Has the Great Decline begun in China?

If you get the feeling the Chinese economy is running out of steam, your instincts are sound. Leaders of the Chinese Communist Party are also concerned it is time for the laborious task of doing all the dirty dishes, taking out the trash and cleaning up the house.

Every party has its listless aftermath.

Damien Ma, a fellow at the Paulson Institute and author of In Line Behind a Billion People: How Scarcity Will Define China’s Ascent in the Next Decade, says Communist Party leaders have recognized that the current growth model isn’t capable of taking the country much higher, and they are looking to promote more privatization while curbing China’s notorious government interference.

Andrew Browne, China columnist for The Wall Street Journal, sees a population that is increasingly questioning the sustainability of the country’s incredible ascent. Browne talks about capital flight, as the richest people in China send their wealth overseas. Citizens are scrambling to get foreign passports as they grow concerned about getting their families out in the event a major economic displacement and a popular uprising comes to pass. The discontent is also being driven by pollution, as poisonous air chokes urban areas, causes health problems and lowers the quality of life.

Susan Shirk, chair of the 21st Century China Program at U.C. San Diego, reports a swelling demand for an improved quality of life that extends well beyond pollution to include the safety of Chinese-produced food and medicine and other products. Shirk speaks of a young friend in China who is “completely obsessed” with what he will do when his wife stops breastfeeding their child because he cannot get domestic baby formula that he trusts. He has also spent a great deal of money buying Japanese paint for his apartment because he doesn’t trust the purity of the paint manufactured in China.

It’s a sad state of affairs created by the government’s lack of regulatory standards and its inability to quell corruption. Public and anti-government protests erupt by the thousands each year in China. Most are rapidly quashed by the iron fist of central authority. But, given the social media tools of instantaneous communication, the potential for a mass uprising would make Tiananmen Square look like a junior high school fire drill by comparison.

China might be the World’s Workshop, but there is no long-term future in simply assembling and shipping products invented by others. The future belongs to those who create intellectual property and drive innovation, and China’s centralized decision making is not a fertile environment for a creating a knowledge-based economy. Distributing authority and decision making still frightens China’s terribly paranoid and immature government.

Let’s hope the Chinese leadership finds a way to peacefully and successfully transition to a more open and decentralized society and economy. Global wealth depends on more — not fewer — powerful economies doing business with one another.

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

‘Tis the season to save, save, save!

It seems that these days the holidays — i.e., Hanukkah, Christmas, etc. — are no longer about what they originally stood for, religious celebration, but more about shopping for the right gift to give someone on that special holiday.

With all of that spending going on, where are retailers sitting as far as earnings?

Most figures won’t come out until after the new year, but in the Forbes article “Christmas 2013 for the Retail Business: An Early Look at the Winners and Losers,” contributor Walter Loeb thinks retail sales are below retailers’ conservative plans. He states that uncooperative weather provided a very different situation than in 2012. Internet sales continued to be a help, increasing by at least 15 percent between Thanksgiving and Christmas, but even with that help, Loeb states budget-priced stores such as Walmart, Old Navy and Target had a tougher time than anticipated.

Pre-Christmas spending wasn’t what was expected. According to Reuters, despite deeper discounts, U.S. consumers shopped less on the final weekend before Christmas, but shoppers are showing signs they will do more of their spending after Dec. 25 than they did in the same period last year in hopes of snagging even more deals.

Reuters also reported that analytics firm RetailNext estimates that U.S. retail sales fell by 7 percent at brick-and-mortar stores on the weekend before Christmas, two of the four most important shopping days of the season, compared with the same days in the previous year (not including online sales, which have been strong).

The reason?

Reuters states that consumers are holding out for bigger bargains, up 25.1 percent from 20.8 percent in 2012, turning this year into the most competitive holiday season since the recession. I’ll admit that, yes, I waited until last minute; I am like any other consumer, waiting for the after-Christmas deals to see if I can find one thing I can save on.

I guess we’ll have to wait until the next big holiday (Valentine’s Day) to see what the final holiday shopping numbers were, but I think those waiting for deals will find them, and consumer spending will be up before the year is out.

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DenisefinalwebDenise DeChaine is special projects editor at Institutional Real Estate, Inc.

Year-end reflections

As 2013 draws to a close, I’ve been thinking a lot about the discussions we’ve been having with investors around the globe. As readers of this blog post might remember, we hold several Editorial Advisory Board meetings in different locations around the globe each year.

This year, we’ve met with investors in Laguna Beach in Southern California, in Bangkok, in Rome, and in Half Moon Bay just south of San Francisco — investors from more than 120 different investment institutions, who collectively control well over $4.5 trillion in total assets, including more than half a trillion dollars in real estate and infrastructure assets under management. And, as I think back on these discussions, several themes seem to emerge.


