Global Real Estate Transparency Index 2004

Transcription

1 Global Real Estate Transparency Index 2004 Executive Summary Real estate is a global business today. Once dominated by local competitors, markets throughout the world now attract a range of international investors, lenders, occupiers and developers seeking cross-border opportunities in search of optimal investment returns. Newcomers, however, often encounter unfamiliar and at times unfair practices in what, to them,are foreign markets. To level the playing field, they need to learn how the locals play the game. Asia Pacific Transparency Index IN CN TH MY SG ID HK TW VN KP PH JP Highly Semi- Low-Transparency Not Covered Measures that track the transparency of overall business environments, political risk and financial/accounting systems are currently available in most global markets. Information regarding the transparency of real estate markets has been harder to come by. Recognizing this need, Jones Lang LaSalle and LaSalle Investment Management introduced the first Global Real Estate Transparency Index in Designed to help real estate players better understand local market dynamics, the Index seeks to characterize the relative transparency of key global markets. The 2004 Global Real Estate Transparency Index, which addresses transparency in 50 countries 1,has been refined to focus on issues of greatest concern to our clients today. These include: Availability of accurate financial and market information Regulatory and legal environment European Transparency Index AU FI SE NO EE DK GB IE NL BE DE PL CZ UA FR CH AT HU RO IT PT ES GR TR NZ RU Security of legal title and enforceability of property rights Financial disclosure and governance of listed real estate companies Zoning and building codes In the period since we created the first Real Estate Transparency Index, 22 countries have maintained their ranking, 25 have improved by one or more tier, and none have slipped back. The inescapable conclusion is that global real estate markets have become more transparent in this time. Six countries, strong in all areas, stand out as beacons of high transparency: Australia and New Zealand in Asia Pacific, the United States and Canada in North America, and the United Kingdom and the Netherlands in Europe. With exemplary underlying legal and regulatory factors, and a high degree of institutional real estate ownership, these countries serve as role models in their respective regions. North and South America Transparency Index CA US MX CR CO BR CL AR 1. Argentina, Australia, Austria, Belgium, Brazil, Canada, Chile, Colombia, Costa Rica, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Germany, Greece, Hungary, India, Indonesia, Ireland, Israel, Italy, Japan, Malaysia, Mexico, Netherlands, New Zealand, Norway, P.R. China and Hong Kong, Philippines, Poland, Portugal, Romania, Russia, Saudi Arabia, Singapore, South Africa, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, Ukraine, United Arab Emirates (UAE), United Kingdom, United States and Vietnam. 1

2 emerging economies, weak in most areas, sit at the other end of the spectrum. In addition, most, if not all, of the countries that are not covered in the Index would fall into the opaque category. They have not been ranked, because they do not tend to be featured in the investment plans of many international investors, lenders, developers or occupiers. Most countries in the Index lie in a gray area: 39 are classified as either transparent, semi-transparent or of low transparency. This is the area in which the most change has occurred in the last four years. More than half of the countries included in our 1999 Index have improved by one or more tiers. As a region, Europe shows the greatest improvement. One-third of Asia Pacific countries are classified to a higher tier in 2004, due largely to improvements arising from the widespread introduction of REITs and more active cross-border capital flows. A full list of the 2004 Global Real Estate Transparency Index is included in the Appendix (see page 17). The Index can be a useful device for analyzing the risk profiles of national, regional or global property markets. But it should never be employed as the only factor in decision making. Low transparency can certainly impose risks and additional costs, for example, but this does not necessarily mean that all opaque markets should be avoided. In fact, the assistance of a knowledgeable, trustworthy advisor can help foreigners navigate such markets profitably. According to the Index, for example, Mexico and Japan are semi-transparent in terms of real estate practices and information. This means that firms used to dealing in highly transparent real estate markets often have to manage these risks and adjust their expectations when conducting real estate transactions in these countries. The importance of strong local partners becomes much more apparent in markets where information is scarce and local practices are so different from what international firms may be used to. At the other end of the spectrum, high transparency eases the free flow of capital and information but also makes it more difficult for occupiers and investors to identify undiscovered bargains. Definition and Purpose We define a real estate market of pure transparency as one that: Is completely open and clearly organized Operates in a legal and regulatory framework characterized by a consistent approach to the enforcement of published rules and regulations between corrupt practices and real estate market transparency. But a transparent real estate market is not only about freedom from corruption; it is also about the availability of information and the efficiency of the market. Real estate participants moving across borders have encountered many contributors to low transparency: Absence of financial benchmarks Lack of historical or current market statistics on supply, demand or rent Financial statements of listed vehicles that are neither detailed nor standardized according to GAAP/IAS Real estate tax procedures and building and zoning codes that are not published or are selectively enforced Situations where local assistance or under-the-table payments are required to navigate the investment/development/ management process Lack of title records or title insurance Environments in which government or public utilities acquire private property on short notice, introducing risk that owners will not be fairly compensated The 2004 Transparency Index provides an overview of the state of development in a country s private and public real estate markets. Its five sub-indices provide real estate players with a rigorous framework for comparing the level of transparency of real estate markets in the 50 documented countries. It can also be used as a strategic tool to classify markets and evaluate market risk. The Index is based on an analysis of a structured survey conducted with our global network of researchers. 