Comment: Local capital to the fore

In Asia, indigenous institutions are scaling up their regional property activities. Foreign private equity real estate investors could benefit.

Name a mega-trend in Asian real estate investment today. Urbanisation? Tick. In China alone, 200 million people are expected to move from the countryside to the cities in the next 15 years. The property development required to accommodate these people constitutes a massive investment opportunity for anyone who can access it.

But demographics isn’t the only phenomenon set to transform Asian real estate in the coming years. Another one, equally significant but perhaps less well documented at this stage, is the rise of local capital as a dominant source of funding across the region.

In Japan, the rise will in fact be a revival. At present, Japanese pension funds have less than one percent of their capital allocated to property – the wounds sustained during the country’s real estate meltdown in the 1990s have still not fully healed. But now the recovery is finally underway: encouraged by the success of Japanese REITs, which from a standing start at the beginning of the decade have reached a market capitalisation in excess of $50 billion, pension funds are expected to finally move back into the asset class. Japanese pension funds have more than $2 trillion in assets: when they do finally come back into real estate, the effect on institutional capital flows into the market will obviously be significant.

Equally important is the prospect of Chinese institutions ramping up their exposure to property. In China itself, mainland investors are already the dominant provider of capital to the market. According to government statistics, approximately seven eighths of total real estate investment in China is currently funded locally. Of the 13 percent or so accounted by offshore investors, the bulk comes from developers in Hong Kong and Singapore, meaning that international financial investors such as private equity funds have made only very limited inroads into the Chinese market so far. Now local institutions such as the country’s giant insurance companies are scaling up their real estate investment operations even further. Not only is this likely to consolidate their leading role in the Chinese market; market practitioners also expect significant amounts of Chinese capital to move into other Asian markets – North Asia, Southeast Asia and the Indian subcontinent.

For international private equity funds operating in Asian real estate, the growing influence of local investors is a double-edged sword. The bad news is that asset prices are likely to rise, and pressure on yields will intensify. Local money usually has better access to deal flow, a thicker skin when it comes to regulatory risk, and a lower hurdle rate than foreign buyers. In other words, international opportunity funds looking to acquire assets in markets flush with local cash are bound to encounter stiff competition.

The good news is that a deepening pool of domestic capital has the potential to bring a level of stability to the Asian market that has never existed before. There is still a huge untapped investment opportunity in the region. Just think that China today has less than one percent of the world’s total investable real estate: the scope for development is simply enormous. With liquidity increasing and volatility diminishing, international funds should find it easier to participate going forward