The first of these is capital, or more specifically, too much of it. Central banks around the globe, but particularly in Europe, the United States and Japan, have been vigorously engaged in a multi-year program of quantitative easing. Quantitative easing is a euphemism for government-sponsored bond buying programs. Essentially, the central banks have been printing new money and deploying that newly minted money to buy up mostly government or government-backed bonds in the open market.

In the U.S. alone, the Federal Reserve’s activities have driven money supply (M2) from roughly $7.6 trillion in 2008 to more than $10.8 trillion by 2013. That’s a 40 percent run-up in the supply of money in just five years.

The intent of these bond-buying sprees by central bankers was to support flagging bond markets that, in the wake of the Lehman Bros. collapse, appeared to be on the verge of collapse.

The intent also was to keep demand for bonds high relative to supply and, thereby, to help keep the lid on interest rates that otherwise might have risen rapidly due to the market’s perception of the riskier post-GFC environment.

Central bankers also hoped that all that money they were printing would eventually find its way into the consumer markets, eventually stimulating growth in the form of investments in new plants, equipment and the jobs needed to deploy those capital investments.

They did succeed, at least on the first two counts. But instead of stimulating investment in physical plant, equipment and jobs, most of that fresh new capital found its way first onto the balance sheets of financial institutions (the largest segment of the bond-buying marketplace) and, eventually, into the equities and alternative asset markets, including real estate.

Since the natural human reaction to financial downturns is to retreat toward quality, not surprisingly, most of the money moving into real estate has been targeting the ostensibly safer core property types and markets. This has held cap rates down to historically low rates for a surprisingly long time.

Meanwhile, as the economies of Asia have continued to grow, capital has been forming and concentrating in the hands of large Asian financial institutions, such as the fast growing pension funds of Korea and the huge life companies of China, which have been given the license to begin to deploy capital more aggressively globally.

In addition, the massive, fast growing sovereign wealth funds continue to increase their investment activities around the globe, joined by a huge influx of more entrepreneurial capital from a growing cadre of ultra-high-net-worth investors, including many of China’s newly minted billionaires.

All of this money has been competing with traditional Western pension fund and financial institution capital. But because these newbies have no or much lower current yield requirements, the traditional investors are finding it increasingly difficult to get their mandates prudently invested.

Frustrations are growing, and frustration eventually leads to different strategies. Some of these more traditional investors are ramping up to execute more “build to core” types of strategies. Others are casting their nets wider, either by beginning to invest in core properties in markets that a year ago would not have been considered prime targets (suburban and second-tier markets, for example.)

Some are seeking to meet their investment objectives by investing in more niche-type products that they believe can deliver core-type investment characteristics, such as senior housing, student housing, self-storage, medical office and related traditionally noncore type investment strategies. Real estate debt–related strategies such as whole loan, mezzanine and securitized investing are being pursued by some traditional core investors because they view these alternatives as reasonably suitable core substitutes.

Still other investors have determined that, at this pricing, it might make better sense to sell off a good percentage of their existing domestic core property holdings and redeploy the net proceeds in core investments in alternative, nontraditional assets, build-to-core (and hold) strategies, and/or by making core investments in offshore markets.


Investors around the globe, however, also are increasingly and nervously eyeing the other guy’s hands. Because economic developments in one region of the world can now have such huge impacts on developments in an investor’s own domestic markets, no one is investing without white knuckles these days. Consequently, given the underlying vulnerabilities baked into the economies of Europe and the Americas in the face of changing political and economic forces, no one in property investment land seems to be having very much fun — not even the most active of investors.


Quantitative easing policies have proven to be a tiger that is easy to mount, but from which it is has proven much harder to dismount. Just the whisper from a former U.S. Fed chair that the Fed Open Market Committee might be thinking about possibly engaging in a gradual tapering of its bond buying program sent the bond markets around the globe into a state of disarray. Imagine the potential impact were the Fed and other central bankers actually to begin to implement a bona fide tapering program.

Tapering, of course, is only the beginning of the unwinding process that eventually needs to take place. Don’t forget, after tapering comes to a close and the government eventually stops actively buying in the bond market, the next step will be to gradually de-monetize the system by selling back into the market those trillions and trillions of dollars of bonds holdings they’ve been steadily accumulating.

Don’t expect to see any of that happening any time soon, however. If the market can’t sustain itself in the face of even a mention of a possible pending tapering, it still isn’t strong enough to sustain a series of actual “for real” tapering measures.

What this ultimately means is that the apparent relative strength of the bond market today is nothing more than just an illusion. The market still isn’t strong enough to stand on its own two feet.

