Nowhere has the global appetite for Asian property been more evident than in China.
While there is a plethora of wildly varying statistics on the exact amount of foreign investment into Mainland China real estate, the one thing all sources agree on is that the trend has been up in a big way. One organisation, DTZ, a global real estate advisor, found that during the first quarter of 2006, US$4.6bn foreign investment was utilised in purchasing properties in China, exceeding the US$3.4bn total of last year.
China's National Bureau of Statistics claims that total investment in property in China from all sources increased by a whopping 19.8% year-on-year in 2005.
Predictably, the result of such rampant increases in real estate investment has seen rapidly increasing prices this year, particularly in urban centers such as Beijing, Shanghai and Shenzhen. Rises have been recorded at between 5% and 12% year-on-year. In parallel have come rising central government fears of a fast-overheating real estate bubble.
"In the past, the restrictions for foreign investment in the real estate sector have been relatively looser than for other sectors," says Xuebing Zhang of mainland law firm Zhong Lun. "Also, the rate of return is significantly satisfying for investors. These are good enough reasons to make the industry favoured by foreign investors," Zhang comments.
However, thanks to the influx of investment, all mainland firms' practices in real estate have been flourishing in line with their clients' investments in the market.
"Since last year, many large overseas funds have entered the domestic real estate market," says Jincheng & Tongda partner Guozhong Shao. "Not only are they buying lots of completed buildings, but also, they are queuing for some new projects that are still under construction or not completed due to the developers' financial problems."
Zhang says there are increasing numbers of foreign investors acquiring shares in domestic real estate projects, and that the firm has seen more real estate and private equity funds from the US and Europe tap into the mainland market in the last year.
US investors in funds have definitely been lured by high return rates in China, with some funds returning between 20-30% compared with domestic fund returns of about 6%. By the end of 2005, some 100 managed funds from overseas had invested in the real estate market with a total value of US$15bn, according a report by Sunref Real Estate.
Another reason for the pursuit of mainland property by foreign investors is the appreciation of the renminbi (RMB). Since the end of last year there has been large-scale overseas buying of real estate, due to the anticipated revaluation of the RMB. Buying activities have hiked since the exchange rate was adjusted recently.
Lei Jie law office partner Lei Ge says "low risk with high potential of appreciation to buy RMB assets, especially real estate projects, with foreign currencies, is one of the reasons why foreign-funded banks favour high-grade buildings."
However, the house warming party for foreign investors has been cooled somewhat. Concerned about the overheating property market, in July the central government introduced a string of policies to strengthen the supervision of overseas investment in real estate.
As a result, institutions can now only invest in Chinese real estate through mainland incorporated enterprises. Investors with a total investment of more than $10 million must now have at least half of that registered as capital in a mainland enterprise.
This has stymied international property investment for the moment, as investors - who typically invest through companies incorporated offshore - are forced to reassess their investment strategies and structures to abide by these new regulations. For example, the structure used by the much-publicized GZI REIT - which saw investments in mainland properties listed in Hong Kong - could not be used under the current regime.
However, no one doubts that mainland property is a long-term proposition for most investors, and that the regulations will not stop the long-term flow of investment.
Not just China
The interest of foreign investors in Asia is definitely not limited to Mainland China. Baker & McKenzie partner Angela Lee, head of real estate for the firm in Asia, says there has been a definite "sea change" in the type of investors interested in the market regionally. She says that four or five years ago, domestic investors dominated, but since then a wave of international players has come into the region.
The rapid growth in interest globally has led to the accelerated construction of products which took a much longer time to develop elsewhere - namely REITs. Originating in Australia and the US more than 20 years ago, REITs have gained popularity in Asia, particularly in Hong Kong, Japan and Singapore, and have the potential to be a continuing real estate growth story as the market continues to mature.
Land of the rising REIT
Japan can claim the title of the most developed REIT market in the Asia-Pacific region (behind Australia). At present, there are 39 REIT products listed in the country.
All have been listed in the six years since 2000, when regulatory changes were made to permit the construction of REITS. These changes came in tandem with amendments in the same year to laws dealing with asset liquidation and another set of land lease laws that stimulated investor confidence in the real estate sector.