2 Questions were asked about the following key attributes of real estate transparency: Legal factors Regulatory burden Availability of information on market fundamentals Listed vehicle financial disclosure and governance Availability of investment performance indices Respects private property rights Low transparency is frequently considered to be synonymous with corruption. Indeed, our analysis suggests a close correlation 2. A description of the 2004 Transparency Survey methodology is included in the Technical Notes on page 18. 2

3 We prepared a composite index and sub-indices for each attribute and grouped the countries/markets into five broad tiers of transparency: Tier 1: Highly Tier 2: Tier 3: Semi- Tier 4: Low Transparency Tier 5: Global Analysis While the neutrally-weighted 2004 Global Real Estate Transparency Index presents a fair and impartial starting point for comparing real estate markets, it does have limitations. Investors with a preference for 100% ownership or a particular ownership structure, for example, will first need to satisfy themselves that this is available. Cross-border investors will also need to consider the level of tax leakage to which they will be subject. Local rules, regulations and market practices vary widely from country to country, and different investors have different motives and risk-return profiles. A single global ranking probably cannot reflect the relative risks of such a range of investment needs and opportunities accurately. And, since transparency may be as much about perception as it is about reality, one could argue that any index might differ along several dimensions: The domicile of the investor: What is good from a U.S. perspective might not be as good (or as important) from a French or Indonesian perspective (e.g., availability of financial data in English). The nature of the subject: Factors that may be very important to an investor (e.g., performance indices) may not be as important to a developer or occupier. The nature of the real estate interest: Investors in indirect markets may attach greater importance to additional or different factors (e.g., listed vehicle governance) than investors in direct markets. By weighting factors according to a client s own perspective, the database we have developed on over 20 aspects of real estate transparency allows us to examine the implications of different domiciles, real estate subjects and the nature of investment on a client-specific basis. The analysis can be tailored to a client s circumstances and requirements to help underpin business decisions. It can also be calibrated to their specifications to identify new locations that may present opportunities with comparable risk/return profiles. It is a powerful tool to help investors understand the complex world of global real estate. Global Overview Real estate transparency is a structural factor in real estate markets. As a result, the 2004 Global Real Estate Transparency Index is not something that will change on a frequent basis. In fact, a country ranking is likely to change only when its legal or regulatory environment changes. It is striking,however,that,while 22 countries have maintained their ranking in the four years since our first Real Estate Transparency Survey, 25 have improved by one or more tier, and none have slipped back. The inescapable conclusion is that global real estate markets have become more transparent in this period. This improvement coincides with real estate s coming of age as an asset class, alongside stocks and bonds. It also corresponds to a period in which real estate returns generally exceeded those of stocks and bonds, with real estate offering stable returns in a period of stock market weakness and volatility. In addition, it coincides with an increase in the number and profile of crossborder investors. Chart 1: Real Estate Transparency: Overall # of countries Highly Semi- Low- Transparency Chart 1 shows that six countries, strong in all areas, stand out as beacons of high transparency: Australia and New Zealand in Asia Pacific, the United States and Canada in North America, and the United Kingdom and the Netherlands in Europe. With exemplary underlying legal and regulatory factors, and a high degree of institutional real estate ownership, these countries serve as role models in their respective regions. Since 1999, the Netherlands has joined the five other countries in Tier 1. emerging economies, weak in most areas, sit at the other end of the spectrum. In addition, most, if not all, of the countries that are not covered in the Index would fall into the opaque category. They have not been ranked, because they do not tend to be featured in the investment plans of many international investors, lenders, developers or occupiers. 3

