Look for countries
with strong middle-class growth -- say, China or Brazil. Stick mainly to
housing and retail. Focus on the long term. And don't attempt to do it without
a local partner.

That was the
consensus among the global real estate developers, investors, finance
specialists and executives who spoke at the recent Knowledge@Wharton Real
Estate in Emerging Markets Forum. With the economy in a tailspin and demand
drying up in the U.S. and Western Europe, it's not surprising that real estate
investors are more attracted to emerging markets than ever before.

In the U.S., for
example, housing starts are at an all-time low -- down 2.7% in December,
according to Bloomberg -- and builders have seen their share values drop 76%
since the housing bubble burst. In early January, research firm Reis reported
that mall vacancies have reached a 10-year high and are likely to go up as more
stores claim bankruptcy and close their doors following six consecutive months
of declining sales in 2008.

Now it seems that
the unstoppable consumer demand and high returns once guaranteed by
hypergrowth markets like the fabled BRICs -- Brazil, Russia, India
and China -- are no longer a given, either. Although the Forum panelists and
speakers saw value in individual markets, they agreed that the
decoupling hypothesis -- the notion that emerging markets can
maintain growth independently of any major disruptions in the U.S. economy --
has proven to be untrue. In fact, as one panelist noted, the current situation
would be more accurately described as turbo-coupling.

Ignatius Chithelen,
managing partner of New York investment firm Banyan Tree Capital, pointed out
that between 2003 and 2007, the Standard & Poor's Index rose by 80%, and
during the same period, the MSCI Emerging Markets Index was up nearly 400%. Today,
the U.S. market is down 50%, and emerging markets are down 60% to 70%. This
isn't decoupling.... Very simply, when [the U.S. market] goes up, it goes up
much higher in emerging markets, and when it goes down, it goes down much


Chithelen noted that
the BRIC classification was originally developed for marketing purposes.
You can't view these markets as one single entity. Each one needs to be
judged individually according to the underlying fundamentals. Within the
BRIC classification, for example, China stands apart as the world's
banker, he said, citing the country's $4 trillion in reserves, its trade
and budget surpluses, and its ability to allocate huge resources to
infrastructure projects. Today, [China] is the best-situated


Because it has been
singled out as the world's fastest-growing economy, China is perhaps the poster
child for the kind of trouble that may lie ahead for emerging markets. Far from
being immune to the ongoing recession in the U.S., China has seen a dramatic
drop in exports, and manufacturing job losses are on the rise, numbering close
to four million so far. In mid January, Fitch Ratings issued a statement that
China's economy will experience a hard landing in 2009, with growth
estimated at 6%. (A growth rate below 8% is considered a recession by the
Chinese government.)

The economic
uncertainty has filtered down to the real estate sector -- particularly in
housing, where consumers' lack of confidence is being felt. According to the
January 16 edition of China Daily,
housing prices are likely to see a huge downward pressure as
prospective buyers put their purchasing plans on hold. Meanwhile, the
government has asked developers to lower prices to stimulate sales, and large
developers are cutting back on the floor area of new projects -- some by as
much as 30% to 40% -- to hedge against any reductions in sales.

But despite current
ills, China does have one thing that several participants viewed as critical
for evaluating investments in emerging markets: its huge population of 1.4
billion people, which, long term, will fuel the demand for affordable housing
and retail. GDP [growth] will ultimately follow population, said
Philip Mintz, managing director of Warburg Pincus Asia in Hong Kong. Selecting
a market with long-term prospects for growth and choosing the right asset class
can give a semblance of decoupling, Mintz noted, because the
investment is driven by macroeconomic trends, not by current market forces.


In fact, Warburg
Pincus recently launched a $1.5 billion fund with 75% focused on Asia. Of that
amount, 60% is focused on China where Warburg Pincus has invested in existing,
stabilized assets with only 40% to 50% leverage. It has also started businesses
from scratch. You couldn't do [the latter] in the United States,
Mintz said. The U.S. is not a growth market.

Sam Zell, chairman
of Equity Group Investments and Equity International, who spoke as part of a
keynote panel, underscored that point as he offered his take on various
emerging markets. When asked why he would look to invest in emerging markets
like Egypt or Mexico versus the United States or Europe, Zell responded,
The answer is demand. When the world begins to recover from the
current economic turmoil, he said, the populations in these regions will be
looking to fill their basic needs first, like housing. That's not the case in
markets like the U.S., Japan and Western Europe, where the only play has
been to leverage things up. And although growth in emerging markets has
slowed considerably from 100% to 60%, that's still 60% [growth] over

or Bust

In addition to
projects developing affordable housing in Cairo and in Mexico, Zell's Equity
International is focusing heavily on Brazil, which he singled out as a
particularly strong opportunity for investment. Like Mexico, Brazil subsidizes
low-income mortgages, so consumer access to financing has been largely
unaffected by the markets. The country also has unlimited [natural]
resources, and, unlike Mexico, a strong executive talent pool to help
outside investors achieve scale in operations. On the retail side, Zell noted
that store sales are up 12% from last year in the malls owned by his group -- a
stark contrast to the recent U.S. figures. If you look at all of the
facts, I don't think there's another environment in the world that's better
than Brazil.

