Churchouse Letter
December 2009         by Peter Churchouse

A Stimulus Too Far. Have Asian Policy Makers Over-reacted?

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When the definitive history of the current global financial imbroglio gets written, a chapter on Asia’s role and response to it all could be an interesting sidebar to the main event.

History will possibly judge that the response to the global financial crisis by many central banks and governments was excessive, and possibly misdirected. This may also be a verdict particularly in some Asian markets where governments and central banks followed the frenetic lead of fiscal and monetary stimulus promulgated by western countries. Fear has forced Asian authorities to follow suit, in some cases in almost as big a way as western counterparts. All major governments and central banks around Asia have embarked on programs of monetary easing of various kinds as well as fiscal stimulus measures. China has been probably the most notable with a panicked response in late 2008, early 2009 that involved directing major local banks to pump approximately US$1.1 trillion of new loans into the economy in the first half of 2009. This was on top of programs to put around RMB5 trillion (approx. US$730 billion) into infrastructure spending.

Asian Real Estate Stock Indices Performance - Up Big From Lows; Still Well Below Highs. Includes Bombay SE Realty Index, FTSE ST Real Estate, FTSE ST Real Estate Investment Trusts, Hang Seng Property Index, HS REIT INDEX, NZSX Property Group Index, S&P/ASX 200 Property Trusts, Shanghai SE Property Subindex, Taiwan SE Construction Index, Tokyo SE TOPIX Real Estate Stock Price Index, Topix REIT Market Index. Close Prices at 09 December 2009.

Massive dislocations of this kind almost always bring with them risks of unintended and unpredicted consequences. The financial meltdown in the US and western Europe put the fear of god in many Asian policy-makers, most of whom have vivid memories of dealing with the Asian financial crisis and its far-reaching and unexpected consequences just a few years ago. I am sure visions of a repeat performance of the Asian financial crisis, in the face of what seemed like global financial Armageddon in Q4 of 2008, drove governments to very quickly adopt extraordinary measures to shore up domestic economies from what seemed like a potentially disastrous outcome. Western governments were also quick to encourage Asian economies to indulge in huge bouts of Keynsian stimulus, no more so than in China.

Was this response in Asia too much, too little, about right? The global response to this crisis has been driven by the perceived policy failings of earlier recessions, most notably that of the 1930’s, failings that exacerbated the severity of that recession. History will probably not judge western policy makers for failing to act quickly, decisively and powerfully to the 2008 financial crisis, but will judge them as having failed to spot the crisis in the making and to act to prevent its ultimate birth. It may accuse them of adopting misguided responses as well.

It will be hard to criticize most Asian governments for responses to the western created financial tsunami (we love that word in Asia!) as having been too aggressive. Few economies have not slid into recession, the big exceptions being the big economies of China, India and Indonesia, and surprisingly to many, certainly me, the Philippines. Without the numerous measures adopted by governments and central banks, recessions would have undoubtedly been sharper, and possibly more protracted.

Bloomberg Asia Property Index (BPRREAL:IND) from December 2007-2009

China is one country that can be argued as having perhaps reacted more aggressively than might have been warranted. And continues to do so, bringing risks to its financial system further down the track.

China’s reaction has not been entirely driven by purely economic motives. For many years, it, and many China watchers have remarked that the Communist Party’s political legitimacy could well be questioned if it fails to deliver a measure of growth that supports a given level of income growth, job growth, and consumption growth. The level of GDP that most assume is the minimum to support such needs is around 8%, though I have not seen any strong analytical evidence that supports this number. Regardless of the facts, this is the number that it seems the powers that be in China work off, correctly or not.

Most Asian Economies have fallen into outright recession. The “Big Three” (India, China, Indonesia) & Philippines have avoided negative GDP.

India and China's GDP growth rate circa December 2009

Indonesia and Singapore's GDP growth rate circa December 2009

Hong Kong and Japan's GDP growth rate circa December 2009

Australia and Malaysia's GDP growth rate circa December 2009

Philippines and Thailand's GDP growth rate circa December 2009

Taiwan and South Korea's GDP growth rate circa December 2009

There have been three main threads to China’s stimulus:

  1. Massive new centrally dictated bank lending.
  2. Substantial new infrastructure spending initiatives.
  3. Changes in a host of administrative measures put in place in the boom times aimed at curbing for example, property market excesses, consumption controls and changes to export tax levies.

