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Shenzhen Real Estate Statistic


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									C E N T E R O N J A PA N E S E E C O N O M Y A N D B U S I N E S S


                     October 27, 2004

                            he real estate markets of East Asia are attracting increased inter-

                     T      est from the international investment community. Economic

                     growth but also distress, as well as changing government regulations

                     and other factors, have created significant new business opportunities

                     across the region.

                     Japan and China, two of the world’s largest economies, are both located

                     in the East Asian region and share growing economic interests, yet in many respects offer very

                     different real estate markets and investment opportunities. What are the similarities and differ-
                     ences of the Japanese and Chinese real estate markets, how are these markets evolving, and what

                     are the implications for investors, both foreign and domestic?

                     To answer these and related questions, The Program on Alternative Investments invited George
                     von Liphart, Managing Director of the Global Commercial Real Estate Group at Lehman Brothers,

                     to offer his views on these two dynamic East Asian real estate markets. Mr. von Liphart, based

                     in Tokyo, has played a key role in his firm’s expanding real estate activities in both countries

                     over a number of years. This report covers Mr. von Liphart’s initial presentation as well as the

                     ensuing question-and-answer session with the audience. This program was co-sponsored by the

                     Paul Milstein Center for Real Estate.

                     The Program on Alternative Investments of the Center on Japanese Economy and Business analyzes three sets of
                     alternative asset classes—private equity, hedge funds, and real estate—in Japan and elsewhere in East Asia in
                     international perspective. The Program meets its substantive goals through a combination of research projects
                     and seminar presentations, the latter led by leading practitioners in each of these three alternative asset classes.
                     For information on the Center on Japanese Economy and Business, please visit
                     For a schedule of upcoming events and other information about The Program on Alternative Investments, please

                     Lead Corporate Sponsors: Daido Life Insurance Company; Nomura Holdings Inc. Corporate Sponsors: Advantage Partners, Inc.; Shinsei Bank, Ltd.
2   Center on Japanese Economy and Business   Program on Alternative Investments

            REAL ESTATE:
            October 27, 2004
                                                       From left to right: Mark Mason, George von Liphart, and Hugh Patrick

                                                      MARK MASON                                               Then he suggested that I do a com-
                                                      Director, Program on Alternative                         parison and contrast. That is a huge
                                                      Investments, Center on Japanese                          task, but I’ve assembled a collection
                                                      Economy and Business, Columbia                           of statistics and topics that I hope
                                                      Business School
                                                                                                               will illustrate some important points
                                                      It is a pleasure to introduce today’s                    of comparison.
                                                      speaker. George von Liphart is
                                                      Managing Director of the Global                          Let me start first by setting the con-
                                                      Commercial Real Estate Group at                          text of Lehman Brothers’ real estate
                                                      Lehman Brothers. George has an                           and Asian real estate franchises. First
                                                      impressive background in finance,                         of all, the two groups that are prima-
                                                      real estate, and Asia, including a key                   rily involved with real estate–related
                                                      position with GMAC in Tokyo prior                        investments in Asia are the
                                                      to his current responsibilities at                       Commercial Real Estate Finance
                                                      Lehman. I understand that George’s                       Group and Lehman Brothers Real
                                                      work is now focused largely on real                      Estate Partners. The Commercial Real
                                                      estate investment in China, but he                       Estate Finance Group is the group
                                                      has kindly agreed in his presentation                    that’s responsible for acquiring non-
                                                      today to compare and contrast key                        and subperforming loans and for
                                                      characteristics of the Chinese and                       originating new loans, including both
                                                      Japanese real estate markets.                            conduit-style loans and mezzanine
                                                                                                               debt. In the case of the mezzanine
                                                      GEORGE       VON   LIPHART                               loans, we either hold them to maturity
                                                      Managing Director                                        or sell them if the appropriate oppor-
                                                      Lehman Brothers (Japan)                                  tunity presents itself. In Asia, it is this
                                                      Thank you. When Mark asked me                            group, not Real Estate Partners, that
                                                      to come and speak about real estate                      has made all direct real estate invest-
                                                      investment in Japan, I told him that                     ments to date.
                                                      I had not been actively involved for
                                                      the last couple of years and so that                     Lehman Brothers Real Estate Partners
                                                      my information might be a bit dated.                     (LBREP) is Lehman’s predominant
                                                            October 27, 2004     Investing in Commercial Real Estate: Japan versus China   3

          There’s corruption in China, and it is one of the biggest concerns for all the Western firms.

          We’re very concerned about our reputation.

                                                                                           —George von Liphart

vehicle for investing in real estate      who live in urban environments, and,         favored by all investors, and for good
equity in North America and Europe,       presently, there are 500 million             reason. It is likely that your invest-
and it is anticipated that LBREP 2 will   Chinese in such settings. But here’s         ments will be mainly there, perhaps
invest in Asia beginning in 2005.         the really interesting thing about this      some in Osaka, or in Fukuoka, in
                                          statistic: the Chinese plan to have an       the case of Colony Capital, but,
In Asia, Lehman Brothers’ Global          additional 350 to 500 million people         essentially, you will be Tokyo-centric.
Real Estate has five offices and 79         move into the existing cities, and           In that sense, Japan is very similar
professionals, not counting an associ-    probably some new cities, over the           to France or the United Kingdom or
ated company, Capital Servicing,          next 10 to 15 years. As it is, right         some of the other Asian countries
which is responsible for providing        now there are approximately 100              such as Korea, Taiwan, or Thailand,
asset management, underwriting, and       cities in China with populations of          all of which are dominated by one
due diligence services to us through-     more than one million and about 40           major metropolis.
out the region. We cover Northern         cities with populations of five to six
and Central China primarily from          million. So, obviously, there is going       China, on the other hand, is very
Tokyo, with some assistance from          to be a need for new residential real        much more like the United States
Seoul. Our Hong Kong office covers         estate, for shopping, for leisure, and,      geographically. You have multiple
South China.                              essentially, for everything.                 markets—some 40 cities with five
                                                                                       million people or more. Most inter-
I am one of the three Managing            Now, real estate opportunities in            national investors focus on three key
Directors in the Asian Real Estate        Japan are going to be different.             areas: the Beijing/Tiajin megalopolis,
Group. For the last two years, I’ve       They’re certainly not going to be            which is located on the northern
been the Country Manager for Real         driven by the same kind of growth.           coast; the Shanghai/Yangtze delta
Estate Principal Investments in China.    We’ll come back to that later.               region on the central coast; and the
I spend 60 percent of my time there,                                                   Pearl River delta, which includes
and the rest of my time either in the     China has a much larger physical             Shenzhen, Guangzhou, and
U.S. or in the Tokyo office.               area than Japan (25 times larger).           Guandong province in the south.
                                          This emphasizes the fact that if you
Let’s now compare China and Japan.        are an investor and an operator in           Other areas that investors look at
First of all, in population terms it is   Japan you have a relatively simple           include the northeast: the Chinese
no surprise that China is ten times       environment. You have essentially            “Rust Belt,” where old industry pre-
larger. There are 100 million Japanese    one city: Tokyo. Tokyo is the city           dominates. Because this region of
4   Center on Japanese Economy and Business    Program on Alternative Investments