At least, that’s what the bond markets today seem to be telling us.


With all that new money circulating, many investors believe it’s only a matter of time before we start to see real inflation begin to rear its ugly head in the markets. If and when we do see such inflation, most investors seem to believe it will be moderate and controllable and, therefore, probably good for the real estate markets.

Part of the reason for this relatively positive outlook is the fact that, despite a gradual economic recovery, there hasn’t been much new development in the past several years, at least not since the global financial crisis first began to unfold.

If economic growth engines begin to rev up, it should continue to be a landlord-friendly leasing market for some time. That should enable owners to pass along a good percentage of any run-up in operating costs to their tenants, and, therefore, most investors believe real estate should continue to provide a reasonably good inflation hedge, at least for a while.

Interest rates

Most investors believe interest rates eventually have to rise. But most also believe central bankers will continue to hold the lid on rates for as long as they can, and that any rate hikes that do emerge are more likely to be relatively moderate and manageable than horribly radical and disruptive.

Capitalization rates

Most investors also seem to believe that capitalization rates will rise along with interest rates. Most also seem to believe that cap rates, when they do start to move, will only move up grudgingly, and not as dramatically and not as quickly as interest rates are likely to move. (And, remember, they don’t expect rates to rise by much.)

Many investors also believe that any eventual upward movement in cap rates will most likely be offset by corresponding rises in rental rates and, ultimately, increases in net operating incomes. Consequently, few investors are very worried.

There is some evidence to support this rosy view. Data and analysis developed by CBRE suggest that when interest rates rise, cap rate spreads tend to widen, and, therefore, cap rate rises do tend to lag the rises in interest rates.

But not everyone is so optimistic. Some point to the long-term historical record for NOI growth and argue that if interest rates rise higher than 200 basis points or faster than most expect, there is no precedent for the kind of NOI growth rates you would need to see — and sustain — in order to keep values from dropping.

Meanwhile, property underwriting continues to be a game of jiggling your numbers and assumptions. How much do you have to push your rental rate growth assumptions and your net operating income figures in order to offset for each 100 basis point rise in assumed inflation, interest rates and capitalization rates? So underwriting, too, has become no fun for most investors.

The ultimate question

The ultimate question comes down to: are these investors right? Will inflation and interest rates rise? And, if so, will they only rise moderately? And how soon? And, if they rise, no matter how high or how fast, how much and how fast will cap rates move in sequence?

Black swans and the bottom line

Many of you may be familiar with Nassim Nicolas Taleb’s classic work, The Black Swan. Taleb’s thesis is that the market often ignores or fails to plan for surprising events.

In the titular example, for centuries, almost everyone believed all swans were white and there was no such thing as a black swan — until, that is, one was finally spotted. Now, everyone knows black swans are quite common if you only know where in the world to look for them.

Before the global financial crisis, everyone knew that the deepest the U.S. housing markets had ever dropped was 14 percent in a year. This was true, of course, up to and until the time directly following the crash of Lehman, when the U.S. housing market dropped more than 45 percent in one year.

The March 2011 Japanese nuclear power plant accident occurred precisely because the plant had been designed to withstand the largest earthquake and flooding conditions to which the nation had ever been subjected — instead of the conditions that it actually experienced when the most recent earthquake and resulting tsunami actually hit.

Part of the reason we miscalculate these kinds of “surprises,” Taleb points out, is because we assume the worst that is likely to happen has already happened at least once. We often fail to consider the worst that actually could happen may simply not have happened yet. We assume, because we’ve never seen a black swan, no black swans actually exist.

Right now, most investors seem to be thinking the worst that could happen to interest rates, and the worst that could happen with inflation, would be something in the order of magnitude of a 200 basis point rise. They also are assuming that when these rates eventually do rise, any corresponding cap rate increases will lag.

Not only are these assumptions ignoring the worst that could happen, they aren’t even considering the worst that actually has happened in the past. Right now, the U.S. 10-year Treasury rate stands at 2.57 percent. Just 12 months ago, it stood at 1.68 percent. That means interest rates have risen already by 52 percent in less than one year’s time.

Unfortunately, because rates have been so relatively low for so long, most people aren’t even taking into consideration how high they could go, not to mention considering the forces that most likely could drive them there.

When, for example, was the last time we saw interest rates at 6 percent? The answer is 1997, or about 16 years ago. When was the last time they were at 8 percent? 1991, or 22 years ago. At 9 percent? 1989, or 24 years ago. At 10 percent? 1980, or 33 years ago. For many of you younger real estate professionals today, that’s equivalent to a lifetime ago. And because many of you haven’t seen these kinds of rates for a long, long time, too many of you are assuming we may never see them again, at least, not in your own remaining business careers.

