Going Over the Hedge

The unofficial theme at APREA’s 2011 Property Leaders Forum in Beijing was inflation — a point underlined by April 15 data, which showed that inflation in China accelerated to a three-year high in March.

“What we have in Asia is a textbook case of a wage-price spiral,” said Philippa Malmgren, president and founder of the Canonbury Group, in a keynote speech to delegates, which asserted that rising inflationary pressure could be with us for some time, even as monetary and fiscal policies are tightened.

The warming up in recent months of the global macroeconomic climate is palpable: from the European Central Bank’s decision to raise interest rates to the discontent triggered by rising food prices across the Arab world, change is in the air.

“Even Wal-Mart cannot stop this process,” Malmgren said, after noting how the cost of a basket of core goods sold by the world’s biggest retailer has risen by 5% in the past year, in part because its Asian suppliers are no longer making things as cheaply as they used to.

Among the issues raised at the APREA conference were: How is higher inflation going to impact global capital flows and to what extent will it support some assets over others? Might Asian real estate benefit given property’s reputation, albeit questionable reputation, as an inflation hedge?

Offering the industry some hope was an APREA-sponsored study by Patrick Lecomte of the ESSEC Business School in Singapore and Yun Park of Chung-Ang University and California State University at Fullerton, based on a “co-integration test” developed by two Nobel laureates, no less.

According to the study, inflation rates and real estate returns are correlated in the long run, suggesting Asian real estate assets do hedge inflation over a period of 10 years or more. Perhaps surprisingly, property shares in Hong Kong, Singapore and Japan scored particularly well.

Some in the audience, though, were skeptical.

The past is not necessarily a solid guide to the future, and the report, as one delegate pointed out, contradicted an earlier study of British commercial real estate, which looked at a far longer period when global inflation both rose and fell.  

A second question from the floor also cast doubt on the relevance of the property security indexes used. These, the delegate said, were developer-heavy rather than REIT-orientated and so reflected equity market risk rather than real estate risk.

Thinking through the potential relationship between inflation and real estate also raised other issues. As Lecomte himself noted, commercial property rents in the region are generally not linked to the local rate of inflation, with the notable exception of South Korea.

For real estate investments to act as a hedge against rising inflation they need to generate unencumbered cash flow that keeps pace with prices. It helps if supply is constrained. But where the stock of real estate is still largely being built and the choicest, stabilized assets are tightly held, as in Asia, it is unclear how investors can reliably put on that hedge.

As other speakers noted during the conference, there are relatively few REIT-standard assets across much of Asia.

In any case, as Malmgren said, there are better inflation hedges than property out there. Aside from gold, which is already richly valued, diamonds are an investor’s best friend.   

She also tipped must-have hardcore manufacturing assets, citing Warren Buffett’s recent acquisition of specialty chemical firm The Lubrizol Corp.

Nearer to real estate home she singled out agricultural farmland, in keeping with the growing global clamor for better food security in the face of rising soft commodity, grain and meat prices.

Malmgren said there was a growing interest among sovereign wealth funds to acquire agricultural land where the rule of law is strong, such as in Australia, Canada and the U.S. There is also the potential for Middle Eastern buying interest in fellow Islamic states such as Indonesia and Malaysia.  

With the global population poised to hit 7 billion soon and incomes rising rapidly but belatedly for a huge chunk of that population, that’s an inflation hedge more people can believe in.

Source:  SNL

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