4 Six opaque counties are: Ukraine, Romania and Turkey in Europe, Egypt and Saudi Arabia in the Middle East and Vietnam in Asia Pacific. Their Index rankings remain unchanged. Both Turkey and, to a lesser extent,vietnam, have shown signs of improvement, albeit not enough to move them up to a new tier. Although underlying legal and regulatory factors remain problematic in these two countries, the availability of market fundamentals research has improved. Chart 2: Correlation between Wealth and Transparency GDP Per Capita (US$) 45,000 30,000 15,000 0 Turkey Vietnam 5 (), EIU Chart 3: Real Estate Transparency Sub Indicies Overall Investment Performance Public Company Performance Market Fundamentals Regulatory Legal Highly Brazil Russia China 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Semi- 4 Japan Mexico Low-Transparency 1 (Highly ) Most of the countries in the Index lie in a gray area: 39 are classified as either transparent, semi-transparent or of low transparency. This is the area in which the most change has occurred in the last four years. More than half of the countries included in our 1999 Index have improved by one or more tiers. As a region, Europe shows the greatest improvement. One-third of Asia Pacific countries are classified to a higher tier in 2004, due largely to improvements arising from the widespread introduction of REITs and more active cross-border capital flows. While 3 Italy Real Estate Market Transparency Sweden Hong Kong 2 US UK Australia transparency levels were raised in many parts of Asia Pacific, individual country scores often did not improve sufficiently to trigger a change in ranking. This phenomenon does suggest an area to scrutinize in the years ahead. The correlation between wealth and transparency is illustrated in Chart 2. The wealthier a country, the greater real estate market transparency tends to be. There are exceptions, however. Japan is perhaps most notable. A wealthy country, given its level of economic development, Japan s real estate markets look like an untapped opportunity for international capital, especially if real estate transparency continues to improve as it has in recent years. Investors would do well to look for countries poised to move in a positive direction in this chart, either through rising wealth or improving real estate transparency. These countries will likely offer attractive returns through their potential to combine income growth and capital appreciation. Chart 2 does not, however, prove causality. For example, it does not show that wealth enables societies to develop a more transparent real estate market, nor does it provide clear evidence that a more transparent real estate market necessarily leads to greater wealth. There is probably some degree of truth in both viewpoints, however. Because property is by far the largest store of wealth, development economics suggests that property rights are the bedrock for economic development. In the fast-growing urban areas of the emerging economies, secure legal title to land can be the key for the poor to raise the finances to improve their homes or start a business. Using legal factors as a starting point, we developed a series of sub-indices: Investment Performance, Public Company Performance, Market Fundamentals, Regulatory and Legal. These are shown in Chart 3. These sub-indices have the same thresholds and tier structure as the overall Index. Since each sub-index is based on the answers to only two or three questions, it is inappropriate to publish subindex transparency country rankings in detail. Instead we examined the distribution of countries in each sub-index. In the overall Index, there is a broadly normal distribution. In some cases for the individual sub-indices, however, strikingly different patterns emerge. As shown in Chart 3, the legal sub-index, for example, is skewed towards greater transparency, while the performance sub-index shows an even distribution. Are such differences significant? The correlation between the rankings for the sub-indices is greater than 0.7 in all instances, suggesting it would be inappropriate to attach too much importance to the variations.yet to understand the drivers of the overall Index rankings, it is helpful to go through the distribution by sub-index. 4

5 Legal Sub-Index Chart 4: Real Estate Transparency: Legal 30% The security of legal title and the enforceability of property rights are critical issues for investors, lenders, developers and occupiers. In the other sub-indices, it is possible to offset a low score by adopting a higher risk premium. However, in this sub-index a low score on any variable might indicate a go-no go issue. Where there is no security of title or where enforceability of contract is not enforced consistently or an under-the-table payment may be required to obtain remedy international investors simply may not be prepared to invest. Or, they may not be allowed to invest by their domestic regulators. 25% 20% 15% 10% 5% 0% Highly Semi- Low- Transparency As shown in Chart 4, the majority of countries have a satisfactory legal framework in place. In these countries, the distribution is skewed strongly towards transparency. Indeed, over 50% of these countries rank as transparent or highly transparent. Less than a quarter rank as opaque or of low transparency, and these are all emerging markets. The legal factor is the most important aspect of transparency on which they must improve, since all else is built on its foundation. Regulatory Sub-Index Regulatory burdens can represent an area of dissatisfaction for contradictory reasons. Perceived over-regulation can be just as great a challenge for developers and investors as perceived underregulation. The Regulatory sub-index takes into account both the tax burden and the burden of planning and building regulation. It focuses on the degree to which there are clear, published codes that are applied with fairness and consistency. It also considers whether there are legal, inexpensive and commonly used means to reduce tax burdens or obtain variances from planning or building codes. As shown in Chart 5, few countries are highly transparent in this respect, although many are transparent. In fact, this is one area in which even the most transparent countries show room for improvement. However, as two-thirds of all countries rank as transparent or semi-transparent, they start from a high base. Chart 5: Real Estate Transparency: Regulatory 40% 35% 30% 25% 20% 15% 10% 5% 0% Chart 6: Real Estate Transparency: Market Fundamentals 30% 25% 20% 15% 10% 5% Highly Semi- Low- Transparency Market Fundamentals Sub-Index The availability of market-fundamentals research for the main real estate sectors of the major cities of a country is an essential underpinning for a sophisticated real estate market. We have examined the availability of time series on major variables such as supply, demand, vacancy rate, rent and yield for offices, multifamily/residential, retail, industrial/warehousing and hotels. As shown in Chart 6, the aggregate distribution of countries is close to a normal distribution. A quarter or more of countries are transparent, semi-transparent or of low transparency. Of the remaining countries, half are highly transparent and half are opaque. 0% Highly Semi- Low- Transparency It is noteworthy that many countries rank highly in one or more sectors, but few have universal coverage with sufficient time series. The highly transparent countries are the Tier 1 countries. The opaque countries are primarily in Asia Pacific and Eastern Europe. This category is likely to change very slowly. Once a consistent quality data source is established, it generally takes many years to build a time series. Thus, this is an area of transparency in which improvement is generally predictable. 5

