September 28, 2007

UNLOCKING THE VALUE OF REAL ESTATE IN MICRONESIA

Keynote Speech of David B. Cohen,
Deputy Assistant Secretary of the Interior for Insular Affairs
before the Fourth Micronesia Real Estate Investment Conference Guam, U.S.A.
September 28, 2007

[Acknowledgements]

Hafa Adai, ladies and gentlemen.  Thank you for inviting me to be here with you today.  I believe that most of you are familiar with the U.S. Department of the Interior's role in Micronesia and in other island communities.  For those of you who don't know, the Secretary of the Interior generally administers the U.S. Government's relationship with its territories, specifically Guam, American Samoa, the U.S. Virgin Islands and the Commonwealth of the Northern Mariana Islands.  He also administers the financial assistance we provide to the nations in free association with the U.S., namely the Marshall Islands, the Federated States of Micronesia and Palau, under the Compacts of Free Association.  Those duties are delegated to me and my staff in the Office of Insular Affairs.  OIA has an annual budget of $430 million, most of which is provided to the Pacific in the form of grants.  Five of the seven jurisdictions that we are responsible for are in Micronesia.

Our top priority for the islands is private sector economic development, and the showcase event for our efforts in that regard this year will be our fourth Conference on Business Opportunities in the Islands, which will be held right here on Guam on October 8 and 9.  I hope to see all of you at our Conference, which will be held at the Hyatt Regency.  The Conference will offer an excellent opportunity to learn about business opportunities throughout the U.S. insular areas, including but not limited to those related to the Guam military buildup.  It will also offer an excellent opportunity to meet the people you need to meet, in both government and the private sector, to pursue those opportunities.

The theme of my talk is "Unlocking the Value of Real Estate in Micronesia".  We're all aware of exciting developments here on Guam.  I'll touch on those, but I also want to talk about the rest of the region.  In most parts of Micronesia, unlocking the value of real estate will require reform of policies relating to real property.  As we will discuss, some of these policies are deeply rooted in culture, and we must all respect the fact that it will be for the indigenous people of Micronesia to decide how best to harmonize their economic aspirations with their respect and reverence for their own culture.  We can point out the economic costs and benefits of those policy choices, but we must respect that those policy choices are for the people of the Micronesian region to make.

Let's start our tour of Micronesia here in Guam.  We all know about the planned relocation of 8,000 U.S. Marines and 9,000 of their dependents from Okinawa to Guam.  The cost of the relocation will exceed $10 billion, and will include the construction of a new military base.  The existing military facilities on Guam, including Naval Base Guam and Andersen Air Force Base, will require complementary upgrades that will cost in the billions of dollars.  One of the upshots of all of this is that the total population of Guam is likely to increase by over 35,000, or more than 20 percent.  Some will come because they were ordered to come, but many will come voluntarily because of the economic opportunities that will be generated by the buildup.  Most of these new people will be civilians.  These people will need places to live, places to shop, places to dine.  They will need utility service, and places to dispose of all of the solid waste that they will generate.  All of this will have important implications for the real estate market on Guam.  Demand for real property will increase significantly, and the last time I checked, the supply of real property on Guam has not increased.  We can therefore expect significant upward pressure on real property values, some of which is likely already reflected in the market in anticipation of events to come.
The other major driver of Guam's economy is tourism, and much of the recent real estate activity on Guam has been driven by tourism.  Japan's Ken Corp., in particular, has been very active, with its recent $73 million purchase of the Hilton Guam Resort and Spa adding to an impressive stable that now includes the Hyatt Regency Guam, the Pacific Islands Club, the Sheraton Laguna Resort, the Santa Fe and the Country Club of the Pacific.  All of these acquisitions have occurred since May 2005.  Ken Corp. and/or its affiliates reportedly now own over 40 percent of the major oceanfront hotel rooms in Guam. This is a clearly a vote of confidence in Guam's future, a display of optimism that may becontagious.
With so much of Guam's tourism infrastructure under its control, Ken Corp. now has the ability to significantly redefine Guam's image in the eyes of the international traveling public.  It has the incentive, and has shown the inclination, to move Guam's tourism industry up-market.  It has the ability to market Guam's new image in Asia, and this should benefit not only Ken Corp. but its competitors in Guam as well.  The pressure on room rates in Guam is now upward, not downward.  Ken Corp. has a network of well-heeled potential travelers from its properties in Japan, which are largely high-end residences for ex pats.  If Ken Corp. has the ability to convince a significant number of these ex pats to vacation in Guam, it will be good for Ken Corp. and good for Guam.

The Northern Mariana Islands, as we all know, is currently suffering through difficult economic times.  The tourism market is still recovering from the cessation of scheduled service from Japan Airlines in 2005.  That decision was implemented just four months after the visit of the Emperor and Empress of Japan to Saipan brought the natural beauty of that island to millions of Japanese television sets, providing what would have been, under other circumstances, a tremendous marketing boost to Saipan in its efforts to attract Japanese tourists.  Instead, the JAL pullout resulted in a sharp drop in tourism and left the Hotel Nikko, owned by a JAL affiliate, in a state of limbo.  The hotel, which is in need of renovation, is reportedly offering deep discounts to Japanese tour operators.  This in turn is putting downward pressure on room rates in Saipan. 