          China is in severe recession, similar
                                                         TA B L E A
          to old industrial areas anywhere else
          in the world, the government has
          made a determination to invest lots
          of new money and create tax incen-
          tives to induce investors to go there.
          One consequence is that you will
          hear about the three northeastern
          provinces as being favorites for non-
          performing loan investments in China.

          In addition, there is the West.
          Chungqing is now a Special
          Administrative Region (SAR), the
          same as Beijing and Shanghai. The
          government created the SAR several
          years ago as a countermagnet to the
          coast to attract people coming off the
          farms, so that they wouldn’t all go
          east. Chungqing is now generally
          referred to as the largest city in the
          world, with a population of 30 mil-
          lion people. It’s not quite that simple.     urement in the future as it has been         you use the proxies of such items
          It’s similar to Indianapolis in the          in the past. Housing, for example, is        such as automobiles, housing, and
          United States when it expanded its           now very much a market-driven pri-           mortgages, those growth rates run in
          boundaries to include the entire             vate enterprise, so I think that to some     the 20s and 30s in percentage points
          county. The city itself is probably          extent that adjustment loses its validity.   (see Table B).
          only 12 million. Also in the West is
          Chengdu, which is the capital of             Here’s the real story: The Japanese          Let’s move on to one major business
          Sichuan province. Several investors          economy has been experiencing 3.3            for Lehman Brothers and for a lot of
          have also expressed an interest              percent growth this year. But Japan          the Western investors, which is non-
          in the resort island of Hainan (see          has been in recession for much of            performing loans (NPLs). Now, my
          Table A).                                    the recent past. In point of fact, you       source for this is predominantly the
                                                       see that the nominal GDP is $4.3 tril-       annual Ernst & Young report—the
          As for nominal GDP, Japan has a              lion. When I first came to Japan in           “bible” of the nonperforming loan
          much larger economy than China’s.            1997, the number we were using was           industry. Its estimate for Japan has
          On a per capita basis, there is a vast       $4.8 trillion. As a matter of fact, at       always exceeded $1 trillion dollars.
          difference, and this tells us that we’re     that point the United States’ GDP            It’s generally been between $1 trillion
          dealing with two entirely different          was about 160 percent of Japan’s, but        and $1.5 trillion.
          types of economic environments.              because Japan’s has declined in the
          Some of China’s key coastal cities           last eight years, the gap has widened        In China, the estimates have ranged
          are now experiencing per-capita GDP          considerably.                                from $400 to $600 billion, and as
          in the $5,000 range—but that’s still a                                                    of two years ago, Ernst & Young said
          long way from Japan’s.                       Now, China’s 9.1 percent growth              it was $480 billion. Now, Ernst &
                                                       reflects the fact that the Chinese econ-      Young has just come out with its
          If you adjust for purchasing power           omy has been growing consistently at         2004 report, which estimates Japan’s
          parity (PPP), the gross GDP flips, and        8 to 10 percent per year. The major          at $442 billion and China’s down to
          while the per capita GDP is still terri-     cities have been growing at 12 to 15         $414 billion. Essentially, what the
          bly low, we now see that the Chinese         percent. If you look at a segment of         report is saying is that nonperforming
          economy measured this way becomes            those markets to get a sense for what        loans are well on their way to
          significantly larger. I’m not really sure     is happening in terms of the emer-           becoming a dinosaur in Japan. Do
          PPP is going to be as relevant a meas-       gence of a middle class, and for that        I believe this? Not exactly. Ernst &
                                                             October 27, 2004    Investing in Commercial Real Estate: Japan versus China   5

                                                                                       Wall Asset Management Corporation,
  TA B L E B
                                                                                       but these are deals that either have
                                                                                       gone sideways, in which case of
                                                                                       course they’re not reported as having
                                                                                       gone sideways, or they’re still in the
                                                                                       approval process.

