By Peter Grant
Investors are showing more interest in commercial real estate in Asia, South America and other emerging markets, where growth trends and the lure of outsize returns overshadow the additional political and financial risks these regions can pose.
From 2012 to 2016, investors mostly were fleeing markets like Brazil, Russia and India as those countries were hit by political turmoil, weak growth and shaky values. But in the last 18 months, some of the biggest names in real-estate investing have become more bullish on emerging markets as growth has picked up and some governments implement reforms.
In India alone, private-equity firms are expected to acquire a record $4.2 billion in real-estate assets this year, according to Knight Frank Research. Recent big deals include Singapore's sovereign-wealth fund, GIC Pte Ltd, which agreed in August to buy a $1.4 billion stake in one of India's biggest real-estate developers, DLF Ltd.
Investors looking for deals in India also include Blackstone Group LP, KKR & Co. and Brookfield Property Partners, according to people familiar with the matter. Brookfield is about to close its $1 billion purchase of the office and retail space in a sprawling master-planned community in the Powai suburb of Mumbai from its developer, Hiranandani Group.
Meanwhile in Mexico, PGIM Real Estate has built Terrafina into the country's largest owner of logistics properties, with a market capitalization of $2 billion, up from $900 million in 2013. Further south, Sam Zell's Equity International last year purchased a stake in Brazilian parking lot operator Estapar Estacionamentos SA for $154 million, the firm's first investment in that country since 2012.
"Our appetite has increased and our enthusiasm has increased," Mr. Zell said of current emerging market opportunities.
No one is comparing today with the golden decade of emerging market investments that ended after the global financial crisis. During that period, investors were on a buying spree as the so-called BRIC economies -- named after Brazil, Russia, India and China -- posted stronger growth than most of the rest of the world.
Warning flags continue to wave over some countries following the selloff. Most big investors from the U.S. and Western Europe continue to have little interest in Russia because of concern about the legal system there. Many countries remain too volatile or small to attract global investors.
The Brazil economy is big enough, but has numerous weak spots. For example, vacancy in the São Paulo region remains stubbornly high at 26.7% at the end of the second quarter, according to Cushman & Wakefield.
India is more popular with global investors, but that doesn't mean there aren't headaches. For example, India still hasn't seen its first real-estate investment trust launch even though its real-estate industry has been working with government officials for years to make this happen.
Still, over the past year, the International Monetary Fund has repeatedly revised up its growth forecasts for emerging economies, which are now expected to expand 4.8% in 2018 from 4.1% in 2016, the slowest pace for these countries since 2009. To real-estate investors, this means hikes in hotel room stays, shopping center traffic and demand for office space from expanding companies.
Emerging markets are particularly compelling because growth rates there are expected to outpace those of developed markets.
"Any real-estate investor is probably looking to some extent at levels of economic growth as a proxy for what cash flow growth could potentially be," said Ritson Ferguson, chief executive of CBRE Global Investors, which has made investments in high growth economies of Eastern Europe and Asia.
Investors also have been reassured by political and economic reforms that are being put in place in countries like India and Brazil and the transformation of real-estate markets to take on western qualities. For example, office buildings and malls in some countries increasingly have one owner, rather than being carved up among numerous investors and occupiers.
When deals succeed, investors are well compensated for the risks they take. Returns can exceed 20%.
"If you were pricing ground up development risk in an emerging market, you would be entitled to earn at least 1,000 basis points more on a currency hedged basis return relative to a U.S. project of similar ground-up real estate risk," said Ralph Rosenberg, head of KKR's real-estate business, which has committed about $800 million to real-estate projects in China and India since 2011.
One example of a success story: Blackstone built a 29-mall portfolio in China between 2013 and 2015 and sold it last year to a domestic buyer, China Vanke Co., for a $300 million profit, according to people familiar with the matter.
Investors predict the current emerging markets cycle will be different from those of the past. For example, in some countries, like China, finding deals has become more difficult because domestic investors have grown to become more formidable competitors.
At the same time, emerging market economies are changing, which presents new opportunities. Historically, emerging market growth has been primarily dependent on cheap labor and exporting commodities and other goods, said Taimur Hyat, PGIM's chief strategy officer. In the future, success will be determined more by demand from emerging consumer classes and trade among emerging market countries, he said.
"Those become much more idiosyncratic stories rather than a single monolithic story about rising and falling on the coattails of developed markets growth," Mr. Hyat said.
Carolyn Cui and Shefali Anand contributed to this article.
Write to Peter Grant at [email protected]
Corrections & Amplifications
This item was corrected at 2:51 p.m. ET to show that Blackstone built a 29-mall portfolio in China between 2013 and 2015, not India.