A taste for Asia

Global listed property has become a key building block in investors’ portfolios in recent years. This has been driven by strong property returns and the growing awareness of the diversification benefits of this sector away from equities and bonds.

Over the long term, property securities can provide diversification from equity markets in general, with a relatively low degree of volatility.

Global property growth has been driven by strong economies, increased demand for income generating assets and changes in regulations that have prompted the expansion of real estate investment trusts (REITs) around the world. This has been helped by the increasing age demographic of most Western countries (including China).

UK commercial property, for example, returned an annualised total return of 15 per cent over the past five years to the end of 2006, and grew 18 per cent alone in 2006, according to the Investment Property Databank (IPD).

Global commercial property has delivered an annualised 11.1 per cent return in local currencies over the past five years, with a 14.9 per cent return in 2006.

Three-year average annual returns in Europe and Asia have been higher at 27.3 per cent and 30.1 per cent respectively in dollar terms.

There are now concerns, however, that the commercial property market has peaked or is slowing.

It is not all doom and gloom for property, however.

There are short-term risks associated with investing in property securities, but we believe the long-term outlook is still positive.

Going forward, the asset class should be supported by strong global economic fundamentals, liquidity flows and the growth of Asia.

Property, of course, is not a homogeneous group.

When investing in REIT shares or funds, investors should evaluate the quality of the underlying assets and management (especially their past track record). They also need to consider geographical weightings and opportunities in REITs.

If you buy major trophy investment real estate assets like shopping centres, office towers and industrial parks, and provided tenants do not go broke, investors can be confident that both cash flow and income will continue even through challenging economic times. This can be accomplished relatively easily through the medium of REITs or listed property security funds.

It is a riskier proposition to put your money in lower quality property developments, because often these types of properties are hit harder in a market downturn, vacancies can be more difficult to fill and cash flows can be a lot less certain.

It is also important to analyse the manager’s ability to grow the earnings of its developments and construction businesses in a sustainable way. There are a number of global property businesses that do this well, including Land Securities, Goodman Management, Centro, Stockland and Pro Logis.

There are reasons for reviewing the allocation of your property exposure on a geographical basis as well.

For example, we have some concerns about the cost of property in London’s West End office market in the UK and parts of the Manhattan office market.

The US and Australia are mature markets, and the investment opportunities lie in the expanding Asian REIT markets and in Europe, where the UK and Germany have more recently introduced REITs.

But, at the moment, the most attractive region for property stocks is Asia, especially Hong Kong, Singapore and China.

Asian property securities, for example, have outperformed strongly this year, with the UBS Asia Property index rising by 22.2 per cent.

The appeal of Asia

The Asian markets are varied in their maturity and openness, but are generally high growth, reflecting the high gross domestic product (GDP) growth nature of these countries’ economies.

We continue to be optimistic about the Asia Pacific region because the fundamentals are strong. The two main drivers of the property markets in Asia are macroeconomic growth and demographic trends, such as the emerging middle class in China and the aspirational population of 1.3 billon people whose incomes are doubling every four years.

Since it was first permitted around eight years ago, there has been a rapid expansion in private property ownership. In this regard they are no different to the populations of many Western countries, who place a high level of importance on home ownership. We see that residential property is especially strong in Singapore, coastal China, south east Asia and Tokyo as cities grow.

Asian countries have some of the highest levels of economic GDP growth in the world.

While the US has GDP growth of 2 per cent to 3 per cent per annum, China and Singapore are expanding at nearly 10 to 11 per cent per annum. This is over four times the average GDP growth of Western economies. We expect this to continue for the foreseeable future.

There are many property companies in Asia enjoying earnings growth that is 10 times the amount of those in Australia and other Western markets.

However, the price earnings multiples of many of these stocks, while high by Western benchmarks, is actually relatively low when the high level of earnings per share (EPS) growth is taken into account.

With the increasing per capita income of the Chinese consumer Asia has been profiting from changing retail patterns, which have led to the building of shopping malls, while the hotel, logistics and industrial sectors have also been growing rapidly as the amount of domestic consumption increases.

Asian office markets are also in good health.

Vacancies in the Japanese office market are currently at low levels, with an increasing trend in rental growth. Hong Kong and Singapore have also enjoyed a recovery in rental growth.

We also expect REIT-style legislation will be introduced in China and India within the next decade.

Leading stock markets such as the Shanghai Stock Exchange are considering launching REIT products to allow more Chinese investors to benefit from escalating property prices. We also see significant growth potential in South Korea, Taiwan, Thailand and Vietnam as well.

We like management teams that have expertise in specific Chinese provinces because many provincial cities have populations of five to 10 million.

As an example, we have holdings in Chinese property development companies such as China Overseas Land and Investment, Guangzhou R & F Properties and Agile Property Holdings.

We like property development companies based in Hong Kong and Singapore that have businesses and assets located in mainland China. Both countries have a high level of regulatory and financial infrastructure that is fairly transparent and this gives us an added degree of confidence when analysing such stocks.

In Japan and Hong Kong, there are many major developers that own and develop mixed property types. These include Mitsui Fudosan, Mitsubishi Estate and Sun Hung Kai.

As previously mentioned, we also invest in emerging developers, as we believe they offer great opportunities for growth. Many of them use profits from their residential developments to acquire and grow a presence in retail and office property, particularly in China. Examples include Kerry Properties, Hang Lung Properties and China Resources Land.

There are risks associated with investing in Asian property stocks, of course. These include political developments and rising interest rates in China, which are currently around 5.2 per cent.

It is important to remember that in China, the central government controls both the regulatory and overall financial system.

Despite these risks, strong fundamentals should support property stocks on a selective basis, particularly in Asia.

We expect the global property market to continue to grow and to reach around US$1.5 trillion by 2011.

Therefore, we believe global property securities should be a key part of an investor’s diversified investment portfolio.

John Snowden is head of global property securities at Colonial First State Global Asset Management.