While most investors lack a deep understanding of emerging markets overall, most of them know enough to be excited about these countries and the investment opportunities they offer. That excitement is not unwarranted; however, some business sectors within these emerging markets offer greater opportunity than others.
The Strong Potential of Real Estate in Emerging Markets
Real estate is one of those sectors that stands out in emerging markets. Joel Wells, portfolio manager of Alpine Emerging Markets Real Estate Fund (AEMEX), highlights that the hallmarks of emerging markets align perfectly with the real estate sector, especially residential real estate. As a result, his fund has allocated 50 percent of its investments to homebuilder stocks.
"Real estate drivers such as job creation, rising incomes, positive demographic trends, urbanization, and credit growth are in lockstep with emerging markets growth," Wells asserts. "Real estate companies that are active in emerging markets are targeting citizens who are rising up the income curve toward the middle class."
While local and regional real estate companies have found ways to tap into the growing emerging markets, it is more challenging for U.S. investors to do the same. Each fund has its own criteria for defining emerging markets. For instance, Fund A might consider Indonesia as an emerging market, while Fund B may not.
Most funds labeled as emerging markets funds do not primarily focus on real estate and allocate only a small portion of their investments to the sector. According to Jeff Tjornehoj, head of Lipper Americas Research, the MSCI Emerging Markets Index only has 1.74 percent invested in real estate. Property rights have been historically sensitive for many emerging market nations due to their negative experiences with colonialism and resource exploitation.
Shifting the Balance: Growing Importance of Emerging Markets Real Estate
While there are only a few real estate funds that solely invest in emerging markets, and emerging markets represent a small percentage of global real estate funds, Wells believes this imbalance will change in the coming years as emerging market economies continue to expand and transition to a role of global leadership.
AEMEX, which started trading in November 2008, was the first dedicated emerging market real estate fund in the market. Additionally, there is the FTSE EPRA/NAREIT Emerging Index (FENEI), launched in January 2009, serving as a real estate emerging market index.
"The critical thing for real estate investors to understand is that, at this point in time, emerging markets funds are not yield-focused vehicles. They are growth vehicles because they primarily focus on the development cycle," explains Wells. "If they feel comfortable with sub-4 percent yield from an established portfolio and modest growth prospects in the REIT world, then emerging markets funds may not be the right fit for them. However, as the platforms of real estate companies in emerging markets reach a certain scale and commercial assets stabilize, we will see yield coming through, just not at present."
The Rising Middle Class in Emerging Markets
The term "emerging markets" is often ill-defined and ambiguous, creating confusion in already opaque markets. At its core, an emerging market is one that has undergone reform, leading to a new economic reality.
Over time, the term has evolved to describe regions or countries that have the potential to reshape the global economic landscape. The BRIC nations (Brazil, Russia, India, and China) are the most well-known emerging markets due to their existing economic size and future growth potential.
BBVA Research recently coined a new term, EAGLEs (Emerging and Growth-Leading Economies), to emphasize how emerging markets challenge the economic supremacy of the G7 countries, including the United States.
Alicia García-Herrero, the chief economist of BBVA Research, suggests that these EAGLE markets deserve closer attention from investors, considering the business opportunities that will arise, potentially exceeding those in the developed world. These economies experience high growth rates, have larger and younger populations, and are growing faster compared to the developed world.
"Taken together, these factors indicate promising business opportunities for investors," García-Herrero claims. "The population dynamics in these markets are much more favorable than in the developed world. Fast-growing urbanization and industrialization are driving increased investment in physical capital."
In 2011, BBVA Research identified ten emerging countries that would contribute more to global growth than the G7 average over the next ten years. In their most recent update, nine out of the ten original EAGLEs retained their status (China, India, Brazil, Indonesia, Korea, Russia, Turkey, Mexico, and Taiwan), with Egypt being the only exception.
García-Herrero highlights two common key areas across all EAGLEs: the rise of the middle class and the need for infrastructure.
According to BBVA Research's ten-year forecasts, over 250 million people across EAGLEs will enter the middle class, around seven times the number expected in G7 countries. This growing middle class will drive growth opportunities in consumption expenditure, particularly relevant for retailers.
Additionally, the lack of infrastructure remains a significant obstacle to increased productivity and potential growth. Infrastructure encompasses transportation, utilities, telecommunications, and public facilities such as hospitals, schools, and prisons. It also includes both residential and commercial real estate.
"The infrastructure needs of EAGLEs should be of special interest to construction companies in the developed world looking for new opportunities to boost their production capacity," García-Herrero emphasizes.
The Exciting Path Ahead
Today's emerging markets can be accurately compared to the United States in the 1950s. During that period, the U.S. experienced significant economic expansion, population growth (thanks to the baby boomers), and the development of road infrastructure, social infrastructure, and housing, including high-rise buildings in urban areas and single-family home developments.
In emerging markets, rural-to-urban migration is increasing, and residents are establishing households at a rapid pace. Multigenerational living is less desirable, and the younger population is choosing marriage and children, making residential and retail property developers thrive. For example, in Brazil, the annual housing demand is $105 billion, based on the potential demand for 1.5 million new homes per year, according to J.P. Morgan Research. The country currently faces a housing deficit of 5.6 million houses.
"The difference between emerging markets and the U.S. after World War II is striking," says Wells. "While the U.S. build-out took 20 years, it won't take as long for these emerging markets. It's happening right in front of us, and investors can participate in this growth. Moreover, the developed markets can share their knowledge with emerging markets, allowing them to benefit from the lessons learned."
As emerging markets continue to evolve and mature, the real estate sector is poised for significant growth. Investors who recognize the potential in these markets can seize the opportunities that lie ahead. Emerging markets are not only reshaping the global economy but also offering exciting prospects for those who are willing to embrace them.