No place like home

As the economies of Asia take flight, PERE takes a trip around the region to look at the residential markets of China, Japan and India— what is making them tick, what do buyers want and how can foreign funds participate? By Aaron Lovell

As the largest and most populous countries in Asia continue to grow, the reverberations of the expansion are being felt throughout their economies. Naturally, this has affected the taste and attitudes toward housing—be it ever-larger township developments outside Mumbai for IT employees, multiple-tower complexes with fancy new clubhouses inside Shanghai's Inner-Ring Road or a centrally located Tokyo building that is exclusively for pet owners. With increased spending power, consumers in these countries are looking for a place to live with all manner of modern-day accoutrements.

As luxury products seem to be a popular entry point for foreign institutional investors looking to penetrate these markets, such changes are important to keep in mind. And as more and more firms expand their mandates to include Asia, set up JVs with local partners or establish country-specific vehicles, investment-grade residential opportunities will no doubt play an important part in their investment strategy.

Growth in the Chinese residential market is fueled by the country's often-discussed mass-migration from rural areas to the nation's large cities. The World Bank estimates 10 million people per year are making the move to China's primary, secondary and tertiary cities, with the housing stock in major cities undergoing intense and rapid change.

Simon Treacy, a managing director for Macquarie Global Property Advisors, says the Chinese are building more than 25 million residential units per year to meet this growing demand. “That's like building a new Manhattan every month,” he says. “Residential is taking a massmarket approach.”

While the majority of the apartments aimed at the middle- and lower-class market are smaller, usually with around three bedrooms and 40 square meters of space, there is also increasing demand for higher quality housing, as well as properties aimed at China's growing upper-class market. According to market participants, this strata of the economic spectrum is where foreign institutional investors are finding their niche, thanks to higher margins and lower volume—and the fact that the middle-class sector is still very competitive, fragmented and dominated by local players.

“Luxury projects are certainly the best investment opportunities in China at the moment,” says Randall Hall, Shanghai-based chief executive officer of Savills China, an arm of the UK estate agent. “The relative scarcity and limited future supply of these high-end properties, as a result of recent government policies, is expected to continue pushing property prices up even higher in the long-term.”

“Luxury projects are certainly the best investment opportunities in China at the moment.”

Nevertheless, the luxury market is also where the Chinese government has cracked down in an effort to lower housing prices and stymie speculative investing in metropolises like Shanghai. Changes to the law include a required down payment of 30 percent and a capital gains tax of 5.5 percent of a property's value if it is sold in less than five years. Most recently, the government has stipulated that more than 70 percent of units must be less than 90 square meters, a law to encourage the development of more modest abodes, though some players wonder how that particular statute will be enforced.

The luxury projects themselves have a distinct profile, taking into account the changing demographics in China, as well as traditional attitudes towards community and housing. Most agree that in recent years the public services and infrastructure in Chinese residential developments, which can incorporate around 12 towers and a mixed-use component, have improved immensely. Hall notes that new projects often include clubhouse facilities, as well as better access to schools and transportation. In the residential areas further from the city centers, which are often more attractive to families with children, there will often be sports fields and gardens.

Of course, these sorts of creature comforts come at a price. According to Savills China, average transaction prices in the Shanghai residential market have crept up since 2001, hitting a peak of around 9,000 yuan per square meter in the first quarter of last year. Despite some volatility throughout last year, prices were once again approaching their early 2005 peak this May.

Still, while prices are trending upwards, Hall says that the prices are still reasonable compared to other world-class cities in Asia. He points out that residential prices in Hong Kong are roughly ten times those in Shanghai.

Much like China, a growing number of private equity real estate firms have set up joint ventures to explore Indian real estate investment. The growing economy and inefficient property markets seem poised to—one day—offer outsized returns to opportunistic foreign institutional investors.

It isn't hard to see why. The Indian subcontinent sported a gross domestic product of $500 billion in 2004 and the country's GDP is predicted to grow at an annual rate of 6 percent over the next few years. And in 2005 the government relaxed regulations regarding foreign direct investment in real estate, particularly the residential sector. Foreign groups can now invest up to 100 percent in township and housing projects.

But there are also concerns about the country's lack of infrastructure, from questions about roads and water systems to regional planning, as well as government bureaucracy in the real estate sector.

“India is certainly behind China,” Macquarie's Treacy says. “But like China, there is a shift towards the cities.”

In addition to an increase in urbanization, India has a growing working population with more disposable income. There are also fiscal incentives for Indians taking out home loans, a relatively new financial product. According to Ashwin Ramesh, a principal with Mumbai-based private equity real estate firm Primary Real Estate Advisors, house loans still only represent around 3 percent of India's GDP, but their use is growing at a clip of 30 percent per year.