What you may be missing here is what actually happens to relative asset class demand when interest rates rise.

Right now, there’s a lot of money that has been squeezed out of the bond market by the central bankers’ buying activities and by the prolonged and relatively low interest rate environment. Much of this money has found its way into the equities markets and alternative assets, such as real estate, which has been driving all the property asset inflation we’ve been seeing of late.

People tend to forget that this is not a “normal” environment.

When I first came into the business, most pension funds had 35 percent to 50 percent — and some even more — of their portfolios invested in the bond market. Today, at least for pension funds in most Western nations, bond market exposure is lower than 25 percent to 30 percent of total assets, and even lower for some.

Why the dramatic reshuffling? Back when allocations were higher, interest rates were higher — in the 6 percent or higher range. And that, on a relative basis, made the bond market a great deal more attractive to these kinds of investors.

If interest rates were to rise 300 basis points or 400 basis points, for example, the bond market would start looking a whole lot more attractive to pension and similar long-term investors. If you can get closer to your actuarial investment return underwriting assumption at far less risk, why wouldn’t you reallocate and redeploy more of your portfolio into bonds? (Same goes for individual investors, who typically — particularly as they approach or become engaged in their retirement years, as most of us boomers are — prefer low-risk, relatively high yielding investments such as higher-yielding, strongly rated debt securities.)

Consequently, in the face of that kind of dramatic uptick in rates, a lot of money is likely to find its way out of the riskier equities and alternative asset markets, and back into the bond market. Will this happen? Is it even likely to happen? No, probably not. The point is, however, it could happen, and very few have factored that possibility — even assuming a low probability of occurrence — into their investment strategies.

The bottom line here, as I like to note at the end of most of my editorials, is: “It’s important to be careful. It’s important to be very, very careful. After all, it’s a whacky world out there.”

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GeoffFinalv5forwebGeoffrey Dohrmann is president and CEO of Institutional Real Estate, Inc.

A climate of fear?

12-20 blog PwCIt is possible to be 100 percent green. It was reported this week that a refurbishment of the nine-story headquarters of PwC — another accounting firm rebranding like EY/Ernst & Young; PwC, you know who that is, don’t you? — at One Embankment Place in London achieved a 96.31 percent BREEAM Outstanding score, including 100 percent scores for materials, transport and management. Apart from asking how did they measure it, and how much did it cost them, you also have to wonder — where do they go from here, and can they keep it up?

PwC’s BREEAM Outstanding score is the highest ever achieved for both newbuild and existing structures. The firm’s London headquarters is a 450,000-square-foot office building that was built in the early 1990s; it comprises nine floors of office space above Charing Cross railway station just north of the River Thames and a basement below. A landmark building, it nevertheless presents operational and technical challenges. PwC recognized that the working area was outdated and inefficient and wanted the refurbishment to address these issues and more. Achievement of a high BREEAM environmental rating and a top Energy Performance Certificate score were seen as priorities.

Being green — and being seen to be green — doesn’t come cheap, especially when you have to work round the staff who are continuing to work in the building. The refurbishment contract involved a complete office refit and refurbishment as well as full central plant replacement in the basement areas, roof and terraces while the 2,000 staff remained in occupation.

Sustainability was built into the design from the outset, and PwC engaged energy consultants to develop options for achieving its target high BREEAM rating. The program included installation of biofuel combined cooling heat and power (CCHP), with absorption chillers using biofuel sourced from locally collected and refined waste vegetable oil. Through a knowledge transfer partnership between PwC and London South Bank University — and as evidence of how seriously those involved in this sustainability business take these things — “the biofuel is certified to EN14214, making it a clean, carbon-neutral resource with A-rated energy performance.”

Other features include green walls and landscaped garden planting, waterless urinals and low-flush toilets, comprehensive metering strategy and building management systems, an interactive screen in reception confirming building energy usage, and a staircase installed within the atria to promote vertical movement without the use of lifts. Some of this may seem obvious, but it all counts. And it all costs.

“The impressive BREEAM score for this iconic building shows just how much can be accomplished,” says Gavin Dunn, director of BREEAM.

The plaudits are due. It is possible to be totally green, and it is possible, too, that the aggregation of all these efforts around the world will one day seep into the human consciousness and save the planet. PwC has done it now, but can it do it again?

And the climate of fear? The image, surely, that is evoked of PwC’s green guards walking around the building, making sure that the staff who work there keep up the sustainability effort. They will also be looking for the missing 3.69 percent.

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

Have the floodgates opened?

