Tumultuous real estate markets in Asian countries could translate into superb investing opportunities for those with the cash and fortitude to ride out the ups and downs, according to speakers at Wharton’s recent Asia Business Conference.


“Opportunities are extraordinary right now” in Korea and Japan for investors willing to provide mezzanine financing (a high interest-rate hybrid of debt and equity), said Pietro Doran, chairman and principal of Doran Capital Partners, which raises private equity funds in the two countries. The failure of companies such as Lehman Brothers has left a vacuum in the market, noted Doran, one of three panelists who discussed how much the U.S. economic downturn will affect Asia. “You can’t get anything out of the ground right now unless you can bridge yourself for two years.”


Recently, tight credit markets around the world have caused real estate markets to come almost to a halt in rapidly emerging economies like China and India. Chinese economic growth of 9% in the third quarter of 2008 remains strong compared to most other countries, but economists expect that number to fall to 8%, and possibly lower, in the fourth quarter. The Chinese central bank has cut rates with little effect so far. Central bank officials in China have expressed worry that the problem could spread and they are especially concerned about declining prices, or deflation.

But others are betting that the strong underlying growth in Asian economies will make today’s real estate prices look like bargains, especially in China. Merrill Lynch & Co. recently raised US$2.65 billion for an Asian real-estate fund, for example. Panelist Donald “Skip” Conover, chairman of Bhavana Developers in Hyderabad, India, said that Asia and India represent solid opportunities. “Surely … there will be huge growth.” But only well-funded firms will be able to capitalize on those opportunities, he noted. “The question in real estate right now is, ‘Where is the money,’ because you’re not going to build anything if you don’t have money.”


Worldwide financial turmoil has tightened lending standards in many Asian countries, Doran pointed out. Lenders that once financed 60% of the value of a building will now provide only 45% or 50%. In India, Conover noted, banks are not allowed to lend money for land purchases, which has limited development there. Tools commonly used in the United States to finance development, such as loan syndication, in which several banks buy portions of a loan, and commercial mortgage-backed securities, are almost nonexistent in most developing countries, the panelists said. Real estate investment trusts, which pool money to invest in loans secured by real estate, however, have become more popular in Asia and are spreading to the Middle East as well. Conover noted that he disapproves of a new law in India that will limit real estate investment trust ownership to 15% of a building, leaving those investors almost no say in how the development can be used.


Doran predicted that financing eventually will loosen because economic conditions in most Asian countries are relatively strong. Vacancy rates in Seoul, for example, are about one third of 1%, even though the economy there is growing at a 3% yearly rate. “You shouldn’t have that much trouble getting lending, but you do [have trouble] right now simply because there’s this massive global paralysis going on.”


On the Ground


Even well-funded firms must understand that markets in Asia and India operate very differently from those in the West. “If you don’t know the politicians and how things get done on the ground, there is no hope,” Conover said. Panelist Leanne Tobias, founder and principal of Malachite LLC, an advisory firm that develops, manages and finances environmentally friendly real estate projects, noted that partners also are often necessary in the United States to gain an understanding of local markets. “I wouldn’t go into a United States market without a very strong local presence,” Tobias said. “It takes a while to understand the dynamics for your home country very well.”


Developers must vet their local partners thoroughly, Conover noted. “You need to follow the first rule of wing-walking: Don’t take the next step until you’re steady in the last one. You have to have very strong trust in your partners.” An experienced local partner can compensate for legal systems in many developing countries that are less predictable than in the United States. “You can’t [only] rely on a contract that you negotiate very well.” When he was working in Taiwan, he was surprised to see a business partner sign a thick contract without reading it. The partner explained that the contract was less important than other, relationship-based factors. “That’s what you have to understand. You can be a great lawyer. You can be a very smart person, but the way you’re going to control the situation is by controlling the power in the relationship.”


Doran argued that despite the prevailing view, legal systems had improved in some locations, especially in larger cities in developing countries. “I’ve bought real estate in Japan. I’ve had to go to court in Korea. We’ve found in the courts of law in many places that are modernizing, such as Shanghai, [courts are improving]. I just invested $1 billion in 2007 in Japan and Korea. I wouldn’t have been able to do that if I couldn’t assure investors that I could manage the risk. The old cowboy days, the pith helmet and pistol way of getting into business, is going away, but it’s still there.” Besides, he added, American cities can be equally parochial. “Go to New York, and get in trouble with a partner who’s been there for 20 years and see how well you do,” Pietro said. “Any relationship that starts with a prenuptial agreement — I would argue don’t get married in the first place.”


Conover urged people interested in investing in real estate abroad to understand that countries are also at vastly different stages of real estate development. “Companies that have built in China today are very experienced in building large buildings. There are almost no large buildings in India today. Almost all buildings are under four stories.” Indian markets are also largely closed to foreign investors, which has depressed prices there, Conover said. “When the Indian government wises up and makes it a little easier for foreign direct investment,” prices should improve. “In Hyderabad, the cost of real estate is only about 20% percent of prices in Manhattan.” Even so, real estate is more open to outside investment than other industries in India, he said. “You just need a partner.”


By contrast, China seems to have embraced free markets more strongly than India, which means development occurs more quickly there, Conover noted. Tobias agreed: “The feedback that I get is that [real estate development in] China is orderly, if you work with the government.” In Conover’s view, Indians “prefer to deal with Indians. They perceive that everything is fine [if it’s from] India. But they have to deal with the rest of the world” if they want the real estate market to grow.

In some ways, the panelists noted, many Asian markets are more forward-looking than the United States – particularly in terms of environmentally sound development. India and some Asian countries are beginning to focus on “green” development, Tobias said. “India, for example, has built green requirements into developments, and so have Taiwan and Singapore…. Thailand, going back to the 1990s, has embraced energy efficiency standards more than any other nation on earth.” Green real estate, or sustainable real estate, “works very well under conditions of land scarcity,” which is often the situation in these countries, Tobias noted. “In addition, there is very strong interest in [constructing] these types of buildings locally because corporations are becoming interested in them,” she said, citing research conducted in the Asia Pacific region and in Europe that showed 20% of businesses were willing to pay a premium for environmentally friendly office space. But Doran said it was hard to make a business case for such developments until governments set environmental standards to “even the playing field” so that green buildings become more common.

When asked what advice he would offer to those interested in entering Asian real estate, Doran responded, “It’s an every day learning experience. Markets change fairly dramatically. They have been changing fairly dramatically in Asia. I suppose if I were to give anybody advice, it would be to have maximum flexibility.”