How worried should investors be about the apparent resurgence of the Cold War between Russia and the West? Was the dramatic slowdown in the Brazilian GDP really just a blip? Is China about to suffer its own subprime crash, and how might a?make-or-break general election in India affect its ?real estate market?
These are crucial questions – not just for international property investors but also for the global economy. It is now 13 years since the BRIC countries were grouped together by Goldman Sachs economist Jim O’Neill, and in that time the emerging economies of Brazil, Russia, India, and China have taken their place among the world’s powerhouses. Since O’Neill’s 2001 report, their combined GDP has grown more than five-fold and their share of global wealth has increased from 8% to nearly 20%. Even a small blip in any one of them can send shockwaves through global markets.
With 40% of the world’s population living on more than a quarter of the world’s land area, the BRIC grouping’s growing prosperity made for an apparently unstoppable real estate boom, barely checked by the global financial crisis. The countries’ demographic momentum and structural undersupply still present opportunities, even though their growth may have slowed in recent years. But are the rewards high enough to make the risks worthwhile – or were the BRIC countries just too good to be true?
Brazil
Erratic. That’s probably a fair description of Brazil’s economic performance over the past five years. In 2012 it was the BRIC that looked the most unstable as GDP growth slowed considerably – from 7.5% in 2010 to 2.7% in 2011 and a mere 0.9% in 2012 – and productivity slipped into negative territory. This has been twinned with an increasingly mixed public perception across the globe fuelled by concerns surrounding the country’s preparation for the FIFA World Cup followed by the Rio Olympic games in 2016. Whether or not Brazil will be ready for either is a question that has been raised consistently amid cost overruns, delays and building collapses in the run-up to the World Cup this summer. Hardly the best advert for a country on the brink of hosting the two biggest sporting events in the world in quick succession.
But on the fiscal side at least, this year has seen Brazil’s fortunes looking up.
In fact, the combination of the country’s own improved economic outlook and the emergence of growing problems in Russia, India and China mean that Brazil might now be the safest investment bet of the four.
International Monetary Fund figures released this year estimate GDP is likely to expand by 2.5% in 2014 and 2015 thanks to strong consumer spending, infrastructure investment and the influence of the growing petroleum industry. And Brazil’s currency and benchmark stock index soared by 0.66% last month.
In the last quarter of 2013 GDP grew at double the rate anyone was anticipating, prompting finance minister Guido Mantega to say: “It was a surprise – even for the government.”
Improved economic outlook has, in turn, boosted confidence in Brazil and foreign investment stands at a healthy 2.2% of GDP, according to the World Bank. This equates to more direct investment than anywhere else in the world bar China and the US. And the prediction is that the country will continue to be a good investment opportunity now for the next 25 years.
“The economic slowdown we have seen in Brazil has been a blip rather than a trend,” says Marcelo Costa Santos, vice president of Cushman & Wakefield South America.
“It has been an adjustment following a period of extreme growth rather than a permanent decline. If you look at the plans for infrastructure and the emerging middle class, we think Brazil will be a good investment option for the next 25 years,” he says.
That is not to say Brazil’s GDP slowdown has not been without repercussions. Quite the opposite. The country’s severe underperformance became the first real indication of the risks attached to basing investment decisions off the back of the BRIC predictions. And despite signs of improvement, warnings that the market is unlikely to spring back as fast as some are anticipating are already rife.
“Productivity growth has slipped into negative territory and Brazil’s labour productivity is one-fifth of that of the US and lower than that of Mexico and Chile,” says Danny Leipziger, professor of international business at George Washington University and a former vice president of the World Bank. “Brazil may not be as well positioned to take advantage of its demographic dividend, – when a rising share of working-age people creates new opportunities for economic growth – as its leaders believe.”
While now on a far clearer upward trajectory, Brazil’s economic performance looks set to be as erratic in the next five years as it has been in the past five years. Investors will have to decide whether the potential benefits outweigh the uncertainty of ploughing funds into such a volatile market.
Russia
In the space of just a few weeks, Russia’s annexation of Crimea has shaken relations with the West to their worst level since the Cold War and threatened to plunge its economy into recession. But the economic news from Russia has been gloomy for some time.
Against a backdrop of falling oil and gas prices, the Russian government has been struggling to refocus the economy away from consumption and towards investment. GDP growth in 2014 had been downgraded last autumn by the IMF and the World Bank, to 3% and 2.2% respectively. Now it is expected to be flat or negative, with the World Bank anticipating a 1.8% contraction and warning of record capital flight by both foreign and domestic investors.
In the less-liquid real estate market, there is plenty of anecdotal evidence of deals put on ice and projects postponed. Hopes for investment volumes in 2014 weren’t optimistic but the crisis has dashed them – in April, JLL revised its forecast from $70bn (£41.7bn) down to just $3.4bn, the lowest since the global financial crisis.
Russia was already a daunting market for investors, and while the limited sanctions imposed by the US and EU have no real impact on business, the uncertainty has hit hard. “It would take a brave investor to go into Russia now,” says Andy Rothery, head of real estate at Deloitte.
