Challenges to Multifamily Investment and Development on the Global Stage
- May 16, 2011
In the United States, the multifamily sector of commercial real estate has been hot, fairing extremely well coming out of the global economic meltdown and looking promising for the foreseeable future. There are more people ready to rent than there are units to put them in. However, the rental market seems to be flourishing strictly within the confines of the U.S. borders. Opportunities do exist for U.S. investors and developers looking to penetrate foreign markets, but the number of hindrances they meet along the way is staggering.
For starters, far fewer people in other countries want to rent. This of course varies dramatically from region to region, country to country, city to city, but the pool of renters in general is much shallower than in the United States. Also, the investment structure for large-scale U.S.-style apartment developments simply doesn’t exist, partly because of that shallow renter pool and partly because that structure has never taken off and isn’t understood. And on top of those general challenges, a blockade of governmental and bureaucratic impediments pop up in myriad places as a company wades through the approval processes.
When it comes to the rest of commercial real estate abroad, such as office development, there is very little difference from the U.S. model. Jones Lang LaSalle’s Global Market Report for the second quarter of 2011 describes the global real estate recovery as “characterized by strengthening investment markets, increasing corporate optimism and robust price growth for prime assets across multiple markets.” The report notes the continuing emergence of BRIC countries (Brazil, Russia, India and China), which now account for 13 percent of global investment volumes, up a long way from approximately 2 percent in 2007. But tapping these markets on the apartment front tells a different story.
Despite its burgeoning economy, differences in income, differences in consumer perspective and knots in its infrastructure make India a tough room to enter. “For foreign developers it’s very difficult,” Richard Green, director of the USC Lusk Center for Real Estate Development, tells MHN, “because there are laws about who can own property. You can invest, but you’re almost certainly going to be a minority in the property. Another pitfall is, the court’s enforcement of leases is spotty. If you have a tenant you want to kick out, it might take six or seven years in the courts before you actually get resolution.”
Green adds that yields are tiny in India, running in the neighborhood of 1 to 2 percent. “The second thing,” Green says, “is that vacancies are high because it’s hard to build down to the bulk of the Indian market. To put India in some perspective, if you look at the cutoff for the top 10 percent of income in India, it’s about the same as the bottom 10 percent of income in the U.S. It’s just a little higher than that.” For those who might want to build large-scale, U.S.-style communities, this presents obvious difficulties.
Indians are also of a different mentality than the average American renter, in that they typically stay at home and save their money until they can buy a condo. These differences in mentality and infrastructure are evident in other countries as well, keeping many U.S. companies understandably at bay. Green says, “People kind of kick the tires on this, and then they realize how hard it is and they don’t do it.”
China presents its own challenges. Patrick Phillips, CEO of the Urban Land Institute (ULI), tells MHN that China doesn’t particularly need foreign capital to house its population, as there is no shortage of capital in the country. “There’s probably an appetite for international investment in China,” Phillips says, “although it’s still fraught with risks—political risks associated with a communist dictatorship with a market economy, or at least the semblance of a market economy.”
However, ULI recently conducted a survey focusing on investment in second and third-tier markets in China and found that most of these markets are largely unfamiliar to Western investors. “With the exception of Chongqing, there’s a list of very large cities that nobody’s ever heard of in the West,” Phillips says. “So we have a long way to go before there’s the kind of investment or capital flows to and from China that there are between the U.S. and many other countries.”
Stan Harrelson, CEO of the Pinnacle Family of Companies, has done work in China as well as Japan and Korea. In comparison to the environment in Tokyo or Seoul, Harrelson tells MHN, “China is not nearly as easy to navigate. The least open, not from a standpoint of being eager but from a standpoint of assuring some level of fidelity, is China. China has an appetite and a desire, but the government is a very big challenge. Many times contracts mean little.”
Again, these things vary from city to city, but anywhere in China, the government plays a heavy hand. When asked what the biggest surprise has been in dealing with a government of questionable ethics, Harrelson responds, “the unilateral decision not to pay you, and the absence of consequence. It has tempered our enthusiasm, not to the point of taking us out of an interest level, but certainly of how much we’re willing to risk.” This is a government that is used to control, so relinquishing any control to an outsider creates resistance.
