Onshore, offshore, nearshore — here, there and everywhere

Anecdotal evidence has it that the great move of European manufacturers to lower-cost production centers in Asia — first China, then other Asian emerging economies as China became too expensive — is slowly being reversed.

Manufacturers are bringing production back to Europe, we hear, perhaps not all the way home to the original domestic base in western Europe, but to a nearshore destination in the lower-cost but highly skilled markets of central and eastern Europe.

It’s still all about cost, but it’s also about quality, quality control and being near enough to the center of the action to be able to go out and deal with the day-to-day issues that arise. In a niche manufacturing sector that I know quite well, the truth is that production in China became both too expensive, as wage levels increased, and quality fell away, as experienced and skilled workers — enticed by higher pay in other sectors — were replaced by new, untrained workers. Quality control also fell away as western manufacturers balked at the cost of paying yet more for someone to supervise the workforce and assess the output. That’s a false economy, though. Remember — low-cost production only works if someone buys what you produce. And definitely doesn’t work if someone decides not to buy what you produce.

Not so, apparently, on the anecdotal evidence. Put your anecdotes away. Colliers International and CoreNet Global have produced a report, Home vs. Away: The repatriation of manufacturing in Europe, that debunks the theory that manufacturing is coming home or nearer home.

The report concludes that the repatriation of manufacturing to Europe is still the exception for many multinationals. Instead, they are adopting a “best-shoring” approach, a pick-and-choose way of placing operations around the world to price and competition advantage. But Europe may be well placed to benefit from best-shoring, explains Guy Douetil, managing director of EMEA Corporate Solutions at Colliers International.

“Companies’ strategies are far from being one-dimensional,” Douetil says. “The good news for Europe is that it is set to increase its appeal as a ‘best-shoring’ option.”

Douetil agrees that the findings of the report are surprising “as the general perception, based on all the hype around offshoring and re-shoring, was that manufacturing businesses were flocking back to Europe. It was commonly believed that multinationals were returning to Europe, driven by a need for proximity to their client base, supplier chain and escalating labor costs in traditional offshoring locations.”

The survey found that, although nearly 25 percent of manufacturing businesses have moved parts of their production activities back to Europe in the past five years, this was rarely part of an explicit repatriation strategy. Only 11 percent of manufacturing companies plan to return to Europe, or “re-shore,” in the next three years. Interestingly, though, half of the survey respondents said that they intend to ramp up production in eastern Europe, Russia or Turkey in the next three years.

“The sharp rise in labor costs and the consequent erosion of cost advantages in emerging economies is now a key concern for global businesses,” Douetil suggests. “In China, salaries have more than doubled since 2007, and the introduction of mandatory employer social welfare contributions and rising wage expectations from employees is also likely to place total labor costs under further upward pressure.”

Regardless of where manufacturing is undertaken, it still doesn’t augur well for those firms that don’t pay enough attention to quality and quality control. If goods are found to not meet the specifications required by customers, then customers won’t buy those goods. Equally, if goods are damaged in transit due to deficient packaging and handling, then the manufacturer has to bear the cost of rectifying matters or writing off the goods.

You can onshore, offshore, nearshore, best-shore and re-shore all you want to. But the product has to be right.

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RichardFlemingRichard Fleming is editor of The Institutional Real Estate Letter – Europe.

A flood of capital

Investors from China may be set to unleash a flood of capital on the global real estate industry.

New regulations put in place in 2012 by the China Insurance Regulatory Commission (CIRC) have widened overseas investment options for Chinese insurers, which have an expected $14 billion available for overseas commercial real estate investments, according to Chinese Insurance Funds Target Overseas Real Estate, a recent report by CBRE.

According to the report, the new regulations allow Chinese insurers to invest 15 percent of their total assets in “non-self-use” real estate. With total assets of $1.2 trillion combined among Chinese national insurance institutions at the close of 2012, this allows for more than $180 billion to be invested in real estate. If these institutions follow asset allocation patterns seen among insurance funds within developed nations, they’ll allocate 6 percent of their total assets to direct property investment, with 20 percent of those investments being made overseas. This would lead to $14.4 billion in overseas commercial real estate investments.

Though the Chinese real estate market enjoyed particularly rapid growth and high levels of domestic investment for the first 10 years of the 21st century, large increases in the price of land and expanding demand for property and investment have led to rapidly escalating prices. In response, the Chinese government has launched a series of policies aimed at curbing domestic real estate speculation, especially in the residential sector, namely through administrative, loan, taxation and other restrictions. Consequently, many Chinese investors are facing limited domestic investment channels.