The result has been a booming market. Data from the Japanese Association of Real Estate Securitisation shows that real estate securitisation in Japan was valued at $US15.6bn in 2000, and has more than tripled since to $US57.8bn.
Nagashima Ohno & Tsunematsu real estate partner Utsumi Kenji says the type of assets being securitised has diversified greatly beyond a traditional emphasis on office assets, toward an array of other types of real estate, due to greater understanding of the sector.
The metamorphosis of the market since 2000 has also meant a lot more legal work for law firms. Real estate transactions prior to 2000 were often made without the help of lawyers, with a short purchase and sale agreement being the legal currency of the time.
In the year 2000, Nagashima Ohno & Tsunematsu had only two or three real estate attorneys in total, and now the firm has five real estate partners and 30-40 attorneys who regularly work on these sorts of deals either full or part-time.
With so many REITS (or JREITS as they are referred to in Japan) having been listed over the past six years, much of the legal work being done now is follow-on REIT-related work, either to do with new property acquisitions or public offers. Utsumi says he expects the volume of work to increase from this area for the next three or four years at least.
The Japanese economic recovery is also playing its part. Although foreign investors had a field day during the early years of the millennium, as banks sold off assets at bargain basement prices to recover bad loans, domestic investors are now thriving in the market.
The Asian REIT market
Although not quite as well developed as Japan, the rest of Asia has also seen its fair share of REITs, with the most talked about markets being of course Hong Kong and Singapore.
Hong Kong blew onto the REIT scene in the final quarter of 2005 with the much-publicised Link REIT, the world's biggest IPO of a property trust at almost US$2.8bn.
The Prosperity REIT, investing in Hong Kong commercial property, and GZI REIT, the first China property trust investing in office buildings, followed quickly after Link.
However, initial exuberance in the market has been tempered, although a fourth REIT, the Champion REIT - the first to have a single prime office building in the central business district of Hong Kong - was launched in the second quarter of 2006.
Baker & McKenzie corporate partner Milton Cheng says the firm, involved in all four REITs to date in Hong Kong, had been working on five or six other serious HK-REIT projects, with some of them up to almost the point of launch, but many have been suspended for the time being.
Part of the reason for this stall in new REITS has been concern about the expected gains available - after the overvalued Champion REIT dropped 25% - as well as some concerns over the financial engineering of the Champion REIT product.
Another reason has been the comparative attraction of Singapore. In actual fact, the first REIT to include Hong Kong assets of any kind was Singapore's Fortune REIT in 2003.
Baker & McKenzie's Angela Lee says some REITs that could have listed in Hong Kong have been choosing Singapore, to take advantage of more flexible seed legislation.
Although Hong Kong has the advantage of being a deeper financial market than Singapore, with products being more actively traded, Lee says that if parties are facing too many regulatory hurdles they will have no choice but to go to Singapore. There are now 13 REITS in Singapore, with six listed this year alone, while Hong Kong still sits at only four. The Securities and Futures Commission (SFC) in Hong Kong has flagged a review of its regulations, although commentators are unsure about how long it will take for this to bear fruit.
Drew & Napier director Petrus Huang predicts the popularity of the REIT market in Singapore will continue. He says property developers are increasingly realising the economic arguments for them to put their expertise and capital to use in the development of land, and let investors do the holding of already developed property.
While much hype surrounds Singapore and Hong Kong's recent spurt of REITs, the products are not foreign to the rest of Asia. Malaysia's property trust framework was established back in the 1980s, and new guidelines stimulated the market, resulting in the Axis REIT of August 2005, the first under these guidelines. In Thailand, there have been several REIT-like vehicles listed on the Stock Exchange of Thailand (SET), while Taiwan saw its first REIT, Fubon No.1, listed in March 2005. South Korea has also tried to invigorate its REIT market with legislation changes.
Still in its early stages of development, the REIT market in Asia is sure to continue to blossom as demand for property increases and development continues apace.
In general, there is a great expectation and optimism in the property market in Asia, Huang says, with a continued belief in capital appreciation.
"Investors in Asia believe in property, he says. "The perception is that property will appreciate rapidly in value, as land is finite, and demand keeps growing."
FIRM PROFILE: The Japanese Financial Instruments and Exchange Law: Possible impact on business registrations for private real estate funds in Japan
Koki Ohira, a partner at Atsumi & Partners, examines the possible impact of the new Japanese Financial Instruments and Exchange Law on private real estate funds, with particular emphasis on business registrations for TK operators and asset managers.