                                                                                       At present, a lot of the Japanese NPL
                                                                                       business has rationalized itself. We
                                                                                       think of there being ten fundamental
                                                                                       and consistent sellers in the market,
                                                                                       not counting a handful of regional
                                                                                       banks that come in and out of the
                                                                                       market. Here’s the problem with
                                                                                       China: it’s essentially monopoly or
                                                                                       oligopoly selling. The situation here
                                                                                       is that the second and third NPL
                                                                                       trades to international investors that
                                                                                       occurred in China were based on
                                                                                       the first Huarong Asset Management
                                                                                       Corporation sale, which was bid
                                                                                       and negotiated in November of 2001
Young’s report states that $600 billion    Now, here is the interesting statistic:     and which finally closed with all
has been resolved, but by “resolved”       somewhere along the line, and I             approvals in March 2003.
it means moving it off the books of        must have been sleeping when it
                                                                                       There were two buyers in that trans-
the banks. The actual resolution of        happened, the Japanese all of a sud-
                                                                                       action. The first was the consortium
the individual assets happens later—       den embraced the concept of selling
                                                                                       led by Morgan Stanley, of which
perhaps much later. If you subtract        nonperforming loans. For a very long
                                                                                       Lehman Brothers is an integral part.
the $600 billion from $1.2 to $1.3 tril-   time, since I have been in Japan,
                                                                                       As a result of that trade, the word
lion, the current estimate for Japan is    there has been a serious cultural
                                                                                       went around the investment commu-
probably somewhere in the area of          struggle. Selling NPLs was deemed to
                                                                                       nity that Huarong was the only real
$600 to $700 billion.                      be a practice not necessarily in har-
                                                                                       seller in China. It proceeded to live
                                           mony with the goals of Japan, but to
In the case of China, I’m sure that                                                    up to that reputation by holding
                                           date there have been at least 1,200
Ernest & Young’s methodology was to                                                    another auction last fall, again
                                           nonperforming loan transactions in
take the published resolution statistics                                               appointing Ernst & Young as financial
                                           Japan—since 1997— but really only
of the four Chinese Asset Management                                                   adviser. Huarong decided to organize
                                           in the last three to four years.
Corporations (AMCs) and deduct this                                                    into 23 separate pools, delineated
amount from the prior year’s total of      Now, I’m sure you have read in the          geographically by province. Of those
NPLs held by the AMCs, plus the esti-      newspapers that China is working to         23 trades, only about three bidders
mates of remaining NPLs in the four        solve its nonperforming loan prob-          cleared the reserve price. It then
main Chinese state-owned banks.            lem. It is true that, on the domestic       invited back the highest bidders who
There has been no attempt to some-         level, Chinese banks have arranged          did not reach the reserve price and
how rationalize the fact that loan         resolutions by selling loans to             negotiated directly with them, picking
growth in China has been increasing        Chinese state-owned enterprises             up another seven or eight transac-
by 25 to 30 percent a year and that        (SOEs), but the total number of NPL         tions in this way. Then it negotiated
some of these new loans may be             sales in China to international pur-        joint ventures in which, using very
heading for nonperforming status.          chasers that have actually closed,          creative accounting, it was able to
                                           to date, is . . . three. You may have       claim higher values for the nonper-
The next group of statistics just          read about Morgan Stanley and China         forming loan trades than it would
reflects what NPLs represent as a           Construction Bank, Goldman Sachs            have, had the deals simply been
proportion of bank loans and GDP.          and ICBC, and Lone Star and Great           done for a cash price.
6   Center on Japanese Economy and Business    Program on Alternative Investments

          Incidentally, we won two pools—
                                                         TA B L E C
          Beijing and one other province. Now,
          all of these pools are presently in the
          approval process. So Huarong has
          always been our favorite seller, that
          is, until recently, when Cinda, which
          was the AMC that came out of
          Construction Bank—by the way,
          Huarong came out of ICBC—was
          given the nod in an incredible series
          of transactions. It acquired three port-
          folios from Bank of Communications,
          Bank of China, and Construction Bank
          that totaled something on the order
          of $80 billion at face value. This was
          with the proviso that Cinda was
          responsible for moving the assets off
          its books by the end of 2005. All of a
          sudden, the heart rate of every inter-
          national investor beat faster. Everyone
          was thinking that finally there was
          going to be a more liquid market for
          which we’ve been waiting since 2001,         Young man in Moscow to tell me             So these first two lines indicate what
          and that there would soon be an              about the nonperforming loan story         was built and what was sold in
          active NPL business in China.                in Russia. He said, “There isn’t any.” I   Tokyo last year and what was built
                                                       said, “Really, why?” He said, “Because     and what was sold in Shanghai. As
          Last week in the South China                 there are no loans.” The difference is     you can see, a lot more people are
          Morning Post, there were two very            that in China, they set up the four        buying in Shanghai than in Tokyo.
          interesting articles. The front page of      state-owned banks and then set up          Admittedly, they’re paying a lot more
          the business section read, “China            this incredibly large group of state-      in Tokyo, so that on a dollar volume
          Cuts Red Tape to Ease NPL Purchases          owned enterprises. Then they had           basis, Tokyo has the more expensive
          by Foreigners.” Hooray. It talked            the four banks lend to the SOEs. But       housing because it is a developed
          about the six different entities that an     these weren’t really commercially-         economy and is clearly far ahead of
          investor goes through to get approvals       based loans; they were basically           Shanghai. But in terms of number of
          being reduced to a couple. But then          policy-driven directives to fund these     units, that’s the story. Then look at
          if you turn to Page B2, “Cinda Bad           groups. In Russia, comparable opera-       the growth rates. These are 2003
          Loan Resale Leaves Foreign Players           tions were funded as direct invest-        numbers. The total outstanding resi-
          Out in Cold,” this article says that the     ments by various state ministries. In      dential mortgage balances are for all
          other three AMCs are going to have           China, now they were owned and             of Japan and China.
          first pick at the Cinda assets; if they       operated by SOEs and financed by
          can’t sell them, then, at Cinda’s            state-owned banks.                         There is one real similarity in the
          option, they can invite the foreign                                                     residential real estate markets. The
          players in. So who knows? Since it’s         But it is interesting that today Russia    Japanese have limited options in
          such an important business for us            doesn’t have a mortgage system and         fixed income instruments because
          and for many other firms, I imagine           yet China does. So, ironically, there      interest rates are so low. The Chinese
          we will just stick it out.                   appears to have been method to             have no place to invest because there
                                                       China’s madness.                           are no fixed income instruments to
          The distressed loan story in China is                                                   speak of.
          somewhat artificial—an accident of            Let’s talk about the residential real
          economic history. I recently took a          estate market (see Table C). Here          So with the high savings rate, the
          trip to Russia and I asked the Ernst &       we’re comparing Tokyo to Shanghai.         Chinese have chosen to invest in real
                                                            October 27, 2004    Investing in Commercial Real Estate: Japan versus China   7

                                                                                      854,000 square meters absorbed in
  TA B L E D
                                                                                      Tokyo. In Beijing, the comparable
                                                                                      number was 210,000 (in 2003). And,
                                                                                      in 2004, to date it is 580,000. So
                                                                                      building is occurring of all real estate
                                                                                      property types.

                                                                                      This is reportedly the national inven-
                                                                                      tory for retail. My sense is that it
                                                                                      won’t be too long before China over-
                                                                                      takes Japan. Wal-Mart is expanding
                                                                                      in Japan through acquisitions and
                                                                                      through trying to be a rehabilitation
                                                                                      sponsor for Daiei, but it has 30 devel-
                                                                                      opment deals that are set to start in
                                                                                      the next 15 months in China.

