by Gregory J. Karns
turmoil in Asia has had a broad and dramatic effect on all economic
sectors, but perhaps most severely on real estate. Although Asian
governments were quick to enact laws and programs designed to spur
foreign investment, Asian real estate values continued to fall.
The severe capital crisis, exacerbated by a dizzying level of short-term,
dollar-based debt, has led to an extraordinary number of defaults
and bankruptcies, even among some of Asia's largest and most respected
companies. Many of these companies tried to sell their real estate
to raise desperately needed capital, and yet, more than two years
after the outbreak of "contagion," almost no real estate transactions
have been completed.
lack of activity in the Asian real estate market could be traced
to an unwillingness to accept the circumstances. This almost universal
denial is understandable, given the prior 30 to 40 years of unprecedented
success. For example, Korea's annual growth rate of 6.6 percent,
sustained over the last 40 years, makes it one of the best performing
emerging markets in the world. Similar accomplishments abound in
the region. It is not surprising then that Asian nations did not
immediately abandon decades of proven business techniques at the
outbreak of the crisis. However, even now that the problems are
more fully recognized, real estate transactions still are not occurring.
One major impediment
to "transactioning" stems from the general lack of reliable data
concerning Asian real estate assets. Surprisingly, this has less
to do with so-called "market transparency" (the current buzzword
in Asian circles), and more to do with the consequence of what could
be called a "market vacuum." The problem is a veritable paucity
of real estate transactions in any major Asian commercial district
during the decades preceding the crisis. In a culture where land
represents power and wealth, the disposition of real estate assets
could be considered a sign of weakness. The few transactions which
did occur often were not arms' length, and so not useful as an indicator
of value. Over the years, this lack of reliable market data fostered
and nurtured largely speculative assumptions of value, and in the
Asian market vacuum, with speculation serving as the basis for valuation,
prices always increased.
apparent obstacle lies at the heart of Asian real estate finance
principles. For many years, Asian banks lent freely to businesses
using real estate as collateral, and then lent again (and again)
against its expected increase in value. Over time, the amount of
this "real estate" debt far exceeded any income-based valuation
of the real estate collateral. In essence, Asian banks were loaning
on real estate, but with an eye on the owner's corporate earnings.
In a lending arena where speculative real estate values, and not
the actual income generated by the real estate, secured debt, the
speculators could continue to push Asian real estate values higher
and provide a basis for additional lending, so long as Asia economy
continued to expand and Asia's corporate earnings continued to grow.
Thus, it is appropriate
that the miracle economies of Asia were referred to as "bubbles."
Quite simply, once corporate liquidity shifted and currencies fell,
corporate earnings dropped. As a consequence, speculation could
no longer fuel the real estate markets, the banks stopped lending
and the bubbles burst.
One might assume
that in the Asian real estate market foreclosures would be rampant,
producing significant buying opportunities for investors with cash.
However, before Western investors pack their bags, they should know
that despite a broad liberalization of laws governing foreclosure,
in many parts of Asia, foreclosure has been difficult and sometimes
impossible to accomplish. Again, an understanding of the dilemma
provides a clue to the problem. Given that most Asian banks loaned
on real estate without any expectation that it could support the
debt it collateralized, they have been unwilling to write down their
loans (which the banks always underwrote on the basis of corporate
earnings) to match the deflated value of the real estate. For foreign
investors utilizing income-based approaches to valuation in an environment
focused upon land premiums, the challenge is to structure a deal
which makes (enough) economic sense to the investor without causing
too great of an economic (indeed, even cultural) upheaval for Asian
key events are now occurring in Asia that should improve the odds.
First and foremost, one must recognize the relatively short supply
of institutional grade real estate assets in Asia. The lack of investment
grade assets, coupled with the general improvement in Asian economies
over the last year, should provide encouragement for investors to
pursue these top quality buildings, even at what is still perceived
to be a premium over the prevailing market. From the seller's standpoint,
the stabilization of most Asian currencies should improve investors'
offers, which often included a pricing hedge against currency volatility.
From the buyer's standpoint, several key bank mergers which have
been completed or are in the process of completion should bring
about more significant write downs of non-performing assets, which
in turn will generate a wave of buying activity. Of course, the
competitive advantage will belong to investors who understand and
can be sensitive to the issues facing Asian property owners, and
who can come up with more creative structures to soften the valuation
and other hurdles which they face.
key to sustained and comprehensive recovery remains a continued
commitment to market liberalization and institutional reform. When
the Asian crisis peaked in 1998, government and business leaders
stood in agreement on the need for fundamental economic and political
reforms to spur recovery and withstand future downturns. However,
as Asian nations grow stronger and move away from their economic
precipice, some government and business leaders now believe that
they have little to gain and much to lose from radical change. More
than just a temporary repricing of assets, the challenge for Asia
will be to find a way to carry through with the economic, political
and social reforms needed to propel the Asian miracle into the 21st
once wisely observed, the movement towards (new) order cannot be
achieved without some chaos. And as every good real estate investor
knows, out of chaos comes real opportunity.