6 Public Company Performance Sub-Index The quality of governance of listed vehicles has earned increasing importance with the growth of listed property companies and REITs. In most countries, the quality of governance of listed real estate vehicles is closely correlated to the overall quality of corporate governance. This sub-index focuses on the quality of financial disclosure, the availability of financial data in English and the extent to which the interests of shareholders and management are aligned. Chart 7: Real Estate Transparency: Public Company Performance 30% 25% 20% 15% 10% 5% 0% As shown in Chart 7, the distribution of countries is quite even between each of the transparency tiers. To a significant degree this probably reflects the impact of globalization, as international accounting standards have been adopted increasingly around the world to attract international capital at lower risk premiums. One distinguishing feature that remains, in some cases, is the availability of financial reports in English.Another subtle difference emerges in the alignment of interests between shareholders and management. Especially in the more emerging markets, numerous companies are controlled by family or friends who share little or no alignment of interest with minority shareholders. Chart 8: Real Estate Transparency: Investment Performance Index 45% 40% 35% 30% 25% 20% 15% Highly Semi- Low- Transparency Investment Performance Sub-Index The availability of reliable performance indicators based on hard data is a key advantage in the eyes of many institutional investors. Performance indices based on national data provide some comfort, but they are poor substitutes when it comes to benchmarking performance against peers. Performance indices for indirect real estate markets are generally well-established wherever listed real estate companies or REITs have emerged. Direct real estate market performance indices are becoming more common, but their acceptance has been slow in some locations. As shown in Chart 8, the distribution of countries in the Investment Performance sub-index is bi-polar. Where direct and indirect market performance indices have been available for a reasonable period of time, they make a major contribution to high transparency. This accounts for over 20% of countries represented in the Index. Where real or notional indices do not exist, they are a source of low transparency or opacity. This accounts for 55% of countries. Asia Pacific Overview Patterns within the Region The heterogeneous countries of Asia Pacific reflect a wide range of real estate market transparency. The region has the world s most transparent real estate markets and some of the least. To the extent that there is a geographical pattern, it suggests that there is much greater transparency in Australasia than in Asia. Chart 9 illustrates this broad pattern. It does not reveal particularly effectively, however, areas of greater transparency within Asia Pacific: Hong Kong and Singapore. Physically and demographically small, they rank well above their weight economically and in terms of concentrations of high-value real estate. The real estate markets in Australia and New Zealand are ranked as the most transparent real estate markets in the world, marginally ahead of the United States and the United Kingdom. They score highly on all categories, but perhaps stand out most in terms of their legal framework, the availability of public and private performance indices, and market fundamentals research. Hong Kong and Singapore are close behind, with few, if any, areas of significant weakness. The introduction of REITs into the Singapore market in 2002 and the adoption of a REIT Code in Hong Kong in 2003 will serve to consolidate their positions. 10% 5% 0% Highly Semi- Low- Transparency Real estate markets in Japan, Malaysia, Taiwan, South Korea, the Philippines and Thailand have all become more transparent in recent years. In part, this is a product of their greater openness to international investors following the Asian Financial Crisis of In Japan, one of the world s most advanced economies, 6

7 a painful period of restructuring in the aftermath of a bubble economy has required greater transparency in the real estate sector. This emerged as a prerequisite to dealing with nonperforming loans in the financial sector secured against real estate assets. The successful introduction of REITs into the Japanese market has also been a key catalyst for improving transparency. Malaysia is the principal beneficiary of a greater emphasis on underlying legal and regulatory issues; its high scores offset weaknesses in the governance of listed vehicles, quality of market fundamentals research and the availability of investment performance indices. In Asia s emerging economies, similar pressures have produced similar results, although primarily, perhaps, through the actions of the International Monetary Fund and various versions of Resolution Trust Corporations. In Asia Pacific s semi-transparent real estate markets, many of the improvements have come through welcome systemic change. The quality of market fundamentals research, however, and the availability of investment performance indices remain challenging. many international investors portfolios because of their small size and, in the latter case, because much international capital remains deterred by ownership restrictions and the legacy of recent capital controls. Chart 9: Asia Pacific Transparency Index IN CN TH MY SG ID VN HK KP TW PH AU JP Highly Semi- Low-Transparency Not Covered The trend is also towards greater openness and transparency in China, India and Indonesia. But at present, there remain low levels of transparency within a number of areas, especially governance of listed vehicles in which further improvement would be desirable. Vietnam remains the only country we classify as opaque, although a number of other countries such as Cambodia, Laos and Myanmar would likely also fall into this category if they were included in the Index. Impact on Cross-Border Investment There is no consistent data on cross-border investment in Asia Pacific that can be used to judge the impact of transparency on capital flows. If there were data, it would be interesting to test two complementary theses, namely that real estate investors allocate larger amounts of capital to: Chart 10: Transparency Influences Capital Flows GDP Per Capita (US$) 40,000 30,000 20,000 A Strong Correlation R 2 =.63 Japan Core NZ Hong Kong Singapore Australia More transparent markets and Markets experiencing or expected to experience the greatest improvements in transparency. 