Tom Mundy, head of research at JLL, Russia and CIS, agrees. “So much trust has been lost,” he says. “Events in the Ukraine have been good for Vladimir Putin’s popularity ratings, but not very good for the economy or for perceptions of Russia in the eyes of investors.” Even with an immediate resolution, recovery will take months.
Confidence aside, conflict makes it difficult to do business on a purely technical level, says Denis Sokolov, head of research at Cushman & Wakefield in Moscow. “It increases the time taken to make decisions on transactions, because making sure that all activities are in compliance with the regulations takes time and business models have to be adjusted to the changed risk profile.”
And what if there isn’t a swift resolution? Any extension of sanctions beyond president Putin’s immediate circle could make it very difficult for Western companies to do any business in Russia at all.
“There’s a lot of Russian state participation in various businesses, including real estate,” says Sergei Ostrovsky, head of the Russia and CIS group at law firm Ashurst. “Many have quite diversified businesses, so if there is an extension of sanctions, it could be very difficult.” Equally, oligarchs own swathes of the Russian economy and have their fingers in many pies.
The irony is that, while relations between the West and Russia are at their lowest point since Perestroika, commercially they have never been so united. Most of Russia’s exports go no further than the EU, and EU countries are heavily reliant on Russian energy.
“Economic sanctions would be catastrophic,” says Ben Aris, the Moscow-based editor-in-chief of Business New Europe.?“It would be mutually assured economic destruction.”
Russia itself is unlikely to do anything to drive foreign investors away. The Kremlin has stated that Western companies and investors are welcome, Aris adds.
He believes Russia remains an attractive market for Western corporates, with ?many not only remaining but expanding. Foreign capital ?had been accounting for an increasing proportion of the real estate market, to reach 30% by the end of 2013, with investors such as Morgan Stanley, CalPERS and Hines making a long-term commitment to Russian property.
This market share is expected to drop as the costs of compliance for foreign companies rise, but established investors in Russia will have already factored in some element of risk, Sokolov says. “Change in Russian politics was expected and has been priced in since mid-2013, reflected in relatively high cap rates. That is why we do not see any changes so far in property values. What we see now is a reconciliation and adaptation of business models to the new economic realm.”
With growth predicted to be below 2% during 2014-16, the real damage is to Russia’s reputation as a land of business opportunity. “Slow growth and lower returns, along with high risks, do not make the market very attractive,” Sokolov says. On the other hand, it will be fuelled by repatriation of capital by Russian companies and he expects a full recovery in 2015.
In the longer term, Russia still presents opportunities, believes Damian Harrington, head of research for eastern Europe at Colliers, because there is a structural under-supply of modern offices, shopping centres and logistics facilities, which won’t reach Western levels for another 20 years. “Russia remains a good long-term play,” he says. “But it remains to be seen how things pan out over the next few weeks or months.”
What would make investors run is any escalation of the conflict with the West. For now, it looks as though Putin has stepped back from the brink, but the threat of conflict remains, with the planned election in Ukraine in May.
Neil Blake, head of UK and EMEA research at CBRE, believes prospects depend on the complexion of the government that is elected. “A government open to devolving powers to eastern Ukraine would substantially diffuse the situation,” he says. “Any overt Russian military move into eastern Ukraine would kill the market off.”
India
The world’s largest election is currently under way in the world’s biggest democracy, and the results are expected to be game-changing for both India and for would-be property investors. Though the country’s economic potential is undeniable, it remains an uncomfortably restricted and opaque market for foreign investors, which have so far held back. In 2013, their share of Indian real estate was just 6%, or $22bn (£13bn), down from 9% the year before, according to Knight Frank.
Frustrated by the ruling Congress Party’s poor management of the economy, India’s 815m voters are expected to turn to the opposition Bharatiya Janata Party. BJP prime ministerial candidate Narendra Modi has promised to focus on urbanisation, infrastructure and removing red tape and has campaigned on his strong economic record as chief minister of the state of Gujarat. According to the polls, the question is not whether the BJP will win, but by how much – and whether it will secure enough of a majority to break India’s long run of coalition governments.
“This election is going to have a make-or-break impact on not just real estate but the general economy,” says Sanjay Verma, chief executive of Cushman & Wakefield’s Asia-Pacific business. If the opposition wins a clear mandate or enough seats to form a government, he believes it will be positive. “A hung parliament would put the country back for a couple of years,” he says.
Dr Samantak Das, chief economist and director at Knight Frank India, believes the current general election is the most important in the history of Indian politics, and one that will have a tremendous bearing on the real estate market.
“The current government has failed to deliver with regard to the transparency of the real estate market and in bringing in several important reforms,” he says. “An opposition victory would definitely have a positive impact. It would be more investor- and foreign-investor-friendly and more proactive in implementing big infrastructure projects. That is the key in the Indian economy right now.” The stock market has already rallied in anticipation of a BJP government, Das notes.
