Friday Letter Distress in the BRICs

Until recently, the talk surrounding emerging markets was all about growth. Now the story also includes distress. 

The theory that emerging markets are decoupled from the global financial system has been shot to pieces in the past few weeks.

Now, instead of the BRICs just being a growth story, there is also an emerging tale of distress. Opportunities that most would have thought impossible 12 months ago, are now becoming increasingly apparent as the world’s banking system impacts real estate growth.

And it is something private equity real estate firms are beginning to take quite an interest in.

The Economist highlighted the weakness of the decoupling argument last week in an article called Beware Falling BRICs. In it, the magazine cited tell tale signs that show the world’s markets are interdependent.

Russian stock exchanges were forced to suspend trading on September 18 in the wake of Lehman’s failure. In China, the People’s Bank cut its benchmark lending rate by 27 basis points in a show of concern over the darkening economic mood, while in India, the governor of the central bank said he would continue to cushion the fall in the rupee. The magazine suggested that risks could be prompting investors to back away.

However, the current market weaknesses – particularly in China and Russia – are encouraging for opportunistic funds.

Chinese and Russian developers are now finding it hard to access debt to progress their projects. In China, the government has also attempted to rein in growth resulting in additional restrictions on lending. A report in the Wall Street Journal last month said that, according to property brokerage DTZ, bank loans to the industry are expected to fall by about a quarter in 2008 compared with last year.

For opportunity funds there are opportunities to provide these local companies with financing. Just this week, Pramerica, the real estate investment arm of US life insurer Prudential Financial, invested $73 million for a 99 percent stake in a housing project in Nanjing, China in a joint venture with Hong Kong conglomerate, Minmetals.

The Wall Street Journal report also revealed Hong Kong property tycoon Vincent Lo had spent approximately $700 million in the past year acquiring at least a dozen big real estate projects left unfinished by cash strapped developers.

PERE has also spoken with Asia-based private equity real estate investors, who say the opportunities are beginning to present themselves.

The story for emerging markets in 2009 therefore may prove not to be exclusively about growth opportunities, but also distress.