Additionally, while regulation has become more stringent at home, these investors are seeing the major overseas property markets experience a continued pick-up in investment momentum coupled with their high-yielding assets maintaining depressed values from the 2009 financial crisis. Add in the escalating purchasing power that the continued appreciation of the RMB has afforded Chinese investors, and it becomes clear that a large window is opening through which billions of dollars of Chinese capital will soon flow.

According to Marc Giuffrida, executive director, global capital markets, with CBRE:

“Chinese insurance institutions are already well established in domestic markets, but following a series of government policy changes, they will look to target overseas commercial real estate markets. The insurance industry, in particular, is thriving; buoyed by ever-increasing funds they will target gateway cities around the world such as London, New York, Toronto, Singapore, Hong Kong and Sydney in increasingly large amounts. The low liquidity, value-added potential and stable cash flow of prime office and retail assets offers a perfect match for these investors.

“Compared with developed countries, the allocation by Chinese insurance companies to overseas real estate investment is still relatively low, even with a modest increase in allocations given the capital base the flows could be quite substantial. Using the Malaysian and Korean outbound investing experience as a guide, big industry leaders will lead the way, but once they demonstrate success the rest of the industry to follow.”

But Chinese insurance companies will face a number of challenges as they enter the global real estate market, namely due to their inexperience. According to An Expanding Horizon — Chinese Capital Tapping into Overseas Real Estate Markets, a separate report released by CBRE this year, Chinese insurers will be confronted with a number of challenges when making overseas investments, including:

  • How to make choices on different investment areas/destinations;
  • How to close a deal as quickly as possible amid keen competition;
  • How to determine the right investment horizon, optimize the transaction structure and identify the best financing arrangement to maximize the ROI; and
  • How to manage and operate the acquired assets effectively.

Additionally, these investors could be facing a relatively long learning curve due to unfamiliarity with local laws, market rules and regulations. They will also have to adapt to domestic regulations on overseas investments that limit Chinese insurance companies to investing in mature retail and office properties located in central areas of major cities in 25 developed markets such as the United States, United Kingdom and Australia, as well as the listed REITs in these 25 markets.

In order to contend with these challenges, Chinese insurers may follow in the footsteps of some major real estate enterprises, such as Vanke and Wanda Group, which have chose to enter into partnerships with experienced foreign partners in order to make sound investments. But, while a desire to better understand foreign markets and regulations may have caused some Chinese insurance companies to be tentative with their overseas investments over the past year, it certainly hasn’t slowed the Ping An Insurance Group, which acquired the Lloyd’s Building in London for £260 million ($403 million) earlier this year.

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ReggieClodfelter91x119Reg Clodfelter is a reporter at Institutional Real Estate, Inc.

There are no answers, only questions

Some questions just make my head hurt thinking about them. “What is the meaning of life?” “What came first, the chicken or the egg?” “Where do those missing socks go?” And, most recently, “What will be the effect of higher interest rates?”

Interest rates already have crept up from historical lows in the past months in anticipation of the Federal Reserve’s plans to temper its vast bond-buying program. What will rising interest rates mean for consumers, investors, businesses?

I’ve thought about it and, thanks to my journalistic bent, as usual, I’ve come up with more questions than answers.

  • Housing market — Higher rates will price some potential homeowners out of the market. Will this falloff in demand put a damper on the housing market? Or will these higher interest rates go hand in hand with a strengthening economy, which could sustain momentum in the housing market and fuel home price appreciation, wealth creation and increased consumer spending?
  • Commercial real estate market — Cap rates will go up and commercial real estate values will go down. At least that’s the conventional wisdom. However, based on the improving economy theory, it has been noted that NOI growth could offset the negative effect on value. Will property owners take a hit on values, or will rejuvenated space demand tighten vacancies and push up rents, ultimately enhancing property values?
  • Job market — There will be winners and losers. The mortgage industry already has taken a hit from higher interest rates and the anticipated lower volume of lending and refinancing. Bank of America, Citigroup, JP Morgan Chase and Wells Fargo all have announced plans to lay off thousands of workers in their mortgage businesses during the coming months. On the other hand, the hiring outlook overall is positive and additional employment gains are expected. Where is the inflection point when uncertainty ends and renewed confidence spurs additional consumer spending and prompts corporations to stop hoarding cash and initiate expansion and hiring plans?
  • National debt — Interest rates on the U.S. 10-year Treasury note have climbed more than a 100 basis points in the past year. Every uptick in interest rates adds a few more billion dollars to the United States’ annual net interest payments. Every additional dollar devoted to servicing the debt gets subtracted from another government program — or added to the yearly budget deficit. Will this insanity never end?