Typically infrastructure spending initiatives can take some time to filter into the real economy, but the trillion plus dollars of new bank lending is immediate as a crack cocaine fix. As we know, much of this new lending has found its way into asset markets, particularly including land, property and stock markets.

While excesses are perhaps most obvious in China, asset price inflation, especially in real estate is becoming of concern to authorities in markets like Hong Kong, Singapore and Korea.

There is a growing concern that the very forces that created the debt fueled financial crisis in western economies are being encouraged in parts of Asia, particularly China. China’s huge surge in debt is perhaps sowing the seeds of a debt repayment problem a few years down the track. Much of the increase in lending is going into real estate assets of one kind or another, both from the supply side and the demand side. Housing transactions volumes across China have accelerated this year, prices across the country are picking up, and property developers have not been slow in soaking up lending to buy substantial new land-banks and accelerate new construction projects. We are seeing local investors buying commercial properties at yields lower than ever seen before. Risk appetite is higher than ever in real estate in China.

China's Monthly Houseing Transaction Volumes 2006-2009. Combined monthly primary sales from Shenzhen, Guangzhou, Shanghai, Hangzhou, Beijing, Tianjin, Chungdu and Chongqing

Home Ownership is a New Phenomenon in China. Will Consumers Continue to Service Mortgage Debt When Times Get Tough?

China’s housing market is a relatively new phenomenon. Private ownership of housing has only been part of China’s economy for about 15 years. China’s consumers are new to the debt game. In earlier generations consumers did not take on debt – the iron rice bowl economy did not need consumers to be responsible for their own housing. That was the responsibility of the work unit. How will China’s consumers react to a real economic downturn when it comes to paying back mortgages that are now so commonplace in China? The country has no history of consumer debt. Previous generations had all daily necessities including housing provided for them.

In neighboring Hong Kong major economic crisis has been met with uncommonly powerful resilience from the consumer. For example, in the Asian financial crisis when housing prices fell by around 65%, non-performing residential mortgages rose to a very manageable 1.3% or so. Such figures would be the envy of the US banking system. What we do not know, is whether China’s consumers will respond in the same way when the times turn tough, or whether they will be able to respond in such a way. Given that the country’s state owned enterprises (SOE’s) have not shown a strong culture of repayment of debt (borrowing from banks have often been viewed as equity rather than debt to be repaid in the SOE culture). It is hard to know if the consumer will adopt a debt culture more akin to that of the SOE’s or more in line with cousins in Hong Kong and Singapore.

Central bankers and government officials are showing signs of concern at the potential risks to the banking system of the recent surge in lending. But at the same time are continuing to espouse a policy of maintaining an easy monetary policy with an aim of supporting economic growth at perhaps unrealistically high expectations.

This easy money policy is raising the temperature in local property markets, encouraging even further investment in the manufacturing sector in face of current overcapacity and weak demand. Easy money is leading to inefficient investment and probably misallocation of resources.

Old style economics – Means of Production: Land, Labor, Capital.

We were taught in our early economics classes that economic activity is made up of the interplay of three means of production: land, labor and capital. All economic activity uses each in varying amounts. Even activities in cyberspace require land and capital. That cyber activity may have been generated by some whiz kids out of a garage, still land, and is carried out via vast collections of servers located around the world in server farms. Our teachers taught us the obvious – when the price of a particular means of production is low, demand for it will rise, more of it will get used. This is so for the price of capital as much as any other input to the production process. Western central banks (led by the Fed) kept the price of capital artificially low for many years, and lo and behold demand for capital soared, with a great deal of it parked in land/property and manufacturing capacity, much of that in emerging markets. Excess capital creates bubbles in other means of production – land/property in particular. It has also produced a surplus of manufacturing capacity globally with predictably dire effects. Thousands of factories in China have folded in the past 18 months in China, and some 50 million people have been put out of work according to some estimates.