“For anything that we have been discouraged by in China,” Harrelson says, “we have been encouraged by in Korea.” He attributes this to having the right partners, a paramount component of dealing anywhere abroad. “It’s so critical when working anywhere outside of your own backyard to have the right partners,” he says. “You can’t emphasize enough the need for due diligence on those partners, to make sure you’re not doing for them more than they’re doing for you.” Nurturing those relationships at the local level can be the best way to navigate your way through governmental impediments.
Although Harrelson believes that Tokyo and Seoul represent cities of size and substance where there is an opportunity and need for a rental industry, “the challenges are several fold. One of them is that they have very definite notions as they relate to security deposits or what they call ‘key money,’ frequently requiring a year’s worth of rent in commercial spaces and near that much in residential spaces for the occupant to take possession. That’s a tough model to build to. There’s also not much of a competitive nature. I think there is an opportunity to go in there and define a rental sector, but as yet nobody has done it in consequence.”
Surprisingly, the apartment market in Europe is just as untapped. Despite recession-induced austerity measures, capital is still moving in Europe, but again, the apartment model is very different, even in the United Kingdom, where one might expect similarities to the U.S. model. “In London,” Harrelson says, “the average landlord owns fewer than four units, and they tend to be all over town. And they’re flats, in all different conditions and locations.”
Colleen Pentland Lally, associate director of the multi-housing group at CBRE Capital Markets, reinforces this point. “In the U.K. there is a huge pool of renters,” she tells MHN, “but it’s not institutional rental property. It’s not investment as far as blocks of buildings. Seventy-three percent of U.K. residential portfolios contain fewer than 10 units. The rental housing sector is worth about $925 billion in the U.K., and that’s more than the entire commercial property sector combined. Less than one percent of that $925 billion is held by institutions. So it’s just not a sophisticated investment market. All of those units are scattered around with different people.”
Pentland Lally has hosted several groups of investors and architects from the United Kingdom, taking them through Class A properties in Boston. She says, “They had never been in an institutional-grade apartment building, and they were taking notes. Architects from the U.K. have now partnered with architects who specialize in multifamily here in the U.S. to get that kind of guidance. The knowledge base just isn’t there to make that kind of investment.” She adds, “They were overwhelmed by the services that were provided by traditional multifamily here in the U.S.”
Of the post-Soviet countries in Eastern Europe, Joseph Karp, senior vice president of Apollo-Rida in Poland, tells MHN that “Poland is probably the most healthy, most market-driven.” But whereas the U.S. market has developed over the past 250 years, the market in Poland has been created in basically the last 20. “When someone asks what the value of a residential unit was in 1990,” Karp says, “no one can give you an answer, because there weren’t market values; there weren’t appraisals; there wasn’t anything except someone looking at a cost approach.”
Over time, the government has been able to move units into private hands. “There is a rental market,” Karp says, “but there are no classic American multifamily developments where a developer builds a building containing 250 units and rents them on a monthly basis. And I can tell you, in Ukraine and Belarus and Russia, that’s not the case, either. There are no apartment developers in the American standard.” In Poland, “it’s 95 percent condo, a few co-ops, but there’s no dedicated rental property.”
In these countries it is typical for people to stay at home with their parents until they’re 30, because they don’t have enough money for an apartment and are ultimately saving up for a condo of their own. “Poles as well as most Eastern Europeans still are cash buyers, cash savers,” Karp says. In terms of mobility, Poles are also very different from Americans, much more likely to stay in one spot and pay a place down until there’s nothing owed on it.
Banks in Poland, which are especially conservative these days, are reluctant to loan toward a rental product that historically hasn’t existed. And governments are just as hesitant to sign off. “The whole process of building permits and approvals is complicated here,” Karp says. “Visualize the bureaucrat in the local city government who’s been handed a request to build a project that’s not condominium, not cooperative. He doesn’t understand a rental apartment, so [that affects] the approval process.”
Phillips believes Turkey may be the strongest market in Europe. He says, “It’s a really fascinating market—politically moving in generally the right direction, with a robust economy and plenty of demand. Turkey has done really well by having an investment-friendly climate and good, solid growth prospects.”