Since the Abe administration took power in Japan in December 2012, there have been talks about the government wanting pension funds in Japan to be more active and creative with the capital they have under management. The capital these funds have accumulated over the years is staggering. The largest of them, the Government Pension Investment Fund, has $1.4 trillion under management.

And yet, as of now, most of Japan’s Government Pension Investment Fund capital is invested in stocks and bonds. According to the “Significance of Real Estate in Asian Pension Funds” survey presented by Dr. Graeme Newell at Institutional Real Estate, Inc.’s VIP – Asia Investor Roundtable conference held in Hong Kong in November, 60 percent of the GPIF’s assets are allocated to domestic bonds, 10 percent to international bonds, 16 percent to domestic stocks, 13 percent to international stocks and 1 percent to short-term investments.

I don’t need to tell you how low the yields on fixed-income instruments have been around the world in this global deflationary environment. Couple this with the aging population in Japan, and you get a pretty grim picture. Clearly, having 70 percent of the GPIF’s total capital allocated to fixed-income instruments will not allow the fund to create yields necessary to meet its obligations.

Realizing this, the Abe administration created the Panel for Sophisticating the Management of Public/Quasi-public Funds based on the Japan Revitalization Strategy adopted by the cabinet in June 2013. In September, the panel compiled a preliminary report that was finalized and became available to public in November 2013. As many of us expected, the panel advised, among many other recommendations, to “diversify investments by investing in new types of assets (including real estate investment trusts, real estate, infrastructure, venture capital, private equity and commodities).”

Creating a real estate portfolio, identifying investment strategies and finding asset managers appropriate for them will take time — and probably a lot of it. But if South Korea, Japan’s neighbor, can serve as an example, this is all achievable, and it is not too early for global asset managers with required skills to start lining up and sharpening their tools.

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AlexFinalv3webAlex Eidlin is managing director – Asia Pacific with Institutional Real Estate, Inc.

End of year shopping spree

In September, I wrote about summer sales and Labor Day sales ending. Investors were buying retail companies and retail properties, making billion-dollar headlines. Now it’s the holiday season, Black Friday was last month, and it’s a week or so until Christmas morning. The big spending continues. Individuals and families are spending and gearing up for Dec. 25. And the same can be said for global institutional investors spending the big bucks during the holiday season.

New York City continues to have high-priced transactions, particularly in Manhattan. Australian developer Grocon struck a deal to buy a 95 percent stake in Manhattan’s Park Avenue Tower, a 615,857-square-foot office building. The sales price was $800 million. Another Australian investor, The Westfield Group, purchased a 50 percent interest in the retail portion of New York City’s World Trade Center development it didn’t already own for $800 million. Nearby Ashkenazy Acquisition Corp. paid $400 million for the ground lessor’s position at 625 Madison Ave.

In the New York City office sector, Vornado Realty Trust agreed to sell 866 United Nations Plaza, a 360,000 square-foot-office building in Manhattan, for $200 million. Another big ticket office property was the NYMEX Building, which sold for $200 million. Brookfield Office Properties was the buyer and the CME Group was the seller. In addition, institutional investors advised by JPMorgan Asset Management paid $498.5 million for a controlling stake in Manhattan’s 195 Broadway.

On the West Coast, the Massachusetts Pension Reserves Investment Management Board, in a partnership with DivcoWest, acquired 333 Bush St. in the financial district of San Francisco for around $270 million. And further south, a unit of Hines REIT paid $506 million for Howard Hughes Center, a five-building office complex in Los Angeles, from a venture between Brookfield Office Properties and The Blackstone Group.

North of the U.S. border, Sears Canada sold its 50 percent joint venture interest in eight properties in a deal valued at about C$315 million ($301 million). And the Canada Pension Plan Investment Board sold three regional shopping centers across Canada in deals with a combined value of C$500 million ($475 million).

On the selling side and an ocean away, the government of Canada sold a large embassy building in London’s luxury Mayfair district to Indian developer Lodha Dwellers for more than $500 million. Another London-based transaction was Lloyds Banking Group plan to sell its stake in St. James’s Place for about £680 million ($1.1 billion). Also in Europe, Starwood Capital Group acquired seven retail parks and shopping gallerias in Sweden from Kooperativa Forbundet for approximately SKr 3.9 billion ($589.2 million).

In bundle deals, where institutional investors are buying portfolios, Newcastle Investment Corp. acquired a 52-property portfolio of senior housing properties from subsidiaries of Holiday Acquisition Holdings for approximately $1.01 billion. Another senior housing deal was CNL Healthcare’s purchase of a portfolio of 12 senior housing communities for approximately $302 million.

In the apartment sector, Rainbow Estates Group paid $340 million for 84 apartment properties in northern Manhattan. Another apartment portfolio acquisition was the $610 million deal between Berkshire Group and Crow Holdings. The portfolio consists of 2,300 multifamily units.