When it comes to capital, the traditional model of banking saw a broad equilibrium created when savings represented by bank deposits were matched against loans to users of capital. Cost of capital is determined by the relationship between the return paid to depositors and price paid by borrowers. That model broke down in this instance with the development of instruments which allowed banks to sell loans (which may have been sensibly backed by deposits), and then go out and lend all over again. The relationship between traditional sources of capital (savings) and demand for capital has broken down.

China in its rush to maintain growth at all costs by force feeding the economy on a rich diet of debt is running a big risk of creating the same kinds of asset bubbles that led to the demise of the western banking system.

China’s Policy Makers See the Risks, But Will Continue to Pour Liquidity into the Domestic Economy.

While we should be concerned, there are indications that policy makers in China are not totally blind to these risks. But they are caught in a bind, similar to that faced by policy makers everywhere. China’s leaders exhibit characteristics of severe paranoia about the potential of slower than desired economic growth, and indirectly the potential threat that such might bring to the regime’s political legitimacy. A sort of uneasy social contract seems to exist in which China’s autocratic regime is tolerated so long as it continues to deliver economic and social improvements to the lives and livelihoods of its citizens, something it has done with commendable efficiency over the past 20 years.

The downside of priming the economy with a torrent of lending is the potential risk of that lending turning sour with banks slipping back into a regime of huge non-performing loans and another round of state financed bailouts and capital injections a few years down the track.

The central authorities seem to be judging the risk trade off between a socially and politically dangerous economic slowdown and potential bad loan problems for the major banks as being a risk worth taking.

As an aside, the massive wave of new lending is likely to lead to a new round of capital raising by China’s large banks in order to maintain capital adequacy ratios. Analysts at BNP Paribas estimate that this may amount to about RMB300 billion (approx. US$44 billion) of new capital, relatively small in the context of the size of these banks. However, this may be sufficient to act as a near term drag on bank share price performance. We could also look forward to seeing China’s central bank regulator pressure the big banks to lift loan loss provisioning at some point in the coming year.

China's Monthly New Loans and China's Monthly Money Supply Growth (M2) from 1997-2009

In view of this discussion the following conclusions seem reasonable:

  • China’s monetary response to the global financial crisis has been on the aggressive side, arguably unnecessarily aggressive, and has had the unintended consequence of pushing asset prices up sharply (both stocks and real estate).
  • Much lending has been effectively forced down the throats of borrowers, resulting probably in less than efficient allocation of capital.
  • This raises a real risk of a rise in non-performing bank loans in a couple of years time.
  • Central authorities and the central bank will continue to maintain easy monetary conditions to support the domestic economy, though loan growth will slow from north of RMB10 trillion, to probably something more like RMB 7 trillion (approx. US$1 trillion) in 2010, still a huge number.
  • However, we can expect implementation of administrative and other efforts to prevent the possibility of further asset bubbles, particularly in the real estate sector. Look for the introduction of many measures that were put in place in the last up-cycle in 2006/07. In effect more stop-go policies in property markets.
  • Near term we expect the upward trajectory of residential real estate prices to continue, but the pace to moderate further into 2010 as cooling measures take effect. Measures will be introduced on a “suck-it-and-see” basis. A stream of monetary and administrative measure will be implemented on an increasing basis until the desired effect is achieved.
  • China property companies listed in Hong Kong will likely continue to achieve the highest average earnings growth of any property sector in the region in 2010, many likely to achieve 20% – 30% net profit growth.
  • The threat of cooling measures will likely act as a drag on property shares in China, despite strong earnings growth for 2010. This growth expectation is already well reflected in share prices for most developers.
  • Easy liquidity and solid economic growth is likely to keep prices for commercial property resilient in 2010, and potentially provide a floor to commercial property rentals.

In the short term, such easy liquidity will make local players the “main game in town” for commercial real estate, with local buyers paying top prices, while foreign players stay on the sidelines, probably more net sellers than net buyers. This situation will provide an exit for some pressured foreign private equity real estate funds.

The Execution and Expectations of Property Market Cooling Measures will Weigh on China Property Stocks in the Near Term.

