PREI PRUDENTIAL REAL ESTATE INVESTORS. Executive Summary

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1 PREI ABU DHABI Sizing Up the Emerging Markets: 2012 Update DECEMBER 2012 ATLANTA BEIJING CHICAGO HONG KONG ISTANBUL LISBON LONDON LUXEMBOURG MADISON MEXICO CITY MIAMI MILAN US Research MUNICH NEW YORK Paul Fiorilla Vice President Tel: PARIS RIO DE JANEIRO SAN FRANCISCO Manidipa Kapas, CFA Director Tel: SAO PAULO SEOUL SINGAPORE Youguo Liang, PhD, CFA Managing Director Tel: REF: PFIA-92HKMY SYDNEY TOKYO

2 Executive Summary In emerging markets, commercial real estate demand is best measured not by overall population and GDP, but by the size and economic output of the consumer class, which is the segment of the population that earns and produces enough to use institutional-quality real estate. Our universe of 24 emerging markets totals 3.9 billion people that produced $21.1 trillion of GDP in 2012, or $8,000 per capita. China, with 1.3 billion people, and India (1.2 billion) have by far the largest populations. GDP leaders are: China ($8.1 trillion), Brazil ($2.3 trillion), Russia ($1.9 trillion), India ($1.8 trillion) and Mexico ($1.1 trillion). Our universe s consumer class currently totals 452 million, which is projected to grow to 948 million by China has the largest consumer class, 164 million, which is forecast to grow to 421 million in Other top nations are: Russia (50 million today, 88 million in 2022), Mexico (33 million today, 44 million in 2022) and India (31 million today, 96 million in 2022). Within emerging markets, the consumer class is growing disproportionately larger as a share of population. Consumer class population is set to rise to 22% of emerging market population in 2022, up from 12% today. Meanwhile, the economic output of the consumer class is projected to rise 12.7% annually over the next decade compared to 10% for the overall national GDP. Total GDP produced by the consumer class is forecast to rise to $33.8 trillion in 2022 from $10.2 trillion today. By way of reference, US GDP is now $15.7 trillion, and it will grow 4.5% annually to $24.4 trillion in Currently, the GDP of developed nations is more than four times the amount of GDP produced by the consumer class in emerging markets. Within a decade, GDP of the consumer class in emerging markets is projected to be more than half that of developed nations and within two decades, productivity of the two segments will be roughly level. Our analysis of the consumer class in emerging markets is predicated on the idea that understanding the future landscape of markets is essential to creating a forward-looking investment strategy. Markets are not static, either in absolute terms or in relation to other markets. What we can see from our model which is based on easily available metrics such as population and gross domestic product (GDP) is that the demand for commercial real estate in emerging markets is set to grow at a rapid pace, both in absolute numbers and in relation to the developed world. As the GDP produced by emerging markets grows in coming years, the total wealth and resources in those nations will produce a growing number of residents who have the means to use institutional-quality real estate, such as shopping malls, office buildings, modern apartments and hotels. To be sure, market size is just one element of investing other factors have to be evaluated, such as liquidity, the legal and political environment and overall risk. But emerging markets are likely to produce a growing number of opportunities for commercial real estate investors over the long haul. 1