Other package deals include Kite Realty Group Trust’s purchase of a portfolio of nine retail properties for $304 million. And the U.S.-based real estate arm of Investcorp acquired a group of high-quality office and retail assets in the greater Chicago, Los Angeles, Minneapolis and New York City areas valued at $250 million.

Cole Corporate Income Trust acquired five single-tenant corporate properties for approximately $202.1 million. Griffin Capital Corp. also purchased a single-tenant portfolio, buying an 18-asset portfolio of predominantly single-tenant office properties for $521.5 million.

And Extra Space Storage acquired a portfolio of 17 self-storage properties located in Virginia for $200 million. Another storage deal was Clarion Partners and partner Private Mini Storage sale of their 30-property, 2.35 million-square-foot self-storage portfolio for $257.9 million.

Smaller portfolio deals were:

  • Shorenstein Properties buying the two-building Denver City Center for $286 million
  • ASB Real Estate Investments purchasing two luxury apartment towers in Rosslyn, Va., for $222 million
  • Washington REIT completing two separate sale transactions for $307.2 million
  • Rouse Properties agreeing to acquire two regional malls from affiliates of The Macerich Co. for $292.5 million

The year is coming to close. And I predict more high dollar transactions in the next few weeks and the start of 2014.

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

Asian pensions’ real estate investment

Dr. Graeme Newell, a professor at the University of Western Sydney, has just completed the second tranche of a multi-staged research assignment commissioned by the Asia Pacific Real Estate Association on the “Significance of Real Estate in Asian Pension Fund Portfolios.” The first report from the study was completed and first presented at our first annual VIP – Asia Investor Roundtable in Singapore, held in 2010. A copy of that original report can be obtained from APREA.

The results of phase two of the study were just presented on Nov. 20, 2013, at our fourth annual VIP – Asia Investor Roundtable, held at the J.W. Marriott in Hong Kong. The final written report from this study will soon be available from APREA. Meanwhile, the following are just a few of the highlights from Dr. Newell’s most recent presentation.

The results of the first study completed in 2010 captured the mood of Asian pension funds and their need to start diversifying their portfolios away from their, at the time, decidedly fixed-income orientation. This year’s study focused on momentum — the considerable progress that has been made by some of Asia’s largest pension funds to actually begin that diversification process.

Pension funds in general have become an increasingly important source of capital for the real estate markets. World pension assets now stand at more than $30 trillion, and for many large pension funds, real estate allocations typically are in the 5 percent to 10 percent range.

Asian pension funds include five of the top 10, 10 of the top 50, and 29 of the top 300 largest pension funds in the world.

  • The largest of these is the Government Pension Investment Fund of Japan, with $1.292 trillion in assets under management. GPIF is the largest pension fund in the world today.
  • The second largest in the Asian region is the National Pension Service of South Korea, with $368 billion in assets. NPS is the fourth-largest pension fund in the world.
  • The Local Government Pension Plan of Japan is the third largest in the region, with $201 billion in assets. It is the world’s seventh-largest pension fund
  • The Central Provident Pension Fund of Singapore is the fourth largest in the region, with $188 billion in assets; it is the world’s eighth-largest pension fund.
  • The National Social Security System of China is the fifth largest in the region, with $177 billion in assets; it is the 10th-largest pension system in the world.
  • The sixth largest fund in the region — the Employees Provident Fund of Malaysia — is the world’s 12th-largest fund, with $176 billion in assets.

But many if not most of these Asian pension funds still have relatively conservative asset allocation mixes in their portfolios, with a decidedly undue over-concentration in fixed-income securities.

Because of the over-reliance on fixed-income securities in their portfolios, it will be incredibly difficult if not impossible for most of these funds to finance their future pension fund liabilities, particularly in light of today’s low interest rate environment.

  • The current asset mix of the GPIF of Japan includes 60 percent domestic bonds, 10 percent international bonds, 16 percent domestic stocks, 13 percent international stocks and 1 percent in short-term investments, with zero allocated to alternatives, which means, zero allocated to real estate. This kind of asset mix is typical for many Asia pension funds.
  • In contrast, South Korea’s NPS has 63 percent of its assets in domestic fixed-income securities, 5 percent in international bonds, 17 percent in domestic equity securities, 7 percent in international stocks and 8 percent in alternatives, including real estate. So while the NPS is much better diversified than funds such as the GPIF, it still has a very high exposure to the fixed-income markets.
  • The EPF of Malaysia has 55 percent of its assets in bonds, 38 percent in stocks, 4 percent in money market funds and the remaining 3 percent in real estate and infrastructure investments.
  • The $29 billion KWAP of Malaysia has 54 percent in domestic fixed income, 2 percent in international fixed income, 30 percent in domestic stocks, 2 percent in international stocks, 9 percent in money market funds and the remaining 3 percent in real estate.
  • The $19 billion GPF of Thailand has 62 percent in domestic fixed income, 10 percent in international fixed income, 8 percent in domestic stocks, 8 percent in international stocks, 1 percent in commodities and the remaining 11 percent in alternative assets, including real estate.