China property stocks listed in Hong Kong have rallied more than 100% from their lows in most instances and now trade at 10X – 20X forward earnings. This is not overly expensive given growth prospects of 20% – 30%. Like many other markets in the region, we expect to see better news flow in commercial property markets over the coming months. Good news in residential markets is now well known. As a result, we think focus on commercial property oriented property companies in Asian markets is likely to produce superior returns over the coming 6 months or so as better news for office and retail property markets becomes more obvious. There are no major pure office market property plays in China, but companies such as SOHO China Ltd (0410.HK), and China Resources Land Ltd (1109.HK) give investors some exposure to this sector. SOHO China is likely to produce around 22% EPS growth in 2010, and is trading at around 7.6 times 2010 earnings. China Resources, (controlled by State Owned Enterprise) has significant exposure to office markets and should produce approximately 85% EPS growth in 2010. Singapore-listed CapitaRetail China Trust (CRCT.SI) provides probably the purest exposure to China’s burgeoning retail property market.

SOHO China stock price from 2007-2009

China Resources Land Ltd stock price from 2007-2009

CapitaRetail China Trust price from 2007-2009

As a sidebar to this scenario, China is likely to see continuing pressure to resume its stalled path of currency appreciation. The perceived likelihood of this encourages inflows to RMB based assets. Do not be surprised to see China impose measures to control the inflow of foreign investment into RMB assets if these flows become significant enough to look like inflating domestic asset prices once again. A surge in foreign demand for real estate investment in 2007 prompted authorities to impose controls on inflows of such capital.

A rise in demand for RMB assets by foreigners may prompt the authorities to once again revisit the “through train” concept that would allow freer access to HK capital markets by local investors and institutions. Such outflows would potentially neutralize some of the pressures of inflows betting on RMB appreciation.

China Property IPOs in 2009: Flood of New China Property IPO's May Curb Share Price Growth in the Sector. Kaisa Group Holdings, Fantasia Holdings Group, Longfor Properties, Mingfa Group (International) Company, Evergrande Real Estate Group, Excellence Real Estate Group Limited, Yuzhou Properties Co, Powerlong Real Estate Holdings Limited, Glorious Property Holdings Limited. Circa December 2009.

Comparative Housing Cost Analysis. Howe Expensive is London, New York, Hong Kong, Tokyo, Singapore?

For those of us who find ourselves traveling around the world on business and for pleasure, the subject of cost comparisons provides almost endless fodder for dinner party conversation. For some years I have noticed that for many commonly consumed items around the world, the key difference in price seems to be the difference in GST/VAT or other such domestically imposed taxes. This seems particularly the case with respect to such items as cameras, computers, phones, music kit and other electronic consumer equipment. Where VAT can be as much as 17% or more, such taxes really make a big difference to the amount the consumer coughs up for goods.

And then there is the currency effect. Sharp trend movements in currencies can make price comparisons quite sharp. The recent run-up in the Euro vs. Stg possibly accounts for the surge in European accents being heard on Oxford Street and Kennsington High Street. It may also be supporting the surprising resilience of London’s residential property market.

London does not however seem cheap for those from across the pond. For some time many of us have noted that buying goods and services is UK vs. US is a pretty simple one-for-one relationship. A product in UK selling for say Stg100, can be bought in New York or San Francisco for the same number, but in dollars, representing about 60% of the UK price. VAT may account for a substantial amount of this difference but not the full amount of the difference.

With many professionals angered by new government tax proposals and looking at relocation to more “friendly” regimes the tax and housing cost equation is important to personal finance decisions.

We have for years heard these kinds of comments applied to housing costs, particularly amongst that set of people who are beneficiaries (or victims?) of globalization of industry and capital. Our world is increasingly populated by professional people who are carted around the world by their companies to run increasingly international businesses in just about any field you can care to name – manufacturing, shipping, advertising, law, finance, accounting, medicine, pharmaceuticals, engineering – the list goes on.

A common subject of discussion around this phenomenon is the cost of housing in various locations, particularly in the key global financial capitals of the world.

