Churchouse Letter
July 2010               by Peter Churchouse

Asian Urban Future Shock

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A Quick Ten Year Glimpse into Asia’s Real Estate Future

The following is a brief, terse assessment of where Asia’s real estate industry is heading over the next decade.

Housing a 67 billion square foot opportunity

Continued rapid rural-urban migration together with natural population growth will ensure that Asia’s cities will accommodate an additional 285 million inhabitants a decade from now. A total of 70 million new homes will need to be constructed, involving around 6.27 billion sq m (67 billion sq ft) of additional residential floorspace, just to house incremental urban population. This does not count any replacement housing that will certainly take place. In many Asian cities existing housing infrastructure is woefully inadequate, with vast slums a feature of many large Asian cities, particularly in India. Our numbers here do not include “replacement” or upgrading stock.

This urban construction will be the equivalent of building about 23-24 Londons over the coming decade.

  Value % Value % Value % Value %
Total population (m) 1,142.1 100% 1,267.0 100% 1,354.1 100% 1,431.2 100%
Rural population (m) 840.1 74% 813.9 64% 718.3 53% 644.4 45%
Urban population (m) 302.0 26% 453.0 36% 635.8 47% 786.8 55%
Total Population (m) 862.2 100% 1,042.6 100% 1,214.5 100% 1,367.2 100%
Rural Population (m) 641.9 74% 754.2 72% 850.0 70% 903.9 66%
Urban Population (m) 302.0 26% 453.0 36% 635.8 47% 786.8 55%
Total Population (m) 177.4 100% 205.3 100% 232.5 100% 254.2 100%
Rural Population (m) 123.1 69% 119.1 58% 129.6 56% 132.0 52%
Urban Population (m) 54.3 31% 86.2 42% 103.0 44% 122.3 48%
Total Population (m) 62.4 100% 77.7 100% 93.6 100% 109.7 100%
Rural Population (m) 32.1 51% 40.4 52% 47.8 51% 52.0 47%
Urban Population (m) 30.3 49% 37.3 48% 45.8 49% 57.7 53%
Total Population (m) 56.7 100% 62.3 100% 68.1 100% 71.4 100%
Rural Population (m) 40.0 71% 42.9 69% 45.0 66% 43.6 61%
Urban Population (m) 16.7 29% 19.4 31% 23.1 34% 27.8 39%
Total Population (m) 66.2 100% 78.7 100% 89.0 100% 98.0 100%
Rural Population (m) 52.8 80% 59.4 76% 62.0 70% 61.7 63%
Urban Population (m) 13.4 20% 19.3 24% 27.0 30% 36.3 37%
Source: United Nations

The physical challenge of creating this housing infrastructure will be met. Asia’s development community and the regions banks have the necessary skills and financial wherewithal to achieve these outcomes. India is possibly the least well positioned of the “big 3” in this regard. Savings levels in Asia are also high with savings ratios of 30% of GDP quite normal. China’s saving rate hit around 47% recently. High savings ratios will underpin genuine demand (as opposed to merely need) for housing and the ability to pay for it. In addition, many Asian countries have substantial reserves. There is good reason to believe that the companies that will take on this development will increasingly list on local stockmarkets, providing another source of financing for this development boom.

Impact on Office Space due to change in Rural/Urban population %, increase in Incremental Population in Cities, Incremental Workers, Incremental Office Workers and Incremental new commercial square feet from 2000 to 2010 to 2020, for the following Asian Countries: China, India, Indonesia, Philippines, Thailand, and Vietnam.

Impact on Residential Space due to change in Rural/Urban % of population, increase in Incremental population in Cities, Incremental Workers, Incremental Office Workers and Incremental new residential square feet from 2000 to 2010 to 2020, for the following Asian Countries: China, India, Indonesia, Philippines, Thailand, and Vietnam.

Homeownership levels in most of Asia’s large cities will be the equal or in excess of those in the west ten years from now. A key risk to this ownership scenario can come from the creation of property price bubbles which would adversely impact affordability, and would produce the inevitable crash in property prices. Asia is no stranger to property bubbles.

The Iron Rice Bowl is Broken!

Housing increasingly will be seen as an asset, a store of wealth, the roots of long term personal financial security as people come to realize that governments will not be in a position to fund their retirements. The cradle-to-the-grave underpinning of many socialistically oriented societies, the “iron rice bowl” being China’s equivalent, is increasingly being broken down. Families are increasingly realizing that they need to look after their own long term future, their children’s education, their health care needs. As in the west, home ownership and more generally property ownership is viewed as providing some financial support for these needs. It may come to be an ATM also, much as has been the case in the west during the past decade.

