The global real estate recovery will be longer, slower and more muted in mature economies than it will be in India or China feels Mr Colin Dyer, Global CEO and President, Jones Lang LaSalle Inc. In an interview with Business Line, Mr Dyer discusses the structural changes in the real estate sector as a result of the recession and about the short-lived opportunity to buy at lucrative prices.
Excerpts from the interview:
Has the real estate market across the world undergone structural changes post the crisis? If so, what are they?It varies from market to market. In India, for example, the structure has not changed.
There has been no permanent damage done either to the financing system to real estate or to any major players or developers. For certain there has been a tactical rather than a long term structural change.
Whereas in the US, for instance, the banking system relied upon securitisation of real estate to provide liquidity for the investment sales market. Well at least for the next year or two, the market for securitisation of commercial real estate is closed, so that means capital will not be available.
So that is again a structural change. We have seen some Real Estate Investment Trusts (REITs) of major real estate companies in Australia and the US simply disappear or be absorbed by others.
But in general for India, it's back to business fairly soon.
The realty downturn was fairly synchronised across markets but the recovery does not appear to be so?
Well, the boom was synchronised, the downturn was synchronised in India and Europe/US and the recovery for sure was different by region. In general, you can say that countries which had strong growth rates before the recession came — Indonesia, Malaysia, India, China and Brazil — will be recovering quickly and coming back to fairly healthy growth in real estate activity as well.
When you look at the lower growth economies, the mature economies of Western Europe and the US, the recovery will be longer, slower and more muted than it will be in India or China.
Is the recovery backed by a fundamental demand for space or is it being viewed as an investment opportunity?
It depends on the sector and country. In India, the fundamental demand for residential space is for single family and multi-family homes; there is a pretty healthy demand for retail space as well. You can say the same of both sectors in China.
But there isn't a fundamental demand yet for office space really anywhere in the world.
This is because reducing employee numbers and space per employee has resulted in no net take-up in office space. There does not seem much prospect for office space in 2010. I think in 2011 there could be some demand.
If you look at the investment sales market, the stock markets anticipated broad economic recovery for the last year and a half, so has real estate been anticipating a broad economic recovery. So there has been a recovery in asset prices which is well ahead of fundamentals.
India seems to be far way off from having REIT structures?
The fundamental factor for REITs to work effectively, for them to be liquid and for them to trade on the underlying value is that you need a liquid and transparent real estate market so that values can be continuously established and investors can understand the value of the real estate in the REIT.
The Indian real estate market is not sufficiently deep, liquid or transparent for REITs to be as effective as they have been in Australia, Britain France, Holland and the US.
Do you see a supply glut in Asian markets going by the current activity?
In China, for example, office markets do have 30-40 per cent vacancy rates in secondary cities. That's a glut.
But China is doing 12 per cent a year and it is urbanising on top of that. So a 30 per cent vacancy rate, which would a disaster in Chicago and would take six years to clear, is probably a two-year problem in Chinese cities. So in Asian markets, even speculative development was a smart thing to do because there was such underlying growth. The rate of growth, if it is maintained at what we have seen over the last half-year — up in the high single or low double digit figures for China and India — will see these markets clear their gluts within two years.
The availability of quality assets at once-in-a-lifetime prices lasted about three weeks and very few people reaped the benefit. In retrospect what everyone expected would happen, broadly speaking, was that a lot of distressed assets would be dropped into a very thin real estate market. Why, because it was assumed that developers would be unable to finish projects- because people believed there would be a scenario of capital being unavailable for a long period and financial institutions would be forced to foreclose. But that did not happen.
In practice what has happened is that banks in most countries have been backstopped by their governments. So they have been given the liquidity or the ability to discount their loans with the central bank and the ability to delay the problem in the commercial real estate market, thus pushing the issue down the road. So there was no sudden rush of distressed assets in the markets. That was the first unexpected effect. The second unexpected effect is that although commercial asset prices dropped by up to 50 per cent, they have picked up under cover. In many markets, there has been a 20-30 per cent recovery. Which means as the banks delayed dealing with the problem; the assets have actually recovered some value — so the problems are becoming less severe.
So if you put these two things together the availability of distressed assets was short-lived and the assets began to recover. Any assets that were being sold were withdrawn from the market, because the sellers know that if they wait for six months they get a better price. So a lot of things have been surprises to people or things that were predicted happened much faster.
How do India and China score on the transparency factor in real estate?
Well the transparency measures drive the level of investor interest. Truth is that there has been very little inward institutional investment into either India or China. For India it was $2-4 billion and China's peak was $7-8 billion of inward institutional investment. That's about the size of investment sales in Paris in any one year. So they are very small markets. Transparency is about clear visibility on pricing and returns and means low levels of bureaucracy. It is also lack of corruption and a legal system which actually operates if you get into trouble. Exit routes or repatriation systems are also important. India and China depict very similar pictures on this front. They do not score high on the above factors.
Will withdrawal of restructuring packages to real estate and higher interest rates hurt real estate demand?
The restructuring packages into real estate directly, once withdrawn, may not have a big impact. The support packages for banks internationally will certainly have a big impact once withdrawn. And I think there are signs of those being removed, which will force banks to deal with their capital bases and deal with some of the bad loans given to real estate. That's expected to be a trickle or flow rather than a tsunami. The interest rate issue is more subtle. We have seen in India a tightening of 25 basis points — that is not going to change anybody's point of view on the economics of projects or purchase or pricing.
Much more impactful is what China is doing, which is changing the reserve ratios against lending. That drains immediately the level of liquidity available. It is not so much pricing that will have an impact, it is the availability. So we are seeing signs in China and I suspect India will follow of governments draining the availability of debt from the market because they are seeing inflation coming through wither in asset bubbles or in pricing of food and consumables. And that's something that will affect the viability of finance for real estate and therefore the level of activity.
Do you see a possible debt crisis in other countries besides Greece, as a threat to real estate recovery?
It depends on how far the sovereign debt crisis goes. I think it is quite disturbing to see both England and America running deficits on their annual budgets and running levels of sovereign debt which are headed up towards a 100 per cent of GDP. That's bad, but what's worse is that there is no apparent urgency to deal with that situation. So what we have seen in Greece could potentially be a broader problem. I am not an economist but it is disturbing me that the issue of how to reduce debt is not being addressed by two pretty major economies and there are rather similar situations in Spain and Italy. In terms of what it could do to real estate – if you consider a situation where the risk-free bond rate which is traditionally the US Treasury Bond is no longer the lowest risk instrument in the world because if Warren Buffet can borrow for less than the US government, they you have got some fundamental realignments which are necessarily going to take place in the capital markets world wide. What its consequences will be, I don't know but it would for sure mean that the rules for availability of capital in different sectors get adjusted and changed. It is something we need to pay attention to and watch out.
How far are we from the peak and how long would it take to get back there?
Real estate cycles have typically been eight years long from trough to peak. Maybe 10 years from peak to peak. So from where we are now, with the recovery just six months old, we may be six to eight years away from the next peak, assuming it follows the previous cycle. That's a big assumption because what I just said about the recession is that things happened that people didn't expect or did not happen or happened faster.
