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Emerging International Real Estate Markets

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This research was commissioned by the IPF Research Programme 2011–2015DECEMBER 2015Emerging InternationalReal Estate MarketsSHORT PAPER 282011–2015Emerging International Real Estate MarketsThis research was funded and commissioned through the IPF Research Programme 2011–2015.This Programme supports the IPF’s wider goals of enhancing the understanding and effciency ofproperty as an investment. The initiative provides the UK property investment market with the abilityto deliver substantial, objective and high-quality analysis on a structured basis. It encourages the wholeindustry to engage with other fnancial markets, the wider business community and government on arange of complementary issues.The Programme is funded by a cross-section of businesses, representing key market participants. The IPFgratefully acknowledges the support of these contributing organisations:Emerging International Real Estate Markets© 2015 – Investment Property ForumIPF Research Programme Short Papers SeriesEmerging International Real Estate MarketsIPF Research Programme 2011–2015December 2015The IPF Short Papers Series addresses current issues facing the property investment market in a timely butrobust format. The aims of the series are: to provide topical and relevant information in a short format on specifc issues; to generate and inform debate amongst the IPF membership, the wider property industry andrelated sectors; to publish on current issues in a shorter timescale than we would normally expect for a more detailedresearch project, but with equally stringent standards for quality and robustness; and to support the IPF objectives of enhancing the understanding and effciency of property as an investmentasset class.The IPF Short Papers are published in full and downloadable free of charge from the IPF website. For moreinformation on these and other IPF Research Programme outputs contact Pam Craddock, IPF ResearchDirector (pcraddock@ipf.org.uk) or log on to the IPF web site at www.ipf.org.uk.Emerging International Real Estate MarketsAuthorAndrew Burrell, JLLProject Steering GroupBen Sanderson, Hermes Real EstateGraham Parry, GrosvenorNoel Manns, Europa Capital LLPPam Craddock, IPFDisclaimerThis document is for information purposes only. The information herein is believed to be correct, but cannot be guaranteed,and the opinions expressed in it constitute our judgement as of this date but are subject to change. Reliance should notbe placed on the information and opinions set out herein for the purposes of any particular transaction or advice. The IPFcannot accept any liability arising from any use of this document.CONTENTSEmerging International Real Estate Markets1. Executive Summary 12. Emerging Markets in Real Estate 23. Are Emerging Real Estate Markets Becoming More Important? 44. What Factors Drive Emerging Market Development? 135. Are Major Cities Driving Emerging Market Capital Flows? 185. Conclusions 23Emerging International Real Estate MarketsEmerging International Real Estate Markets 11 By ‘investable’/’investability’, it is meant how institutional investors view the suitability of a market for investment purposes.2 A market’s ‘investability’ may be measured by the level of investment activity, known as investment intensity. This is calculated by dividing the threeyear average of investment inflows into a country by its current real GDP.1. EXECUTIVE SUMMARY The term ‘emerging markets’ derived from the economic development debates of the 1970s and 1980s.The world has changed much since then and perceptions of emerging markets have evolved too. This paperexplores the real estate context of this debate, assessing progress over the last decade against developedworld benchmarks to highlight key themes, notably:• What is the scale and balance of investment between established and emerging markets?• Are emerging markets now considered more ‘investable’1 than a decade ago?• What are the main factors that determine the developmental status of markets? Capital flows data indicate that the concentration of property investment in emerging markets remainsmuch lower than their (rapidly growing) economic size and importance. While the imbalance is striking, it isshifting and evidence suggests that it is probably not mis-aligned when compared with other fnancial assets. The growth of investment inflows to frontier and emerging markets has comfortably exceeded developedworld benchmarks over the last decade. Although not maintaining the peaks of the immediate post-GFCperiod, the share of emerging market investment is much higher than in the mid-2000s. Evidence is mixed for ‘investable’ markets. At a national level, the metrics show that developed marketshave seen a larger rise in real estate inflows relative to their market size, though there is much strongerevidence of increased intensity2 in the emerging world’s major cities. Other evidence from national investment flows suggests that neither the more open nor the domesticorientated approach have resulted in stronger inflows in the longer term. Sectoral development also doesnot seem to follow a set pattern in the emerging world. In looking for factors that drive development, economic influences were by far the most signifcant.Correlations of GDP and population growth are high, explaining 90% of the movement in emergingmarket inflows at both city and national level – much higher than for mature markets. This suggests that,with economic and demographic growth continuing to outstrip the mature markets, investment willcontinue to thrive in the emerging world. Results from the non-economic indicators were generally inconclusive; notably, political and credit riskshowed limited statistical relationships. While this may reflect data limitations, it is a key area for furtherexploration before development patterns can be assessed, as these ‘softer’ influences are seen as importantmoderators in any discussion of immature real estate markets. Narrowing the focus to major cities provided some counter-intuitive results: while inflows were moreconcentrated in the major centres of each emerging country, these cities tended to show slightly lowergrowth rates than their outlying economy. The trend in the developed world is the opposite, with thetop cities on average more dynamic. In both emerging and developed markets, the pattern reflectseconomic trends. In addition, emerging markets did not seem to provide signifcantly greater returns for investors tocompensate for the greater risk and volatility encountered there. Data quality is an issue at this level, butthese results suggest that, while cities are clearly central to real estate development, patterns may be morenuanced than might have been expected.2 Emerging International Real Estate Markets3 See Financial Times survey, Redefning EM: Choosing the best matrix, James Kynge, FT, 18 August 2015 http://www.ft.com/indepth/redefningemerging-markets4 http://lexicon.ft.com/Term?term=emerging-markets) (http://lexicon.ft.com/THYPERLINK http://lexicon.ft.com/Term?term=emerging-markets)erm?term=emerging-markets)5 “Market maturity and property market behaviour: A European comparison of mature and emergent markets”6 Redefning Retail Investment (2012) for example; https://www.joneslanglasalle.com/ResearchLevel1/JLL_Redefning_Retail_Investment.pdfThe term ‘emerging market’ derives from economic policy debate of the 1970s and 1980s. These marketswere generally defned as nations with low to middle per capita income (1981, World Bank). This workedwell for economic analysis, though the world has changed signifcantly over the last 35 years and perceptionsof emerging markets have shifted markedly3. In addition, the focus of this research is real estate investment,which, although linked, may occur at a very different pace to economic development. A more appropriatedescription for the purposes of this paper is from the FT4:

Emerging market is a term that investors use to describe a developing country, inwhich investment would be expected to achieve higher returns but be accompaniedby greater risk. Global index providers sometimes include in this category relativelywealthy countries whose economies are still considered under-developed from aregulatory point of view.

A wealth of economic research on emerging markets has helped established benchmarks and developmentmodels, but the literature is thinner for real estate. One important paper in the Journal of Property Research(1994) by Keogh and D’Arcy5 looked at market maturity by a comparison of London with the then emergingmarkets of Madrid and Milan. They highlighted the importance of institutions, professional standards,information and transparency in determining potential, as well as traditional drivers such as economic andpolitical stability. Interestingly, they concluded that there is no clear evolutionary path for emerging markets tofollow and noted that the mature centres were not necessarily a model to be copied. This work highlights thecomplexity of the development process and the importance of historic, culturally-specifc processes.This short paper, rather than using specifc case studies or detailed micro-level analysis, takes a broaderapproach, looking for trends across a range of markets to identify underlying drivers of real estate capitalflows. The results are used to assess which of the emerging markets may be best placed to progress over thenext decade. Key themes addressed by the research comprise: The scale of international investment and balance between established and emerging markets; Whether emerging markets are now considered more investable compared with a decade ago; and The factors that determine the developmental status of markets.If national income per head is not the sole differentiator of market maturity, this makes categorisation harder,so it is important to be clear about terms of reference. Past property and equity classifcation surveys wereused as the starting point in this research. Around ffty global markets were then divided into developed,emerging and frontier groups on the basis of an assessment of investment flows, market transparency andGDP per head. For tractability, the smallest markets were excluded, but the fnal survey sample accounted for99% of the investment universe according to JLL’s 2014 Global Capital Flows (GCF) data6.2. EMERGING MARKETS IN REAL ESTATEEmerging International Real Estate Markets 3

Table 2.1: Classifcation of real estate market types

Market type

Developed (mature, advanced)High levels of per capita income, investmentactivity and transparency
US, Australia, Netherlands, UK, Singapore,Sweden, Hong Kong, Canada, Germany, France,Norway, Switzerland, Finland, Ireland, Denmark,Japan, Belgium, Italy, Spain, Austria, New Zealand

Emerging (growth, transitional)Medium levels of per capita income, propertyinvestment and market transparency
Taiwan, South Korea, Poland, Czech Republic,Russia, Malaysia, Portugal, Brazil, Greece, Hungary,China, UAE, Slovakia, Mexico

FrontierLow levels of per capita income, propertyinvestment and market transparency
Saudi Arabia, Israel, Thailand, South Africa, Croatia,Turkey, Romania, India, Chile, Bulgaria, Lithuania,Estonia, Indonesia, Ukraine, Argentina, Vietnam,Philippines

Source: JLL

Figure 2.1: Map of key market groupings


2. EMERGING MARKETS IN REAL ESTATE4 Emerging International Real Estate MarketsThis section focuses on national and regional trends in emerging markets and how these compare withdeveloped world benchmarks. This analysis is based primarily on aggregates from JLL’s Global Capital Flowsdatabase, based on commercial property transactions and providing aggregate investment volumes overthe period since 2003. This covers roughly a single market cycle and is believed to be the longest consistenthistoric series available globally. Data include commercial property deals, but exclude residential and land sales.Ideally, in a quantitative survey, any analysis would be supported by other indicators, such as rents, yieldsand returns. Unfortunately, the most comprehensive consistent global sources, such as the IPD multinationalindex, covers only four of the 14 emerging markets identifed by the research and only South Africa in thefrontier grouping. Combining JLL’s city-based data into meaningful national aggregates across a wide rangeof markets is problematic, even without the challenges of quality, coverage and consistency in less matureeconomies. For these reasons, the research concentrates initially on the capital inflows for each country, withother metrics revisited in the city-level analysis.Comparing aggregates for groupings provides a clear indication that the concentration of investmentin developed markets is much higher than implied by their economic size and importance. Financialdevelopment tends to lag behind economic advancement, though the imbalance in investment flows isparticularly striking. However, data from MSCI suggest that this gap is wide for equities as well, with themarket capitalisation in their defnition of emerging markets estimated at just 13% of the global total (upfrom a mere 1% in the late 1980s). Although this comparison is not on a like-for-like basis with the realestate capital flows, it highlights how far fnancial development lags economic and suggests that the propertyshare is not necessarily out of line with other asset classes.Whereas advanced markets identifed in this study account for about 20% of global population and some60% of GDP, they still received around 90% of all real estate investment flows in 2014 (see Figure 3.1). Foremerging markets, the balance is about 30% of world economic production and 40% of the people and justunder 10% of real estate investment on average over the last decade.3. ARE EMERGING MARKETS BECOMING MORE IMPORTANT?Emerging International Real Estate Markets 5

