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International Real Estate Markets: Evolution

Introduction

In a market economy, market competition ensures efficient allocation of resources (goods, services, capital and labour) among the various users. Market forces of demand and supply interact to determine the market clearing price of the resources and how they are allocated. Property is both a consumption (use) and an investment good. In the market for the use of property, property resources are allocated to various users that can broadly be divided into households and businesses. Users compete for physical location and space, and competition among them determines who gains the use of space and how much they must bid for its use. Capital for investment in property is allocated in the capital markets. Participants in the capital markets invest in stocks, bonds, mutual funds, private business enterprises, mortgage contracts, property and other assets with the expectation of receiving financial returns on their investments. Investment opportunities that yield the highest returns, considering risk, will attract a flow of capital. Property as an asset competes with a diverse set of investment opportunities to attract investment. Government affects property markets in a number of ways through planning, legal, taxation, subsidy and a host of other regulations. The value of the property is determined through the interaction of three functional divisions: the property use market, financial markets and government. Property values determined in this way become a guide to property developers. When market values exceed the cost of production of new properties, developers are inclined to build, thereby adding to the supply of space and simultaneously to the supply of investible property assets.

This chapter presents an overview of property market activity in an international context. To simplify the presentation, the market activity is discussed in the context of three property submarkets: (i) use market, (ii) investment market and (iii) development. This chapter also presents an overview of the trends in financing property investment. The description in this chapter relies heavily on data information from various research reports published by real estate service providers such as CBRE (various years), Jones Lang LaSalle (various years), RREEF (various years), PwC (various years) and other sources that are individually referenced.

The discussion of the international context is incomplete without discussing the motivation for internationalisation of property markets. Internationalisation of the use market is closely linked with globalisation of economic activities, evidenced through growth of Transnational Corporations (TNCs) and substantial growth in foreign direct investment (FDI) and trade. All these lead to greater demand for space, and this demand shifts across national boundaries. Globalisation has also led to increased capital mobility for investment across countries. Property, as well as being one of the asset classes, is also a recipient of cross-border investment. Bardhan et al. (2008) describe two transmission mechanisms through which globalisation affects property rents and values. They argue that economic openness leads to higher local productivity and output, which increases the demand for non-tradeable goods such as property. Elasticity of supply in property markets is low, which causes rents and values to increase disproportionately. Another argument put forward by these authors is based on the Balassa-Samuelson hypothesis, which states that increasing internationalisation leads to asymmetric increase in productivity of tradeable goods vis-à-vis non-tradeable goods. The impact of higher productivity is that wages in the tradeable sector rise, and assuming that the labour within the economy is mobile between the tradeable and non-tradeable sectors, this raises wages in the entire economy. The relative price of property, a non-tradeable sector, will also rise.

If the markets are opaque, they offer opportunities for excess returns over risk-free rate for investors investing in property. With increasing international financial integration, the opportunity for excess returns will eventually reduce, thereby diminishing arbitrage opportunities, if they exist. Country and currency risk-adjusted returns will equalise across various property markets. Studies have been conducted to explain the forces that drive differences in property returns across countries/regions. Hamelink and Hoesli (2004), in their study on property security returns in 21 countries, find that country, scale and value/growth factors are important in explaining returns. Eichholtz et al. (1998), Eichholtz and Huisman (1999), Ling and Naranjo (2002) and Bond et al. (2003) find that country-specific variables play an important role in determining differences in property returns across countries.

If country-specific variables are an important determinant of property returns, could diversification benefits, in a mixed- or single-asset portfolio context, be achieved through investing in international property? A number of studies have been conducted on the interrelationship between property markets across national boundaries, particularly from the point of view of examining the international property investment diversification potential. Conover et al. (2002) show that foreign property investment provides diversification benefits beyond those obtainable from foreign stocks. Liu and Mei (1998) find that inclusion of international property securities in a portfolio improves risk-adjusted returns, after accounting for currency risk. A similar result was found by Hamelink and Hoesli (2004), who claim that portfolio diversification benefits are created by including property assets in a mixed-asset portfolio. A contrasting view, however, was given by Stevenson (2000), who found that the potential diversification benefits that could arise from investing in property securities are not generally statistically significant.

The research, as presented earlier , is inconclusive at one level but on the other hand raises an important aspect to be explored further - trends in international property investment and investor profile. In addition to market activity, this chapter also presents changing trends in international property investment and investor profile.

Size of property market

Estimating the size of property markets is problematic due to their largely fragmented and private nature. Various researchers have made attempts to estimate the size of the market (see, e.g. ULI and PwC, 2007; Key and Law, 2005; DTZ, 2006/2007). RREEF (2007) estimated that the size of global property market (total1 stock) was around US$26 trillion in December 2006. Due to data limitations, it is difficult to assess the composition of total stock by property type. RREEF (2008) reports the share of various property types with a caveat. Figure 2.1 presents the estimated size of global property market by property type as of 2007.

In markets for which data exists (in the form of a local index prepared by the Investment Property Databank (IPD)), such as the United States or Europe, the majority of investment-grade property is in retail (30-50%, depending on the country) or offices (35-50%, again a function of country). The share of industrial and other property types is small.

Figure 2.1 Size of global property market by property type, 2007.

Source: ING Real Estate (2008), global vision 2008. Reproduced by permission of CBRE.

Of the total stock of nearly US$26 trillion, nearly US$10 trillion (invested stock) was owned by professional property investors such as funds, property managers, private investment vehicles, listed companies, and institutions. The rest was owner-occupied, termed investible because it may over time become owned by institutions. Most of the invested stock is located in the matured markets of America and Europe. Of the total stock of US$9.5 trillion in America, nearly US$4.7 trillion is already invested (RREEF, 2007). In Europe, US$3.2 trillion worth of stock out of a total of US$9.2 trillion is already invested (RREEF, 2007). Asia has the smallest proportion of the total stock that is invested. Of the total US$5.9 trillion worth of property, only US$1.9 trillion worth of stock is invested. The size of the ten largest property markets is presented in Figure 2.2.

The United States dominates the global invested property market with a share of 48% of the total. Europe and Asia follow the United States, with a share of 33% and 19%, respectively. Within Europe, the Western countries dominate, with the four largest markets of Germany, the United Kingdom, France and Italy representing nearly 70% of the total. In Asia-Pacific, the more mature economies of Japan, Australia, Hong Kong and Singapore account for 80% of the total (RREEF, 2007).

Emerging markets in Europe and Asia have a small, but the fastest growing, share in invested property. Central and Eastern Europe accounts for 5% of the value of the European property stock. In Asia, China and India have grown dramatically in recent years, and their invested stock represents around 10% of the regional total.

Besides the differences in the size of the market, these markets differ in the share taken by different property types. Highly mature markets like the United States, the United Kingdom and Australia have a high share of retail property space, reflecting the maturity and concentration of retail industry in these countries. RREEF (2007) estimates that nearly 56% of invested...