3 Emerging Market Universe At $8.1 trillion, China leads our universe of 24 emerging markets (which exclude African and Middle Eastern countries) in terms of GDP, followed by Brazil ($2.3 trillion), Russia ($1.9 trillion), India ($1.8 trillion) and Mexico ($1.1 trillion). China also tops in population (1.3 billion), followed by India (1.2 billion). Together those two Asian countries represent nearly two-thirds of the population of our emerging market universe (Exhibit 1). 1. UNIVERSE OF EMERGING COUNTRIES, RANKED BY GDP Population (M) GDP (US$ B) GDP Per Capita (US$) China 1,329 8,097 6,090 Brazil 195 2,314 11,880 Russia 143 1,936 13,560 India 1,220 1,841 1,510 Mexico 115 1,117 9,720 Indonesia ,540 Turkey ,490 Argentina ,140 Poland ,580 Venezuela ,780 Colombia ,650 Thailand ,260 Malaysia ,250 Chile ,900 Philippines ,410 Czech Rep ,770 Peru ,290 Ukraine ,820 Romania ,580 Vietnam ,640 Hungary ,190 Slovakia ,130 Ecuador ,790 Bulgaria ,940 Tot./Wtd. Av. 3,936 21,106 8,007 United States ,651 49,790 Japan 126 5,958 47,250 UK 63 2,454 38,860 Source: Economist Intelligence Unit (EIU); data for 2012 Yet in terms of GDP per capita, both China and India are among the poorer countries on the list, both falling below the average of $8,007. India ranks at the bottom ($1,510) and China is eighth from the bottom ($6,090). The Czech Republic, with a tiny 11 million population, tops the list in GDP per capita at $18,770, followed by even smaller Slovakia ($18,130), which has a population of 5 million. Other markets near the top of the list are Chile ($14,900), Venezuela ($13,780) and Russia ($13,560). Other countries with the lowest GDP per capita include: Vietnam ($1,640), Philippines ($2,410), Indonesia ($3,540) and the Ukraine ($3,820). The emerging universe is a far cry from the developed world. The US, for example, has a $15.7 trillion GDP, with $49,790 GDP per capita. Japan s GDP is $6 trillion and its GDP per capita is $47,250. In compiling our list of emerging countries, we used the definition by World Bank, which essentially classifies all countries as emerging except the US, Canada, Japan, Australia, New Zealand, the nations of Western Europe and the four Asian Tigers: Hong Kong, Singapore, South Korea and Taiwan. All GDP numbers and projections come from the Economist Intelligence Unit (EIU). 2

4 General Growth Characteristics Nominal GDP is forecast to grow at a fairly robust pace over the next decade in emerging markets (Exhibit 2). Our 24-nation sample is projected by the EIU to grow on average by 10% per year. (The growth figures are all derived from GDP in nominal US dollars, which include inflation and currency fluctuations.) That is a much higher growth rate than is projected for developed nations. India (13.9%) is projected as the fastest-growing emerging market, followed by China (12%), Indonesia (10.9%) and the Ukraine (9.6%). Countries with the lowest forecast growth are: Venezuela (-2%), Mexico (3.9%), Argentina (5.6%) and Peru (5.8%). 2. FORECAST NOMINAL GDP GROWTH IN EMERGING MARKETS ( ) India China Indonesia TOTAL Ukraine Malaysia Thailand Chile Philippines Turkey Vietnam Hungary Brazil Poland Russia Ecuador Romania Colombia Slovakia Bulgaria Czech Republic Peru Argentina Mexico Venezuela Source: EIU, PREI Research -2% 0% 2% 4% 6% 8% 10% 12% 14% Consumer Class Population Rapid economic growth will fuel the increase in the consumer class in our emerging market universe, which we project will grow to 948 million in 2022, more than double the 452 million in 2012, an annual increase of 7.7% (Exhibit 3). By contrast, growth in developed nations (in which 100% of the population is assumed to be consumer class) will be much less, or even negative in some countries. For example, the US population is expected to grow at a rate of 0.8% annually. 3

5 3. CONSUMER CLASS POPULATION IN EMERGING COUNTRIES Consumer Class Population (Mil) Compound Annual Growth Rates China % 6.7% 8.3% India % 9.9% 11.0% Russia % 4.3% 5.0% Brazil % 5.4% 6.0% Mexico % 4.8% 3.9% Poland % -0.5% 2.2% Turkey % 6.2% 5.9% Indonesia % 8.2% 9.3% Argentina % 5.7% 4.9% Malaysia % 5.7% 5.4% Thailand % 6.5% 6.3% Chile % 5.8% 6.7% Czech Republic % -0.5% -0.3% Colombia % 4.7% 5.3% Hungary % -0.4% 2.4% Romania % 8.6% 7.0% Ukraine % 8.4% 8.7% Peru % 5.4% 5.4% Venezuela % 4.2% 2.6% Philippines % 7.8% 8.0% Slovakia % -0.3% -0.2% Vietnam % 7.6% 8.5% Bulgaria % 5.8% 6.3% Ecuador % 5.3% 5.0% Total CC Pop , % 6.3% 7.0% Total Pop. 3,936 4,262 4, % 0.5% 0.7% Source: EIU, United Nations, PREI Research; data for 2012 The consumer class in emerging markets will grow much faster than the increase in total population due to economic growth and rising GDP per capita. Total population in our universe is forecast to grow to 4.3 billion, from 3.9 billion, or only 0.8% annually. As a result, by 2022, the consumer class will constitute 22% of emerging market populations, up from 12% today. China now has the largest consumer class population (164 million), and it is projected to grow by 9.9% annually to 464 million by India is forecast to have the most rapid growth rate (12%) over the next decade, and its consumer class population is expected to more than triple, to 96 million in 2022 from 31 million today. 4

