Hedge funds specialising in property are rare, even in the United States, and in Asia there is only one: the LIM Asia Alternative Real Estate Fund. This was one of AsiaÆs most successful specialist hedge funds in 2006, recording a 37% return. Its manager, Peter Churchouse, attributes this success to both the volatile nature of AsiaÆs markets as well as his fundÆs ability to short listed property plays.

The biggest market for property is the United States, which is dominated by real-estate investment trusts (Reits). These securitised offerings of real estate offer transparency and liquidity, which pleases investors but also provides lower, more predictable returns.

Asian banks, in contrast, are only beginning to securitise their property loan books, and developers are only starting to tap global equity to finance their projects. Therefore 60% of listed property plays are stocks of high-growth property developers, while another 25% consists of build-and-hold players.

This makes Asia property more volatile û and provides more chances for active property-oriented hedge funds to generate excess returns.

For an example of volatility, one need only look below oneÆs feet. Fund managers based in Hong KongÆs IFC 2 have seen their rents soar from HK$20 per square foot to HK$120. Typically at this point in the property cycle one sees cranes everywhere and they are the seeds of the next bust, but those cranes are not there. The market is not in danger just yet û neither in Hong Kong, nor across the region.

ôThere has been some short-term overbuilding in Beijing pre-Olympics but thereÆs not enough supply in China to kill the marketö, says Shu Yin-Lee, portfolio manager at Dalton Investments, which has approximately 35% of its portfolio in property. ôIn Shanghai for example, it is only in very specific pockets that you have over-building.ö

There is tight supply in the commercial property area, and some balanced equilibrium in the residential sector. Yet the past few years have seen Asian property fall into some horribly deep holes during events such as SARS and the Asian financial crisis. That means hedge funds that can short property stocks are at an advantage.

ôThere would be mayhem if the US property market experienced the kind of volatility we have here,ö says Peter Churchouse, director of LIM Advisors in Hong Kong. ôIf you are long-only in Asian property, you will get killed.ö

He would not comment on what stocks he is currently shorting.

Fund managers report that global demand for real estate remains strong, with money from the US and Europe going to real estate in Japan and Hong Kong, and to a lesser extent Singapore, often through private equity or via giant property funds managed by Wall Street giants. Today the big investment bank-related funds are picking through China as well.

Churchouse says a niche hedge fund such as LIMÆs can dance around these large, long-term investors.

ôWeÆre riding on the backs of those giant funds,ö says Churchouse. ôWhat I mean is that weÆre just minnows in this space compared to their size.ö

The big funds arenÆt passive, of course. Joseph Smith, managing director at ING Clarion, which manages $20 billion in real estate securities, also agrees that active management is essential in AsiaÆs property markets. ôIn the Asian environment, the standard deviation in the property markets means you simply would have to run a hedged strategy.ö

The problem, however, is that many Asian markets restrict the ability to short. Where shorting is legal, it remains difficult to borrow the right stocks cheaply enough for sufficient duration. For small boutiques this is less of a problem, which is why they can be more nimble than giant property funds.

Many mainstream property investors, therefore, hope to see the Reit story in Asia progress. Singapore and Japan have had a good start, with Japan-listed Reits (many investing globally) now accounting for nearly $25 billion of assets under management. But Reits have been slow to develop in Hong Kong, and do not yet exist in China û which many investors view as the regionÆs most promising long-term development.

Reit markets have their origins in disasters, as wholesale property sales have been packaged up and sold off. For example, AmericaÆs 1991 savings and loans crisis and the late 1980s property crash in Australia forced banks to unload properties from their balance sheets. If the Chinese property market trips up, then that might be the big driver to a Chinese Reit market.

At this point we are still in a cyclical upswing, so macro-shorting ideas are few and far between. Should catastrophe occur though, such as a new SARS-derived disease or some kind of financial panic, the property hedge funds believe they are far slicker movers than their private-equity counterparts.

Whether those property hedge fund managers will themselves remain at their desks in the quarantine zone remains a mystery.