10,000 Taiwan South Korea New Zealand There is no clear evidence that international investors allocate larger amounts of capital to highly transparent countries than to relatively low transparency countries in absolute terms. As Chart 10 shows, however, to an extent this may be because Asia Pacific s more transparent real estate markets tend to be found in its smaller countries. Thus international investors may be investing more relative to market capitalization in Australia, Hong Kong and Singapore. These three highly transparent real estate markets tend to form an overweight allocation in many cross-border investors portfolios, particularly for investors with more risk-averse investment profiles. The same cannot be said for New Zealand and Malaysia, however. They do not form an overweight allocation in P.R. China India Indonesia Vietnam 0 Philippines 5 () 4 Thailand 1 (Highly ) Transparency in Japan and Korea has improved significantly in recent years. Arguably this is both a cause and an effect of international capital flows. Given the size of its underlying 3 Real Estate Market Transparency Size of GDP (US$ BIllions) Malaysia 501 or above

8 economy, Japan in particular tends to be a large but underweighted part of many investment portfolios. Both countries attract considerable attention from international investors, particularly from opportunistic investors, but more recently also from investors with less appetite for risk. In recent years, Japan and Korea have not been significant sources of international real estate capital flows. It is noteworthy, however, that in the 1980s, Japanese and Korean investors, with semitransparent home markets, found that a similar lack of transparency in Southeast Asia was not a deterrent to investment. Recently there have been tentative signs that Korean capital is again beginning to look offshore towards Southeast Asia. China and India tend to attract less international capital than their market capitalization would suggest. For example, China, probably the most active and rapidly changing real estate market in the world, is drawing considerable international investment. Much of the capital is either recycled Mainland Chinese money or comes from overseas Chinese individuals and companies, and much of it is channeled through Hong Kong. This local mediation helps to mitigate the challenge and risk of opacity in the real estate markets in Mainland China. Foreign and Domestic Investors Foreign investors are often thought to be at a disadvantage compared with local investors due to real estate market transparency. The idea is that,with better access to local information, and in some cases lower tax and other regulatory burdens, local investors will ascribe a lower risk premium than international investors looking at the same market. Under such conditions, the local investor will outbid the international investor. Chart 11: Transparency and Corruption Real Estate Market Transparency (Highly ) () A Strong Correlation R 2 =.86 Thailand Philippines China India Indonesia Vietnam 2 Malaysia Taiwan South Korea 4 6 Corruption* * 0 being most corrupt, and 10 being least corrupt. Hong Kong New Zealand Australia Japan, Transparency International 8 Singapore 10 In fact, the results of our 2004 Transparency Survey for Asia Pacific give very little support to this viewpoint. There are only isolated instances in which international investors are at an explicit disadvantage. Generally, there are easy and inexpensive legal ways to offset the types of withholding taxes that are thought to disadvantage foreign capital, for example. Indeed, international investors can actually be at an advantage, due to preferential policies that encourage foreign direct investment. Generally it is, or can be, a fairly level playing field for foreign and local investors. Korea is a possible exception. There, the standards of financial disclosure for listed vehicles tend to put indirect investors at a slight disadvantage. Financial reporting meets local standards, but these are not overly detailed and are not consistent with IAS or GAAP. Frequently, financial information is available in Korean but not in English. The tax regulatory burden for direct investors is a further distinguishing aspect. While a consistently applied, simple real estate tax code applies to foreign and domestic investors alike, it is more expensive and less simple for international investors to adopt legally acceptable and commonly used mechanisms to reduce the taxes payable. These issues have held Korea back in our transparency rankings. Indonesia and the Philippines are also exceptions. To some extent their status is counterintuitive. In many aspects, the tax and regulatory burden for foreign investors scores slightly better for foreign than for domestic investors. Foreigners are more likely to be given consistent treatment than domestic investors and are less likely to be subject to the same degree of pressure for under-thetable payments. Chart 11 shows that there is a striking correlation between perceptions of corruption according to international monitor Transparency International and our Real Estate Transparency Index scores. Why, then, is there a widespread perception that the playing field tilts sharply in favor of local investors in less transparent markets? There are three possible explanations. First, the answer may lie in the word perception. In less transparent markets, foreign investors are often simply not sure whether domestic investors are receiving favorable treatment. Second, it may be that there are differences in practice that have not been adequately captured by our Transparency Survey. For example, there may be simple, legal, inexpensive ways to offset tax for both foreign and local capital, but if one is slightly easier or results in a slightly lower tax burden than the other, then a significant difference may emerge. Finally, it may simply be that domestic investors have locational advantages-long established networks and familiarity with the local market and its regulations. Transparency and Real Estate Practices The level of real estate transparency affects real estate practices in different countries within the region in different ways for investors, lenders, developers and occupiers. As Chart 12 shows, 8