6 Consumer Class GDP The total economic output of the consumer class is projected to grow fairly rapidly over the next decade. All told, the GDP produced by the consumer class of our universe is set to more than triple to $33.8 trillion in 2022, up from $10.2 trillion today (Exhibit 4). Total GDP in those nations will rise to $54.9 trillion from $21.1 trillion today. Consumer class GDP is forecast to grow by 12.7% annually, compared to 10% annual GDP growth overall. 4. CONSUMER CLASS ECONOMIC OUTPUT Consumer Class GDP (US$ Bil) Compound Annual Growth Rates China 3,409 16,004 46, % 11.3% 14.0% Brazil 1,331 3,294 7, % 7.9% 8.7% Russia 1,266 3,274 7, % 8.2% 9.1% India 337 2,151 8, % 14.6% 17.4% Turkey 456 1,287 3, % 9.1% 10.0% Mexico 751 1,176 2, % 6.5% 5.5% Poland , % 6.5% 8.3% Indonesia , % 11.3% 14.3% Argentina , % 8.0% 7.5% Malaysia , % 6.6% 8.9% Thailand , % 10.5% 11.0% Chile , % 8.4% 9.7% Colombia % 6.7% 6.9% Czech Republic % 5.3% 5.6% Hungary % 5.5% 8.2% Romania % 13.2% 11.9% Philippines % 10.8% 11.6% Peru % 6.9% 7.2% Venezuela % 3.9% 1.1% Slovakia % 7.5% 6.9% Ukraine % 12.6% 14.3% Vietnam % 11.4% 12.5% Ecuador % 9.0% 8.1% Bulgaria % 9.1% 8.9% Total CC GDP 10,189 33,798 89, % 10.3% 11.5% Total GDP 21,106 54, , % 8.1% 9.0% Source: EIU, United Nations, PREI Research; data for 2012 China leads our universe in consumer class GDP, at $3.4 trillion, and it is forecast to grow by 16.7% annually and reach $16 trillion in Other countries with high consumer class GDP include Brazil and Russia, both of which are projected to grow to $3.3 trillion in 2022 from roughly $1.3 trillion today. The fastest rate of growth in consumer class output is in India, where it is projected to grow 20.3% annually over the next decade. 5

7 Consumer Class Productivity Economic productivity of the consumer class in emerging nations is set to rise over the next decade, in some cases by a significant amount (Exhibit 5). The top three nations in productivity come from Latin America. At $43,231, Brazil s consumer class has the highest per capita GDP in our universe, and will rise 2.6% annually to $56,053 in Colombia is next, at $37,446 that is forecast to grow by 1.2% annually to $42,309 in Chile is third, at $34,489, and is expected to overtake Colombia by Some countries in which productivity is lower will experience faster growth. For example, India s consumer class productivity of $10,901 is projected to grow 7.4% annually, more than doubling to $22,327 in Meanwhile, in China current productivity of $20,769 is estimated to grow 6.2% annually to $38,054 in Largely because they have more education and marketable skills, members of the consumer class have higher economic productivity than peers within the same country, and therefore it has higher GDP per capita than the national average. The gap is largest in the Philippines, where consumer class GDP per capita is 8.5 times national GDP. Other notable countries in which the consumer class is a multiple to the country as a whole are: India (7.2 times), Brazil (3.6 times) China (3.4 times) Mexico (2.3 times) and Russia (1.9 times). In the Czech Republic and Slovakia, the entire population is above the consumer class GDP hurdle and thus has a multiple of HIGH PRODUCTIVITY OF THE CONSUMER CLASS Per Capita GDP of CC (US$ Bil) CAGR Multiple of Current Nat l Per Capita GDP Brazil 43,231 56, % 3.6 Chile 34,489 47, % 2.3 Colombia 37,466 42, % 4.9 Thailand 24,605 40, % 4.7 Malaysia 22,211 39, % 2.2 Indonesia 20,870 38, % 5.9 China 20,769 38, % 3.4 Russia 25,276 37, % 1.9 Turkey 21,412 35, % 2.0 Slovakia 18,130 34, % 1.0 Czech Republic 18,770 34, % 1.0 Argentina 24,115 31, % 2.0 Philippines 20,455 29, % 8.5 Peru 22,621 27, % 3.6 Hungary 15,630 26, % 1.3 Mexico 22,747 26, % 2.3 Ecuador 20,475 26, % 4.3 Poland 16,207 26, % 1.3 Venezuela 34,478 26, % 2.5 Romania 15,082 24, % 2.0 India 10,901 22, % 7.2 Ukraine 11,829 22, % 3.1 Bulgaria 18,446 21, % 2.7 Vietnam 13,415 19, % 8.2 Wtd. Avg. 22,518 35, % Source: EIU, United Nations, PREI Research; ordered by 2022 figures 6