With the passage on June 7, 2006, and later promulgation on June 14, 2006, of the Law for Partial Amendment of the Securities and Exchange Law and Other Related Laws (Law No. 65, 2006), the Japanese Securities and Exchange Law (the 'Securities Law') will soon be reconstituted as the Financial Instruments and Exchange Law (the 'Financial Instruments Law'). By its terms, the new law must take effect within one and a half years after the promulgation date, and there is speculation that the law may come into effect as early as summer, 2007. Some amendments must take effect before the implementation of the law as a whole, and the amendments which address criminal penalties became effective on July 4, 2006.
The following four points summarise the most significant changes:
(1) Expansion of the number of regulated products and services through changes in the definition of what constitutes a security; expansion of the range of businesses to be handled by licensed traders; and more flexible structure concerning the regulations corresponding to the attributes of investors and types of business;
(2) Implementation of a quarterly disclosure system; the strengthening of internal controls related to financial reports;, and revision of the tender offer system and large holding disclosure system;
(3) Provisions affecting operation of self-regulation in exchanges; and
(4) Increasing criminal penalties for securities violations.
In a typical private real estate fund, an originator entrusts real property to a trust bank and assigns the beneficial interest to a special purpose vehicle (an 'SPC') in the form of a newly-established Japanese limited liability company (a godo kaisha, or 'LLC') or an existing limited company (a yugen kaisha). It is common to procure financing for the SPC through non-recourse loans and silent participations through 'TK investments' by individual and corporate investors. (A TK agreement is an investment agreement under which one party - the 'TK Investor' - invests in the business of the other party - the 'TK Operator' of the business - and receives a distribution of profits from such business, but does not have any right to participate in management of the business.).
In most cases, the asset management services provided to the SPC - including advising on the acquisition of the beneficial interest, exercise of the beneficiary's right to instruct the trustee, and advising on the sale of the beneficial interest - are conducted by an asset manager.
The Securities Law was amended in December 2004 such that a TK investment is now considered to be a security, with certain exceptions. Thus, even before the recent amendments, an offering of TK investments required compliance with the Securities Law. However, the solicitation of TK investors by the TK operator, namely the SPC itself (so-called 'self-solicitation'), has not been regulated.
Under the Financial Instruments Law, the TK operator might need to obtain a licence to conduct 'Second type Financial Instruments Exchange Business' (Dai-2-shu Kinyu Shohin Torihiki Gyo), if it offers TK interests to prospective TK investors. In such cases, the SPC must register with the Prime Minister and will be subject to regulations affecting internal operations such as personnel and minimum capital requirements. However, it may be practically impossible for an SPC, which is required to be a bankruptcy-remote vehicle, to satisfy such regulations.
With respect to this point, an official in charge of the amended laws published his opinion that if third parties other than the issuer of the securities in fact conduct all substantial activities for solicitation, and the issuer does not conduct substantial activities, it is understood that the issuer will not be considered to be involved in solicitation activities requiring such license. Since in many cases, solicitation of TK investors has been consigned by an SPC to a securities company, the impact of the amended regulations on this practice should be minimal.
Under the Securities Law, beneficial trust interests have been deemed securities only when (i) the trust is created by using certain laws established for particular investment purposes; or (ii) specific categories of assets are entrusted. Under this system, beneficial trust interests issued by trustees holding real estate as trust property have not been considered to be securities.
However, under the Financial Instruments Law, beneficial trust interests, including beneficial interests in trusts which hold real estate, are generally considered to be securities. Consequentially, an SPC acting as the TK operator which holds beneficial interests in real estate trusts are at risk to face new regulation.
Under a TK agreement, a TK operator manages capital received from TK investors. In the past, a licence to conduct discretionary investment business (Toshi Ichinin Gyo) has not been required of the TK operator for the management of such capital, even though in theory, the TK operator has "discretion" to manage the "investment" of funds contributed by a third party. Under the Financial Instruments Law, the management of money received from TK investors is considered to be 'investment management business' if such money is invested mainly in securities (including trust beneficial interests) or rights related to derivatives transactions, based on investment decisions made by the TK operator after analysis of prices and other factors. Therefore, an SPC in a private real estate fund acting as the TK operator which purchases beneficial trust interests in a real estate trust - ie, which purchases securities - might be required to register to conduct 'investment management business'.
