Chinese real estate

It does appear that China will launch its first REITs in the second half of 2010. This is a positive development, not for the injection of new capital to the real estate market, but for the development of a sophisticated investor market.

Firstly, the Chinese government appears to be taking a cautious path; only a couple REITs will be allowed so that the government can monitor securities firms sale practices, market demand, and REIT managers' abilities to operate. This is the right way for the government to proceed since these three areas are unknown, not least of which is the ability of domestic asset managers. Only a couple REITs will list and only selected domestic institutional investors will be allowed to purchase shares (or units). This will prevent a mass introduction of new capital into the real estate market.

Secondly, the goal is to create a set of professional asset managers where previously there has been none. Part of the lack of asset managers is due to the bubble-like real estate industry which is developer-heavy and amateur investor-heavy. I imagine the large banks and insurance companies will be allowed a head-start to form asset managers, followed by the more savvy and long-term-focused developers.

Hollowing of Japan's interior vs. air travel

Although personally I am a proponent of supporting Japanese regional economies, many regional airports and unprofitable air routes to these regional airports should be closed. There is simply not enough demand to support many of these regional flights. Japan Airlines has run these flights for the past twenty years as part of the greater bureaucratic and political horse-trading with regional prefectures. However, the bankruptcy of Japan Airlines most likely signals the end for many of these regional flights, and therefore, the regional airports. On the other hand, Japan Airlines turnaround is still mired with much politics and it is unknown how this re-structuring will end.

On the positive side, Japan boasts a vast and efficiently-run train system throughout the country, which compensates for lack of air demand. Secondly, there is an opportunity for low-cost carriers to emerge, although Skymark Airlines and Air-Do Airlines have struggled to build momentum since their inception.

Chinese real estate bubble?

Like so much economic analysis, opinion on the current real estate boom in China shifts on a weekly basis like the winds of the Gobi desert. This week's pundits favor the bubble theory, suggesting that there is a bubble and the central government is stepping in. The China Daily goes so far as to title their piece, Real Estate Time Bomb Ticking! Of course, the reality of the situation, as well as the substance of these same published articles, is more nuanced.

The surface statistics point towards symptoms of a bubble; rapidly rising prices, greater inability of the middle class to purchase homes, and trend of developers to sell pieces of newly completed properties as strata-title to the highest bidder. Defenders of the real estate market point to the "China story", which is demographics (1.3 billion people!) and urbanization.

I see the central government's tight grip on financial markets as being the key here. The central government is able to control capital flows to each industry, including real estate, and does so to both induce a boom and to deflate a bubble. As complaints from the middle class increase, one sees signals that the central government is applying the brakes; some key and recent instructions include - all non-real estate SOE's need to submit exit plans from real estate investments, increase of down payment required for second homes and investment properties, and articles in government news organs focusing on potential real estate bubble.

One must not forget that the central government still has several instruments to prevent the collapse of real estate prices, not least of which is pushing forward REIT and CMBS markets, thereby drawing in more capital.

On a final note, one concern I harbor is the central government's ability to keep local governments and prefectural governments in line, and preventing a potential blow up in one region's real estate market to infecting the nation.

Chinese and Japanese navies

It is widely understood that control of global waterways has allowed empires mercantile advantage. As the sole naval power of the 20th century, America was able to control the flow of global trade and profited immensely. During the 21st century, will America be able to maintain this grip on waterway traffic, or will it have to share with other naval powers?

Immediately, Somalian pirates come to mind. Since the outbreak of pirates off the coast of Somalia, national navies have escorted their commercial vessels. While this allows the U.S. a lesser financial burden for protecting all commercial vessels, this also signifies the end of American naval dominance as other countries gain modern naval know-how, including operation of equipment and vessels in a hostile environment, in addition to logistical and supply-chain management.