Pension reform is obviously needed in Asia, and in many regions, it is ongoing. The drivers of this reform:

  • Demographics (aging populations)
  • Urbanization (more workers covered by plans)
  • Costs and deficiencies in funding
  • Growing nature of future liabilities
  • Financial market and regulatory reforms
  • Changing asset allocations

Demographic forces — the aging of the population — is having a rapid and immense impact on policy decision making:

  • Today in China, there are 9 people working for every single individual in retirement; by 2050, there will be 3 people working for every single individual in retirement.
  • In Hong Kong, today there are 6; by 2050 there will be 2.
  • In India, today there are 13; by 2050 there will be 5.
  • In Japan, today there are 3; by 2050, there will be 1.
  • In Singapore, today there are 7; by 2050 there will be 2.
  • In South Korea, today there are 6; by 2050 there will be 2.
  • In Taiwan, today there are 7; by 2050 there will be 2.
  • In Thailand, today there are 9; by 2050 there will be 4.
  • In Malaysia, today there are 14; by 2050 there will be 4.
  • In the Philippines, today there are 14; by 2050 there will be 5.
  • In Indonesia, today there are 11; by 2050 there will be 4.
  • By way of contrast, in the OECD countries, today there are 4 people working for every retired person; by 2050 there will be 3.

Collectively, the Asian pension funds surveyed in the study control in aggregate more than $792 billion in total assets under management, of which $30 billion, or roughly 3.8 percent, is invested in real estate.

Were the Asian pension funds sampled in the survey to increase their real estate allocations to the 5 percent to 10 percent range common among their Western pension fund peer group, it would create the potential for an additional $9.6 billion to $49.2 billion of additional real estate investments. Asian pension funds are growing at a relatively fast rate, so the amount of real estate investment potential these funds represent is considerably greater than that number.

The issues Asian pension fund investment executives face with respect to implementing their diversification plans, including real estate:

  • Benefits
  • Vehicles
  • Investment manager selection
  • Domestic versus international
  • Overall view on real estate’s role in the portfolio
  • Different strategic considerations for plans with larger versus smaller AUM
  • Other challenges

If you are interested in purchasing a copy of the final report of this survey, keep an eye on the APREA website. Dr. Newell indicated at the close of his presentation at VIP that APREA’s goal is to have the report available for sale and distribution by Christmas 2013.

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GeoffFinalv5forwebGeoffrey Dohrmann is president and CEO of Institutional Real Estate, Inc.

All I want for Christmas…

TO: Santa Claus
CC: Ben Bernanke, Janet Yellen
FROM: Larry Gray
DATE: Dec. 11, 2013
SUBJECT: Christmas list

I’m not gonna lie, Santa, 2013 wasn’t a very good year. Don’t get me wrong, it wasn’t a bad year … after all the unemployment rate dropped to 7 percent, the lowest level in five years, and the stock market put forth a strong rally, with the Dow Jones Industrial Average closing above 16,000 points for the first time ever. 2013 was definitely better than the preceding few years. But something just doesn’t feel right.

Maybe it’s the bad taste and disillusionment left by the U.S. government shutdown in October. Maybe it’s the sense of political inadequacy in Washington, D.C., a feeling that politicians are unwilling or incapable of addressing and solving the numerous issues of the day. Or maybe my uneasiness is rooted in the global financial crisis. It planted a fear of the unknown that’s been hard to shake. And it wasn’t very reassuring when Mr. Bernanke’s hint of a slowdown in quantitative easing efforts produced a tailspin in the financial markets.

What I really want for Christmas, Santa, is something to boost my spirits, provide some encouragement that things will get better. Maybe my wife has the right idea. She and thousands of other “holiday junkies” are faithfully tuned in to the Hallmark Movie Channel, where at this time of year they can watch holiday movies, all day and all night. Whether it’s A Dog Named Christmas or Single Santa Seeks Mrs. Claus or A Season for Miracles, my wife will watch it. These Hallmark holiday movies are predictable, but they’re certain to fuel your holiday spirit with a joyous happy ending. When you watch these formulaic “feel good” movies, you pretty much know what you are gonna get.

And, Santa/Ben/Janet, that’s all I really want for Christmas: a reasonable degree of certainty for a happy ending.