In particular, there are two pieces of crucial legislation stuck in the sidings, awaiting final notification. One would create a regulator for the real estate sector, comparable to those that have already improved transparency in banking, insurance and telecoms; the other would introduce REITs. Congress has dragged its feet, but both bills could be enacted very quickly by a new government.
It is generally expected that rental and capital values will rise after the election, particularly in the micro-markets that will benefit from new infrastructure projects, says Rohit Kumar, head of India research at DTZ. This expectation has led to pre-election spikes in demand for residential in pockets of major cities. Commercial occupiers also hurried to complete their real estate strategies in 2013.
For now, commercial and residential property markets are largely at a standstill, as domestic and foreign investors wait for the outcome.
Even if the BJP does not form the new government, India is likely to become a more attractive market, says Kumar. “If any other party forms the new government, it will most likely try to build attractive policies for foreign investors, ?as that will help to provide the impetus for economic growth.”
Whatever happens at the polls, India’s long-term potential remains. “The biggest strength is that this is a consumption-driven economy,” says Verma. “There are one billion people who need jobs, services and somewhere to live. No one can take that away. The worst-case scenario is that it bumps around and ?then there’s another election in two years and the government gets its act together then.”
China
Zhejiang Xingrun Real Estate, a regional residential developer in the lower-tier city of Fenghua in Zheijang province, isn’t the kind of property firm that usually makes global headlines. But the news that it was unable to repay debts of 3.5bn yuan (£340m) has raised fears that China is on the verge of a US-subprime-style meltdown, gripping the attention of investors worldwide.
But property analysts in the region believe that warnings of a Chinese property crash are heavily exaggerated. Real estate in China is tightly regulated by the government, which has implemented a range of measures to cool its overheating market and stem spiralling personal and corporate debt. Further insolvencies are inevitable as consolidation takes place among China’s more than 50,000 property developers, but this will present growth opportunities for larger players. In any case, the government has no interest in seeing its biggest property companies fail.
“Regulation is key,” says Richard Divall, head of cross-border capital markets at Colliers International. “China is so cash-rich, with federal reserves of $3.3tn, that the government could just pay the debt off if it wanted to.”
James Shepherd, head of research for greater China at Cushman & Wakefield, says the market has been calmed by the huge number of successful regulations that are in place. ?“If the market slowed to any significant extent, it would be very easy for the government to stimulate demand,” he adds.
It acted in exactly this way when the Shanghai office market suffered after the financial crisis, relaxing the usually strict deadlines governing project starts. “They are extremely flexible and prepared to take action when required,” Shepherd says.
Andrew Ness, head of North Asia research at DTZ in Hong Kong, agrees that China is nowhere near to a crash: “There is going to be a progressive shake-out as liquidity tightens and a number of small-time developers are going to go belly up, but that doesn’t mean the whole thing goes down the tubes.”
Much of the panic has centred on reports of an oversupply of housing, creating “ghost towns” in tier three and four cities. Ness believes this too is exaggerated. According to the SouFun-CREIS 100 Cities Index, the price of new homes has continued to grow – by 10% in the year to March. The pace of growth did decelerate for the third consecutive month, but only 12 cities out of the 100 recorded a fall.
“Even in cities that are suffering from some degree of oversupply, it’s down to specific local factors and individual market segments, so it is concentrated on some districts or one development that’s not very well pitched,” Ness says.
Not everyone is worried. In March, the Canadian Pension Plan Investment Board announced it would invest $250m through a venture with China’s largest residential developer, China Vanke.
At a strategic level, the fundamentals of the Chinese market remain very positive. It has more than 100 cities with populations greater than 1m, and Shanghai and Beijing top 23m and 20m residents respectively. “I don’t see any oversupply problems in downtown areas in tier one cities,” says Thomas Lam, head of research and consultancy for Greater China at Knight Frank.
Lam is more wary about commercial development, with a glut of office space expected over the next three years. But he says that the greater problem for foreign investors is the lack of good-quality assets at affordable prices. Since the 2008 crisis, which hit developers’ cashflows, the government has encouraged them towards income-producing commercial and mixed-use projects. “But many local developers don’t have the skillset or experience to manage such schemes,” he says. Competition has pushed up the price of the best-performing properties, driving yields down to 2-3%, he adds.
In the longer term, the commercial real estate sector looks sound. Prudential Real Estate Investors is predicting the sector will grow from $2.5tn today to $10tn by 2021, putting it on a par with the US.
“As the Chinese middle class continues to grow, saving models will become more sophisticated,” says Andy Rothery, head of real estate at Deloitte. “The financialisation of the market will mean there’s more capital going into banks and insurance companies and some of that will find its way into property.”
Meanwhile, in January the government lifted a four-year suspension of the issue of new share capital on the two mainland Chinese stock exchanges, a move that will give larger developers greater access to funding. Smaller ones remain at the mercy of the shadow banking system and its high interest rates.
“If I were in a business relationship with that kind of private, unlisted player, I might be concerned about their financial stability,” Ness says. “But there would have to be a catastrophic event in the Chinese economy before the government would permit any of its real estate giants to fail.”