Over the years the complaints rumble through how Tokyo is ridiculously expensive – a cry very much of the late 1980’s, how London knocks the stuffing out of housing budgets. Hong Kong has almost always been branded as a high cost destination on the housing front.

While it is very easy to make dollar for dollar cost comparisons of housing cost across borders, we are often not comparing like for like. That apartment in New York at US$1 million seems cheap when compared with a similar quality apartment in Hong Kong that changes hands for equivalent of US$1.3 million.

Here we attempt to look at the housing cost equation on the basis of after mortgage cost and after taxes.

In essence we are asking, “what is a household’s the net disposable income after housing cost and income tax for an equivalent property in the major financial capitals of the world.”

We are trying to look at the kind of property that our international business road warrior might find him or herself gravitating to in these major financial capitals.

For the purposes of our little exercise, we are looking at the costs of buying and servicing a mortgage on a good quality apartment or house in our subject cities of New York, London, Tokyo, Hong Kong and Singapore. We then look at the differences in net disposable income in each location after housing costs (including local property or municipal taxes) and personal income tax.

Our benchmark property is a roughly 1,500 sq ft good quality apartment in a good location, but not ritzy, razzle dazzle high end. In London this might embrace areas such as Kennsington, Chelsea, Holland Park, Notting Hill. In New York, Manhattan, upper east side, upper west side, or similar. In Singapore, District 9, 10, or 11, favorite destinations for expatriate residents. In Tokyo our target destinations are Minato-ku, Shibuya-ku.

We are not looking at entry level housing here, and this is not the first time buyer market typically.

Absolutely strict comparisons are always going to be difficult due to different local practices and rules. For example, types of land and property tenure vary. Not everywhere operates on a freehold land/property title basis, and many cities have both freehold and leasehold tenure. New York’s co-op system is unfamiliar to other major cities. Mortgage practices vary. The US market is much more familiar with fixed rate mortgages, something not common in other jurisdictions where adjustable rate mortgages are more common. Local authority tax practices vary, as do such factors as stamp duty payable on property purchases. Capital gains taxes may or may not be applicable.

Housing Cost Comparisons for Major Financial Countries. Disposable Income Analysis - After Housing Costs and Income Tax for London, Tokyo, Hong Kong, New York and Singapore circa December 2009.

Finally, real estate is not a homogeneous commodity, with prices likely to vary, even within a similar location according to such factors as view, decoration, facilities and so on.

Despite all of these factors, we do believe it is possible to make broadly valid cross country comparisons that demonstrate key differences between them.

Figure 22 presents our findings. In London there is ample property in the category that we are considering selling for around Stg900 – Stg1,000 per square foot. In New York prices of around US$1,000/sq ft are the norm, and for Hong Kong pricing in the secondary market for the districts canvassed is around HK$10,000 – HK$12,000/sq ft. We are using the higher figure. For Singapore we are using a figure of S$1,400/sq ft as an average for the districts we are focusing on.

In all of these cities, there is plenty of high end property that sells for a great deal more than the numbers we are quoting here. Much of this however, is well outside the “normal” ranges that professional people are buying and financing through standard mortgages.

Hong Kong and London are at the top of the price tree for our 5 cities, and the other three destinations are remarkably similar. When the total cost of housing is calculated, including the annual mortgage payment, building management fees, and local authority rates/taxes, the differences between the cities widens.

Singapore is way ahead in the modesty of its housing cost at about US$74,000 annual outgoings, (see row f) with London at the other end of the spectrum at around US$137,000 annual outgoings. This makes London 85% more expensive than Singapore. Interestingly Tokyo’s total housing outgoings are next cheapest, a far cry from the late 1980’s and shows what the bursting of that country’s housing bubble in 1990/91 has done for affordability.

Of the major financial cities around the world, the annual cost of owning a 1,500 square foot upper market apartment in Singapore is by far the cheapest at around US$74,000/year, and most expensive in London at US$137,000. On the assumption that mortgage cost is 40% of income, our apartment owning professional in London would need to earn around US$342,000 compared with $186,000 in Singapore and $254,000 in New York to support such a mortgage.