In such a case, the SPC will be subject to regulations requiring, for example, the establishment of a board of directors, hiring of personnel with expertise in this business, minimum capital, net worth, limitations on subsidiary business and qualifications of major shareholders. Of course, it will not be easy for an SPC in a private fund context to satisfy such requirements.
Notwithstanding the above, if the TK investors consist of only (1) persons of a type designated by Cabinet Order (not yet available), who are not 'qualified institutional investors' (Tekikaku Kikan Toshika) and are fewer than the number provided by Cabinet Order (not yet available); and/or (2) 'qualified institutional investors' - such investors in (1) and (2) being collectively referred to as 'qualified institutional investors, etc' (Tekikaku Kikan Toshika Toh) - not falling within any category under (a) to (c) below, then the TK operator will not be required to register to conduct 'investment management business' and will only be required to submit notification to the effect that it is conducting investment management business only for 'qualified institutional investors, etc, referred to as 'exceptional business for qualified institutional investors, etc' (Tekikaku Kikan Toshika Toh Tokurei Gyomu).
(a) Specified purpose company (Tokutei Mokuteki Kaisha) under the Law Concerning Securitisation of Assets whose asset-backed securities are acquired by persons other than qualified institutional investors;
(b) a TK operator entering into a TK agreement with an investor who does not qualify as a qualified institutional investor; or
(c) persons similar to (a) or (b) and designated by Cabinet Order (not yet available)
The exact definitions of 'qualified institutional investors' and 'qualified institutional investors, etc' will have to be established by future Cabinet Orders. However, in light of the fact that TK investors in private real estate funds generally are only a limited number of corporate investors, it is likely that there will be many cases wherein only notification for the conduct of 'exceptional business for qualified institutional investors, etc' will be needed. A question remains in this regard, as to how an SPC can effectively confirm whether its TK investors will not fall under the above (a) to (c). Perhaps the SPC may only be able to remedy this situation by amending its TK agreement standard form to include representations by TK investors to the effect that they do not fall under the above (a) to (c).
In addition, given that the SPC typically consigns the management of its investment to an asset manager - with the same line of reasoning as to solicitation, it may be understood that the SPC is not performing activities constituting investment management business, and therefore business registration for investment management business as well as notification for the 'exceptional business for qualified institutional investors, etc' might be unnecessary. It will be necessary to monitor future cabinet orders and guidelines concerning these issues.
To date, no regulations have been promulgated regarding asset management business conducted on behalf of private real estate funds, since beneficial interests in real estate trusts were not deemed to be securities until now. However, under the Financial Instruments Law, asset management business will most likely be considered to be investment management business since real estate beneficial trust interests are deemed to be securities. Therefore, registration may be necessary for asset managers to whom the SPC consigns its asset management activities.
However, if all of the TK investors of the SPC are qualified institutional investors, etc not falling under the above (a) to (c), the asset management activities by the asset manager of the SPC might not require investment management business registration and will only be required to submit notification of the conduct of 'exceptional business for qualified institutional investors, etc'. Again, future cabinet orders and guidelines should be monitored.
Koki Ohira, Partner
Atsumi & Partners
k.ohira@apap.gr.jp
+81(3) 5501 2383
FIRM PROFILE: Land Ahoy!
In investment terms, 'a sure thing' doesn't exist. The grandiose claims of certain 'consultants' notwithstanding, any broker or financial advisor worth his salt will tell you about the ideal scenario of maximising profits while minimising risk. All sound investments, they should go on to say, will contain a relationship between the two that satisfies the customer's investment profile, not to mention his personality.
With more financial instruments and investment possibilities currently available to individuals than ever before, finding the right option has become ever more baffling and, occasionally, treacherous. It really is a jungle out there, but in hunting your prey, to spin out the analogy, it's useful to know what risks you are prepared to take and whether or not, ultimately, the reward will be worthwhile.
Spinning a little more, ask yourself whether you are a cheetah out on the savannah looking for a nice juicy gazelle that won't be easy to catch, or whether you're a relatively slothful lioness who'll be content to take the hindmost buffalo. Not the most difficult hunt perhaps in the latter scenario, but not exceptionally palatable either when it's time to dine.