Upper end housing in the major emerging Asian cities such as Shanghai, Beijing, Mumbai, New Delhi will be priced at “international” levels of major developed world financial centres such as London, New York, San Francisco, Paris, Tokyo and Hong Kong.

Poor Urban Living Environment Can be a Regime Changer

Poor urban planning, dire environmental degradation and transportation gridlock, all aided and abetted by bureaucratic incompetence laced with doses of corruption will make Asian cities pretty dreadful places to live in many respects.

Many are already, and it is not going to get better in the coming decade – just worse. These urban problems will generate significant social unrest and civil action, on a scale that has the potential to bring down governments at a local and even a national level. People in India, China and Indonesia have in the past stood up to perceived injustices and urban problems associated with unfettered development. There are literally hundreds of protests per year all over China in urban centres where communities have objected strongly to actions taken in respect of land acquisition, relocation, land compensation. Protests about environmental disasters and degradation will add to these.

Urban Fiscal Regimes are Unsustainable

Sale of land and property are a major source of funding for many municipal authorities. They are encouraged to keep the property merry-go-round turning. It incentivises the creation of property bubbles in the short term. Without it, the necessary infrastructure to fuel growth and population increases cannot be paid for. This fiscal arrangement is probably unsustainable in the long term. National governments and municipal authorities will need to implement other forms of revenue generation that do not depend so much on land sales alone.

Bubbles Impact Affordability and End Badly

Affordability runs the risk of getting out of whack from time to time as housing prices surge. This can act as a significant brake on housing markets leading to declines in values and slowdown in construction. Systemic risks to local banking regimes will be the result. It is liquidity that is likely to be the main driver of prices and affordability. Unfettered availability of funding for property purchase typically drives prices and produces substantially poorer affordability. Such situations inevitably end badly. The seeds of such an outcome are in place in China right now, less so in other markets.

Structural Shift in Urban Employment to Office Based Uses

The “Servicification” of Asian economies will continue driving a secular shift of urban employment from manufacturing to services. Office based employees account for less than 10% of total jobs in most major developing Asian cities. This will rise towards 15% in the coming ten years in large capital and financial cities, driving a massive increase in demand for commercial real estate in the major cities of the order of 230 million sq m (2.5 billion sq ft) over this timeframe. Institutional ownership of commercial real estate is low. This will increase but slowly, with pension funds and insurance companies increasing their exposure to rent producing real estate assets as pension and insurance industries grow.

REIT Industry will Flourish from Real Estate Based Financial Crises

There will be at least one round of real estate generated financial crisis in the banking sector of Asia’s largest countries in the coming decade – China and India and Indonesia in particular. This will lead to the development of a large REIT industry. REITs elsewhere have tended to surge in number, size and complexity in the wake of large scale real estate loan defaults. REITs provide the ability for owners of distressed real estate to access another source of funding – the retail investor, pension funds and insurance companies, who typically like yield producing investments. REITs fill this bill.

Much of Asia’s recently constructed commercial real estate is of poor quality and will prove to be inadequate to meet the demands of increasingly sophisticated users.

Much of this stock will start to be torn down before the end of the decade, particularly buildings in core, prime locations. High quality grade “A” space will enjoy much lower vacancy rates than poorer quality stock.

Property yields in some Asian markets have moved in ways that are unsustainable – prices rising at a time when rentals are flat or falling. A more “rational” market is likely to develop where capital values more closely reflect rental movements and cost of capital.

Asia’s Listed Real Estate Universe will Dwarf that of US/Europe

Asia already hosts the largest listed property company in the world by market capitalization – Hong Kong listed Sun Hung Kai Properties (0016.HK). The listed property company universe, including REITs, will expand by hundreds of companies in the coming decade, with the listed property sector in China and potentially India dwarfing those of major markets such as the US and Europe in both numbers of companies and market capitalisation.

Sun Hung Kai’s position as global #1 will be challenged probably by more than one China property company. The listed sector will likely still be dominated by developer companies, making up around 60% of the listed universe, with total market capitalization of property and related companies approaching US$2 trillion 10 years from now.

A key risk to the listed sector is the temptation of companies to gear up balance sheets too much in order to take advantage of the massive growth in development of housing and commercial real estate. Many listed companies now already carry debt/equity ratios of 80% plus, a level that will likely prove vulnerable if rates rise and property markets face the inevitable slowdown in sales and/or prices. Hong Kong’s listed real estate companies could provide a role model for others – average total debt/equity ratios for the sector is 30% – 35%.

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