A survey by EC Harris of fund management companies, private-equity firms, hedge funds and investment banks investing in Asian real estate has found 70% of respondents were dissatisfied with investments made with local developers.

EC Harris advises investors on how to structure investments in real estate.

The firmÆs polling was not specific about geographies or types of real-estate deals, other than to cover Asia including Japan. Over the past six to nine months, the environment has deteriorated in many markets, leading to deals failing to return expectations. This is particularly so for private equity, where investors target returns of 20% or more.

Although regulatory complexity, weak judicial systems and tightening credit conditions have played their part, in many cases, the real problem was that investors failed to conduct proper due diligence, or to lay out proper covenants in their contracts with developers, says Richard Granger, partner at EC Harris in Hong Kong.

He notes a lot of basic steps were ignored when deals were struck, including: the establishment of investor approval rights that reflect both partiesÆ interests; ensuring robust development control systems and processes; and defining measurable success criteria around key milestones and realistic exit strategies.

ôThese are basic things that can be put in place,ö Granger says. ôThe current dissatisfaction with investment returns isnÆt about the credit crisis or regulatory complexity. ItÆs about a booming market, a rush to close deals, and an over-reliance on relationships with developers.ö

He says the challenge for real-estate investors now is to structure deals with proper controls, which may require asking awkward questions to developers û something many investors may shy away from if the developer is promising access to future developments or an attractive landbank.

In many cases, he says, investors have also overestimated developersÆ capabilities. Given the youth of the industry in many Asian markets, investors have financed projects that proved out of developersÆ depth.

Losses often stemmed from the supply chain, where developers were given too much leeway because of their local connections. Investors will need to insist on approval rights when developers contract out for materials or services. In some cases, leakage occurred because of inexperience; in other cases because developers knew how to skim off the top. Either way, the result is that investors may have found themselves 1-2% below target.

Investment into new real-estate projects in Asia has cooled off for the past three months, partly because financing conditions worldwide have worsened, but also because there is a widening gap between what developers expect upon exit versus what investors are beginning to deem realistic.

ôFunds are still there but they need to look at deals more smartly,ö Granger says. ôAnd if investors still want higher returns, they will have to look more at development deals.ö He believes the premiums on some core and core-plus investments that some investors enjoyed in Asia will no longer exist.

For investment to resume, EC Harris suggests, will not require just a resurgence in global credit conditions or Asian stock markets. The key ingredient for investors will be finding those developers able to prove they can execute a deal rather than hide their inexperience or lack of credibility behind the smokescreen of ôthe relationshipö.