9 transparency is no barrier to occupier demand. The recent Jones Lang LaSalle Corporate Real Estate Impact Survey showed strong levels of demand over the next six months in the Tier 4 countries. Transparency can be an important influence on how occupiers meet such requirements, however. For example, for years many multinational corporations found that the only way to invest in manufacturing capacity in China was to purchase land-use rights and to develop infrastructure, factory and worker accommodations. As openness and transparency in the Chinese real estate market have improved, it has been possible to commission manufacturing facilities on a design-and-build basis and, more recently, to lease space in industrial parks built by real estate investors. As a result, the accommodation strategy of occupiers in China has changed, taking expensive real estate investment off the balance sheet as far as possible. An important trend in recent years has been the growth of outsourcing multinational corporate real estate functions to specialist service providers on a global or regional basis. In part this has been facilitated by improvements in the transparency of real estate markets, in the sense that it has become more practical for small, central, in-house teams to manage a large number of complex real estate transactions with third-party service providers who provide market knowledge and implementation services at the local level. In Asia Pacific, this trend is growing. In many of the mandates, it is the ability to execute transactions in the less transparent markets that drives appointments of service providers. This helps to improve transparency in formerly opaque markets through the development of local market fundamentals. Real estate development remains a largely domestic business. There are few international developers and fewer genuinely panregional developers. A lack of transparency, combined with an insider s local knowledge, can be an effective barrier to entry and a source of monopolistic returns. China is an exception that proves the rule. Many international investors and developers in Chinese real estate, particularly overseas Chinese companies and individuals, are active despite and arguably because of a lack of transparency. It is no coincidence that they have concentrated on a small number of cities, often those with which they have the greatest historic or cultural connection. Hong Kong developers have been very active in Shanghai or in the cities of the Pearl River Delta; Taiwanese investors in the Fujian Province. Access to offmarket opportunities through personal networks and partners has been a key part of the strategy. Attitudes of Investors to High/Low Transparency Investor attitudes to transparency tend to provide both a framework for their regional investment strategies and a basis for assessing country and real estate risk premiums. Although attitudes to risk and reward vary from investor to investor, there are broad patterns, particularly for institutional investors. Core investors tend to focus on the more mature, open and transparent real estate markets: Australia, New Zealand, Hong Kong and Singapore. Chart 12: Transparency is No Barrier to Occupier Demand Net Change in Real Estate Demand (next 6 months) Highly Australia Semi- However, most core investors also include Japan and Korea, with an appropriate risk premium added, because of the sheer size of their economies. Malaysia tends to be excluded from core programs, because it is small, perceived by many as potentially overbuilt and has restrictions on ownership and a recent history of capital controls. Opportunistic investors will also consider less mature, less open, semi-transparent real estate markets but demand a higher return commensurate with the higher associated risk. Only the most opportunistic international investors will consider less transparent and opaque markets: China, India, Indonesia and Vietnam. Recommendations for Real Estate Investors Low- Transparency New Zealand Hong Kong Singapore Malaysia Japan Philippines South Korea Taiwan Thailand China India Indonesia Vietnam Transparency is already high in Australasia and is improving in Asia. REITs have been a powerful force for greater transparency wherever they have been introduced in Asia Pacific. We expect continued improvements in most Asian Pacific markets. If this trend is sustained, more mature, more stable and more transparent real estate markets should stimulate domestic institutional investment in real estate and cross-border real estate capital flows. This suggests that, by acting ahead of a predictable improvement in transparency, an investor can benefit from enhanced riskadjusted returns. It suggests investors may lower risk premiums in the future, which should reduce cap rates in the long-term and increase capital flows. This may counteract any upward pressure on cap rates as global interest rates start to rise. 9