In Asia, both Japan and China are watching each other closely. Japan's domestic politics have discouraged direct Japanese naval support. On the other hand, Japan does keep a close tab on Chinese military movements, and build-up of a naval presence. Perhaps most threatening is the construction of Chinese aircraft carriers. The development of a modern Chinese navy will break America's monopoly, and will create the threat Japanese hawks have been waiting for as an excuse for Japan to re-deploy its own navy. The U.S. will also have to work hard to maintain its strength in the Pacific to protect its interests; as one strategic point, the fate of the U.S. bases in Okinawa is far from certain.

China's naval build-up is starting to attract new interest - watch this space, as are Japan, Korea and the U.S.

Theories on Japan's ability to finance debt

In light of Greece specifically, and other European sovereign debts issues in general, a new spotlight is shining on Japan and its substantial national debt. Is there a coming debt shock for Japan?

As Japan enters the Golden Week holidays, there seems to be no worry of such a debt shock. In fact, TV pundits are claiming more Japanese holiday-makers are going on long, overseas and more expensive vacations then the preceding several years. Foreign media about a coming debt problem seems like much ado about nothing.

There are two schools of thought on Japanese government debt; 1) no national debt problem, and 2) current national debt is unsustainable. Let's explore the two ideologies:

First, the Japanese conventional wisdom on the subject is that since over 95% of Japanese Government Bond ("JGB")-holders are domestic individuals and institutions who are happy to roll over the debt, there is no problem. Due to low yield and international consensus that the Bank of Japan will not raise interest rates significantly, most foreign investors would rather place their capital in higher-yielding products. The potential cancellation of Japan Post's privatization scheme will also re-open a large pocket of capital for the government to use.

Secondly, there is a much smaller voice sounding out the unsustainability of the national debt. This group points to demographics and the decreasing labor force vis-a-vis a growing pensioner population as an insurmountable problem. In effect, the ability to pay down the national debt is canceled out by pension obligations - in fact, it is not only canceled out but the debt must increase to fulfill these obligations. Therefore, either government revenue must be increased or obligations decreased.

A hike in the consumption tax is often discussed and subsequently discarded; memories of the institution of the consumption tax during a period of economic weakness is still strong. However, there appears to be new interest in near-term need to raise taxes, as recently raised by Naoto Kan. How this will be politically feasible is anyone's guess.

Attacking the other side of the equation, the DPJ is holding fiery debates televised live with bureaucrats and attacking wasteful spending projects. Many of these pet projects will be canceled - the ramifications of this are more political than economic - the DPJ hopes to break the bureaucrats' regional power bases. However, a real issue which must be discussed is lowering pensioners' entitlements. As the country quickly progresses from 2 workers providing for each pensioner to 2 pensioners depending on each worker, something has to give. Stay tuned.

In conclusion, managing the national debt also concerns how the Japanese government re-distributes capital throughout the nation. Japan, post-World War II, has subsidized and supported national champions of industry, while maintaining its social contract of pensions, health care and regional support. Perhaps the most important agenda under re-distribution of capital is to subsidize children and re-build a worker population?

Japan needs to focus on inbound tourists from China

The Japanese government's plan to increase inbound tourists to 10 million in 2010 is fundamental to propping up regional economies (and of course the major metropolises). Regional economies continue to lose workers to the big cities. With fewer agricultural and manufacturing work done in the regions, tourism is the last hope to prop up local economies without government subsidies.

This is undoubtedly one of the key reasons for visa restrictions for Chinese tourists continue to be lowered.

The first step for Japanese retailers who have seen the light - meaning the need to aggressively court Chinese tourists - is to accept China UnionPay, the form of payment most accessible by Chinese.

Chinese capital allocations to real estate

During the financial crisis of 2008, I mistakenly thought part of the Chinese stimulus package would be the creation of various real estate finance vehicles (ie REITs, CMBS), but this is not happening. In fact, the reverse appears very much the Chinese government's current course of action. The question is how the central government plans on diverting the real estate market in the near future.