As capital flies around looking for the best place to land, the big cities in South America show definite promise. Chairman of Equity Group Investments Sam Zell recently said in an interview on CNBC, “In a few weeks you’ll be hearing that the stock exchanges of Colombia, Peru and Chile are merging, making it the second-biggest stock exchange in Latin America behind Brazil, but larger than Mexico’s. This newly merged market will become a major funnel of capital into these markets after this event.”
In comparison to the other BRIC countries, Phillips says he sees the growth in Brazil as “a more modest pace of modernization but still pretty profound.” The country has “a relatively transparent market, an approach to development that is pretty similar to what we do here. It’s a market that could emerge as a potential investment vehicle for American companies.”
Bob Wislow, chairman and CEO of U.S. Equities Realty, agrees that there are markets to be tapped in South America, highlighted by the major cities in Brazil; Santiago, Chile; Bogota, Colombia; Lima, Peru; and definitely Buenos Aires, Argentina. “There’s no doubt that the multifamily market in Argentina has been a very hot market,” Wislow says. “The quality of the buildings has soared dramatically.”
Although the markets in Argentina and Chile have concentrated on condominium projects, there are developers “who are doing lofty kinds of contemporary buildings for successful young professionals to rent and doing extremely well in the market because there just isn’t much competition or much available in terms of those kinds of nice spaces,” Wislow tells MHN. “The market is expensive in Argentina, a little less expensive in Chile. There are certainly international prices on the high-end condo buildings.”
Argentina has a totally different way of financing condominium projects. Historically, developers have pre-sold their buildings before starting development, where the buyers put down half up front, then pay a monthly amount during construction so that the units are paid off by the project’s completion. But that end product of the high-rises, Wislow says, is generally very sophisticated. “You walk into one of those units and you think you’re in a very high-end unit anywhere in the United States—great amenities, great pools, workout rooms, club floors, very nice apartments, nice kitchens. You’d be very impressed, especially in Buenos Aires and in an area called Puerto Madero, which has a lot of foreign investors in it.”
When people talk about the BRIC construct, lumping those four countries together as the hot spots for growth, it’s a useful concept, but only to a certain extent. As Phillips says, “They all do fit within a general category of fast-growing, rapidly developing, rapidly urbanizing countries, and so it’s useful in those ways, but Brazil and Russia couldn’t be much more different, or India and Russia for that matter.” But however wildly divergent these countries are, a few maxims can be applied across the board.
In general, when it comes to an international rental market, there’s simply not a defined product. “Most of the housing is held by people who own a couple more units than they live in themselves,” Harrelson says. “The renters-by-choice aren’t engaged the same way that they are in this country, where mobility and efficiency and access to a fairly robust group of amenities are popular. Other countries just haven’t developed that same level of awareness or acceptance of rental property.”
And even as young people become more attracted to that lifestyle, other pieces have to fall in place. Harrelson points to the absence of any government-supported debt piece in other countries. “If you think about the role of Fannie and Freddie in the U.S., and HUD, it’s been to provide affordable debt to residential, for-rent products.” Investment doesn’t have the same appeal when you’re zero-leveraged.
Some think this may be starting to change. “We’re starting to see glimmers,” Pentland Lally says. “The New South Wales government [in Australia] is talking about developing and investing in rental housing. I believe some markets are starting to see a need for affordable workforce housing, or affordable housing in general. So they’re starting to take note and allow this type of development to start.”
Since Pinnacle has gotten its feet wet in foreign territory, Harrelson’s phone has been ringing. “As we’ve declared our intentions, I’ve received calls from anywhere from Bangladesh to Australia, from people who believe they too are under-served and that there’s an opportunity.” These calls come from both developers and governmental agencies who see the potential. In Sydney, for example, Harrelson says, “The supply-demand would blow you away in terms of the year-over-year rent increases and lack of availability for rental products.”
Harrelson is confident that the row of hurdles in this process of international expansion leads to a worthwhile finish line. “The fact that the world is getting smaller is a good thing,” he says. “I think that, notwithstanding the challenges of our own economy and so forth, there’s an opportunity to enthusiastically go outside our borders. You certainly need to be aware of the risks, [and] prepared for the setbacks; but my belief is that the rewards will be there.”