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 worse.

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 country.

Crumbling BRICs?

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

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 zero.

Brazil 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.

India 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 market.

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

Common Barriers

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

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 effectively].

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.