Other questions to ponder: Is the “new normal” still “new” or is it now just “normal”? What was the best thing before sliced bread? How come Superman could stop bullets with his chest, but he always ducked when a bad guy threw a gun at him? Just wondering.

The bottom line is that rising interest rates are inevitable. Of course, the Federal Reserve will try to effectively manage the rising rates so that the job market and economy will continue to improve. At least that’s the plan.

Like most imponderable questions, after you’ve pondered them for a while you end up more confused than when you started. The question on higher interest rates is not imponderable; it’s just that no one has all the answers yet.

But maybe JPMorgan CEO Jamie Dimon, speaking at a recent financial industry conference, supplied the best answer, when he noted that if the economy is improving, more jobs are created and profitability is high, so “no one is going to care” about higher rates.

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LarryFinalwebv2Larry Gray is editorial director of Institutional Real Estate, Inc.

Growing the listed real estate market in a no-growth environment

If you live north of the Mason-Dixon line, you and your neighbors probably call the 1861–1865 U.S. conflict the “Civil War.” If you live just south of the line, y’all probably refer to it as the “War Between the States.” If you live in the Deep South, it’s “The War of Northern Aggression.” And you probably feel that whatever term you use is the right one because everyone you know calls it that as well.

We all are afflicted with a type of blindness that makes us think that the way we see things is the way others see them. This is particularly true if you are surrounded by people who actually do see things the way you do.

This blindness plays out in our investment relationships as well as daily life. Each year, IREI asks members of its Editorial Advisory Boards in the Americas, Europe and Asia Pacific how well they think their managers are doing, particularly when it comes to transparency and investor relations. Without fail, the majority of managers say they are doing really well, could hardly do any better. Also without fail, the LPs say their managers (who tend to be the ones who say they are doing really well) are doing just OK, and they have a long way to go if they want to be really good.

I was at the EPRA annual conference in Paris a couple of weeks ago, and it looks like the European listed market has a similar disconnect. In a pre-conference poll, attendees were asked to rate the level of alignment between companies and investors on a scale from 0 (no alignment at all) to 100 (perfectly aligned). The average rating came in at just above 50. However, 20 percent of the companies rated alignment as higher than 75, while only 5 percent of investors see alignment at that level.

In the discussion that followed the poll results, as well as an in-house quick tally on how well the industry is aligned, investors said that they thought alignment could be significantly improved if management compensation and incentives were based on total shareholder return (TSR) metrics. Investors would also like to see more transparency and disclosure, especially on business strategies. Company reps in the room said the TSR approach might work, but it’s not a clear-cut answer. Companies felt that implementing TSR-type metrics would need a nuanced approach to work in practice, especially given concerns about the short-term nature of equity markets behavior. (You have the feeling they were trying to be diplomatic in saying, “not on your life” or words to that effect.) They also said that if investors want the companies to be more aligned with investor interests, then the investors are going to have to step it up and take a more active role by voting their interests and engaging directly rather than just sitting on the sidelines and complaining (or words to that effect).

The alignment issue is important because the listed sector desperately wants the stability and growth-potential that institutional cash flows provide. But it’s finding itself caught in a Catch-22. Companies need the influx of institutional capital to grow, yet extremely few are large enough to accept institutional capital flows without being overwhelmed by the size of the bite that institutions take. How to attain this growth is still the primary problem facing the European listed market.

A couple of years ago, all eyes were on Germany with the hope that a strong real estate securities market there would pull all listed markets up, increase their size and make them more attractive to institutions. So far, those hopes have been dashed. Germans simply don’t like volatility, and equities are volatile. Add in that the largest German listed company, IVG, is pretty much on its knees, and the German listed market doesn’t look like it is taking anyone anywhere fast — at least not taking anyone up.

But EPRA isn’t giving up. It is aggressively marketing European listed companies, going so far as to open an office in Hong Kong. It is publishing research showing that portfolios that include listed real estate alongside private real estate do better than those that don’t. And it is working with various government agencies to make regulations more REIT-friendly.

Despite the fact that the industry is still struggling to attain the growth it thinks it should have, there was a feeling of optimism at the conference. It just felt good to be there among people who were all pulling for their industry to make a difference. It’s the type of group you want to visit with again next year to see how it all plays out.