                                                                                      Every major international hotel firm
                                                                                      says that it has a plan to create a new
                                                                                      three-star brand in China and that it’s
                                                                                      going to roll out a thousand hotels in
                                                                                      the next ten years. Specifically, these
                                                                                      include Holiday Inn, which I believe
estate. As long as mortgages are          lived in Japan or have been in Japan
                                                                                      can do it. Hyatt, by contrast, doesn’t
available, you can get 70 to 80 per-      for any time, you will understand my
                                                                                      have a three-star chain, so it would
cent financing, and if it’s legitimately   surprise. I’m a permanent Japanese
                                                                                      have to start from scratch.
your first residence, there are very       resident, I’ve lived there seven years
few restrictions. There always have       now, and I’m not exactly sure how           Hospitality is clearly going to be a
been income and affordability tests,      many lenders there would be willing         very interesting opportunity for some-
but they haven’t always been strictly     to lend to me, if I wanted to pur-          one: for franchisers, perhaps for con-
observed and adhered to. I think that     chase residential property. But that’s      struction companies. It is not so clear
part of the crackdown you’ve been         what’s happening in China: tremen-          for hotel owners, because I’m sure
hearing about in the Chinese finan-        dous liquidity in the residential mort-     there will be much overbuilding (see
cial credit system is about getting the   gage market.                                Table D).
Chinese banks to actually observe
those rules that are already on the       For office inventory figures, we’re           There isn’t a lot of political risk in
books.                                    using Tokyo and Beijing as the              Japan. If [Prime Minister] Koizumi fails
                                          proxies: 55 million square meters           to get reelected and if regimes change
We have a family friend who lived in      in Tokyo, only 9 million in Beijing         in the United States, I’m not sure that
San Francisco for a long time. She        (which represents 42 percent of the         would really make a difference in
grew up as an expat in Taiwan and         class A office space in the country).        Japan. China is perceived as higher
became fluent in Mandarin. She             The percentage probably is understated,     risk. I do think the Chinese have been
moved to Hong Kong and then to            because the major international bro-        very responsible in the way they have
Shanghai. She was in Shanghai about       kerage firms from whom these num-            handled the most recent phase of their
four weeks, and I asked her where         bers come only cover a certain num-         government transition, but you just
she was living. She said she had rent-    ber of markets in China. So this is 42      can’t be sure. It’s not transparent.
ed a flat but that she was going to be     percent of the markets they cover,          Moderate government involvement in
moving into an apartment that she         but on the other hand there probably        Japan is still the case for the economy,
was buying. I said, “Excuse me,           isn’t a lot of class A in most of the       notwithstanding the economy’s market
you’re there four weeks, and you’re       other 40 cities.                            aspects. In China, everything involves
buying an apartment? How exactly?”                                                    the government. In a sense it’s a great
She was going to get a mortgage.          But, interestingly, if you look at
                                                                                      negotiating ploy for them; once you
Now, for those of you who have            office absorption, in 2003 there were
                                                                                      negotiate with the highest-ranking per-
8   Center on Japanese Economy and Business   Program on Alternative Investments

                               In Japan you can own freehold, and in China you end up owning what is known

                               as “land-use rights.”

                                                                                                     —George von Liphart

          son you can find, they can always            Now, let’s discuss creditors’ rights. If   freehold, and in China you end up
          come back to you and say, “Well, my         you are unfortunate enough to have         owning what is known as “land-use
          boss, this ministry or the State            a nonperforming loan from an enter-        rights.”
          Council, says it has to be done this        prise that is the only employer in the
          way.”                                       region, you will not be able to get        There are two types of land-use
                                                      control of the collateral—you will         rights, allocated and granted. The
          There’s corruption in China, and it is      not be able to evict the owner of the      allocated land-use rights essentially
          one of the biggest concerns for all         property. In any event, even if you        have no rights. They typically run
          the Western firms. We’re very con-           are dealing with surplus, noncore real     with the SOE that owns the resources
          cerned about our reputation. We             estate from industrial SOEs, you will      and that operates the facility. They
          don’t want negative stories about us        have to factor in your pricing of the      can’t be traded or hypothecated. You
          in The Wall Street Journal. We have         redemption and fulfillment of all the       can’t do anything with them, but you
          to be very, very careful when we            promises relating to unemployment          can convert them to granted rights by
          do business in China, especially            and the pension benefits of the workers.    paying a percentage of the market
          with whom we’re doing business.                                                        value of the property as though it
          Transparency in Japan has gotten bet-       But there is also inadequate protec-       possessed granted rights. Land use
          ter; we’re calling it moderate today.       tion in the bankruptcy laws of China.      rights have terms. They’re 70 years
          On any given day it can be low, but         There is a new bankruptcy law that         for residential, 40 years for commer-
          in China just about every day is low.       has been announced in the press. All       cial, and 50 years for industrial. It is a
                                                      of the Western law firms have given         little tricky when you’re talking about
          The legal system in Japan is fairly         their predictions on what they think       serviced apartments: some days it’s
          well defined, and there are many             is going to come out, but until the        40 years, other days, if you can sell
          precedents. Things are generally            fat lady sings (or, in this case, the      the actual apartments to individual
          known and generally fair, if you            State Council), we really don’t know       owners, maybe you can argue for 70
          understand the rules. China is evolv-       what’s going to be included in this        years.
          ing in many areas. The footprint            legislation.
          for the legal system exists, but it is                                                 There are a number of major players
          applied inconsistently in two ways.         We should touch on property owner-         in Japan: the big domestic real estate
          First is by geography. The cities that      ship. Japan and China are similar in       companies like Mitsui Fudosan,
          have the biggest Western influence—          the sense that there are different reg-    Mitsubishi Estate, Nomura, which are
          Shanghai, Beijing, and Guangzhou—           istries for the land and for the build-    now a variety of REITs (real estate
          are generally the fairest. They have        ing. So whereas in Western countries       investment trust) and funds. I read
          the most to lose, if Western firms           you have one registry, that’s not nec-     in the International Herald Tribune
          scream too loudly over a situation in       essarily true in either Japan or China.    recently that the number of private
          which they’re clearly a legitimately        In both countries you can own a            equity funds in Japan has gone from
          aggrieved party.                            leasehold. But in Japan you can own        15 in 1999 to something like 390 in
                                                             October 27, 2004       Investing in Commercial Real Estate: Japan versus China   9

