Property Biz Canada

Risk and rewards of CRE investment in developing markets


Investing in real estate in developing markets can present different risk and reward opportunities than in more established countries, and some of these issues were discussed at the Global Property Market conference at the Metro Toronto Convention Centre on Nov. 27.

Global Property MarketPartnerships in developing markets

Ivanhoe Cambridge has a mandate to invest in growing economies and markets, and has been involved with them for 12 years. President of growth markets Rita-Rose Gagne said the company spends a lot of time researching markets and potential partners before it makes an investment. It has a long-term vision and clear business plan before entering a partnership.

Ivanhoe Cambridge looks for partners with technical expertise, links to networks in the market, local capabilities, a good investment track record, a strong reputation, an understanding of a market’s governance and an ability to operate under those circumstances.

“We don’t want partners that are going to take decision-making or information out of our hands,” said Gagne. “You need to have partners in those markets that have significant skin in the game to support aligned decision-making.”

Investing in developing European markets

M7 Real Estate was established in 2009. It has more than 225 employees in 13 European countries and manages more than 8,000 tenants in 1,300 retail, office and industrial properties with a value of approximately $11.62 billion.

This includes investing in and acting as a local operating partner in what are generally viewed as higher risk eastern European countries, including Hungary, Czech Republic, Croatia, Poland and Slovakia.

“The reason we were able to attract a lot of our joint venture partners was because of our infrastructure that we set up in some of these smaller European countries, where we’ve hired the best expertise in these countries to be able to de-risk some of the perceived legal and political risks that are attached to some of these countries,” said M7 divisional director of investor relations Rebekah Tobias.

“The operating partner joint ventures that we’ve formed over time have given us the track record that we needed to raise our own capital, starting in 2013. These capital partners are mainly high-net-worth family offices, with less institutional capital behind us.”

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Tobias said M7 prefers to operate this way for its speed of execution. The company only raises capital off a portfolio of existing assets and doesn’t raise discretionary funds.

When considering investments, M7 looks at how a market is performing from an economic standpoint as well as its room for growth. It only invests at below replacement cost and doesn’t compete for new supply. It looks for a 20-year-plus economic life for its properties and needs a 400-basis point or larger yield spread.

“That allows us to provide protection on capital and on an asset level,” said Tobias, who noted that M7 is exceeding its return targets of between 15 and 20 per cent.

“We generally buy off of 50- to 60-per cent vacancies, so the combination of return for lease-up versus rent improvement and yield compression in some of these markets has been very attractive for our investors,” said Tobias. “That also allows us to buy very well.”

M7 developed software called Coyote which helps it source properties and contributed to its average asset valuation showing a 40- to 50-per cent improvement. Its database has grown to have information on 20,000 assets worth $25 billion across Europe, and the software is now being sold to external parties as an added source of revenue for M7.

M7 has done particularly well with its office and industrial portfolio in Hungary, which has been described as the most high-risk market in Europe.

Investing in Brazil

Dietrich Heidtmann, GTIS Partners’ managing director and head of international capital markets, is based in France but spends much of his time in Brazil because of his firm’s extensive investments there. The company has more than 90 assets encompassing 19.37 million square feet, including more than 14,000 residential units, more than 8.61 million square feet of office and industrial/logistics space, and approximately 10,000 hotel rooms in São Paulo and Rio de Janeiro

Investors generally see GTIS Partners as the operating partner on the ground in Brazil, where it has been investing exclusively since 2007 after prices in the United States became too high. The company has 35 people in its Sao Paulo office, including four full-time lawyers, because of rampant corruption and uncertainties about land titles in Brazil.

“You really want to control your fate rather than being dragged into something by a local operating company that you don’t control,” said Heidtmann. “We still work with partners, but in all the projects that we have, it’s us who controls all of the major aspects and has an extremely hands-on role.”

Interest rates are high in Brazil, so many real estate deals are done without debt. Heidtmann said good returns can be earned without leverage, and this lack of debt can also eliminate risks due to the frequent currency fluctuations in Brazil.

Sao Paulo and Rio de Janeiro are the two largest Brazilian markets and Heidtmann said you don’t gain much from diversifying into other cities because they have less rule of law, compliance, liquidity and infrastructure.

“Brazil will never be the dominant part of your portfolio but, given the size of its economy and population, it’s a market you can’t ignore if you’re building a global portfolio.”

Ivanhoe Cambridge’s portfolio includes 17 properties in Brazil.

Investing in India

Keyur Shah, the Mumbai, India-based chief financial officer of investment adviser HDFC Property Ventures Ltd., pointed out some of the ways in which the real estate industry has evolved in his homeland.

Indian companies historically didn’t rent office space; they owned it and located it near their factories. Possession was almost equal to ownership, which made it difficult to evict tenants.

Shah said government insurance companies owned 60 per cent of commercial real estate in India until the 1980s. Things became more liberalized in the 1990s and multinational corporations including General Electric, The Coca-Cola Company and PepsiCo opened in India and wanted to rent real estate. Leases were typically nine years, with rent escalations every three years.

After manufacturing companies arrived in India, technology companies set up huge campuses. Now data centres and clinical research facilities have followed. GIC, Brookfield Asset Management and Blackstone are among the large international investors in Indian commercial real estate, which Shah said offers attractive capitalization rates of nine to 10 per cent.

Shah said India is very much a regional market with no national development players, and it’s crucial for investors to have an on-the-ground presence to understand these regional nuances.

Multinational investors also want to know that up-to-date labour, environmental, and fire and safety standards and compliances are in place in their buildings, and improvements have been made in India in recent years.

“A lot of requirements of international investors are also now covered by local regulations,” said Shah.

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Steve McLean

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Steve is a veteran writer, reporter, editor and communications specialist whose work has appeared in a wide variety of print and online outlets. He’s the author of the book Hot Canadian Bands and has taught reporting to college students. He is based in Toronto.

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