Foreign Property Values
Could Finally Moderate

The sky-high prices for commercial real estate in Europe and a growing interest in China are expected to dominate a summit of global real-estate executives this weekend at the resort city of St. Moritz in Switzerland.

The most pressing question for many investors is whether current price levels for real estate can be sustained on a long-term basis, says Henri Alster, president of American European Investment Bankers and chairman of the New York-based Global Real Estate Institute, which organized the conference.

"All real-estate sectors have benefited from the extraordinary amount of money that has poured into real estate for a variety of reasons, including low interest rates and the disappointing performance of the stock markets," Mr. Alster says. "But, as prices rise, the question is whether people will keep their money in real estate or whether there will be a withdrawal away from real estate, which would prompt prices to revert to a more natural historic level," he adds.

Prices have been rising steadily in most European markets for the past 10 to 15 years, which can't be sustained indefinitely, suggesting that prices are likely to reach a plateau in many markets and increase just slightly in others.

"I don't think we see a lot of risk in real-estate values, and we expect to see some continuing improvements in markets such as Italy and France, as well as increasingly converging property yields between Central and Western Europe," says John Nacos, managing director and head of Deutsche Bank AG's European commercial real-estate unit, who is participating in the conference.

China is also on the group's agenda, reflecting international investors' starting to look more closely at Asia's biggest market. With a population approaching 1.3 billion, China is a market to be reckoned with. Annual office yields in Shanghai are hovering around 8% to 8.5%, with Beijing achieving yields as high as 9% to 10%. (The yield, broadly speaking, is the ratio of income from an investment to the total cost of the investment over a given period of time.)

The yields in China are higher than Western European office yields, where they average about 6%, depending on the market. But there are significant economic, political and real-estate risks that justify the higher yield in China, says Peter Hobbs, head of European real-estate research at Deutsche Bank in London.

And even though the Chinese yields are attractive, especially to Europeans, they have fallen sharply from the 15% to 20% of the mid-1990s, despite rising somewhat from their lows, especially in places such as Shanghai, where they fell to as low as 6% to 7%.

Global banks have been the first to invest in Chinese real estate, with U.S. investment bank Morgan Stanley one of the first to enter China's property market. In June, Morgan Stanley's Real Estate Fund IV International teamed up with Shanghai Dragon Investment to acquire nonperforming assets from China Construction Bank for about $344 million (€262.4 million). The portfolio comprised 154 assets from 16 branches of the Chinese bank, located in central and southern China. The deal included some assets under construction that could require additional capital investment. Deutsche Bank has also acquired some distressed commercial assets in the region.

"Banks such as Morgan Stanley have a presence in China's banking sector, which they have been able to leverage to buy real-estate assets there," says John Kukral, senior managing director at Blackstone Real Estate Advisors in London. "The question for other investors is whether there are laws in place in China to protect them and whether the market is transparent enough," he adds. Blackstone currently isn't planning to invest in China, says Mr. Kukral.

U.S. and European investors are intrigued by China, says Mr. Alster. "The problem is how do you go about doing business there," he says. "There is so much money in China that global capital is finding it hard to find a home, although the desire to invest is certainly there."

One way into the Chinese market might be via the residential sector. It is estimated that about 250 million to 300 million Chinese seek to move from rural areas to cities, and the shift is expected to create opportunities in the residential and retail markets.

Meanwhile, back in Europe, Germany remains flavor of the month, with the country's residential market and open-ended funds both on the agenda in St. Moritz.

"Germany is the biggest real-estate market in Europe, and we expect to see corporates, governments and financial institutions dispose of well north of €10 billion in real-estate assets in 2005," says Deutsche Bank's Mr. Nacos. "This will create opportunities for investors, advisers and lenders and will accelerate the development of a German REIT [real-estate investment trust] and commercial-mortgage-backed-securities market."

Germany's open-ended funds continue to garner interest. Such funds have been some of the most prolific investors during the past four years, and any change in their movement of capital could have a big impact on the real-estate market. Open-ended funds have access to a lot of liquidity as they are funded by shorter-term money. If the German government gives the go-ahead for REITs, the REIT structure could enable open-ended funds to better finance their long-term assets with permanent capital.

"How Germany's open-ended funds act and manage their assets is obviously very interesting to us," says Blackstone's Mr. Kukral. "If they become massive sellers of assets, for example, then that is something that would interest Blackstone."

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