                                           Many of the Chinese real estate SOEs           units to investors who lease out the
                                           are now also in the market to attract          units to small “mom-and-pop” stores,
                                           strategic institutional investors and          the core of the Chinese retail commu-
                                           then to eventually do an IPO (initial          nity. But there really is no institution-
                                           public offering), either in Hong Kong          al for-sale market in China yet. That
                                           or in New York, in rare cases.                 will come. Will it come this year? I
                                                                                          don’t know. Will it come next year?
                                           Financing is readily available in              Then, of course, you can try to
                                           Japan. If you go to aggressive mezza-          aggregate a portfolio and then find a
                                           nine lenders, you can sometimes                way to make an IPO somewhere,
                                           finance up to 90 percent of acquisi-            somehow. In theory you can list as a
                                           tion cost. In China, as part of the            REIT in Singapore. Nobody has done
                             Mark Mason    credit crackdown—they really are               that yet, but I’m sure everybody is
                                           serious about this—the maximum                 going to try.
                                           you can borrow in a conventional
                                           sort of way is 65 to 70 percent. From          You don’t need an exit strategy from
2004. A number of these are real
                                           the financing perspective, there aren’t         Japan, but you do in China because
estate funds, and they are driven by
                                           a lot of choices. The Chinese state            of the currency controls. The way it
the fact or the perception that there
                                           banks are the primary ones, and now            works in China is that when you fin-
is an economic recovery in Japan
                                           we’re seeing foreign lenders permitted         ish a transaction, you apply to wind
(which, by the way, is in Tokyo pri-
                                           to lend in local currency in China.            up your venture. After your wind-up
marily). These funds and REITs yield
                                                                                          has been approved, then you apply
far in excess of any kind of fixed          With regard to the range of returns            to remit the registered capital of your
income equivalent. Then you have           as measured by IRR (internal rate of           venture.
the foreign investors. So it’s basically   return), they are very low in Japan,
a very liquid, competitive market          and that’s because of the tremendous           Foreign investors are all creatively
in Japan right now. The foreign            competition. In China, we won’t do             trying to find ways to monetize regis-
investors who have been there for a        a deal if we don’t think we have a             tered capital. As part of a Chinese
number of years are now going into         chance of getting 20 percent, but I            joint venture structure, you’re
more exotic investments (we’ll come        could probably put out a billion dol-          required to have a minimum of 35
to that when I talk about what I think     lars in six months if I were willing to        percent per registered capital and
the real estate opportunities are in       take 15 percent. For 25 percent or             then the remaining 65 percent in
Japan). Most now participate in            above, the amount I’m going to be              either bank loans or self-funded as a
development and in platform acquisi-       able to invest goes down dramatically.         shareholder loan from offshore. You
tions on a regular basis.                                                                 can repatriate that shareholder loan
                                           For exit strategy in Japan, again              easily, without too much trouble both
In China there really are only the         because of the plethora of available           in terms of interest and in repayment
SOEs. There are private real estate        players, you can sell to a variety of          of principal, but then you’ve got that
companies as well, but they are defi-       sources—to the funds, to domestic              last 35 percent. Then there are profits
nitely in the minority. When we            institutions, and to international             and dividends that are also
invest, we have to find a partner. We       investors, etc.—and you have the               exportable. If you own a nonper-
try to pick the SOE that we think is       ability to refinance out as well. You           forming loan portfolio, the accounting
the right partner for that specific deal,   can refinance not only conventionally           for that is essentially cost recovery.
for example, a district government-        but also through the dramatically              So before you can say you’re making
owned developer for a project in that      increased CMBS (commercial mort-               a profit and before you can generate
district. Shanghai has about 13 dis-       gage-backed securities) market in              dividends that you can export, you
tricts, just as Tokyo has 21 kus. Each     Japan.                                         have to recover your full basis,
district has its own development
                                                                                          including that last 35 percent of
company. You definitely want to be a        As for China, you know there are               registered capital, plus all accrued
partner with the district development      buyers for residential units out there         expenses that you have incurred.
company.                                   and that there is a big investor mar-          You have to bring your total basis
                                           ket for retail, where you sell retail
10   Center on Japanese Economy and Business      Program on Alternative Investments

         down to zero. Then you are prof-
                                                           TA B L E E
         itable; you can start declaring divi-
         dends once a year and take them
         out. But you still have your registered
         capital “trapped” in China.

         So clearly all of the bright feverish
         minds are trying to solve the question,
         “Though we have zillions of RMB (ren-
         minbi) here in the Bank of Shanghai,
         why can’t we monetize them some-
         how?” That’s the cutting edge right
         now, and we’re working on that.

