Real Estate Industry Can Provide Growth Engine

By An Gye-hwan

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.