10 Europe, Middle East and Africa Overview Patterns within the Region The region covered in this section is geographically diverse, from Finland to South Africa, and encompasses a wide variety of business environments and cultures. Chart 13 displays the countries in the region according to their transparency scores (excluding the Middle East and Africa). There is a distinct pattern of transparency moving eastward from the United Kingdom and the Netherlands (both Tier 1), which have the highest scores, at the western edge of the map. There are naturally exceptions to this broad geographic pattern Greece, for example but the pattern is clear. The results of the 2004 Global Real Estate Transparency Index are, in fact, very highly correlated with the Economist Intelligence Unit s (EIU) country ratings for the quality of the overall business environment. Chart 13: European Transparency Index PT IE Highly Semi- Low-Transparency Not Covered ES GB NO DK SE NL BE DE PL CZ FR CH AT HU IT GR RO EE FI Omitted from Chart 13 are South Africa (transparent), Israel (semi-transparent), United Arab Emirates (low transparency), Egypt (opaque) and Saudi Arabia (opaque). The level of transparency in these countries broadly conforms to our identified pattern, with the exceptions of Israel and South Africa. Countries not evaluated in our 2004 Index could be other exceptions.direct comparisons between the 2001 Index and the 2004 Index are difficult, as the variables that were analyzed have changed. However, some broad trends can be identified. Overall, 17 of the 27 countries analyzed in 2001 increased their scores relative to the 2004 Index (two markets were not covered by the last analysis); 10 markets remained static and no markets moved backwards. UA TR RU Countries in Central Europe have generally improved their transparency over the past two years, and we would expect these European Union accession countries to continue to improve their position in the short- to medium-term. Our rankings for the Nordic countries have also generally improved, reflecting the fact that these markets are opening up to outside investors, and that the provision of indices and information on market fundamentals has improved greatly. Finally, the southern European countries, from Portugal to Greece, have generally improved their transparency, with all raising their rankings by at least one position, and in the case of Greece, two positions. At the top of the rankings, the Netherlands has also improved its ranking in recent years, although this is partly explained by our increased focus on public market transparency, where the Dutch market is particularly strong. At the other end of the scale, parts of Eastern Europe and the Middle East have failed to increase their scores. The one exception is Russia, which has moved from Tier 5 to Tier 4. Impact on Cross-Border Investment Cross-border investment within Europe is driven by a number of factors in addition to transparency. Our latest analysis of crossborder capital flows in Europe reveals that the dominant destinations for international capital over the last two years have been the UK and France, dominated by the London and Paris office markets (see Chart 14). Clearly the UK and France are both transparent markets, being Tier 1 and Tier 2, respectively. However, transparency on its own does not explain the attraction of these markets to international investors. Germany, for example, is also Tier 2, but its share of cross-border capital has remained in the 0%-5% range over the past few years, largely as a result of pricing issues. The Netherlands, Sweden, Ireland, Belgium and Spain have also typically attracted 3%-7% of overseas acquisitions, despite having relatively high transparency rankings. The main reasons why the U.K. and France continue to dominate are the size and depth of the markets, and the resulting opportunities for investors. At present there is no shortage of capital looking for product within Europe, particularly from debt-driven private investors, and in part as a result of the recent poor performance of alternative asset classes. This money is chasing a relatively narrow band of prime properties let on long leases to good quality tenants, providing secure income streams. The London and Paris markets are currently still the most likely sources of such assets. This is not to say that there is no relationship between transparency and capital flows. Sweden, for example, has seen its share of international capital increase from 0% in 2000 to 11% in Although Sweden has had a performance benchmark from Investment Property Databank since 1997, we believe its openness 10

11 to overseas investors, including information on market fundamentals and access to product, has improved significantly in recent years. A further interesting aspect of the cross-border market in Europe relates to the retail sector. In most European countries, the office market is much more transparent than the retail sector, and the scoring in our Transparency Index tends to reflect the most transparent sector,i.e.,offices. However, in contrast to the office sector, where most purchases are still made by domestic investors, we estimate that 74% of shopping centers with a gross leaseable area of over 25,000 square meters that have been sold since 1999 have been acquired by cross-border investors. Consequently, in southern European countries such as Portugal and Italy, where the retail sector accounts for the majority of cross-border investment, the transparency of the retail sector is better than that for offices. In these circumstances, the national transparency score can understate the transparency of the retail sector. Foreign vs. Domestic Investors In Europe, there is little regulatory and legal evidence to support the viewpoint that transparency is different for a domestic investor than for a foreign investor. By most measures, the environment is considered to be the same for both domestic and overseas investors. The one exception to this is the tax regulatory burden, where, for the majority of countries, the transparency burden is considered to be lower for domestic investors than for overseas investors. The difference is not considered to be great, usually only a single point, and largely relates to the availability and cost of legally acceptable and commonly used mechanisms to reduce the taxes payable. But the behavior of international investors is influenced by more than just the transparency of markets. An example would be Germany, which is generally considered to be a transparent market, but where we have seen very little overseas investment in recent years. This is partly due to the success of the German openended funds in attracting money from private German