Real Estate Really Becoming :Finance, Finance, and Finance;?

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

June 2006

Your humble author recently has had the pleasure of participating in a few professional real estate related conferences, even as one of the invited guest speakers in a couple of the occasions. Naturally, apart from offering a platform for exchanging views and experiences with counterpart professionals, sharing and learning at the same time, such events are also a conduit for networking and business development. Your author had also attended a presentation by a seasoned professional who thought that real estate has gone from being a :location, location, and location; issue to a :finance, finance, and finance; concern.  

Notwithstanding there might be some reality in the thinking, your author begs to differ. For readers who have been reading our articles on a regular basis, you would realize that while we think the popular motto of :location, location, and location; is misleading, then, now, and in future [refer to the 3rd article in this quarterly newsletter =], we do not think real estate is all about finance either, despite real estate as an asset class has been securitized, e.g. via REITS (real estate investment trusts), and that there is now a wider array of financing / capital products, arrangements, and structures for real estate assets and projects than before.  

Here are a couple of opinions: 

A)     Real estate finance, securitization, and the like are NOT really a new phenomenon = notwithstanding these could be relatively new to markets such as Hong Kong / China / Asia. Nonetheless, the various real estate related financial products, REITS, CMBS (commercial mortgage-backed securities) and so on have been in existence for decades especially in the USA though one may say such had gained popularity in any significant numbers only in the last 15 years or so. Admittedly during the period, financial concerns, issues, and applications have been gaining importance, sophistication, and attention even for what used to be the relatively simple .bricks and mortar・ real estate asset, and invariably, professionals, such as accountants, bankers, financiers, investment advisors, and the like, whose participation and influence used to be sparse in real estate in the old days, have also seen their input gaining importance and sometimes even dominance. This may sound a bit depressing for .brick and mortar・ professionals who used to have the last say in matters relating to real estate, yet the same / similar phenomenon applies to almost each and every industry and asset class. A manufacturer may keep on producing sports wear, but once he or she decides to go for public money via an IPO (initial public offering), the financial angles are raised and financial professionals such as investment bankers can exert a huge impact on the way the business is to be .presented・. The manufacturer still needs to keep his or her plant engineers, sales teams, material buyers, and even book-keepers and accountants, just that these people may need to work toward a viable IPO plan and the financials that go with it. Likewise, a real estate developer-investor contemplating a REIT would definitely require financial advice to address the various financial issues, yet the real estate portfolio would still require the various real estate and building professionals for development, maintenance, management, renovation, tenant liaison, marketing, and the like. Yes, the financial professionals may earn more in salaries and fees than most if not all of these .bricks and mortar・ professionals under these circumstances, but this in itself does not negate the contribution from the latter group. As to why finance professionals seem to earn more and / or enjoy more say even in real estate matters, this is beyond your author・s comprehension and even if he is up to it, this may mean writing a book, not an article. Nonetheless, the size and growth of capital markets worldwide (real estate markets included), and the monies that flow between them, not to mention the multiplying effect, should explain in part if not in whole, the reason for finance professionals making generally good money and enjoying growing status. Also, when so much capital is at your disposal, there is a chance the one may exert an influence on the market conditions and pricings (movers and shakers), if not for long at least for a short while, unintentionally or otherwise.


B)     Real estate bubbles (bursts) generally have something to do with .financing・ = in the broadest sense of the word. These could mean banks and financing institutions over-lending indiscriminately to real estate developers resulting in probable oversupply, or households buying more home than is required owing to low mortgage rates, or even investors going for real estate not due to having confidence in the market but the tax shelters offered by various projects (this was quite popular in the USA and Canada in the late 1980s and early 1990s yet when the market fell, many of such tax shelter investors lost heavily). In short, the various financial products and mechanisms do not seem able to be of much help if and when real estate markets dive or behave in a volatile pattern. In some cases, such financial products and mechanisms may become a double-edged sword, i.e. they enhance the return when times are good, yet they are a double whammy when times are bad. A REIT which utilizes some form of creative financing and mortgages may enjoy lower than market rates in the initial years on the understanding that it will face higher than market rates after such initial years. This may assist in obtaining a better pricing for the REIT initially, yet the heavier subsequent financial burden could be a concern. If rental income rises sufficiently to cover for this, the financing scheme can work quite well. If not, the REIT will start to show lower income and probably lower share pricing.  

Not being a financial expert, your humble has the impression that finance has in many instances to do with using OPM (Other People・s Money), contemplating the form the money is to be obtained e.g. as equity, loan, bond, or a hybrid etc, analyzing and shifting / sharing the risks involved to / with others, structure the money to suit including relevant tax and accounting practices, enhance the cash flow (perceived) strength and steadiness, setting up exit mechanisms and fall-back tactics etc. As such, a good financial scheme and plan would not only enhance value but also help a business / asset ride out the short term storm, yet probably no financial schemes would make a long term lemon into a success (without retorting to Enron-like practices).  

In some ways, if finance is likened to make-up, a suitable (good) make-up does enhance the beauty and appeal of the person, while an overdone (bad) make-up conveys a feeling of unease and artificiality. Caution is advised whenever investors feel uneasy when looking at an investment opportunity.

Notes: The article and/or content contained herein are for general reference only and are not meant to substitute for proper professional advice and/or due diligence. The author(s) and Zeppelin, including its staff, associates, consultants, executives and the like do not accept any responsibility or liability for losses, damages, claims and the like arising out of the use or reference to the content contained herein.

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