         Then there is the possibility to sell
         the entity or your interest in it, but
         you have to find someone who wants
         to buy it. It may be that you can sell
         it to your partner in the Chinese joint
         venture, or maybe not. In any event,
         this is another dimension in China
         that Japan does not have, and it is
         one of the major impediments to get-
                                                        In terms of platforms, you’re familiar    class. Another alternative model is, if
         ting enthusiastic investment commit-
                                                        with Shinsei Bank, a financial plat-       you have housing retail, you can sell
         tee approval (see Table E).
                                                        form. You’ve heard about the golf         off the housing and retain the retail.
         In Japan, I think that core and value          plays. Right now there’s a ski plat-      Essentially, you’ve got a zero basis,
         added—depending on the value                   form in play. We have done a hospi-       and then you can figure out what
         added—are probably only going to               tality platform called “Weekly            to do with it later. With all of those
         work if you’re a domestic investor.            Mansion” in Tokyo. There are market       hotel rooms, maybe there’s an oppor-
         All the major international players are        niches in Japan based on opportuni-       tunity there.
         focused on corporate distressed—               ties to upgrade facilities, both in
                                                        terms of larger living units, creating    One way of cutting down the devel-
         meaning situations where you act as a
                                                        functional hotel operations, and          opment cycle, which I have here as
         sponsor for a company that’s insolvent.
                                                        developing health care facilities that    the last series of slides (see page 15),
         The most attractive targets tend to            we all feel demographically have got      is to basically buy a well-located
         be real estate leasing subsidiaries of         to be an opportunity. Mezzanine           building that is topped out but has
         some of the financial institutions.             financing is not per se a niche, but       been abandoned because the bank
                                                        the way you play the game is a            has stopped funding and is controlled
         Another opportunity is what we’re              niche. In our case, we’ve identified a     by the bank.
         calling DPO, or “discounted payoff.”           few borrowers, and if they call us up
         For example, in the case of the trou-          on a Wednesday and say “we need           As for financing in China, the rules
         bled UFJ bank, many of its borrowers           funding by next Wednesday” we say,        aren’t there to permit it by foreign
         need to find ways to pay off their              “okay,” and that’s how we keep the        investors yet, but it is a work in
         loans. UFJ is willing to make a deal           clients (see Table F).                    progress. Then, of course, we’re all
         with these borrowers today to clean                                                      looking for platform investments as
         up its balance sheet, so you finance            In China, I’ve said that we’re not cer-   well that will allow us to grow with
         them. You structure some sort of par-          tain if NPLs are really going to be a     the economy.
         ticipation that allows you to get a            viable business in the near term, but
                                                        we’re going to hang in there. In real     One of the beautiful things about resi-
         majority of the proceeds of a subse-
                                                        estate it really comes down to servic-    dential development—I’ll conclude
         quent sale of the asset, and in a hot
                                                        ing the needs of the emerging middle      with this—is that in China you can
         real estate market that works.
                                                           October 27, 2004     Investing in Commercial Real Estate: Japan versus China   11

                                                                                       want to develop in China, and so we
  TA B L E F
                                                                                       stay for that reason.

                                                                                       Question: I’m focused on China and
                                                                                       am looking at the investment distor-
                                                                                       tion bubble and various industries in
                                                                                       China. The prime example is real
                                                                                       estate. I’m wondering if you could
                                                                                       comment on a possible scenario
                                                                                       where this real estate bubble bursts,
                                                                                       what would be a trigger, and how it
                                                                                       might unfold? Or maybe you could
                                                                                       describe a scenario where China is
                                                                                       basically invulnerable to something
                                                                                       like this because the banks are state
                                                                                       owned and the government could
                                                                                       always step in. I’d just be curious to
                                                                                       hear your viewpoint on that.

                                                                                       von Liphart: Well, I think clearly
                                                                                       there has been a dramatic run-up in
                                                                                       prices in a number of the major
                                                                                       Chinese cities. I don’t think it’s in the
have a binding sales contract before     von Liphart: Well, you probably need
                                                                                       nature of a bubble, though. If you
you complete construction. The gener-    to ask them that question. My view
                                                                                       look at Japan, the bubble there really
al rule now is when you top out you      is that [Lone Star] never got traction;
                                                                                       was a bubble. I mean land prices
can go to the purchaser, receive your    they never won a deal.
                                                                                       have come down 70 to 80 percent
30 percent down payment from him,
                                         Lone Star never won anything in               from the top. But it’s really hard to
and within a month he goes and gets
                                         China. They won big in Taiwan, so             see that happening in China.
one of those wonderful mortgages I
talked about. You now have 100 per-      they stayed in Taiwan. They believe,
                                                                                       There are two major issues now in
cent in your hand, not in escrow, of     and I think rightly, that they have lots
                                                                                       residential development. The first is
the price of the unit. Typically, in a   of opportunities in Japan, and they
                                                                                       the relocation of the people who are
hot market such as Shanghai’s, that      just felt that it was a better use of time
                                                                                       on the sites that are being redevel-
means you’ve got all the money,          and management expertise. As far as
                                                                                       oped, and the second is affordability
although of course you have an obli-     the rest of us are concerned, we all
                                                                                       of the development. On a typical
gation to finish the building. But it’s   have integrated financial businesses.
                                                                                       block in China now there are a thou-
much nicer to be in that position than   We all see what’s happening in China
                                                                                       sand families. Those people have to
to be in the position of having to       or what will happen over time, and
                                                                                       go. Now, they read the paper, they’re
collect at the end of completion.        we believe it’s important to be there.
                                                                                       literate. They know what’s going on,
                                         There also is a lot of important inter-
                                                                                       and therefore it is harder and harder
I’ll conclude here.                      play with the banks, even if they’re
                                                                                       to relocate them. So in my view the
                                         technically not allowed to sell NPLs.
                                                                                       price that you end up paying for
    Discussion                           By the way, I forgot to mention this.         your land use rights is now at least a
Mason: We’ve all read about the          The banks can’t sell NPLs because             100 percent for the cost of relocation
quite public decision by Lone Star       they can only sell loans at book              and zero percent for the “land use
to withdraw from China, yet the          value. But it’s all part of the integrat-     premium” to the government. So
Morgans and Lehmans and Goldmans         ed financial community. The regula-            that’s issue number one. That is slow-
and so forth have chosen to remain       tors who are involved in NPLs are             ing down development dramatically
in the Chinese market. Why did Lone      people who have things to say about           which has the effect, of course, of
Star leave—or why have the others        other aspects of our business that we         raising the price of the affordable
chosen to stay?                                                                        stock.
12   Center on Japanese Economy and Business   Program on Alternative Investments