8 Increasing Economic Clout of the Consumer Class As the consumer class increases its productivity and grows in number, the proportion of GDP produced by that class within each country will rise (Exhibit 6). The entire population of the Czech Republic and Slovakia already are deemed to be in the consumer class, and therefore consumer class GDP is 100% of national GDP in those countries. In Exhibit 6, we list the percentage of GDP produced by the consumer class in each country. With the 6. CC GDP AS A PERCENTAGE OF NATIONAL GDP OVER TIME Argentina 67% 76% 90% Brazil 58% 66% 77% Bulgaria 55% 70% 93% Chile 68% 82% 98% China 42% 64% 82% Colombia 57% 60% 67% Czech Republic 100% 100% 100% Ecuador 47% 49% 58% Hungary 76% 100% 100% India 18% 32% 45% Indonesia 22% 38% 51% Malaysia 64% 74% 86% Mexico 67% 72% 81% Peru 50% 59% 69% Philippines 26% 35% 44% Poland 78% 100% 100% Romania 47% 67% 99% Russia 65% 84% 100% Slovakia 100% 100% 100% Thailand 51% 62% 74% Turkey 58% 73% 91% Ukraine 23% 40% 65% Venezuela 55% 58% 64% Vietnam 17% 28% 37% Wtd. Avg. 48% 62% 75% Source: EIU, United Nations, PREI Research exception of the two countries that are already at 100%, each country will see an increase over the next decade. Two other Eastern European countries Poland (78% today) and Hungary (76% today) are projected to rise to 100% by Many of the biggest changes will come from countries in Asia with relatively low GDPs per capita, where even small increases in productivity will lead to big changes. China, for example, is projected to see GDP produced by its consumer class increase to roughly twothirds in 2022, up from 42% currently. In India, the percentage is set to grow to 32% in 2022 from 18% today. Latin American countries with relatively larger consumer classes today will improve at a less dramatic rate. Mexico is forecast to increase to 72% in 2022 from 67% today, while Brazil is projected to rise to 66% in 2022 from 58% today. Rising Importance of Emerging Markets The growth of the consumer class in emerging nations is or should be of acute interest to investors, since consumer class economic output is growing faster in emerging markets than developed nations (where the entire nation is deemed to be consumer class) and eventually the two will converge (Exhibit 7). Today, the GDP produced in developed markets is $43.6 trillion, more than four times the $10.2 trillion GDP produced by the 7

9 consumer class of emerging markets. However, over time the numbers will level out. In 2022, developed markets are projected to produce $61.9 trillion of GDP, not quite double that of the $33.8 trillion of the consumer class in emerging markets. And in two decades, the GDP produced is forecast to almost be the same: $95.6 trillion in developed markets and $89.7 trillion by the consumer class in today s emerging markets. 7. GDP OF DEVELOPED MARKETS VS. CONSUMER CLASS GDP OF EMERGING MARKETS (US$ TRILLIONS) TOTAL CC GDP IN EMERGING MARKETS TOTAL GDP OF DEVELOPED MARKETS Source: EIU, United Nations, PREI Research Appendix A: Key Model Inputs The key economic variables used in our estimation of the size and economic productivity of the consumer class purchasing power parity, GDP per capita, Gini coefficients and the country-specific per capita GDP threshold to consumer class in each country are listed in Exhibit 8. To determine the size of the consumer class in each country, we chose a global GDP threshold level of $10,000 per capita in 2000 U.S. dollars, which is based on the experience of newly industrialized Asian Tigers when they moved from the ranks of emerging to developed countries. The threshold is adjusted each year by the US inflation rate, and currently stands at $13,324. To account for differences in the cost of living across countries, we calculated the consumer class threshold in each country using purchasing power parity, which takes into account differences in the price of the same basket of goods and services in countries relative to the US. For example, a typical basket of goods and services that costs $100 in the US would cost $38 in India, $64 in China, $77 in Russia and $97 in Brazil. The last column in Exhibit 8 lists the 2012 GDP per capita threshold for defining the consumer class in each country. 8