investors. These funds saw record inflows of 15 billion in 2002, while inflows in 2003 were slightly lower at just under 14 billion. Despite their increasing overseas investment activity, some 40% of money invested in 2002 (some 5.2 billion) was spent in the German market, bolstering prices and creating an extremely competitive environment for overseas investors at the prime end of the market. In fact, most international investors choose to avoid the German market, because they cannot achieve the returns available in the other main European markets. Chart 14: Destination of Overseas Purchases 2002 and Billion Source: Jones Lang LaSalle Chart 15: European Cross-Border Investment Volumes Billions Germany 6.1% % Netherlands 4.5% Sweden 5.3% Italy 6.1% Spain 5.0% Belgium 6.7% CEE 3.1% Germany 3.4% Spain 5.3% Netherlands 5.8% Italy 6.8% Source: Jones Lang LaSalle CEE Belgium 2.5% Finland 3.0% Sweden 11.4% Denmark Finland 0.7% 1.6% 26.6 France 19.8% Billion Denmark 1.7% France 17.2% Luxembourg 0.6% Portugal 0.3% Luxembourg 0.2% Portugal 0.1% 34.7 UK 40.1% UK 39.6% Note: Activity includes sales and acquisitions by foreign investors 11

12 Transparency and Real Estate Practices One area where improvements in transparency do appear to act as a catalyst for long-term change in real estate practices is the level of transparency in public markets. This is particularly true in emerging real estate markets, where there has traditionally not been an open culture and where international investors have not usually been active in private markets. In these circumstances, it is very often the emergence of a quoted public sector, with the accompanying analysis of underlying markets, which acts as a driver for further improvements in transparency. For example, public sector vehicles may adopt innovative financing techniques, attracting international capital and real estate expertise, which in turn have a positive influence on other industry players. Our analysis reveals that the top 10 countries in our Index all have high scores for public sector governance, with the UK and the Netherlands consistently receiving top scores for both the availability of public market indices and the quality of corporate governance. Chart 16: Sources of Cross-Border Investment in Europe 2002 Quoted Property Company 8.7% German Special Fund 2.0% Unknown 4.0% Third Party Managed Fund 7.9% Institution 9.6% Open-Ended Fund 1.9% Bank Sponsored Fund 9.7% Source: Jones Lang LaSalle Closed-Ended Fund 1.6% Owner Occupier 0.7% Public Sector 0.1% Private Property Company 13.8% Attitude of International Investors to High/Low Transparency German Open-Ended Fund 21.4% Private Individual / Syndicate 18.6% European real estate capital markets are becoming increasingly international, with some 38.4 billion of cross-border investment transactions undertaken in 2003, representing 48% of the total investment volume of 80.6 billion in Europe. International investors are aware of the wide variations in market transparency across the region and adjust their return requirements accordingly. For most countries in Tiers 1 and 2, transparency is not an issue in the direct market, and information on market fundamentals, including time series, is good across all the main investment sectors. Performance indices are generally available, enabling performance measurement, benchmarking, assessments of risk and return, and market forecasting. For countries in Tier 3 and below, investors tend to adopt a much more cautious approach. There is a wide variety of reasons why these countries fail to appear in the top two tiers, from lack of private market indices to poor governance for listed vehicles. However, a common factor is relatively poor information on market fundamentals when compared to core western European markets. This type of information serves to underpin investor confidence in a market, and its absence will lead to increased country risk premiums and consequently higher required local returns. In some cases, lack of transparency will cause a country to be omitted from the investable universe when investors draw up their international investment strategies. Although this is not always the case, and while many middle-tier countries remain firmly on the radar screens of mainstream investors (the German open-ended funds, for example), these countries are at present dominated by risk-seeking opportunistic investors who have high leveraged return targets. Tier 3 countries where this type of investor has traditionally been dominant include the Czech Republic, Hungary, Poland and Greece. Recommendations for Real Estate Investors Transparency is continually improving within the region, and there are now only seven countries in Tiers 4 and 5, representing 25% of the sample. At the same time, investment volumes in Europe have been growing.we estimate that total investment volumes grew by 21% between 2000 and 2003, from 66.5 billion to 80.6 billion. Cross-border investment as a proportion of the total increased from under 40% to 48% over the same period, rising from 24.0 billion to 34.7 billion. We estimate that there is currently about 40 billion of available capital (equity) targeted at Europe from a variety of sources: institutions, opportunity funds, open-ended funds, property companies and leveraged private investors. With the exception of the opportunity funds, most of this capital is targeted at the prime end of the market, properties let on long leases to secure covenants. Competition for this type of product is most intense in the mature western European markets, although the opportunities in these countries are greater as a result of the greater size, depth and maturity of the real estate markets. One way for investors to avoid the intense competition of the mature western European countries is to diversify into the less transparent countries in Tier 3 and below. In doing so, they are not only avoiding the competitive threat of cross-border investors who would not consider these countries, but are also potentially exploiting price variations within the region by betting on improving transparency in the hope that this will be accompanied by an inward yield shift. International investors need to be certain, however, that they are not being taken advantage of by local investors. For many local 12