         Number two is affordability. The other      But as a practical matter, with the        policy, as of August 31, if you haven’t
         thing we look at is that, at the end of     incredible number of citizens and res-     paid 100 percent for your land-use
         the day, when you know what your            idents of China who now own their          rights or entered a binding contract
         land use premium plus relocation            own homes through this land-use            where you have funded at least 30
         costs are, and then you add the con-        rights formula, what is the govern-        percent of the price of those land-use
         struction cost and all the other soft       ment going to do, throw them out,          rights, those rights will be recycled
         costs to it and then figure what you         take the property back? No. It’s going     and will be put up for bid. Now, as
         want to make and what the market is,        to have to come up with some sort          someone who has worked long and
         are you going to be able to actually        of accommodation.                          hard on it, you would in effect have
         sell those units to the emerging mid-                                                  a primary lien. You’ve spent so much
         dle class? When you look at all of                                                     money on the property, someone is
         that, I think it is possible to under-                                                 going to have to overbid you by the
         write and justify your investment. It’s                                                amount of what you’ve spent in
         always possible to be stupid, but gen-                                                 order to take it away from you. But it
         erally, if you’re disciplined, I don’t                                                 is not as certain as it once was, and
         think you’ll get hurt. I don’t think                                                   there was a real flurry of activity in
         you’re going to see a wholesale defla-                                                  all the major cities, especially Beijing,
         tion of a bubble in China.                                                             which as the capital city was right
                                                        With regard to . . . IRR, they          under the microscope, for people to
         Question: My question centers                                                          get their deals grandfathered as of
         around the land use issue that you’ve          are very low in Japan. . . .            August 31.
         just addressed again. One of the con-
         cerns in China is what happens when            In China, we won’t do a deal            Question: Could you tell me how the
         somebody shines a spotlight on the                                                     local authorities treat environmental
         way these land uses are granted for                                                    issues in China?
                                                        if we don’t think we have a
         the next three to five years. It says,
         “Wait a minute, these were perhaps                                                     von Liphart: Well, generally they
                                                        chance of getting 20 percent.           don’t believe there’s a problem. We,
         granted as favors or in a manner that
         somebody might disagree with in the                                                    however, are requiring “Phase Ones”
         future, and perhaps the first mortgage
                                                                —George von Liphart             for every project. It is true that a lot
         holder is sort of left with this issue.”                                               of the prime choice sites from a geo-
                                                                                                graphic perspective in Chinese cities
         The second is the renewability of                                                      are owned by companies that manu-
         these land uses. Is this as core of an                                                 facture something. So you have to
         issue as it sort of appears from here?                                                 look at it from a couple of perspec-
                                                                                                tives. One, of course, is that you
         von Liphart: With respect to your                                                      have to assume that the environmen-
         second question, you’re investing in                                                   tal regulations will get more rigorous
         for-sale products—which is not my                                                      as time goes on, but more important-
         problem. So that solves that problem.                                                  ly, for a firm like Lehman Brothers is
         I think people were saying the same         With respect to your first point, again     that you want to make sure that there
         thing about Mexico 30 years ago. If         as I said, China is becoming more          are no reputational issues lurking out
         you’re on the coast and you’re buying       transparent all the time. I don’t know     there. Again, the acid test is how is
         a condo on a 30-year leasehold, what        how many of you are familiar with          this going to look in The Wall Street
         happens? As Mexico has become more          the Xin Tian Di Project in Shanghai.       Journal.
         transparent and more developed, it’s        Vincent Lo was able to get extraordi-
         essentially rolled those leases over.       narily preferential rights to be able to   Question: I’ve been interested in how
         China is getting more transparent and       put that whole project together, not       the big Hong Kong developers sort of
         friendlier every day. In the few years      just there but in other projects in        took an initial plunge into China 10 or
         I’ve been working there, things have        Shanghai. We believe those days are        15 years ago. Nobody made any
         changed. Sometimes they don’t change        essentially over. According to Chinese     money. Even Vincent Lo sometimes
         as fast as you want, but they do change.                                               didn’t make money for a long time.
                                                           October 27, 2004   Investing in Commercial Real Estate: Japan versus China   13

Well, some of the chat is that Vincent    von Liphart: Well, they’re not there.      sale for Hong Kong, which Citigroup
Lo would have made more money if          So that’s how we out-compete them.         won, which was somewhere around
he had invested in Hong Kong rather       Secondly, if you talk to senior real       $500 or $600 million.
than in China. Do you see the Hong        estate executives in Japan and you
Kong developers doing anything to         talk about China, you hear they’re         Mason: Is the money that Lehman
restart?                                  not ready.                                 has invested in China to date all
                                                                                     Lehman principal funds?
von Liphart: Sure. For example, Li        Question: Outside the Hong Kong
Ka-Shing is all over China. It’s well     investors and entrepreneurs, how           von Liphart: To date, it’s all our prin-
known that he’s not making any                                                       cipal. Lehman Brothers Real Estate
money in the Oriental Plaza in Beijing,                                              Partners has not invested in Asia, but
but I’m sure he’s making money                                                       going forward it is anticipated that
somewhere. I would say that many of                                                  LBREP 2 will invest there.
the Hong Kong developers are back
in now, and they’re doing better.                                                    Mason: Do you see much institutional
                                                                                     investor interest in the West in putting
Mason: I know there is some                                                          money to work in Chinese real estate?
Japanese investment in Chinese real
estate, and we’ve all heard about                                                    von Liphart: It’s very limited at this
                                            What’s the key to getting
the Mori Building project, the large                                                 point, and we see this reflected
finance tower in Shanghai. How active                                                 inside our own firm. There is a great
                                            access to quality Chinese                deal of concern over lack of trans-
are Japanese investors in China?
                                                                                     parency, corruption, and all the
von Liphart: Again, it’s what I would
                                            investment opportunities? . . .          things that can go wrong. Actually,
call the entrepreneurial Japanese who                                                the number one question that’s asked
are putting together funds, but these       It’s a question of hiring                is, “How do I get my money out?”
are really very early days. To the best                                              Those kinds of questions are the
of my knowledge, they haven’t done          the people who, one way or               major impediment. Those of us who
a lot yet, if anything. You mentioned                                                have been there and worked there
Mori. Mori has one very successful          another, have [the right] con-           believe that those questions can be
building, which is the HSBC Tower. I                                                 answered, but it’s still very early.
don’t know if the big building is ever      tacts.                                   From one perspective, that’s good.
going to rise out of the ground.
They’re making noise, but nobody in                                                  Question: Could you comment more
                                                     —George von Liphart             about the municipal government, the
Shanghai is sure about the timing.
                                                                                     state-owned businesses that are look-
                                                                                     ing to do development work in
                                                                                     Shanghai? Can you elaborate briefly
R. D. Calkins Professor Emeritus of
                                                                                     on what they look like and what
International Business
                                                                                     their thinking is?
Director, Center on Japanese Economy
and Business
                                          much real money has gone into              von Liphart: Well, one of the inter-
Columbia Business School
                                          China from other foreign investor          esting things is that in China, which
Earlier you said that you really wanted
                                          groups?                                    is still a Communist economy,
20 percent or better on a project. It’s
                                                                                     whether it’s in the genes or whatever,
my sense that many Japanese               von Liphart: Aside from the Hong           there is competition. For example,
investors would be very satisfied with     Kong investors and GIC of Singapore,       one of the best examples as reflected
15 percent, and so they’re going to       not a lot. I think that you’re probably    in Shanghai is the competition among
have a competitive edge. How are          talking about a total from the usual       the district governments for FDI (for-
you going to be able to out-compete       players of maybe $200 million to date      eign direct investment). Now, in gen-
them, and how are you out-competing       that’s actually closed. Again, that’s      eral, in China government officials
them now?                                 not counting the Bank of China NPL
14   Center on Japanese Economy and Business   Program on Alternative Investments

