LPs ignore emerging markets at their 'peril'

Investors will ‘sacrifice’ returns and diversification if they overlook China, Brazil and India. However, targeting the three countries’ real estate markets demands a longer-term investment horizon and plenty of due diligence.

It is an undisputed fact that the emerging markets of China, Brazil and India are the most important contributors to world growth. As the US, Western Europe and Japan struggle with the problem of mounting deficits coupled with slow growth, China, Brazil and India are recording annual GDP growth of anywhere between 6.7 percent and 9.1 percent.

David Lynn,
ING Clarion

The countries’ real estate stories are a similar pattern of growth and appreciation. Yet for many institutional investors in the US and Western Europe, the property markets of China, Brazil and India are still an unknown investment opportunity.


However, David Lynn, managing director and head of investment strategy and research at ING Clarion, advises that now is the time for institutional investors to start looking at real estate markets in emerging markets.

Speaking to PERE, Lynn insists investors – as well as fund managers – can no longer “put their heads in the sand” and ignore the growth being experienced in China, Brazil and India. “If you ignore the growth stories of these economies, you do so at your peril, sacrificing returns and diversification in the process.”

Why would investors sacrifice returns by concentrating on more developed real estate markets, such as the US and UK, rather than looking at emerging markets?
: This is not an either/or proposition where investors forsake the US or UK to invest elsewhere. Developed markets, particularly the US and the UK right now, still present an attractive investment opportunity, and you are seeing huge inflows of capital to these countries  as a consequence of that. However, the emerging markets of China, India and Brazil are the fastest growing part of the international real estate world, and real estate investors also should have a mind of going where the growth is.

But why start targeting China, Brazil and India now, compared to looking at these strategies in five or 10 years time?
You have to learn these countries and do extensive research and due diligence to develop the most appropriate strategies for your set of investment objectives. The devil is always in the details, but it’s not easy to execute deals in any of these markets. However, as an investor, I’d argue you cannot just do nothing, so if you’re not looking at these countries already, now is a time to start researching and actively planning to enter them.

Are LPs starting to eye these real estate markets more seriously in the wake of the credit crisis?
For a long time, these emerging markets experienced extreme volatility during global downturns, but during The Great Recession these economies went through it better prepared and came out of it stronger than developed markets. That in itself was a dramatic sea change and was a big litmus test for a lot of institutional investors.

Investors are extremely mindful of risks today, yet real estate deals in China, Brazil and India will be higher risk by the very nature of the fact many are value-add or pure development plays.
Investors do accept investment opportunities in these countries are higher up the risk spectrum and that they have to invest over a longer time horizon than in developed markets. However, emerging markets already are proving to be the engine of growth for the global recovery and, as the crisis starts to fade from memories, little by little you will see – and are seeing – more and more capital going into China, India and Brazil.

What are the major problems facing investors looking at the emerging markets?
The biggest challenge is getting the right operating partner. It’s like a marriage; you have to ensure you have a high level of trust in them. The second is certainly the legal and regulatory environment, not least of which is understanding how to get capital in and out of the country and how to invest it once it’s there. The rules, as we’ve seen in China, can change overnight without warning, and that can be a pretty scary thing.

What potential exits are emerging for investors already targeting the emerging markets?
The past few years have seen a dramatic change in fortunes among local real estate investors and owners in China, India and Brazil, and they have become one of the main take-outs for many investors. For-sale housing development strategies typically are purchased by in-country retail buyers.  In addition, the development of REITs could be another potential avenue for investors in the future, as we see retail investors increasingly get more comfortable with the asset class.

The emerging markets though are not just about a one-way flow of capital. There currently is a global glut of capital searching for yields and investments, and we are seeing significant amounts of emerging market equity looking to put its money to work in more developed economies as well. We truly are seeing multi-lateral investment flows as the real estate investment world gets larger.

Weighing all the risks of investing in emerging markets, do China, Brazil and India actually represent a compelling deal?
There’s no hard and fast rule. Obviously, it really comes down to the finding the right partners in that country, but there are clear benefits to your portfolio in terms of alpha generation and diversification by targeting China, India and Brazil. At the end of the day, investors should go where the growth is. However, they also need to be ready for the longer-term investment horizon and greater risk when they do.

Lynn is co-author of the book, Emerging Market Real Estate Investing: Investing in China, India and Brazil, written with Tim Wang. He also has written Active Private Equity Real Estate Strategy. Both books are published by Wiley.