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Sheilaflippedfinalv3stSheila Hopkins is managing director – Europe and infrastructure with Institutional Real Estate, Inc.

Summer sales expected to continue to year’s end

Retailers are not just finishing up summer sales and Labor Day sales but being bought by investors.

Making headline news last week, Neiman Marcus was acquired by Ares Management and Canada Pension Plan Investment Board (CPPIB) in a $6 billion-dollar deal. Both companies will own the department store firm’s properties.

Some firms are not  buying the retail company for itself but for its properties.

Also last week, Hackman Capital Partners was bidding hard to acquire all of Hostess Brand’s 140 properties and equipment assets in one transaction.

The retail sales started months before.

Another big transaction this year is high-end retailer Saks being sold to Hudson’s Bay Co. (HBC), the Canadian parent of upscale retailer Lord & Taylor, for about $2.4 billion. The acquisition combines three department-store brands — Hudson’s Bay, Lord & Taylor and Saks Fifth Avenue — and creates a North American upscale retailing behemoth with 320 stores in some of the biggest and most populous cities in the United States and Canada.

The combined company would have flagship stores in cities such as New York, Montreal and Toronto, and HBC said it would consider creating a real estate investment trust to benefit from that portfolio.

The popularity of e-commerce and the slow recovery from recession continue to hurt U.S.-brand retail companies. Some are thriving in the new economic reality, but many are having trouble maintaining high sales rates at their properties. Many have cut locations to improve margins and reverse losses. Currently, the best example of a struggling retailer is J.C. Penney Co.

Retail companies that are expected to not be profitable this year, if they keep many of their properties open, include Best Buy, Sears/Kmart, J.C. Penney, Office Depot, Barnes and Noble, Game Stop, Office Max, and Radio Shack.

With the holiday season approaching, we can expect more retail deals, company mergers and high-priced retail portfolio transactions.

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AndreafinalwebAndrea Waitrovich is web content editor of Institutional Real Estate, Inc.

All aboard for transit-oriented development

The next big thing is actually an old idea: trains. Commercial real estate developers are currently focusing on transit-oriented construction: high-density developments in close proximity to rail stations.

According to the Urban Land Institute (ULI), rail-focused construction is back in vogue. ULI notes:

“What is different about all these station concepts today, compared with renovation projects decades ago, is that, once again, they embrace trains. They also integrate additional development opportunities, ultimately resurrecting the role of train stations as civic linchpins.”

One of the projects being closely watched is the redevelopment of the Transbay terminal and surrounding neighborhood in San Francisco. A new high-speed rail station is planned for downtown San Francisco, connecting with local transit options, including buses and the Bay Area Rapid Transit metro system and Caltrain commuter rail.

Hines and Boston Properties are planning a 1.4 million-square-foot office tower, the Transbay Transit Tower, adjacent to the station at 101 First St. The planned high-rise will be the tallest building on the West Coast, and the seventh tallest in the United States.

In addition, developers TMG Partners and Northwood Investors recently acquired a group of parcels at Mission and First streets out of bankruptcy, and have plans for high-density development near the station of 1.2 million square feet of office space and 605 condominium units.

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LorettawebfinalLoretta Clodfelter is a contributor to Institutional Real Estate, Inc.

The urbanization game

9-9 Shanghai by nightThere’s no denying the trend toward greater urbanization around the globe — especially in Asia — also will continue to influence property and infrastructure development trends aimed at creating the best places for people to live, work and play.

McKinsey & Co.’s latest report, How to make a city great, projects that 60 percent of the world’s population will live in cities by 2030 — that’s 5 billion people living in cities worldwide compared with 3.6 billion today.

Moreover, the report discusses the importance of leadership in effective, competitive and sustainable city development: “Leaders in developing nations must cope with urbanization on an unprecedented scale, while those in developed ones wrestle with aging infrastructures and stretched budgets. … And all are aware of the environmental legacy they will leave if they fail to find more sustainable, resource-efficient ways of managing these cities.”

The best city leaders accomplish three things well, according to McKinsey:

  • They achieve smart growth, incorporating environmental concerns and needs into their economic decision making.
  • They do more with less, including creating opportunities for public-private partnerships.
  • They win support for change, in part by emphasizing accountability and collaboration.

With respect to Asia, the topics of urbanization, livability and real estate development to accommodate the growing needs of city populations are explored in “New urbanism,” the cover story for the October issue of The Institutional Real Estate Letter – Asia Pacific.

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Jennifer-Molloy91x119Jennifer Molloy is editor of The Institutional Real Estate Letter – Asia Pacific.