A massive amount of capital has already found its way into real estate; the stimulus package caused capital to move in the following direction, from government-sponsored banks -> large corporates and state-owned enterprises -> real estate. Due to lower global consumption, many companies were almost forced to take on loans without a need to invest or re-invest in factories or the like. Due to strict capital controls, this abundance of capital has only two outlets in China, real estate and public equities. Real estate has become the beneficiary of choice for both individual and corporate investors with perceived capital gains. This flow of capital to amateur real estate players has caused several bubble-like phenomenon, one of which is the sale of new Grade A office and multi-use developments by strata-title. In the residential property market, soaring apartment prices have caused middle-class angst and concern. One manifestation has been the popular Dwelling Narrowness television drama.

The government is responding; both to appeal to the masses worried about housing costs and to counter a speculative commercial market. Recently, the government has taken steps to reduce flows to real estate, including an order to slowly push large SOE's with non-real estate core businesses to exit real estate positions. In addition, the government continues to change capital gains taxes with an eye on reining in speculation. It remains to be seen whether the central government can control local governments in respect to new developments and new supply of real estate; local governments are a big beneficiary themselves of a booming real estate market through land auctions.

Real change will happen as the central government directs a guanxi (connections) driven business into a professional-managed industry. Part of this requires more mature financial markets, and talk of a Chinese REIT is still just that, talk. The government continues a comment period with major law firms and financial institutions. The next presumed step will be to allow insurance companies to invest in real estate. Presumably, the introduction of government-sponsored institutional investors (in this case, insurance companies), will encourage the creation of professional asset managers who will operate real estate for long-term yield, not short-term capital gains. In fact, this may be the central government's preferred strategy, since presumably the central government will maintain stronger supervision of insurance companies rather than public-listed REITs.

Hollowing out of Japan's interior

The hollowing out of Japan's interior has been a slow and steady process. Over the past ten years, Greater Tokyo/Yokohama has consolidated political, economic and social power to a greater degree and now provides a home to roughly of fourth of the population. Osaka/Kyoto/Kobe continues to be the great metropolis of west Japan, despite a stagnant and stuck economy. In addition, with continued improvements in transportation, such as the bullet train, regional economies are aggregating among four centers, Sapporo in Hokkaido, Sendai and Nagoya, and Fukuoka in Kyushu. Together, these six metropolises represent a majority of the population and an even greater proportion of gross national product.

I would like to highlight one reason for this trend: the need to maintain economic competitiveness both domestically and internationally. Therefore, regional economies have fought for relevance by concentrating around one city that is blessed with good transport connections. The losers are both the rural areas and second-tier cities. For example, Sapporo is the focal point of Hokkaido, while smaller cities such as Asahikawa, Otaru, and Hakodate struggle. Sapporo provides the main international airport in Hokkaido, so while Sapporo (Chitose Airport) and Hakodate are roughly equidistant from the ski slopes of Niseko, traffic (ie tour groups) exclusively land at Chitose Airport.

It seems a foregone conclusion that these six cities have emerged as the survivors of modern Japan. Other cities may maintain a manufacturing base which is difficult to move (ie Kokura in Kyushu or Hiroshima), but by and large the die has been cast and capital investment over the past ten years has concentrated among these six. Even though the bullet train has been extended to Hachinohe in Aomori prefecture, businesses and capital have congregated in Sendai, from which businessmen can take an easy day trip to visit clients in Aomori. This is illustrated by Mori Trust's massive 37-floor multi-use development coming to completion.

Perhaps this hollowing out has spurred the tremendous interest in an otaku sub-culture of haikyo (廃虚) "ruins", which entails visits to buildings and other man-made projects long forgotten and abandoned.

Introduction

Welcome to Logical Progressions in Asian Development. This is a forum for me to express ideas on progress Japan and Asia has made over the past 200 years in becoming part of the modern world. As Japan has led this transformation, I focus on Japan's development, which is instructive of the greater Asian experience. My background is in finance, but it is essential to look at development through a multi-disciplinary lens, encapsulating economics, finance, politics, demographics, international relations, science, and religion. Although touching on all facets of the greater human experience is beyond my scope (and capability), I hope to raise relevant issues.