Real Estate Industry Can Provide Growth Engine
Executive Vice President of Korea Asset Advisors (KAA)
In the past, real-estate properties were classified as fixed assets, which could not create any value on their own. They were viewed either as auxiliary assets acquired to secure space for manufacturing facilities or invested in by long-term investors such as life insurance companies who only expected capital gain, if not a proper level of income.
Real estate assets, however, act like real factories in that they now can generate revenue through stable cash flow. Moreover, increased investment of financial sector funds in the real estate market has enhanced liquidity of large-scale properties including commercial ones.
With the advent of new investment schemes such as REF (Real Estate Fund) and REIT (Real Estate Investment Trust), the real estate sector is also experiencing explosive growth, which was similarly witnessed in the capital market with the creation of public offering of company stocks for fund raising.
Such schemes have channeled individual investors' fund into the real estate industry by helping them invest in big buildings in city centers and thus have contributed to overall market growth.
Initially, funds from the financial sector were mainly invested in office buildings, which are a relatively stable income source and simple to operate. Continuing the momentum from successful initial investments, investment areas have been diversified to include shopping malls, warehouses, hotels and leisure facilities. Not just completed buildings but also projects under way are being invested in.
Recently, for risk hedging, portfolios are being expanded throughout the global market. In 2006, the total cross-border transaction volume was $ 1.16 billion, accounting for 20 percent of total global transactions. In the eight years since 1999 when Korea opened up its real estate market, Koreans have become used to foreign investors owning major buildings in Seoul and Korean financial institutions owning major buildings abroad.
International capital crossing borders, seeking to find secure investment targets and profits, is one aspect of global capitalism that we cannot control, and we will have to pay a high price if we try to reverse the trend, as Thomas Friedman mentioned in his book ``The Lexus and the Olive Tree.''
Such global capital has made it meaningless to divide domestic and foreign capital. Any domestic projects providing profits and opportunities will attract foreign investment and if the domestic market fails to offer such opportunities, even domestic investors will turn their eyes to foreign markets.
Then, what do the funds invested in real estate go after? Financial capital pursues stable income from building operation and capital gain from value appreciation. As more capital rushes into real estate, the cap rate, which shows the cash revenue to invested amount, is continuously decreasing from 7 percent to 8 percent a few years ago to 5 percent to 6 percent nowadays. Recently, cap rates have come into line all over the world due to increased cross-border transactions.
In 2005 and 2006, the total return on real estate investment, the sum of capital gain and NOI (net operating income), was recorded at between 14 percent and 16 percent worldwide. This high return is not just a recent phenomenon _ the average annual yield on real estate for the last 20 years (1986~2006) was 14.5 percent, while the average return on the S& P500 for the same period remained at 10.9 percent. This led to global financial institutions raising the ratio of real estate in their portfolio to 15 percent to 24 percent.
In this regard, we have to take a close look at the approaches that are taken by players in advanced markets. Real estate properties are no longer static and non-productive fixtures, nor assets that can be taken care of by non-professionals. They are dynamic assets that require constant improvement of facilities and services for increased productivity and customer satisfaction and new value creation as cultural spaces.
Investors in advanced markets tend to view a real estate asset as a company generating stable cash flow, rather than pursuing just short-term capital gain. Professional managers are a prerequisite for increased value of such ``company,'' who can set strategies for appropriate investment, cost management and profit making as well as conduct marketing efforts.
However, Korean financial institutions, newcomers in this field, focus on minimized costs rather than systematic operation by professionals. Now there are buildings in Korea that are worth over 1 trillion won. Well-organized and efficient operations by qualified personnel are required more than ever before. In order for the Korean market to narrow the gap between it and advanced markets, advanced management systems should be adopted to develop real estate properties into cultural spaces and create brand value through active capital expenditure and tenant mixture strategies.
The changes in operation and maintenance of properties require, in turn, changes in development processes. So far Korean developers and construction companies pursue just shortsighted income without considering long-term development in their region. ``Bunyang,'' which means the sales of separate units to individuals, is typical behavior, and the recent collapse in shopping mall development results from them.
Unlike Korean developers who implemented projects which have associated risks, with no long-term asset management plans, financial capital has introduced new development models to the market: feasibility studies are conducted before a development project is launched, and sales and operations are guaranteed after construction is completed.
With such systems, constructors have lower risk associated with recovery of their investment and financial institutions which finance a project can greatly reduce construction costs with lower risk premiums resulting from decreased default risk. After completion, continued cost-effective investment is made based on long-term operation strategies not for short-term recovery of investment, but to maximize the asset value by further developing properties into cultural spaces.
In order to foster the real estate industry in Korea as a locomotive of economic growth, it is necessary to take measures to draw financial capital to the Korean market. To this end, it is necessary to adopt new business models and systems covering the entire life cycle of real estate properties from construction to operation.
By employing such new approaches, Korea will successfully establish international financial hubs and attract foreign tourists as well as lay the foundation for the service and knowledge industries in order for the Korean economy to take another leap. Now is the time that we should understand real estate properties have the potential to serve as both physical infrastructure and cultural spaces.
If history can be any guide, it should be remembered that ancient Rome enjoyed its glory when it had established both socio-cultural spaces and infrastructure.