Figure 3.1: Contributions by grouping – real GDP, population and real estate investment

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%200420142004201420042014Population GDP Investment inflowsShares of global totalDeveloped Emerging Frontier

Source: JLL, Oxford Economics

Concentration is a feature even in the developing world, with the fve largest markets alone accountingfor 70% of inflows. It is also clear that the biggest emerging markets are starting to move up the globalinvestment rankings previously dominated by mature economies. Figure 3.2 confrms China as a top-10destination over the last decade, while a handful of other ‘emergers’ and even one frontier market (India)appear in the locations that have seen over $1bn a year inflows on average. While still accounting for a smallmarket share, the scale of these markets is becoming too important to ignore.Comparison over a decade also provides evidence that the balance is shifting towards emerging markets overtime. In terms of economic contribution, the change is consistently upwards. A decade ago, the advancedmarkets accounted for over 70% of global output, with emerging markets under one ffth. Since then, thelatter group have increased their share of total GDP by 8 percentage points (to a 27% share), with frontiermarkets up by 2% (to 11%). This drop in the relative contribution of the developed world marks a signifcantchange in the balance of economic power, related to the rise of the BRICs (Brazil, Russia, India and China) andreinforced by the global fnancial crisis (GFC).3. ARE EMERGING MARKETS BECOMING MORE IMPORTANT?6 Emerging International Real Estate Markets

Figure 3.2: Capital inflows annual average 2004-2014 by country, $USm

Developed Emerging FrontierUSAUKJapanGermanyFranceAustraliaChinaCanadaSwedenNetherlandsHong KongSingaporeSouth KoreaSpainItalyNorwayBrazilRussiaBelgiumDenmarkPolandTaiwanFinlandMexicoAustriaSwitzerlandIrelandCzech RepMalaysiaIndiaNew ZealandThailand71,17812,6404,4453,8021,303010,00020,00030,00040,00050,00060,00070,00080,00090,000100,000179,171

Source: JLL

3. ARE EMERGING MARKETS BECOMING MORE IMPORTANT?Emerging International Real Estate Markets 7For real estate investment, the cyclicality of the data requires greater caution in its interpretation (see Figure3.3). However, there has been a net increase in the importance of emerging markets, with the developedworld share declining about 7 percentage points since 2004. The emergers’ contribution rose steadily, toa peak of 15% in 2011, during the weak revival following the fnancial crisis in the West. The subsequentreversal largely reflects a recent US-led economic recovery and there has been a slight relative decline inemerging market share.While the trend has not been consistent over time or across economies, it suggests that real estate inflowsare following where economic development leads. Global investment levels reached over US$700bn in 2014,with emerging and frontier markets contributing a record $70bn (see Figure 3.3). Unlike developed markets,this is above the 2006-2007 recorded peaks.In moving to a national focus, there are greater challenges in dealing with capital flows data, which evenin the most liquid markets can vary widely from year to year. To reduce this volatility, rather than standardgrowth rates, the most recent three-year average for inflows is compared with the 10-year mean to provide agrowth benchmark. This shows emerging and frontier market investment was 40% higher during 2012-2014than on average over the last decade, compared with an 18% rise in developed markets.

Figure 3.3: Capital inflows annual average 2004-2014, $USm

0%2%4%6%8%10%12%14%16%18%20%$0$100,000$200,000$300,000$400,000$500,000$600,000$700,000$800,0002004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014Developed Emerging Frontier Share of emerging markets (RHS)

Source: JLL

3. ARE EMERGING MARKETS BECOMING MORE IMPORTANT?8 Emerging International Real Estate Markets7 For Hungary, the weakness appears to reflect a combination of more disappointing economic performance than its neighbours, reinforced by politicalconcerns and property market factors. In the case of Malaysia, by contrast, the cause seems to be regulatory changes, which have relaxed the rules onforeign ownership and diverted funds away from the domestic market.8 See http://www.jll.co.uk/united-kingdom/en-gb/Documents/Investment_Intensity_Infographic%20Q2%202014.pdf. Investment intensity is calculatedby dividing the three-year average of investment inflows into a country by its current real GDP (expressed in US$). Figures are indexed, using US/NewYork 10-year average = 1.00 for comparison.The growth in emerging (and frontier) market flows has been signifcantly stronger proportionately than inthe developed group. Nonetheless, this picture is not homogeneous. Of the outperformers, Mexico is anoutlier, with a notably sharp acceleration in inflows over the last three years relative to the past. China toois a major contributor, while South Korea and UAE also rate strongly. A casual observation from the data isthat the investment growth trend appears stronger in the ‘larger’ markets (in terms of economic importance,population and investment share), although this is not a hard rule with Brazil as a counter-example.In contrast, there are a number of countries where recent inflows are below their historic averages. Theseare largely in Europe and the trend, in part, appears to relate to specifc economic diffculties in the Eurozonefringe or CEE. Greece and Portugal are markets that were seen as close to mature in the mid-2000s, butexperienced regression post-GFC, while several eastern European markets also struggled, most notablyHungary. Contraction is not confned to one continent, however, with Malaysian inflows also slipping overrecent years compared with past performance, despite a solid economic backdrop7.