“The younger generation is not averse to taking out home loans,” he says.

To capitalize on these developments, some of the biggest names in real estate investing are getting ready to put capital to work in the country. Last year, New York-based property investment firm Tishman Speyer announced a joint venture with a subsidiary of ICICI, one of India's largest banks. According to press reports at the time, the project was looking to invest more than $600 million in equity and was eyeing townships sporting 7,000 to 10,000 residences.

Ramesh estimates that around six deals have been completed with foreign institutional investors, but a number of players are looking for opportunities. Local developers continue to find deals—in particular, they are looking at larger-scale projects on the peripheries of India's large cities.

For example, Ramesh points to a 700-acre township project outside Calcutta called Rajarhat, which is being developed from the ground-up. The project, a town unto itself, combines residential towers with close proximity to IT employers, who are developing their offices in the same complex.

“The IT is what drives the development,” says Ramesh. “They employ young kids at a good salary.” He adds that, in the past, new residential development was targeted towards wealthy businessmen, rather than the younger employees.

The township projects offer employees the chance to buy a home close to work, as well as providing other services like health clubs, clubhouses, pools and recreational areas, as well as hotels and schools. And younger buyers are placing a much higher emphasis on quality construction and planning, including open spaces.

Unlike residential projects in the large cities of Japan or China, less of a premium has been put on proximity to central business districts. One of the primary reasons for this, according to Ramesh, is that as companies have expanded they have established additional secondary CBDs closer to employees' suburban homes. “The offices have moved to where [people] are living,” he says.

Japan, coming out of 10 to 15 years of recession, has seen increases in income, wages and savings—information that is good news for development, as the country's residential market is largely comprised of old housing stock.

“Buildings were not built to last,” says Alec Menikoff, the Tokyo-based general manager of the investment division of property consultant Colliers Halifax. “If [a building] is 20-years-old, it's an old building.”

Because of lower quality housing, largely built on wooden frames and with low ceilings and sub-code structures, redevelopment of old buildings is relatively limited. Instead, new buildings are simply replacing old ones. “It's not something they can fix,” says Menikoff, adding that it is usually cheaper to tear the old structures down and build anew.

Many of these legacy buildings are also not built to the proper code for earthquakes, says Macquarie's Treacy. Along with the improving economic fundamentals and increasing consumer demand, replacing this older stock is creating what Treacy calls a “perfect storm” for developers.

“There is a whole new generation of housing stock being developed,” he says. “People are preparing to move out of old buildings—which has allowed new stock to be developed.”

Pricing has also become more consumer friendly, falling from the highs of the early 1990s. According to research from Colliers Halifax, the average new Tokyo condominium cost around ¥87 million ($748,000; €596,000) in 1991. By 2000, new condo prices dropped to ¥46 million—and have pretty much stayed there since. Treacy adds that, with land prices 80 percent off their peak, more and more people are being able to afford moving into cities.

“There is a whole new generation of housing stock being developed [in Japan].”

The shift from older buildings to newer construction is also changing the profile of Japanese residential projects. But, as in real estate everywhere, location remains an important factor. And many participants say that Japanese buyers are increasingly interested in living closer to central business districts. “Inner-city living is very chic,” says Treacy.

So is being close to the subway. “People are looking for proximity to transportation, mainly subways or train stations,” says Menikoff. He adds that, from an investment point of view, this helps maintain rents and occupancy, as well as fill vacant space.

In addition to better location, the Japanese are increasingly looking for things more likely found in new construction—like higher ceiling heights. Other amenities are also becoming popular: better security, usually in the form of automatic, key-operated doors; internet-ready apartments with satellite television hookups; fancier kitchen and bathroom facilities, including hi-tech, only-in-Japan toilets and baths.

“The Japanese prosperity has increased over time and that has been reflected in the housing stock,” says Menikoff.

Players also point to the increasing interest in branded product, properties that are differentiated by developer and targeted towards a specific demographic, for example, women, retirees or even tenants with pets. For years, pet ownership was somewhat discouraged in Japanese apartments, but that is changing along with the residential market.

“[Allowing pets] can really expand your tenant base and helps with the [ability to let] the property,” says Menikoff.

Led by this new development for an upwardly mobile population, the face of Japanese residential real estate in cities like Tokyo, Kyoto and Osaka is changing—and creating new opportunities for savvy investors.

“There is a flight to quality,” says Treacy. “There is a flight to safety. There is a flight to big cities. There is a flight to convenience. There is a flight to affordability.”