Flaring the night away

bakken_vir_2012317The development of shale gas and oil in the United States is growing exponentially, and that has been a blessing and a curse. Concerns about water and air pollution are well documented, and recently a lesser-known worry about the boom in shale energy — flaring — is making headlines.

In December 2012, NASA released satellite images of American oil and gas fields that light up the night skies as brightly as some metropolitan areas. Those bright lights make up part of the more than $100 million of natural gas “flared” industrywide each month — burned off into the air — according to a July 2013 report by sustainable business consultant Ceres.

“In 2012 alone, flaring resulted in the loss of approximately $1 billion in fuel and the greenhouse gas emissions equivalent of adding nearly 1 million cars to the road,” notes Ceres’ Flaring Up: North Dakota Natural Gas Flaring More than Doubles in Two Years. The report also states:

“The majority of North Dakota gas (roughly 70 percent) is ultimately marketed; however, a significant percentage of the state’s natural gas production is burned off in flares due to a lack of pipelines, processing and compression infrastructure. Some individual companies have shown leadership in curbing flaring, legislators have introduced incentives to limit flaring, and several billion dollars have already been invested in additional gas pipeline and processing infrastructure. In addition, the state has set a goal to limit flaring to no more than 10 percent of produced gas.”

The primary reason so much gas is flared is largely one of economics. In North Dakota, the Bakken fields are mostly drilled for oil, and natural gas is treated as a byproduct.

One variable in this equation that could change minds about whether or not to burn off “excess” natural gas is the continued pressure brought by anti-flaring efforts. Regardless of how you see the issue, the pressure has led some companies to change their flaring practices, and more could follow if the calls grow stronger. And these industry commitments to reduce flaring should interest investors — increasing demand for natural gas storage and distribution infrastructure requires investment to build it, after all.

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thm_AndrewCampbellDrew Campbell is senior editor of Institutional Investing in Infrastructure.

Poverty comes to the suburbs

Abraham Levitt, the mastermind behind America’s first truly mass-produced subdivisions, must be fulminating in his grave. Levittown Long Island in New York was widely considered the archetype for suburban sprawl in post-war America.

It was a hallmark of one’s success to move to the suburbs with 2.5 children, a Jeep Cherokee and a golden retriever. The schools were good, the neighborhoods safe, and cookie-cutter homes and retail chains abounded.

Someone must have forgotten to slam the gilded gate shut.

The Joneses are moving out. Poverty is moving in.

The fastest-growing enclaves of poor U.S. residents are agglomerating in suburbia. Turns out this trend dates back to the 1980s when the growth rate among suburban poor started outpacing urban and rural areas. It has only accelerated in subsequent decades. The decline in manufacturing jobs and the subprime housing crisis are but two elements driving this resettlement of the impoverished.

The “white flight” from inner cities decades ago that resulted in lily-white suburbs is also being upended. Research from the Brookings Institution and the American Communities Project at American University has documented that the suburbs are becoming more ethnically diverse and politically democratic.

The problem with being poor in suburbia is expense. Many suburbs have little or no mass transit. That means an automobile is required — and perhaps several if you have two working adults, or teenagers in need of mobility. This partially explains why the average age of autos on U.S. roads is at an all-time high. That study, conducted by Polk, found the average age of vehicles has climbed to 11.4 years. And then there’s the high cost of a tank of gas.

Consider that 3.5 million working people have commutes in excess of three hours per day. One can imagine the toll that exacts on fuel budgets, as well as people’s physical and emotional health and relationships.

Meanwhile, many wealthy and middle class people are choosing to move back to the cities. Young people increasingly want to move out of the boring, monochrome suburbs and into kinetic urban cores, in part because many don’t want automobiles. Shocking though it seems to previous generations, rising numbers of young people are choosing to forgo getting a driver’s license, at least until later years. Instead, they are opting for high-density, walkable communities with mass transit options.

Leigh Gallagher, assistant managing editor of Fortune magazine and author of The End of the Suburbs: Where the American Dream is Moving, writes that the 1950s notion of the nuclear family is rapidly disappearing. Among her sources is an executive with Pulte Homes who says the traditional family is the minority these days.

Gallagher uses the term “zombie subdivisions” and predicts they are going to become the future slums of America, even as inner cities are being resuscitated by a fresh influx of people, money and redevelopment projects.

Levittown has become Leavittown.

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MikeCfinalwebMike Consol is editor of The Institutional Real Estate Letter – Americas.