Figure 3.4: Emerging market capital flows, underlying growth 2004-2014 against historical mean

-80%-60%-40%-20%0%20%40%60%80%HungaryPortugalMalaysiaGreeceCzech RepSlovakiaBrazilDevelopedPolandUAETaiwanEmergingSouth KoreaRussiaFrontierChina

Source: JLL

Of the aims of this study is to establish whether emerging markets have become more investable over time.This is not a straight-forward question, as there is no agreed defnition or measure for what investable means.As previously noted, investment activity has been stronger across the emerging world, but is this also true inrelative terms? To understand this, a comparison with a standard of the potential for this growth is required.3. ARE EMERGING MARKETS BECOMING MORE IMPORTANT?Emerging International Real Estate Markets 9Have emerging markets become more investable?JLL Global Research calculates an investment intensity measure that compares the last three years’ averagecapital inflows to current GDP levels8. This provides a gauge of how well markets capture inflows relativeto their size, with GDP a proxy for the property stock in each market and investment volumes smoothed toprovide a balanced comparison. This analysis is perhaps less appropriate as a national measure than for cities,given disparities in national urbanisation rates, but it is a useful benchmark and proves more satisfactory thanother alternatives (for instance per head measures).Even in the developed world, however, there is a wide disparity across countries on applying this measureand there are no clear ranges that differentiate groupings. There is a wide contrast, for instance, between thehigh intensity of the Anglophones and the Nordics and the much lower fgures of some Eurozone markets,notably Italy and Spain, where levels are not dissimilar to many emerging markets. On average, though, thereis a substantial gap between emerging and established markets.For comparability, the fgures are expressed relative to the US historic mean. In 2014, emerging marketintensity averaged only about one third of US levels. The measure varied widely from China and Brazil at oneend of the spectrum (close to frontier averages) to Taiwan and the Czech Republic at the other with intensityapproaching developed norms; see Figure 3.5. However, there appears to be a limited relationship betweenintensity and investment performance, with strong inflows seen in both under-developed (China) andestablished markets (South Korea) over the last decade.

Figure 3.5: Investment intensity 2014 and change versus historic 10-year average since 2004

-0.40-0.2000.200.400.600.801.001.20DevelopedCzech RepTaiwanSouth KoreaPolandMexicoSlovakiaEmergingGreeceHungaryRussiaMalaysiaPortugalChinaBrazilUAEFrontierIntensity measure 2014 Change in 10-year average

Source: JLL, Oxford Economics

3. ARE EMERGING MARKETS BECOMING MORE IMPORTANT?10 Emerging International Real Estate MarketsThe results for 2014 were also compared against historic averages over the whole period to assess changes.These fgures suggest that intensity is generally higher on average globally over the last 10 years, though withmore modest gains in emerging markets (at about 9%) than in developed (11%), while the frontier groupingoutstripped both (17%). There were gains for Mexico, Taiwan, Russia and Korea, but these were offset byweakness elsewhere. Intensity fell in many European markets, which is not unexpected given the pronouncedinvestment cycle, but results for Brazil and China were also subdued.Any conclusions can only be tentative, given the relatively short horizon and the limitations of the approach.The fact that many of these less mature markets experienced exceptional GDP growth over the period isalso clearly signifcant. It is interesting, however, that the intensity measure suggests that emerging markets,while seeing volumes rise strongly, may not have become more investable relative to their economic scale,suggesting that their real estate development may lag their economic progress. The research returns to thisissue in its city analysis in Section 5.The investment data also allow an examination of shares of cross-border flows, based on offce and retailinvestment within emerging markets at the national level. Cross-border shares, on average, are signifcantlyhigher in the emerging and frontier economies than in mature markets (at around 40% compared with 30%for the latter), which may appear surprising, given their risk and relative illiquidity, although this picturevaries widely.Some markets, for example Korea and Taiwan, have developed their real estate using domestic savingsrather than foreign capital, although this has not been typical. Elsewhere, openness to foreign capital hasallowed inflows to flourish, most obviously in Poland, where cross-border is the majority of all investment. Theprecise development model may be more by necessity than choice, depending on the strength of domesticinstitutions, and both models have strengths and weaknesses. Overall, there is no compelling evidence thateither the more open or domestic approach has resulted in stronger inflows or that either acts as a barrier toor promotes development.In sector terms, retail and offce investment are the predominant asset types for investment transactions,accounting for 75% of the measured global universe in this database. There appears to be no consistentpattern of development, however. Differences between the developed and the emerging markets are modest,with slightly higher concentration of offce investment in the latter. More interesting, totals for other types ofasset in the frontier markets indicate a signifcantly higher proportion of deals outside traditional offce andretail, although data quality may be an issue here.3. ARE EMERGING MARKETS BECOMING MORE IMPORTANT?Emerging International Real Estate Markets 11

