Property Magnate

Macquarie is bullish on Asian property and is looking to capitalize.

David Schaefer is the head of property for Asia at Macquarie Real Estate Asia. He runs a business seeking to profit on Asia's resurgent property markets and Macquarie's skills in packaging innovative financing deals. He discusses why now is the right time to be into Asian property and how he is looking to exploit the opportunities.

You recently moved from Seoul to Hong Kong. Have you bought a property to live in here or are you renting?

Schaefer: I'm renting. I have been way too busy in the process of the move to look at buying a place. In a saner world for me I would have looked into buying.

What's the scope of Macquarie's activities in the regional property market?

We're taking a fairly aggressive approach throughout Asia, with a relative concentration in North Asia over South East Asia. In July we opened an office in Tokyo, which now has six people of whom half have come from other parts of the bank and the other half from General Motors Acceptance Corp. We're close to getting our first deal done in Japan.

We also have offices in Seoul, Beijing, Shanghai, Hong Kong and we have just opened an office in Kuala Lumpur. As we go forward we're taking a very active interest in the development of the Reits markets in Asia. We listed a Reit in Korea earlier this year and that has been very successful.

We just released our first half-year results and the dividend we're paying out (8.3%) is considerably more than we forecast in the IPO prospectus (6.55%). The total return if you had bought the Reit at the IPO and held it through to June 30 would have been 14% including the capital gain.

This example illustrates what we're looking to do around Asia. If you look at alternative investment opportunities in Korea, returns on the three-year treasury bonds are 4.24% and the one-year time deposit rate is 3.8%. If you had had your money in the stock market for that period of time you would have lost 1.28%.

So the Reits are much more attractive than fixed income instruments and the stock market. We see that being the same throughout Asia.

There is an ageing population, a demand for yield and very low yielding alternatives. Reits offer a much more competitive yield. Look at Singapore where the Reits listed there have done extremely well. Not only have they had a capital appreciation, but they are also offering yields that are very competitive to other instruments.

Since the first Reit listed in Japan in October 2002, the market now has a capitalization of $14 billion. It's just scratching the surface. So we think that around Asia, the Reit market will be a significant one and that is a core space for Macquarie.

At the end of the day, Reits are still equity. What structures can you use to mitigate against some of the equity risks in these products?

Typically you won't have development risk in a Reit. One of the things you might do is do the development in advance and then use the Reit as the take out when you can get a stabilized yield. The pending legislation in Korea for the K Reits will allow for some minor amount of development risk to be taken. You also generally have very low levels of gearing in a Reit, whereas an investor in an opportunity fund will maximize the leverage to maximize the equity return. Reits will only have around 35% gearing, against the 70% levels you can see with private developers.

In Hong Kong the development of the Reit market has been slow. The government is working on sorting out some of the legislative problems, but at the end of the day, the property companies that have the buildings suitable for a Reit, don't need the money. How do you get over that hurdle? The only entity that has actually said it is going to do a Reit is the government.

I would say watch that space. It is not necessarily so that the only Reits that would launch in Hong Kong would be those launched by a property company. The first government Reit [called HK Link] will be a substantial undertaking. It will be the largest Reit in Asia. It is not the case that Reits are only a mechanism for a listed property company to take assets off its balance sheet. You can build them from the ground up as we have done in Australia and Korea.

What is a better business for Macquarie, investing directly in property yourself or creating investment vehicles for others to invest in?

Fundamentally, Macquarie is not a property investor per se. We recently formed Macquarie Global Property Advisors, which is a real estate global private equity investor. Two-and-a-half years ago we took over as senior advisor to Schroder Asia Property Fund, another real estate private equity fund.

This fund was under water but we turned it around and focused on investing the fund's money in hard assets in North Asia. We put the money to work in Korea and Hong Kong.

We bought three office buildings in Korea. We created re-issue asset backed securities, which had not been done before. These securities allowed us to acquire the buildings in tax-efficient transactions. Macquarie took 10% of each of those deals and Schroder Asia Properties took 90%. That was an innovative transaction.

So going out and buying properties for yield and capital gain is in the private equity fund side. We bring our skill sets into the execution of that.

For instance, during SARS last year, we contracted to buy four floors of retail in Causeway Bay in Hong Kong. At that point, sentiment was very negative; visitors weren't coming to Hong Kong. But the location was outstanding.

So we completed that acquisition, put in place some mezzanine financing to get the leverage up to nearly 80%. We then set about over the next year in renegotiating leases and increasing the net income by 11%. We - Schroder Asia Properties and Macquarie as a co-investor - sold that building in July this year. We were involved in that deal as investment banker, mezzanine financier, equity holder, and asset manager. It was an outstanding return for the investors in the fund.

In terms of property investment, on the one side we have the private equity and on the other we have developing the capital market opportunities through Reits and we have people deployed to develop those opportunities throughout Asia. Working between those two parts of the business, we are trying to create wholesale to retail opportunities. We look at how we can buy an asset and syndicate it to investors.

For instance, we are doing a lot of residential business in China. We're developing 1,600 units in Shanghai, 1,000 of them in the area where China's first Formula One race is taking place. We have a company called First China Property Group, 50% owned by Macquarie and 50% by Schroder Asia Property.

We have a full development team and were the first foreign residential development manager to secure a site through a government auction process. We then got all the permits and then raised a fairly significant amount of equity from a global real estate investor. We still have some equity in it but we run it. So really it's a matter of looking for niche investment opportunities and niche fund management opportunities.

You seem to have a big risk appetite: investing in Korea after the crisis; Hong Kong during Sars; China now during the government cooling off period.

Risk is about managing risk. Business is not about not taking risks. We have an extremely strong risk management culture and as a result it is a matter of understanding the risks, mitigating against them, isolating them and boxing them out. In any transaction we do there is an incredible amount of effort that goes into understanding the risks.

The fundamentals for property in Asia are very strong right now. As a result we have increased the number of people committed to Asia. There is an ageing population and a demand for housing product in many areas. Japan is reflating. The Hong Kong property market is looking positive.

We are looking for niche arbitrage opportunities. The deal we are doing in Japan is an example of good research and understanding trends. It is also about doing deals in a certain space that everyone else hasn't piled into yet. In Korea, when we bought the office buildings, it was because we were innovative. We did our research on the regulations governing asset-backed securities and we were therefore able to put together the re-issue ABS paper. You cannot do that if you are lazy.

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