                                                                                                 a lawyer from NYU who passed the
                                                                                                 New York Bar, and he’s a Beijing
                                                                                                 native. He went to school with
                                                                                                 everybody in all the ministries, the
                                                                                                 state-owned enterprises, the banks,
                                                                                                 everything. So it’s the old story.

                                                                                                 Question: It seems it takes a long
                                                                                                 time to close NPL deals. Do you
                                                                                                 expect that to change sometime
                                                                                                 soon? Do you have any strategy in
                                                                                                 terms of how to deal with those
                                                                                                 loans? Are you going to stabilize and
                                                                                                 sell it or hold it?

                                                                                                 von Liphart: Good question. Every
                                                                                                 day is a new day in China. Everything
                                                                                                 you knew the day before may be
          Audience members                                                                       obsolete. Supposedly they’re cutting
                                                                                                 the red tape. Let’s see what happens.
                                                                                                 In general, yes, because there is a
         are graded. They have a very sophis-        There’s another interesting company
                                                                                                 belief at the top in China that foreign
         ticated management scoring system           that we hope to work with in a dif-
                                                                                                 investors are needed to help solve
         for both party officials and senior          ferent district that has a very interest-
                                                                                                 this problem. The main driver is their
         government officials. One of the             ing model. It’s 50 percent owned by
                                                                                                 wanting to clean up all the banks so
         main drivers of that—and this deter-        four governmental entities from that
                                                                                                 that they can all go public. They
         mines how they get promoted every           district and then 50 percent owned
                                                                                                 need to clean up the NPLs. That’s
         five years when the musical chairs go        by management. It is may be the best
                                                                                                 kind of a trap they have put them-
         on—is how much FDI they have                of all worlds.
                                                                                                 selves into.
         brought in.
                                                     Question: I’ve done a lot of sourcing
                                                                                                 But as you see, there haven’t been a
         So the districts compete heavily to         in Japan, but I know nothing about
                                                                                                 lot of deals that have actually closed;
         get the foreign investors. Everybody        sourcing good deals in China. What’s
                                                                                                 they have to streamline the process.
         wants to bring you in on a deal,            the key to getting access to quality
                                                                                                 So that’s the logical side of it.
         because they want to say that they’re       Chinese investment opportunities to
         partners with Lehman Brothers or            the extent that they exist?                 Your second point: In any environ-
         because at the end of the day they                                                      ment where you cannot really rely
         want to go public in New York,              von Liphart: Well, if you have a
                                                                                                 100 percent on creditors’ rights, you
         Hong Kong, etc., and they want to           name somebody can rent, that helps,
                                                                                                 have to adopt the approach of some
         have a strategic alliance with you.         but it’s a question of people. It’s a
                                                                                                 sort of voluntary resolution to an
         So you get that at the district level.      question of hiring the people who,
                                                                                                 NPL. That essentially means offering
         There is likely to be competition           one way or another, have those con-
                                                                                                 the borrower a deal he can’t refuse.
         among districts for a long time. We’ve      tacts. I have a guy on my staff, a vice
                                                                                                 So if he owes 100 RMB and you
         done a transaction in Luwan district        president of Lehman Brothers, who is
                                                                                                 bought the portfolio—let’s be gener-
         with the district-owned company             a Columbia Business School graduate.
                                                                                                 ous and say you bought it for 25—if
         that’s responsible for development          Before he came to Columbia
                                                                                                 you tell that borrower that he can
         where we’re a financial partner.             Business School, he worked for one
                                                                                                 clean up his act and his good name
         Again, they’re making a point:              of the major Hong Kong developers
                                                                                                 for 40, if he’s an SOE in Beijing over
         Shanghai is a twentieth-century city—       in both Beijing and Shanghai, and
                                                                                                 on the northwest side in the high
         a twentieth-century financial market         because of his personality, he knows
                                                                                                 technology area, he’s very interested
         player—and they want to develop all         everybody. So he’s been a great help
                                                                                                 in your offer, and those kinds of
         the right relationships. That’s why         to us. I have another guy who is an
                                                                                                 transactions happen quickly.
         we’re in the deal.                          associate, an M.B.A. from Chapel Hill,
                                                       October 27, 2004   Investing in Commercial Real Estate: Japan versus China   15

There are situations where you have
                                          TA B L E G
a multibranched industrial corpora-
tion that has an ideal property down-
town that, for example, it doesn’t
really need. They would be willing to
sell that ground to the highest bidder,
and you can make a deal with them
in terms of who gets what when they
make that sale.

Very rarely do you go all the way
through foreclosure. You really don’t
want to do that, but it happens occa-
sionally. You certainly don’t want to
roll the dice on bankruptcy, because
there’s too much that’s unknown
there, and that can stop a lot of
things. The name of the game in
NPLs is speed.                            TA B L E H

Question: In terms of nontransparency
and, especially, corruption, if you
compare China to places like
Indonesia and certain other countries,
would you say China is the worst?

von Liphart: Actually, we have
invested in Indonesia. At one time
we owned the Ritz Carlton in Bali,
but it’s been sold. I think that there
is corruption in other places in Asia
that clearly is as bad as in China (see
Tables G, H, and I).

                                          TA B L E I
Yvonne Thurman
Associate Director
Center on Japanese Economy
and Business

Emiko Mizumura
Program Officer
Center on Japanese Economy
and Business

Naomi Ozaku

Joseph Pineiro


Advantage Partners, Inc.
Shinsei Bank, Ltd.

Columbia Business School
321 Uris Hall
3022 Broadway
New York, NY 10027
Phone: 212-854-3976
Fax: 212-678-6958

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