Increasing global economic integration makes the opportunities in international real estate investment more compelling than ever before—especially given weakness and slow growth in the domestic real estate markets of most developed economies. Although traditional international capital flows were largely directed toward U.S. and Western European opportunities, in the last several years, substantial interest has developed in markets in Asia. More recently, investment has been growing in Latin America, Eastern Europe and Russia.
Although most capital currently going into international real estate has an “opportunistic” risk/reward structure, over the next few years, “value-added” and “core” strategies will follow as comfort with international real estate grows and reduction in portfolio risk becomes more attainable.
Emerging Market Real Estate: China, India and Brazil
Emerging markets are a specific type of international real estate characterized by higher growth, less information and higher risks. China, India and Brazil have gradually evolved their economic and political systems to embrace and flourish in global capitalism, reducing barriers and impediments around the flow of trade goods and capital. China and India are expected to become the dominant global suppliers of manufactured goods and services, while Brazil is becoming a similarly dominant supplier of raw materials.
Combined, these countries have an expanding middle class which will double in number by 2017 and reach 800 million people by 2024! This massive rise in the size of the middle class in these nations will create demand for a wide range of economic goods including real estate. This suggests that a huge increase in demand will not be restricted to basic goods but also will result in greater demand for all consumer segments. High economic growth combined with enormous populations of these nations will translate into a large aggregation of wealth, creating ever more attractive world markets. Multinational corporations will no doubt view these countries as major expansion markets.
Figure 1 illustrates the three countries according to a variety of rankings.
Figure 2 shows the changing GDP positions of the BICs vis-à-vis the current GDP leaders.
The Chinese economy has, once again, shown its resilience in the midst of a difficult external environment, buoyed by robust corporate profitability and rising household incomes. China’s growth has been breathtaking, with an average annual real GDP growth rate of 7.7 percent from 1978 to 2012, faster than that achieved by any East Asian economy during its fastest-growing periods. Although China has a huge population it is also one of the fastest aging populations due to the one-child policy and increasing longevity of the elderly. Despite the slowing labor force growth, there will be an ongoing increase in human capital accumulation. Advances in human capital investment and educational attainment of the general population have boomed.
The renminbi (Chinese currency, of which the yuan is the basic unit) appreciated by around 6 percent in real effective terms in 2011. At the same time, the pace of reserve accumulation has fallen due to multiple factors including a smaller trade surplus, higher global risk aversion, and valuation effects associated with a stronger US dollar. However, given that the current account still has a sizable surplus in US dollars and FDI remains strong, the pace of reserves accumulation should resume in 2014.
One of the keys to sustaining long-term growth will be the gradual shift of the Chinese economy away from exports and towards more domestic, demand-driven growth. To facilitate this situation, China will gradually let its currency appreciate, thereby making imports more affordable for Chinese consumers. It will also likely develop its consumer market as well as its consumer financial services sector to facilitate a wider range of consumer credit products available to the average Chinese households. The expanded use of credit cards would likely spur retail demand and imports, while long-term affordable mortgages will boost housing demand and the concomitant accoutrements associated with home ownership.
Since 2003 India has been one of the fastest growing major economies in the world, leading to rapid increases in per capita income, increasing demand, and integration with the world economy. India has made structural reforms that have led to its growing prowess in certain sectors of the service economy as well. Should the government maintain a growth orientation with respect to economic policy, trade, and globalization, India’s GDP in dollar terms could surpass that of the United States by 2050, making it the world’s second largest economy.
India’s GDP growth at 5 percent in 2012 was the lowest reported in more than a decade. Private capital formation declined due to the high cost of financing, infrastructure bottlenecks, poor investments sentiment, and weak domestic and global demand. The latest data on industrial production and manufacturing suggests very modest growth of 1 percent. Despite the low growth, inflation has continued to remain high, with consumer price inflation (CPI) hovering above 10 percent year over year for most of 2013. Supply constraints, particularly in food and infrastructure, the resulting food price rise, and high dependence on fuel imports have kept inflationary pressures high. In the past gradual opening up of the economy introduced competition that forced the private sector to restructure, emerging leaner and more competitive. The factors leading this change have been international trade, financial sector growth, and the spread and adoption of information technology.
One recent challenge that India has been facing is the reversal of capital inflows. In the past, foreign investors have brought capital into the Indian stock market due to high global liquidity, interest rate differentials between advanced and emerging nations, and better growth prospects relative to the advanced economies. However, lower-than-expected growth, macroeconomic imbalances that include fiscal and current account deficits, poor investment conditions and corporate earnings, and a volatile currency have led to a reversal of the trend. Institutional investors are turning into net sellers in the Indian equity market. The market expectation of an improvement in the US economy and the hint of a possible exit by the US Federal Reserve this year have also contributed to the reversal of capital inflows. In a recent monetary policy review meeting, the Reserve Bank of India (RBI) expressed apprehension of a sudden stop and reversal of capital inflows from emerging markets, including India. The government is considering further opening up the Indian economy including raising the cap on foreign investment in rupee-denominated government debt by up to $5 billion, reducing taxes on such investments, easing access to foreign funds for Indian companies, and reducing curbs on foreign investment in sensitive sectors such as defense, telecommunications, and media.
The twenty-first century will likely see a majority of India’s population living in urban areas for first time in history. India has ten of the thirty fastest growing cities in the world and is witnessing rapid urbanization. This is happening not only in the larger cities, but in small and mid-size cities as well. India’s rapid urbanization has implications for demand in housing, urban infrastructure, location of offices, retail, and hotels. The increasing expenditures in infrastructure will likely drive growth in the transportation sector, spur demand for vehicles, contribute to increasing real estate values along road corridors, and boost suburban growth, the natural next phase of urbanization.
Brazil is forecast to be among the world’s fastest growing economies for the next several decades. By 2050, Brazil is predicted to be the world’s fourth largest economy. The country possesses vast natural resources, sizable pools of labor, growing productivity and high investment rates. Unlike most other Latin American economies, its debt position has improved, having moved from the world’s largest emerging market debtor to a net foreign creditor by 2008. Since the early 2000s, Brazil has made great progress towards putting into place the foundations for growth, with particular emphasis on achieving macroeconomic stability. Brazil’s growth rate has lagged behind China and India in part because of the stabilization measures, which have acted as a drag on the economy, but nevertheless should serve as a strong foundation for future growth.
Brazil’s economy grew just by 0.9 percent in 2012. The economy still remains relatively less open to trade compared with other fast-growing, emerging market countries. Transportation bottlenecks as well as tight and rigid labor markets are limiting Brazil’s competitiveness across sectors. To improve transportation, the government plans to increase investments in areas such as ports, roads, railways, and airports. However, attracting private investors to these projects has been difficult, given the low rate of returns initially offered by the government. In addition, the projects have been facing political delays. Brazil also continues to face a shortage of adequately skilled workers. This, combined with rigid labor laws, has been lowering competitiveness in various sectors.
Brazil has gradually opened up its markets and lifted barriers to trade. Going forward, a combination of capital accumulation, population growth, and total factor productivity should continue to boost growth. In terms of productivity, increased human capital associated with a growing middle class should be a significant driver of economic expansion. This should help move Brazil rapidly up the value chain in terms of its commodity and raw materials sector and further expand its manufacturing base.