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

Infrastructure may not be in a class of its own

Some institutional investors are not yet prepared to invest in the infrastructure asset class. In its recent Discussion Notes report, Norges Bank Investment Management outlines the general heterogeneity of the infrastructure sector and the various risks and uncertainties that have led NBIM to refrain from investing in the sector.

The report ultimately argues, “different and complex definitions might suggest that infrastructure is at best a heterogeneous class, if it can be considered an asset class at all,” and would be more effectively categorized by the investor’s goals regarding each specific asset and how those line up with goals from various asset classes.

While taking a pass on infrastructure, NBIM (which invests on behalf of Norway’s $700 billion Government Pension Fund – Global, one of the world’s largest sovereign wealth funds) has been extremely active in the real estate market of late after the SWF upped its target real estate allocation to 5 percent. It has been focusing investments in Europe and the United States, including forming a joint venture last February with TIAA-CREF to own $1.2 billion of East Coast office space. However, the investment management team has decided not to invest in infrastructure, as the murky nature of the under-documented sector (due to its relatively short history of investment) is challenging to reconcile with the generally transparent nature of the bank’s investing.

The report itself details the wide variety of risks associated with infrastructure investing, including bid risk, operational/management risk, demand risk (which can be caused by risks from demographic, economic and political shifts), maturity risk, liquidity risk and regulatory risk — all of which can be applied to some infrastructure investments and not to others. Some of these risks can be lessened by a long investment period, others not. Some of these risks can be diversified away, others not.

Additionally, the report points to the fact that risk/return ratios for infrastructure investments can exhibit bond, real estate or equity characteristics, and that “the risk/return profile of an infrastructure investment generally arises from the nature of the underlying asset itself, the environment in which it operates and the choice of the investment vehicle.” Ultimately, this leads to investors looking to infrastructure with a wide variety of goals in mind and leaves no easy way to benchmark sector performance.

These widely varying investment properties of infrastructure may lead to it being deemed ineffective as a way to classify investments within a portfolio, as the report states:

“Investors considering investing in infrastructure should reflect on which role(s) such investments are expected to play in their total portfolio, and design their strategy to best support these objectives. The opportunity set is heterogeneous and the risk-return profile is shaped by the underlying investments, the investment vehicle chosen and the environment is which the asset operates. The diversification properties of specific investments should be assessed in a total portfolio context, rather than in the context of a sub-portfolio of infrastructure investments. The high degree of heterogeneity also raises the question of what level of aggregation would be appropriate for a meaningful risk-return-correlation analysis and what assumptions are reasonable to make in asset-liability managing. The combination of early-stage assets and mature-assets spanning a wide range of sectors into one broad category might not be appropriate.”
[emphasis added]

And this may prove that infrastructure is truly not in a class of its own.

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

Measuring Asian property market performance

At our recent VIP – Asia Investor Roundtable, held in Hong Kong on Nov. 19–20, 2013, Sameer Jain, chief economist and managing director for New York City–based American Realty Capital, helped facilitate a workshop on benchmarking and its applications in the Asia Pacific real estate markets.

The presentations spoke to the challenges associated with attempting to create benchmarks for any private market–related asset class such as real estate. Dr. Jain then gave a brief update on the NCREIF indices, the oldest and most accepted U.S. property market performance index series, along with an update on the primary benchmarks that are in the process of being introduced into the Asian markets. Following are highlights from that portion of his presentation.

The TR/GPR/APREA indices:

  • Launched in the beginning of 2013 with Thomson Reuters, Global Property Research and the Asia Pacific Real Estate Association
  • Primary mission: give Asia Pacific real estate securities markets greater visibility through the promulgation of a series of real estate securities–related performance indices
  • Related mission: encourage the further development of REITs and REIT investment products in the Asia Pacific region
  • Index variants:
    • Country-specific indices
    • REIT-only indices
    • Price, income and total return performance measures
    • U.S. dollar, euro, yen and other local currency–denominated data
  • Two investable indices
    • TR/GPR/APREA Investable 100
    • TR/GPR/APREA Investable REIT 100

Other Asian property indices currently available in the market:

  • FTSE EPRA/NAREIT Global Real Estate Index
  • Global Real Estate Fund Index, sponsored by ANREV, INREV and NCREIF
  • S&P Asia Property 40
  • ANREV Fund Level Performance tool
  • IPD indices

In addition, there are indices provided by various consultants and financial services firms. With the increasing number of benchmarks, investors will have an easier time measuring property performance in the Asia Pacific region.

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GeoffFinalv5forwebGeoffrey Dohrmann is president and CEO of Institutional Real Estate, Inc.