Somewhere between the two is, most likely, what we would opt for given the choice, and more and more people are choosing to invest in land for all the conceptual qualities it possesses. Land is solid, land is tangible, and while proponents of this sort of investment will point to the fact that it is a reasonably safe bet, the true cognoscenti will aver that 'betting' doesn't even enter into the debate.
Buying land has previously been the domain of the super-rich; and the property developers of course, but in many parts of the world these two often find themselves either rubbing shoulders at cocktail parties or staring at one another in the mirror. With the advent of Strategic Land Investment or 'Land Banking', if you prefer, this is no longer the case.
What is Land Banking? First and foremost, it's a natty little investment vehicle that enables individual investors to climb aboard the 'gravy train' that canny businessmen have been travelling on and pulling into to the central station at 'Wealth City' for generations.
Mark Twain, ever the succinct wit, observed that buying land is never going to be a bad move since 'they don't make it any more'. In terms of the basic economic principles of supply and demand, it's difficult to refute his logic, but even he couldn't have foreseen the extent to which land would become such a valuable commodity, especially in certain parts of the world.
Land Banking works along a very simple concept. Companies, such as Jardine Smith International, source land, and then divide it up into smaller plots, making them available to individual investors. By pooling resources, so to speak, substantial quantities of land can be purchased - the kind of land that is very attractive to developers, who can make vast sums of money from development projects and are prepared to pay handsomely for the land that will enable those projects to happen.
We're not talking about any land here, although historically it's been a solid investment. Land Bankers have understood the need to identify areas with growth potential, in countries where purchase is possible and the investment is safe.
Believe it or not, the United Kingdom is now one of the safest and easiest places to buy land, particularly in certain parts of England. Many areas of the country are suffering from an acute shortage of housing - just try buying a property in or around London and you'll notice the dent it can make in your net worth. More houses will need to be built, and there is only a limited amount of land, which is why the government is considering, and being put under increasing pressure to release tracts of territory previously gazetted as 'greenbelt'.
The 'greenbelt' designation was a move made after the Second World War and was intended to protect the countryside from development while encouraging developers to build on areas in cities that had been damaged during the conflict. It served its purpose. But with an increasing population, sooner or later, planning permission on these areas will have to be granted, and the developers are licking their lips in anticipation.
So are individual investors, interestingly enough, who are now being provided with the opportunity of buying land - that has yet to be granted planning permission - through the process of Land Banking. Jardine Smith International is one such company that's getting in on the act, enabling smaller investors in Asia to keep their risks low and their potential rewards very high indeed. The company identifies land that's available and that they feel has the greatest potential for development, and buys it up on behalf of their investors. Jardine Smith then takes care of all the planning permission applications, and waits for the right time to sell it on to developers once that permission has been granted. It really is as simple as that.
While there are no guarantees that planning permission will be granted, the land itself is carefully selected - concentrating on the areas that the authorities have earmarked for development, or have intimated that would be suitable for such projects. There are no guarantees either as to how long it will take to get the necessary planning permission, although in most cases, it should only be a matter of time. But then, as the famous adage goes, 'you don't wait to buy land; you buy land and wait'. The worst-case scenario is that the land will appreciate in value - again, simple 'supply and demand' economics will account for that - but once planning permission is secured, the rewards can be substantial.
It's worth pointing out that London has won the right to stage the 2012 Olympic Games, a fact that is likely to increase the demand and therefore the prices of land in southeast England for example, even more, and as Mr Twain mentioned, it's not as though they're going to be able to make any more of it.
Across the UK, land prices have risen a quite remarkable 808% in the past 20 years, according to the Halifax. The trend looks set to continue and while previously these kinds of investment options were only available to developers and the extremely wealthy, Land Banking now puts all of us in a position to benefit.
It's true, no one can talk about a 'sure thing' in investment circles, but Land Banking may be as close as it gets. If maximising potential profit while minimising risk suits your investment profile, owning a small part of England could be a glamorous and surprisingly practical choice.
For more information:
Contact Jon Purr
Ph: 65 - 6887 5335Z
Email:jonpurr@jardinesmith.com
www.jardinesmith.com