Are net inflows the real issue for the next decade?The focus of this study has been chiefly on capital inflows for real estate, but these represent only part ofthe story. In particular, there is evidence of rising outflows from liberalising emerging Asian markets, suchas China and Korea, over recent years. These countries have reached a stage of maturity where domesticinstitutions are looking to diversify and this capital is flowing out, usually to the developed markets (seeFigure 3.6). Outflows from emerging markets have grown steadily over the survey period to the extent thatthey have almost matched inflows in 2014; hence, net fgures in recent years have declined to the mostmodest levels since 2009.While emerging markets will continue to require capital imports to develop their real estate markets, thisis a healthy trend, indicating a two-way flow with advanced economies, which will result in increasinginterdependence in future. In trying to assess emerging markets’ progress, the focus has been on emergingmarkets as a destination for investment. It should also be recognised, however, that these economies areincreasingly a source of capital for western investment, so that inflows are only part of the globalisationstory.Figure 3.6: Net global capital flows by market type (US$bn)-30-1010305070901101301502003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014Developed Emerging FrontierSource: JLL, Oxford Economics


Is there a regional dimension to emerging market development?After looking at the investment data in detail, one question that emerged was the impact of regionaltrends within a market category. One concern is that an emerging market story may be confused with,say, an emerging Asia one. By looking at the regional breakdowns, the effect of desynchronised localinvestment cycles can be isolated and it can be determined whether they are distorting the underlyingglobal aggregates assessed (see Figure 4.1).Asia is certainly the most signifcant region in terms of the emerging market defnition. This is largely aconsequence of the disproportionate importance of China (the world’s second largest economy); whenexcluding China, this changes Asia totals to levels not dissimilar to emerging EMEA and Americas. Themore pronounced cyclicality is in the European component, however. While flows into other regions showminor fluctuations, these are small deviations from a general upward trend. By contrast, European inflowstook the regional lead in 2006-2007, after which there was a prolonged slump, from which levels only fullyrecovered during 2014.In fact, the pattern in emerging Europe is signifcantly more correlated to developed world flows than inother regions. This suggests that in the 2000s, inflows to these emerging markets were more influenced bythe credit boom that prefgured the GFC and that these markets were more influenced by the prolongedhangover that followed. This greater interdependence may be explained by the proximity to a large clusterof developed economies and reinforced by the perception that some markets now seen as emerging haveregressed since the crisis (notably Eurozone members Greece and Portugal). This pattern is not pronouncedin the other regions.Figure 3.7: Emerging and global capital inflows by region (US$bn)5 010152025303540452004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014Europe Asia Pacific US AP (ex China)Source: JLL, Oxford Economics

Emerging International Real Estate Markets 13In this section, the research considers the macro factors that may underpin investment trends by examiningthe strength of relationships with other indicators. As national level drivers remain the benchmark, theanalysis focuses primarily on capital flows.Economic performance is the obvious starting point. Although economics is not the only aspect ofdevelopment, it is widely regarded as the most important influence and is a key driver for real estate.There are many dimensions to economic statistics and an enormous range of possible options to test, onlyconstrained by the need for comparable fgures across the 50 or more economies that were considered.Generally, it was found that the results for high-level macro measures were as good as more granularalternatives and analysis is limited to these for the purpose of this paper.Real GDP measures provided the strongest correlation with investment volumes in the survey, but there weremarked difference between market groupings. This is not surprising perhaps when the varying economicfortunes over the period are considered. On an underlying basis, the emerging group experienced a 22%uplift in real output compared with a 4% rise in the developed world, which was impacted by the fnancialcrisis, and a 19% increase in the frontier markets (see Figure 4.1).Real GDP changes explain over 90% of movement in emerging market inflows and 79% in frontier, althoughthis correlation declines to 39% in the developed economies (see Table 4.1). China accounts for over half ofthe growth in emerging market GDP, but even excluding this only reduces the correlation with capital inflowsto 87%. A scatterplot and basic regression analysis on the changes are shown in Figure 4.2, indicating that foreach additional 1% in output growth real estate investment rises by about 2%.

Figure 4.1: Emerging market capital flows compared against GDP growth, 2012-2014 meanversus historic average (%)

GDP growth Capital flows-80%-60%-40%-20%0%20%40%60%80%100%MexicoChinaFrontierRussiaSouth KoreaEmergingTaiwanUAEPolandDevelopedEmerging ex ChinaBrazilSlovakiaCzech RepGreeceMalaysiaPortugalHungary

Sources: JLL, Oxford Economics

4. WHAT FACTORS DRIVE EMERGING MARKET DEVELOPMENT?14 Emerging International Real Estate Markets4. WHAT FACTORS DRIVE EMERGING MARKET DEVELOPMENT?GDP growth trends also provide support for national level performance in emerging markets, with a fewexceptions, such Malaysia, where the correlation is negative. Although the relationships are slightly weaker onaverage in Europe, economic diffculties clearly explain why Greece and Portugal have regressed as investmentdestinations and why Poland has held up well in contrast. The strength of market performance in China,South Korea and Taiwan is also supported by above-average economic growth rates.