Next we consider the level of income needed to support this kind of housing cost. When I started out in this business, banks had a rule of thumb that suggested mortgage repayment should not greatly exceed about 30% of one’s income, and banks would often limit mortgage lending to this kind of level. Here we have chosen a level of 40%, and used this as a basis for indicating the income level needed to support a mortgage in each country such that the mortgage would not exceed 40% of income. (see row g)

On this basis, a family would need to earn around US$343, 000 in London, and as little as US$186,000 in Singapore, about US$279,000 in Hong Kong and a little less in New York, at US$255,000.

But this analysis so far fails to consider disposable income after payment of housing and income taxes in each country.

For this part of the analysis, we have looked at two situations:

  1. First, what is the disposable income post housing and post tax for the level of income needed to support a mortgage at 40% of income.
  2. Second, assume a common level of income across the markets for our imaginary professional, and then estimate post housing and post tax disposable income.

For the first scenario, (see row h) our professional in Hong Kong is substantially better off than his peers elsewhere with a disposable income after tax and housing cost of about US$121,000 on the assumption that he has an income that allows him to service his mortgage with 40% of his annual paycheck. For other financial centers net disposable income is between about US$73,000 and US$88,000.

Left:Income Needed assuming housing costs no more than 40% of gross income. Right: Additional Income needed to provide equal disposable income across all cities. Graphs for London, Tokyo, Hong Kong, New York, Singapore

Assuming our globe-trotting executive is paid a similar “global” remuneration in each of our financial capitals, in London he would need to be paid about 36% more than his peer in Singapore to enjoy similar disposable income after housing cost and income tax. This would need to be 26% greater in New York, 20% in Tokyo, and 10% for Hong Kong. This gap has narrowed in recent years.

Perhaps more realistically we should assume our professional is a global warrior, an international player, and we can assume that remuneration for such an individual is going to be roughly the same in each of these financial centers. It has certainly been my experience in employing people to work in our organization that remuneration packages and remuneration expectations are pretty much the same irrespective of location across these major financial centers.

In order for our professional to be equally well off in terms of net disposable income after housing costs and personal income tax, he/she located in London would need to be paid 36% more than his peer in Singapore, 26% more in New York, 20% more in Tokyo and 10% more in Hong Kong.

At present, the housing cost/tax equation is rather closer across markets than it was a number of years ago when I did a similar exercise. At that time an owner in London or New York would need to earn about 50% – 60% more than his peers in Hong Kong and Singapore to enjoy similar net disposable income.

Basically the current property price, interest rate, tax conditions favor Singapore and Hong Kong substantially over London, Tokyo and New York. But that gap has narrowed recently.

This may impact business location decisions, particularly view of the tax-and spend policies increasingly prevalent in western economies.

Murmurings from the Global Real Estate Trenches.

I recently attended a global real estate conference hosted by UBS in London, where about 42 real estate companies from mainly Europe, UK, US and Asia presented to investors. UBS has a comprehensive real estate research and dedicated sales team spanning most major markets around the world. In Australia, where they are particularly strong, property companies have confided to me that any capital raising effort in that market almost has to have UBS on the ticket.

The mood generally was rather somber, with George Magnus, UBS’s chief economist painting a cautious but modestly optimistic picture of the global economy with a lot of data that is by now pretty familiar to most observers of capital markets. Recovery is happening, but growth is soggy, job creation in major economies will be slow. A great deal of leverage is still to be worked out of the global economy. Magnus notes that banks have written down about US$1.3 trillion of assets, but he estimates this needs to be about $3.6 trillion. Although banks have raised about $930 billion of new capital in the first half of 2009, another $600 billion of new equity is needed to maintain necessary tier 1 ratios.

It does seem, however, that a disconnect currently exists in capital markets. Global equity markets have rallied extremely strongly, and are pricing in a V shaped recovery. Bond markets are pricing in a low inflation environment, a much slower economic recovery trajectory. Which one is right?

If equity markets are right, we can expect inflationary pressures sooner rather than later, and an earlier withdrawal of monetary and fiscal stimulus measures. If the bond markets are right, governments and central banks can be expected to maintain a steady stream of stimulus for quite some time.

