollar six months to a year ago and 50 cents on the dollar three years ago,” he says. “The problem is, if you buy a portfolio, you are going to have some eastern German exposure, and you want to limit that.” He also sees openings where others see problems: “The lack of transparency in Europe creates a lot of opportunity, especially as corporations and governments sell off non-strategic real estate as part of the ‘Great Exchange’ from users to investors.” And he warns investors to stay away from markets that lack a clear financial infrastructure.

Coyle says his team is spending a lot of time scouting for opportunities in China, India and Japan. He’s upbeat on Japan, especially with the recent recovery in its economy. He also expects “a ton of assets” heading for sale after February 2006, when a new law will take effect requiring corporations to price their assets at fair market value. “You are going to see more and more assets brought to market on behalf of corporations, not just government-owned stuff,” he says.


Earlier this year, India enacted laws that make it easier for foreigners to invest in construction and real estate, and the country has worked on streamlining master planning and zoning. “We’re particularly excited about the Indian market, especially with the recent policy changes and the general growth we expect to see happening there in the office and retail space,” says Todd Thomson, chairman and CEO of Citigroup Global Wealth Management. Other markets on his radar include the Ukraine, where he expects a turnaround, as well as Poland and Hungary.


Bulls in China


Another China bull is Quek Kwang Meng, who heads real estate investment for the Asia-Pacific region at The Citigroup Private Bank for clients in Hong Kong, China, Singapore, Thailand, Malaysia, the Philippines, India and the Middle East. “Asian investors are wary of interest rates, but the dynamics are different in this region because of the huge growth in demand, and there is a shortage of supply,” he says. He points to Shanghai, for example, a city of about 18 million people where the annual supply of 200,000 housing units is equivalent to the whole of Australia. China’s rapid growth is fueling a large migration to cities from rural and suburban areas. Wages in China are rising 15% to 20% annually, and people need housing.


In the June 15, 2005, edition of The View, the monthly investment publication from The Citigroup Private Bank, chief global investment strategist Winter wrote: “China’s needs are so great — 400 new airports, according to the nation’s state planners, more than 500 large power stations, dozens of new port facilities, thousands of miles of railroads and highways — that the bill could easily run into hundreds of billions of dollars.” He noted that dollar flows into the country would accelerate, also because of the need for oil, cement, steel and food “in the increasingly well-fed nation.”


Quek says real estate developers in China are raking in returns of more than 20% on their investments, and Hong Kong’s property prices are up 120% from 2003. He now feels emboldened to launch a few real estate funds. Several large developers have floated their own funds in an attempt to distribute risks and enhance their ability to take on large projects.


Quek isn’t worried about the market risks should interest rates rise, mainly because of the Chinese government’s clampdown on speculative activity. Banks avoid giving loans to people buying their third or fourth house, which also has cooled the market for luxury homes. Elsewhere in Asia, Quek says loan-to-value (LTV) ratios are conservative at 60% to 70%, and governments and banks discourage excessive borrowing. Hong Kong doesn’t tolerate LTVs beyond 70%, and Singapore’s 90% threshold also keeps debts in check. In addition, Hong Kong and Singapore have no capital-gains taxes, something Quek sees as a big plus for his investors.


Real Assets in Latin America


The real estate investing market is also strong in Brazil, where Jan Karsten is the Latin America head of Investment Counseling for The Citigroup Private Bank. His high net worth clients hold an average of 50% of their portfolio in real estate. Brazilians hold a high portion of their investments in real estate chiefly because it has been viewed as the surest way to protect their net worth against inflation.


Karsten says that despite high exposures to real estate, Brazilian investors hold the rest of their investments in liquid, fixed income instruments, besides private equity and hedge funds. A significant portion of Brazilian investments traditionally has been in Argentina, and that continues with Argentina’s robust economy. Karsten says attractive exchange rates also entice U.S. and European investors, especially in agribusinesses and wineries.


Karsten is not worried about interest rates; they are now around 17.25% in Brazil, and “there isn’t much room for them to go any higher.” Also, 2006 is an election year and Karsten expects interest rates will be lowered given the political mileage such a move would offer.


Real estate is gaining an increasingly larger share of high net worth portfolios in Mexico and elsewhere in Central America, according to Eduardo Dosal, global market manager for The Citigroup Private Bank in Mexico. He says credit is more easily available for real estate owners than it was four years ago, and interest rates have been steadily lowered (about 10% currently compared with the punitive 80% a decade ago). Also, the political and economic stability of the region is improving, which has contributed to investor returns of 20% or more in real estate.


A rise in U.S. interest rates would affect Dosal’s markets significantly, especially the dollar-denominated bonds issued by many Latin American governments. He says his investors “have already started asking a lot of questions about private equity deals, and are investing in them.” Much of this investment is destined for the U.S.; he says most local Latin American markets don’t offer the liquidity or depth in stocks and bonds, let alone options in leveraged buyouts or hedge funds.


Against this backdrop of beckoning offshore markets and changing fundamentals at home, Citigroup executives expect many of their high net worth clients to gravitate toward opportunistic plays in search of higher returns. The Citigroup Private Bank CEO Damian Kozlowski says that as large capital inflows have lifted U.S. property values to uncomfortably high levels, “investors are going down the food chain” to look for other situations they may not have necessarily considered in the past. But with such investing where they don’t understand the terrain so well, Kozlowski finds them “less confident that they can make it work like they did the last time.” Clearly, while they are searching for the next pocket of opportunity, they are treading cautiously.