Figure 4.2: Emerging market capital flows compared against GDP growth, 2012-2014 meanagainst history (%)


Sources: JLL, Oxford Economics

Demographic change is part of the economic growth story in the emerging markets. On average, results forpopulation are slightly less satisfactory than for GDP in emerging and frontier markets and show almost norelationship in the developed world (see Table 4.1). There is a preponderance of more populous emergingmarkets at the top of the investment growth rankings, including Russia, China and Mexico. While this scalemay be an important influence, it appears not to be a barrier to relative success in smaller emerging realestate markets, such as Macao, neither is it a guarantee, as shown in Brazil for instance.

Table 4.1: Correlations with capital inflows by market type, 2004-2014

Real GDP, US $
Political Risk
Credit Rating





Emerging (ex. China)

Sources: Oxford Economics, World Bank

Emerging International Real Estate Markets 15One advantage quantitative macroeconomic variables gives is a forward-looking perspective, with forecastswidely available. Over the next fve years, Oxford Economics forecast underlying global GDP will be slightlystronger than over the last decade, with emerging markets gaining a ffth and developed rates recoveringtoo (Figure 4.3). Of the emerging and frontier markets considered in this research, China remains the frontrunner, followed by Malaysia, with notable expansion in India, Vietnam, Indonesia, Lithuania and Chile also.Conclusions about potential winners and losers in real estate investment using these forecasts must necessarilybe highly cautious, especially at the national level but, in general, it appears likely that the strong growthin overall inflows will continue against this strong economic background. In addition, while the relativitiesbetween developed and emerging markets may narrow on the recent past (in line with GDP trends), estimatesfrom this research suggest that the latter will continue to see signifcantly faster growth of capital inflows.

Figure 4.3: Emerging market capital flows versus GDP growth, 2012-2014 mean versus historicaverage (%)

-6-4-28 6 4 2 010200020012002200320042005200620072008200920102011201220132014201520162017201820192020Advanced Economies Emerging MarketsForecastDifference

Source: Oxford Economics

Aside from macroeconomic fundamentals, relationships with a number of other indicators were alsoinvestigated. After economic performance, other evidence was sought chiefly in qualitative measuresderived from the extensive range of global surveys and benchmarks, notably the World Bank’s developmentIndicators. The advantage of these is that they can quantify the greater risks that investors face in emergingmarkets. These measures also allow testing of the factors that influence market evolution by quantifying theeffect of such factors as political environment, legal system, infrastructure, taxation, fnancial developmentand urbanisation.4. WHAT FACTORS DRIVE EMERGING MARKET DEVELOPMENT?16 Emerging International Real Estate Markets7 http://info.worldbank.org/governance/wgi/index.aspx#doc8 The Economist Intelligence Unit provides country, risk and industry analysis across 200 countries worldwide.For this analysis, a wide range of options were reviewed but, as results were generally inconclusive, only twoareas are highlighted: political risk and credit rating. Emerging markets have, in general, medium levels ofpolitical stability according to World Bank governance indicators7. The study group of ‘emergers’, as expected,show signifcantly lower ratings on this composite metric, averaging a score of 4.8 against ratings averagingaround 6.0 for developed markets, out of a maximum of 7.0. The range of governance scores in theemerging category is wide with some approaching developing levels, such as South Korea, Malaysia, CzechRepublic and Portugal, while others see much lower levels, notably China, Russia and Brazil (all below 4.0,which is less than the frontier markets average).For the purpose of this research, the impact of the change in political risk is perceived to be of the greatestimportant. Net changes in this index are small for the emerging group (unlike frontier, where there was astrong rise), but there are big differences nationally. Overall, there is no strong tendency for improvementin political risk in stronger markets and vice versa. Several countries where capital flows have grown andeconomic performance has been strong, for instance, saw a reversal in politics, including high-flyers China,Russia and South Korea. Correlations for this index were poor, so it is diffcult to recognise this as a driver ofperformance over the last decade at least (see Table 4.1).The political risk measure covers a broad range of aspects, including corruption, regulation, rule of law andaccountability. Of these, legal systems gave the best correlation, which is encouraging as anecdotal commentsfrom investors highlighted this as important, but even these results were not especially strong statistically.Finding any relationship of slowly-evolving structural factors with volatile investment data over a relativelyshort time series will be challenging, so inconclusive results were not unexpected.This evidence alone is not enough, however, to rule out political factors as an important moderator ofinvestor behaviour. In particular, while not determining growth, they could prevent market evolution beyonda certain point to, say, achieving developed status. Four of the emerging markets identifed have governmentsthat are categorised as authoritarian on the EIU’s democracy index for example8. Given that all developedmarkets are democratic, it may be that these ‘emergers’ will never be regarded as ‘developed’ by investors,no matter how strong their economic performance.One other qualitative measure examined was credit rating, which relates directly to investor perceptions,albeit on a wider spectrum of assets than property. This measure is derived as a composite from Fitch,Moody’s and S&P ratings, with AAA credit scoring 20. On average, the emerging group scores between 13and 14 on this metric, compared with 18 to 19 for the advanced economies, although there have been someimportant shifts in some markets over recent years and dispersions have widened markedly.Overall, credit ratings have declined, which is not surprising given the upheavals of the period surveyed. Moreunexpected is that trends in the emerging grouping are not signifcantly stronger than economies in thedeveloped world on average. Otherwise, the credit rating indicator provides some link with the investmentdata, albeit far less robust than for economic output measures (see Table 4.1). Changes were dominated by aslump in the ratings of three particular European emergers: Hungary, Greece and Portugal. These all lie at thebottom of the investment volume growth ranking. Rises in credit ratings were seen in some of the strongernations for capital inflows, notably China and Russia.4. WHAT FACTORS DRIVE EMERGING MARKET DEVELOPMENT?Emerging International Real Estate Markets 17Results from non-economic measures were generally disappointing. This is a key area for further research asthese influences are repeatedly raised in the discussion of immature real estate markets. Identifying the keynon-economic drivers of development will be essential to establish the evolutionary path for markets, even ifthe statistical evidence is likely to remain patchy until a much longer historical base is established.4. WHAT FACTORS DRIVE EMERGING MARKET DEVELOPMENT?18 Emerging International Real Estate Markets5. ARE MAJOR CITIES DRIVING EMERGING MARKET CAPITAL FLOWS?In economic development there is an increasing focus on urbanisation in debates on the evolution ofemerging markets. The drift from rural to city living is creating new conurbations and there is evidence thateconomic growth is becoming ever-more concentrated in urban clusters of high-value service industries. As thedeveloped world is relatively mature in this regard, the bulk of this change is occurring in emerging markets.Even without these urbanisation trends, cities are fundamental to commercial real estate. Retail and offceproperty is integral to urban areas and there is also a concentration of other property types within cities,including hotels and apartments. Outside the developed world, major cities are seen as key to opening upless transparent markets, with evidence that investors will seek a foothold in these centres before consideringother opportunities.Given the perception that major cities play a special role as gateways for investors, in this section the mostimportant centre for each country was selected and analysed on this basis. This was generally the capital city,but in some cases a centre was substituted due to its greater importance in commercial real estate terms (forinstance Shanghai in China or New York in the US).