According to Tom
Shapiro, president and founder of GoldenTree InSite Partners, a New York-based
real estate investment firm, Brazil is not seeing the distress found in other
markets. Mortgages account for only 2% of GDP in Brazil, he noted, versus 65%
in the United States and 74% in the UK, so consumers aren't feeling the effects
of credit contraction. Demand is high, and unlike other markets which have seen
rampant speculation, there hasn't been any overdevelopment. Shapiro said that
his firm typically sees 40% to 50% of condominium units in a given complex sold
within two weeks. Recently, GoldenTree sold 70% of the units in an office
project in Sao Paulo in only 10 days.

In Brazil, real
estate purchases require 15% cash up front and a 1% monthly pay-down on the
principal. If the financial crisis has a wider impact, Shapiro said, market
growth may slow among middle class homeowners, who don't receive government
subsidies for mortgages.

and Russia on Hold

India, with more
than one billion people and rapid growth in its middle class, should be high on
anyone's list for investing, but Zell and other Forum participants noted some
drawbacks -- specifically, widespread corruption and arcane formal processes that
hamper any real progress. [In India,] there's bureaucracy beyond
belief, Zell said. We tried to go down that road several times, but
we never got anywhere. For the time being, he said, the potential for
investment in India may not be realized. Moreover, it's not clear what an
outside developer could bring to the market, he added. You need to look
for opportunities that need servicing in order to add value in any

For all development
projects, the participants generally agreed it is critical to have a local
partner and a team on the ground -- although that need is perhaps even more
acute in India and other markets where a lack of infrastructure impedes easy
access to construction sites for foreigners. In those cases, it's imperative to
make the effort to visit any project sites in person. You've got to see
the assets [in India], said Richard Johnson, CEO of Standard
Chartered-Istithmar Real Estate Fund Management in Singapore. You need to
see what they've built. Follow-through isn't always up to Western
standards, he noted. I've been to apartments [where] the three steps
leading to the front door aren't there.

Russia, too, should
merit high marks as an investment destination, with its massive oil reserves
and increasingly wealthy consumers.  Mark Weiss, president of JER
Investors Trust, which has private equity funds in Russia and Georgia, noted
that real estate development in Russia has not caught up with its growing
middle class. He spoke about an Ikea-like store he visited outside
of Moscow that had 100 registers, [all with lines] 10-people deep.
With that kind of opportunity, you would think there's tremendous potential for
retail development. The problem, he said, is funding. We do development
projects ... and the first thing to go [during a financial crisis] is funding
for development deals.... There is no lending going on in Russia. 

But the fundamental
issue preventing many investors from going to Russia and many other markets,
Zell said, is rampant corruption. In Russia, they just steal [your
company], he noted, relating a story about one firm that was taken over
by the Russian tax authorities, leaving its foreign owner with no legal
recourse. It's one thing to trade growth for rule of law, but another
thing to trade growth for kleptomania.


Corruption and lack
of transparency ranked high on participants' lists of reasons to avoid
particular markets. Life is too short when there is much that can
be accomplished elsewhere, said Eyal Ofer, chairman of Ofer Global Holdings in
Monaco, which has investments in Eastern European countries. Unlike Russia, he
noted, the countries he is investing in are civil societies,
reconstituting old European laws.

Another main
obstacle is red tape. Vietnam, for example, has been on real estate investors'
radar screens for some time, but despite its growth potential, it is
totally crippled by its bureaucracy, Ofer said.

For Zell, the key
issue is the ability to achieve scale. Africa, for example -- outside of Egypt
and South Africa -- has great potential for development, but there's no
infrastructure, and no talent to recruit.... Distance is a deal-breaker, and you
need to be able to develop on-the-ground power [to run the business

Although several
untapped markets may look attractive, at present there is enough to do in those
markets that are open to and support development activity -- such as China and
Brazil. Who wants to take their money where they aren't wanted? Zell
asked. I don't see any reason to invest [in a market] unless I see
sufficient premium to reflect the complexity and effort.

Republished with permission from Knowledge@Wharton (http://knowledge.wharton.upenn.edu), the online research and business analysis journal of the Wharton School of the University of Pennsylvania.