10 In order to estimate the size of the consumer class in any country having a GDP per capita above the defined country threshold level, we use a Pareto distribution, which is a common model for estimating the dispersion of wealth, income and productivity. The model calculates the share of population and GDP produced by the consumer class in each country using national GDP per capita, the threshold consumer class GDP per capita and Gini coefficient, which is a statistical measure of the dispersion in income and productivity in a given economy. To calculate the absolute size of the consumer class and the GDP it produces, we need the total population and GDP in each country over the forecast horizon. As discussed previously, we obtained the forecasts of GDP and population from EIU. 8. KEY MODEL INPUTS Purchasing Power Parity GDP Per Capita (US$) Gini Coefficient CC Hurdle GDP (US$) Argentina , ,965 Brazil , ,950 Bulgaria , ,944 Chile , ,861 China , ,586 Colombia , ,810 Czech Republic , ,525 Ecuador , ,008 Hungary , ,196 India , ,036 Indonesia , ,642 Malaysia , ,174 Mexico , ,243 Peru , ,948 Philippines , ,955 Poland , ,947 Romania , ,909 Russia , ,249 Slovakia , ,952 Thailand , ,433 Turkey , ,242 The values of the Gini coefficients for each Ukraine , ,726 country are obtained from the latest Human Venezuela , ,575 Development Report published by the United Vietnam , ,083 Nations Development Program. The Source: EIU, United Nations, PREI Research; data as of 2012 coefficients range between zero and one, with a higher value indicating more unequal distribution of income. On average, emerging countries tend to have a greater degree of inequality than developed countries. We estimated the future levels of Gini coefficients in each country through a model that is based on the current level of wealth and productivity inequality, projected macroeconomic growth rates and the level of economic development. East European countries such as Bulgaria, Czech Republic, Hungary and Slovakia, which are more developed than other emerging nations, have the smallest Gini coefficients and therefore are the least unequal in terms of economic productivity. The highest dispersions in economic productivity come from the Latin American countries of Argentina, Brazil, Ecuador, Chile, Colombia and Peru, which are the only ones with a Gini coefficient of.50 or higher. The Gini coefficients for the Asian countries fall somewhere in the middle. 9

11 Appendix B: Details of the Mathematical Model We use GDP per head (GDH in the formulas below) as a measure of economic productivity per person in a country. If GDH is a random variable with a Pareto distribution, then the probability that GDH is greater than some number, say GDH CC, is given by: Pr(GDH > GDH CC ) = [k/(k-1) x GDH CC /µ)^(-k) (1) The distribution is defined by two parameters, k (a positive number) and µ (average GDP per capita for a country). If GDH CC is properly selected to represent a cutoff point between the consumer class and the lower class in terms of economic productivity, equation (1) is the population share of the consumer class relative to the total population. The mathematical relationship between the Gini coefficient (G) and parameter k in equation (1) is: k = 0.5(1+1/G) (2) Equation (1) can, therefore, be rewritten as: Population share of the consumer class = [(G+1)/(1-G) x GDH CC /µ]^(-0.5(1+1/g)) (3) Total consumer class population = (population share of the consumer class) x (total national population) (4) GDH CC is the minimum GDP per capita that qualifies a person as belonging to the consumer class in terms of economic productivity. The average GDP per capita for the consumer class, however, is substantially higher than the minimum and is given by: Average GDH for the consumer class = (G+1)/(1-G) x GDH CC (5) The total GDP produced by the consumer class is obtained by multiplying the average GDH for the consumer class, which is the result of equation (5), by the consumer class population. Hence, the percentage of the national GDP produced by the consumer class is simply the GDP produced by the consumer class divided by the national GDP. This can also be calculated directly as follows: GDP share of the consumer class = (population share of the consumer class) x (population share of the consumer class)^(-2g/(1+g)) (6) 10

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