Figure 5.1: Emerging market city capital flows, underlying growth national versus major citytrend

-80%-60%-40%-20%0%20%40%60%80%100%ShanghaiSeoulFrontierBratislavaEmergingMoscowWarsawDubaiDevelopedMexico CityTaipeiPragueSao PauloAthensLisbonKuala LumpurNational BudapestCity

Source: JLL

Emerging International Real Estate Markets 195. ARE MAJOR CITIES DRIVING EMERGING MARKET CAPITAL FLOWS?In terms of shares of capital flows, major cities surveyed contributed about one third to the overalldeveloped markets totals, but more than a half to the emerging and frontier markets. This concentrationfts well with the view that gateway cities are more important in these new investment destinations than intraditional markets. But this alone does not guarantee these cities will grow faster. In fact, city investmentgrowth slightly lagged national trends in emerging and frontier markets over the period surveyed. This wasa slight surprise with about half the centres seeing slower growth than at the country level, albeit that theaggregate difference is not wide (2 percentage points) and there is stronger growth in a number of majorcities (including Shanghai and Warsaw).The trend in the developed world is the opposite, with major cities on average more dynamic. This isconsistent with a view that city economies will tend to be faster-growing because of their concentrations ofhigh-value-add service sectors. Conclusions must be tentative, however, given data quality issues at the citylevel. There are also alternative investment destinations in certain markets that have outperformed the majorcity, notably Mexico and Russia.But these differences are also, in part, a reflection of the economic fundamentals. According to OxfordEconomics Global City database, the real GDP fgures show that emerging market major cities expandedby 12% over the last decade (+9% excluding China). This is a more rapid increase than for the developedgroup, which increased by 6% on an underlying basis. The key difference, however, is relative to nationalperformance, with emerging markets lagging the wider economy (at +22%) and developed world citiesholding up better (+4% nationwide).It would be expected that urban markets grow much faster than their outlying national economies, thanks topopulation migration and the contribution of dynamic sectors. The emerging group includes several Europeancities that have suffered particularly badly since the GFC, including Athens and Lisbon (see Figure 5.1).Patterns of strong GDP growth are generally consistent with buoyant city investment inflows and vice versa(with odd exceptions like Kuala Lumpur and Budapest).On average, correlations of city economic performancewith investment inflows were similar to the national results (at just over 90%), as were the regressionstatistics. As with the national trends, forecasts suggest that growth will be sustained at the city level.20 Emerging International Real Estate Markets

Figure 5.2: Emerging market city capital flows and real GDP growth, underlying change

-60%-40%-20%0%20%40%60%80%ShanghaiSeoulFrontierBratislavaEmergingMoscowWarsawDubaiDevelopedMexico CityTaipeiPragueSao PauloAthensLisbonKuala LumpurBudapestCity GDP City inflows