Property investors and developers at this conference certainly did not present a particularly optimistic picture of their business – probably more in the bond market camp than the equity camp as characterized above.

Here are some of the themes noted from the real estate talkfest.

Capital management (aka deleveraging), was upfront and centre of everyone’s agenda. Finding an optimum capital structure that suited each company’s business model is exercising minds at the top of all property companies it seems. Re-positioning of a company’s capital structure is on virtually every property company’s agenda it seems in the developed world. Most have spent a great deal of time with their bankers in the past year or so, with discussion and renegotiation of loans and loan covenants an urgent priority.

There is no common view of the most desirable gearing levels, with some claiming that an average of 20% – 30% is aimed for over the course of the business cycle, while others believed 50% – 60% is a suitable target.

With deleveraging uppermost in the priority lists of much of the real estate industry in the developed world, new development and growth is likely to be very much off the agenda. Companies that can do more than merely survive, and actually target growth opportunities will be winners. Asian real estate companies are very much in this camp at a general level, though many REITs have limits on growth potential due to inability to target new capital where stocks are trading at deep discounts to current NAV.

Debt duration. Most companies were aiming to lengthen the profile of debt maturities, and many claimed success in achieving this.

I have often wondered why Japanese REITs and property companies do not seek to opt for longer term loans, an issue that has certainly proved painful for many property companies there in the past year or so.

Capital raising. A good number of companies have successfully raised capital during the past 18 months through a variety of means – rights issues, placements, convertible bonds, preference shares, MTN programs, straight bonds, asset sales.

Longer maturities are likely to mean higher debt costs for property companies. Another hit to the P&L. Huge central bank/government liquidity influxes in developed countries have certainly helped the real estate sector pull back from the brink of disaster.

Development is dead! Initiation of new projects is virtually dead for most property companies and REITs in the developed world, particularly companies focusing on commercial properties. The only new development is typically in projects that were started before the financial crisis took hold.

Maintenance not growth. Growth is off the agenda. Managing existing portfolios to maintain tenants and rentals is top priority. Little discussion of future opportunities for acquisitions or development – it is all about keeping current portfolios intact and cash generating.

The lack of new project initiation today will result in tight property markets as economies recover a few years down the track. Investors need to target companies that are most likely to be able to be in a position to either grow portfolios into such opportunities and/or hold portfolios that will benefit most from tight market conditions.

Occupancies surprisingly resilient. Most of the companies report that vacancy levels in their portfolios are remaining high, though they may have risen a percentage point or two. Retail occupancies seem to have remained higher than for office space. Industrial vacancies have risen most.

Occupancy rates have been surprisingly high in many developed markets but may have come at a cost of lower rentals.

Tenant failures. Retail operators have seen sharp rises in tenant failures and are experiencing significant sales turnover falls in the order of 12% – 13% in many markets. Estimates suggest that it will take 4 – 5 years for retail sales turnover to get back to 2007 levels.

If correct, Asian economies can expect only a slow recovery of exports over the coming years.

Cost cutting. Both property companies and their tenants are cutting costs with the result that even though top line numbers may be down, EBITDA may be holding up reasonably well.

There is only so far that cost cutting can go in supporting earnings. Once all the fat has been trimmed, there may be only one way for earnings to go – down. Unless sales can be nudged up.

Capitalization rates are up. Cap rates are up anything from 50bp to 200+bp in most developed markets for commercial property, and with rentals trending down, capital values are down in just about every market by as much as 40% or even more. This has invoked breaches of loan covenants in a great many instances. However, in recent months in the UK, capital values for commercial have shown some upside according to the IPD indices, rising a few percentage points.

This could be seen as surprising given the state of demand, growth, employment and general corporate health, but probably reflects easier liquidity conditions created by government and central banks as much as anything else.

Public vs. Private. Publicly listed real estate companies are finding it easier to recapitalize and restructure debt than private companies who have fewer options available, and find banks taking a tougher line. Many public real estate companies have tapped markets through placements, rights issues, new bond issues, convertible bonds. These options are not so easily available to private companies.

Distressed opportunities in real estate are more likely to come from private companies than the publicly listed companies.

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