Corruption on the Orient Express

China's property markets are luring investors from around the world, but corruption and kickbacks can make any real estate a tricky proposition. By Robin Marriott

As luck would have it, my return train ticket from Guangzhou to Hong Kong seated me next to one of the only other Westerners on the trip.

He was on a fact-finding mission to China and his journey had so far taken him in a huge loop from Beijing to Shanghai, then down to Guangdong and onwards to Hong Kong. And he was not traveling alone.

On the other side of the aisle was a Chinese gentleman, dressed in a pinstripe suit, with his shoelaces undone to make the two-hour journey pass more comfortably. Together, the pair had just spent the morning inspecting a site that, at the urging of a very senior Guangzhou official, would hopefully be developed into a leisure park. The nearly-shoeless gentleman was my companion's “in” to the Chinese property market and his extensive contact book had opened doors to investment opportunities across the country, including a development near Tiananmen Square.

What I was told next underlined the difficulties of property investing in any emerging market and confirmed the worst fears of real estate investors, limited partners and Western government officials about doing business in China. My companion's Chinese friend apparently sets aside £500,000 a year for presents that he gives to certain “friends.”

To his credit, my fellow passenger, who sources deals for leisure operators and private equity firms, said it was hard for his company to get involved in such shenanigans—not only is it amoral, of course, but it is also illegal and could result, at least in the US, to indictments under the Foreign Corrupt Practices Act. Nevertheless, the Western businessman was going back to London to give his superiors an update on a particular deal, a transaction that, from my vantage point, was hard to imagine taking place without presents being involved somewhere along the line.

Many other investors in China relate similar stories about corruption and kickbacks among government officials and local operators. With all the money pouring into the country, not to mention the relatively meager salaries of Chinese public officials, such practices are perhaps inevitable.

Transparency International, the global coalition against corruption, ranks China 78th in its 2005 Corruption Perceptions Index, putting it in the same league as Morocco, Senegal, Sri Lanka and Suriname. It received a score of just 3.2 out of 10 based on the views of business people and country analysts.

In another survey, the global property consultant Jones Lang LaSalle ranked China 42 out of 56 in its 2006 Real Estate Transparency Index, which takes into account how much information is readily available as well how fair and consistent a market is. Of the countries in Eastern and Central Europe, only Turkey and Romania were found to be less transparent.

Interestingly, the Jones Lang LaSalle report suggests that a slight improvement has been made. Corporate governance is tightening, accounting issues are being resolved, English documents are increasingly available and more effective legal measures are being put in place for acquisitions.

As the MIPIM Asia property conference prepared to open in Hong Kong last month, the spectre of corruption hit the headlines once again. The local newspapers reported that Chen Liangyu, the Shanghai Communist Party secretary, had been fired as part of a widening probe into corruption involving real estate deals. He was the highest government official to be fired in China in the past decade.

By the end of the week, Sum Luyi, the vice secretary-general of the Shanghai municipal committee, had also been implicated. In total, more than 20 people are currently being investigated for possibly diverting as much as $400 million from Shanghai's pension fund to property projects. Liangyu is accused of aiding illegal business, shielding corrupt colleagues and abusing his position to benefit family members.

On the face of it, the investigation looks like a crackdown on corruption. On the other hand, some observers say it is just Beijing shoring up its power base by curtailing Shanghai.

Foreign real estate investors on the ground in China are no doubt hoping for the former.

Carlyle JV buys Japanese malls
A joint venture between international private investment firm The Carlyle Group and real estate management firm SOW has acquired the Omuta REX Shopping Center in Omuta City, located in the Fukuoka prefecture of Japan. The acquisition was made in conjunction with The Bank of Fukuoka and Japanese commercial developer Office Berkeley. The shopping center was developed in March of last year and has more than 69,213 square feet of floor space. According to a press statement, current tenants include drug store chain Sun Drug, as well as shoe stores Marumiya and Chiyoda. The joint venture between Carlyle and SOW was established earlier this year to invest in mid-sized retail centers in the regional cities of Japan. It has acquired five properties with a purchase price of more than ¥12 billion ($101 million; €81 million).

Goldman seeks $1bn IPO for Japanese golf portfolio
Investment bank Goldman Sachs reportedly planned to list its Japanese golf course roll-up Accordia Golf on the Tokyo Stock Exchange on November 1 in a $1-billion transaction (€831 million). The IPO, comprising 91 courses Goldman acquired at discount prices, is set to be the third largest in Japan this year. Goldman is reportedly planning to sell 55 to 60 percent of its shares in the golf company. Last year, Texas-based firm Lone Star Funds listed Pacific Golf International, a similar Japanese golf company, in a Tokyo IPO valued at approximately $380 million.

Paladin Realty closes $200m Latin America fund
Los Angeles-based Paladin Realty Partners has held a final close on $200 million (€156 million) for its second private equity real estate vehicle targeting Latin America. Paladin Realty Latin America Investors II raised the capital from a number of institutional investors, including the Overseas Private Investment Corp. and International Finance Corp. The majority of the fund will be invested in residential projects, with at least half targeting the affordable housing sector. Primary emphasis will be placed on Mexico, Brazil and Chile, though Paladin may invest across Latin America. One of the firm's most notable investments in the region so far is the development of the Estrella del Mar Golf and Beach Resort in Mazatlan, Mexico. Still under construction, the project will have 1,145 homes and 631 condos when completed.

HK Jockey Club invests in global RE
The Hong Kong Jockey Club, a city institution and institutional investor, has reportedly made its first investment in global real estate with a commitment to Deutsche Bank's RREEF funds. Local press reports are saying the club has committed between $100 million (€80 million) and $200 million to the firm as it looks to increase its exposure to alternative assets. Before choosing RREEF, the club reviewed six asset managers—and may return to invest in these funds at a later date.