China property is a bubble, say real estate funds

Asia-based distressed property-market participants think Chinese real estate is in bubble territory, judging by a straw poll conducted at a distressed-asset conference in Hong Kong this week.

This was the view of most of the audience at the AsianInvestor and FinanceAsia second annual recovery investing summit, a view with which the panellists broadly agree. "Everyone in my office except the China guys think [China is a bubble]," quipped the moderator, Anthony Miller, Japan chief executive of alternatives investment firm Pacific Alliance.

Bubble or no, such a situation provides tantalising possibilities for distressed property investors -- on the assumption that the inflated prices eventually crash to earth with a bump, bringing Chinese developers with them. But, as the panellists pointed out, they appear to be defying gravity.

The panel focused on opportunities in distressed Asian real estate and the other contributors were: Grant Kelley, Asia-Pacific head of recently launched Apollo Global Real Estate Management; Andrew Heithersay, international director at LaSalle Investment Management; Tom Pulley, managing director at Fortress Investment Management; and Kishore Moorjani, founder and chief investment officer of Credit Asia Capital.

When asked where the best opportunities lie geographically in terms of distressed real estate, the panellists tended to agree there is a lot of potential in China, but other markets -- in particular Japan -- are currently more fertile ground.

Fortress's Pulley is interested in markets outside Japan, his main area of focus -- and China is one place he is looking at. "In China, it does feel as though the loan tap has been turned off, which will create an inevitable cyclical change in that market," he says.

"We're going through a period globally of the distressed cycle where ultimately real estate assets will need to be repriced, restructured, recapitalised," he adds. "We see that in Australia and Japan -- when you get outside [those markets], you really have to look at where the individual assets are.

"China is clearly place to look at in that respect," says Pulley. "It has not seen the same sort of [market] adjustment as industrialised countries have to date, but that will happen."

Tokyo-based Miller at Pacific Alliance says China and Japan are the markets he knows best. "They are very different markets, but they have in common that they both have a tremendous amount of distressed assets," he says. "But that doesn't mean there are a tremendous amount of opportunities today."

Miller says Japan is a market where hundreds of billions of dollars in transactions happened with reasonably high leverage - 65% to 75% leverage -- and since prices have dropped significantly, so there are distressed assets.

"There are hundreds of billions of dollars of assets in Japan that are distressed, where equity is wiped out or nearly wiped out," he adds, "and those are opportunities for people like us."

As for China, Miller says: "I do think that Chinese developers do not believe in gravity, and for that reason they are almost invariably over-extended. And if they get some cash out of a deal, they invest it in two other deals, so they remain perpetually over-extended."

Hence, Chinese developers -- apart from the big six Hong Kong-based firms -- are continuing to invest big, even though office vacancies are on the rise and residential sales are slowing down in the country, he says. "That's one thing that everyone agrees on," adds Miller. "Most developers are definitely distressed."

"The question is simply: What type of transactions will happen when [in China and Japan]?" he says.

LaSalle IM's "overarching strategy" for China centres around "the growing middle class, increasing urbanisation within cities and real estate," says Heithersay, "which translates into mid-market residential and mid-market retail and logistics warehouses." But he adds that Japan probably offers more distress and some good opportunities.

Turning to another huge Asian market, Miller put to the panel that India is "almost institutionally acceptable" in terms of distressed-property investing. The general response was that the country remains largely too tricky to tackle, and that there is not a great deal on offer, but things may be improving.

"In the past we felt there was a strong underlying macro [story] but there was too much silly money in the market," says Credit Asia's Moorjani. "We feel that's changed a little in the recent past."

However, the fact remains that, partly thanks to India's banking regulator -- which has "probably been too tight for the most part" -- there hasn't been a lot of distressed real estate opportunities from the banking sector, he says. "There are a handful of opportunities, but they are few and far between."

LaSalle's Heithersay cites a quote about the differences between India and China. "India is all law and no order, and China is all order and no law, which I think sums up the challenges well," he says.