Property bubble not ready to burst

PUBLISHED : Sunday, 14 August, 2005, 12:00am
UPDATED : Sunday, 14 August, 2005, 12:00am

Cheung Kong and Sun Hung Kai Properties 'are dramatically undervalued'

Despite all the talk of a bubble, there is still good value to be had in Hong Kong real estate, according to the chief investment officer of a US$6.6 billion real estate investment fund.

Ritson Ferguson, managing director of ING Clarion Real Estate, a property investment portfolio operated by ING Real Estate, says he intends to boost investment in Hong Kong and the Asia-Pacific region this year. Locally, he likes Sun Hung Kai Properties, which ranks as the fund's second-largest holding, but also sees good value in Cheung Kong, saying the share prices for both trade at a substantial discount to net asset value.

'At present the Asia-Pacific region is interesting to us because of the high economic growth rates,' he says, 'which translate into some of the highest earnings growth rates among the real estate companies that we follow.'

Hong Kong currently accounts for about 9 per cent of the fund's holdings, in line with the territory's weighting in the Citigroup World Property Index. He says the fund would probably have a higher proportion of assets in Hong Kong if it were not for a shortage of real estate investment trusts (reits). Last year his fund applied for a substantial portion of the doomed Link Reit. He plans to invest in a new reit issued by the Housing Authority that is expected to be under way by the end of the year. However, he says most fund managers expect the offer to be more expensive.

The fundamentals for Hong Kong property companies look good, he says citing rising office and retail rents and a strong market for residential flats. A lack of new supply in the next few years also adds to the bullish picture.

'What is interesting to us is that those companies who bought land four and five years ago are clearly achieving much-better-than-expected returns, and that looks like it will probably continue [in] the residential market for at least a couple more years,' he says.

Glance at the price/earnings ratio of many of the big Hong Kong land companies and you end up with a distorted picture of what they are really worth. On one hand, he says, rising office and retail leasing rates have yet to be reflected in earnings. Companies can also juggle the books by paying out less earnings in the form of dividends than a reit, which are generally designed to attract yield-hungry investors. As a result, most Hong Kong conglomerates under-perform on a yield basis but trade at a discount of up to 15 per cent of net asset value. United States land conglomerates trade at a 3 per cent premium to net asset value.

'In a reit culture, real estate tends to trade at more closely to what its private market real estate value is,' he says.

Both Cheung Kong and Sun Hung Kai properties are dramatically undervalued owing to improving fundamentals regionally, and leverage to the top end commercial and residential property in the mainland. He estimates Cheung Kong's real estate portfolio is about 50 per cent undervalued.

The Clarion fund offers a 4.4 per cent dividend yield, outpacing Hong Kong reits at 2.5 per cent and Japanese reits at 3.4 per cent. Mr Ferguson says the performance is due to a global focus on higher yielding reit products, with almost 60 per cent of the fund's assets invested in the United States and Europe.

A former US Air Force computer scientist, Mr Ferguson has spent his entire private career in the property business, and is now based in Chicago with ING's global real estate management office.

He does not see a bubble in either the US or world real estate prices, saying values are still reasonable on an earnings basis. 'I still see an asset class where I can get 4 to 5 per cent income yield and earnings growth of 6 to 8 per cent over the next three years,' he says. 'That is pretty attractive compared to what the bond market offers and broader equities offer.'

He adds the real estate industry is unlikely to be caught in the boom to bust cycles of the past, thanks to better information planning that can help steer off the supply overhangs.

During the late 1980s property bust, decisions on new project approvals were made by bank managers and loan committees. The end result was massive new supply at a time when the business cycle was about to take a dip. He believes the current property investment cycle has several more years to run, having just started in the aftermath of the telecom media and technology collapse in 2001.

Rising interest rates are no reason to panic as long as the economy continues to grow.

Good value also exists in Japan where only 5 per cent of real estate is owned by listed companies. Japanese reits trade at a 35 per cent premium to net asset value, but enjoy relatively high dividend yields. Fund managers have to look beyond the numbers and see what could be an upbeat story if the economy rebounds.

'If you look just at net asset value effectively you have reduced it to a mortician's view of real estate companies,' he says. 'If you froze the company and liquated assets, you would be left with something missing.'

He also likes India, but says with few listed property companies available it is difficult to invest in the country.