Source: JLL, Oxford Economics

One advantage with the urban focus is that it allows the analysis of new data series, notably returns.Conclusions must be cautious as the fgures are only available for prime offces on a gross basis and are notfor all the locations covered in this research. After concentrating on investment, it is interesting to look athow returns vary between market groupings. Emerging markets should provide greater returns to investors tocompensate for the greater risks compared with developed economies (and even more so for frontier markets).Returns are higher in emerging markets, but the spread above developed markets is low, at less than 1percentage point on average over the last 10 years. The premium also seems to be declining over time.Moreover, offce returns in emerging and developed markets move closely in line. This suggests that thereis limited diversifcation beneft from these immature markets as they follow a similar cycle. Data caveatsnotwithstanding, this may explain why property investment has remained concentrated in the advancedeconomies and development elsewhere has been relatively slow.5. ARE MAJOR CITIES DRIVING EMERGING MARKET CAPITAL FLOWS?Emerging International Real Estate Markets 21

Figure 5.3: Average gross offce returns by market grouping

-20%-10%0%10%20%30%40%2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014Developed Emerging Difference

Source: JLL

As a fnal step, the research repeated the investment intensity metrics for the emerging cities and comparedthese with the other groupings. New York’s historic average is used as a comparison for the sample ofgateway centres, so that results are not directly comparable with the previous analysis. By city, results aremore widely dispersed than in the national analysis, but there has been a general increase in the aggregateintensity. Some centres also show a higher intensity than the developed city average, including Shanghaiand Seoul.Conclusions must be cautious, given the relatively short horizon and data quality, but the rise in intensityon aggregate is higher than for the developed city grouping (at 19% compared with 14%). This providesevidence that, for major cities at least, these markets are becoming more attractive to investors: a strongerconclusion than for the national level data.5. ARE MAJOR CITIES DRIVING EMERGING MARKET CAPITAL FLOWS?22 Emerging International Real Estate Markets5. ARE MAJOR CITIES DRIVING EMERGING MARKET CAPITAL FLOWS?

Figure 5.4: City investment intensity 2014 and change on historic average

-1.00-0.500.000.501.001.502.002.50SeoulWarsawShanghaiDevelopedPragueTaipeiBratislavaEmergingMoscowKuala LumpurAthensBudapestMexico CityLisbonDubaiSao PauloFrontierIntensity measure in 2014 Change on 10-year average

New York = 1.0 intensity

Overall, results from the city analysis are less decisive than expected. Although few would doubt theimportance of cities in market development, this high-level analysis of major city trends in emerging marketsadds only limited insight to the previous analysis. This is perhaps a result of the data quality at this moregranular level or because cities may present a degree of complexity missed at the macro-level. Nonetheless,the analysis of city-level intensity provides more satisfactory results than at the national level, while the returnsperspective also adds to the picture.Emerging International Real Estate Markets 236. CONCLUSIONSIn the last decade, growth in capital inflows to emerging and frontier economies have far outstripped thoseto the developed world. This difference was most apparent during the severe post-GFC recession in theadvanced economies in the late 2000s, but the trend has continued since. Activity has been most marked inthe BRICs and Asian Tigers, while, in contrast, investment in some European emerging markets has declined.A comparison of global capital flows indicates that property investment activity remains highly concentrated,with the emerging world accounting for only around one tenth of the total. However, evidence suggests thatthis is broadly in line with other assets.The assessment of emerging market investability is not helped by a lack of standard terms of reference,but measures adopted in this research indicate a gradual improvement over the last decade or so. Nationalresults were inconclusive, but investment intensity in the major cities within emerging markets showed a clearincrease relative to movements in developed markets.Economic drivers provide the clearest explanation for the development of emerging markets in real estateover the last decade. Correlations with output are high at both national and city levels and signifcantlystronger than seen in developed markets. With forecasters pointing to continued strong GDP growth in theemerging world, this suggests that these markets will continue to increase their share of global activity.Many other factors have been suggested for the development of emerging investment markets, includingrule of law, taxation, political freedom and infrastructure. Even where these influences could be quantifed,however, the relationships with property investment were much weaker than with economics. As thesefactors may be important modifers of development, this is an important area for further study.Given that gateway cities are regarded as key channels of development in the emerging world, results fromthe urban analysis were more mixed than expected. Economic growth was, again, a strong driver, but majorcity growth did not always keep pace with national trends, while the pattern of returns in emerging marketswas surprisingly similar to the developed world.A number of challenges arose in undertaking this research. While less transparent markets are expected to beless ‘measureable’, data issues often limited the analysis, particularly working with a historic perspective ofless than one complete cycle. This aspect, at least, will improve over time.A stronger framework for assessing the development of real estate markets would complement thisquantitative analysis – in particular, further work to identify which structures and institutions have been mostsuccessful in promoting emerging market real estate development. Given the data issues highlighted, this islikely to require further detailed case studies and international comparison.Emerging International Real Estate MarketsEmerging International Real Estate Markets2011–2015Printed on recycled paperInvestment Property ForumNew Broad Street House35 New Broad StreetLondon EC2M 1NHTelephone: 020 7194 7920Fax: 020 7194 7921Email: ipfoffce@ipf.org.ukWeb: www.ipf.org.uk
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