We see, however, some parties making significant real estate bets on the CNMI's future.  At least one of these parties has the ability to influence whether its bet will pay off, and that's good news for the CNMI.  KUMHO Asiana is seeking a 40-year lease so that it can operate the Lao Lao Bay Golf Resort on Saipan, and reportedly plans to develop a resort next to the golf course.  This investment cannot succeed without a steady flow of tourists to the CNMI.  Fortunately for KUMHO Asiana, it owns an airline.  Its airline, Asiana Airlines, has recently stepped up service between Korea and Saipan.  The Saipan World Resort is also now in Korean hands, and recently underwent a major renovation that included the addition of a large water park.  The Korean bet on Saipan, backed up with the ability to bring more tourists there, is an important source of hope for the CNMI's future.

There is a great deal of hope in Palau.  Tomorrow, I travel to Palau to dedicate the Compact Road, which was funded by my office for approximately $150 million.  The road will open up Babeldaob, which is Palau's largest island the second largest island in Micronesia after Guam, to significant economic development for the first time.  Palau recently moved its capital to Babeldaob.  The new capital complex in Melekeok sits high atop a hill overlooking the ocean.  Even with the new Compact Road, it is a significant commute from the population center in Koror.  It is clear that they are going to have to develop a new community near the new capital complex.  Everything I just said about the expected new residents of Guam applies equally to the people who will need to live near the new capital of Palau.  They're going to need places to live.  They're going to need places to shop.  They're going to need places to dine.  They're going to need utilities.  The Compact Road will also open up tourism development opportunities that never existed before.

In fact, the entire region has something to look forward to as Guam prepares to welcome tens of thousands of new residents.  As beautiful as Guam is, these new residents are likely going to want to get off the island every now and then.  As Guam becomes more fast-paced and urban, places like Yap, Chuuk, Pohnpei, Kosrae and the Marshall Islands could provide Guam's new residents with an opportunity to relax in an environment of pristine natural beauty.  Since Guam serves as the air transportation hub for the region, all of these places, in addition to Palau and the CNMI, are readily accessible from Guam.  There is now a greater potential for resort development in these areas.

That's pretty much the backdrop.  But before you go rushing out to make real estate investments throughout Micronesia, you might want to listen to the rest of my speech.  I don't intend to discourage anyone from investing in Micronesia; quite the contrary.  But it is important for investors to have a strong idea of the issues that must be addressed in order to invest successfully in the region.

The first thing you need to know about investing in land in Micronesia is that there isn't much of it.  The name "Micronesia", as many of you know, is derived from the Greek words for "small islands".  If you add up all of the land area of Guam, the CNMI, Palau, the Marshall Islands and all four states of the Federated States of Micronesia, you end up with a grand total of 910 square miles.  That's significantly smaller than Rhode Island, the smallest State in the Union, which weighs in at a relatively hefty 1214 square miles.  We're standing on the largest piece of real estate in all of Micronesia, the island of Guam.

The second thing you need to know about investing in real estate in Micronesia is that there is a strong cultural underpinning to all matters affecting land.  Land is sacred throughout Micronesia, as it is throughout the Pacific islands.  In Micronesia, one's identity is deeply tied to one's land.  With its ability to produce food and medicine, land is seen as a source of life.  This is why the idea of losing one's land carries a deep sense of emotional loss that is akin to the loss of life.  Micronesian culture, like other island cultures, emphasizes sharing.  Land is therefore generally held communally, passed down from generation to generation by blood ties and administered by traditional leaders in accordance with the culture.

Generally, in Micronesian cultures, the concept of alienating one's land to aliens is, well, alien.  In most places outside of Guam, it is not possible for non-indigenous people to own real property.  In the Northern Mariana Islands, for example, Article 12 of the CNMI Constitution restricts the acquisition of permanent and long-term interests in real property in the Commonwealth to persons of Northern Marianas descent.  In 2011, persons of Northern Marianas descent—that is, the indigenous Chamorros and Carolinians of the CNMI—will have the opportunity to vote on whether this policy should be retained, abolished or perhaps modified.  In the meantime, non-locals can acquire leasehold interests in real property for terms of up to 55 years. 

Throughout Micronesia, with the exception of Guam, real estate investment by off-islanders is generally done through long-term leasehold arrangements.  The basic limit on lease terms varies from jurisdiction to jurisdiction.  In general, however, to state the obvious, restrictions on alienation affect the risk profiles and economics of real estate transactions throughout Micronesia.  Restrictions on alienation tend to discourage investment by limiting the time horizon in which the investor can get a proper return on an investment, by limiting options for financing and by limiting exit strategy options.  Restrictions on alienation also reduce the ability of indigenous landowners to realize the full economic value of their real property, by limiting the market in which a landowner can sell real property interests and reducing demand of outsiders for real estate investment.  This is not to say that alienation restrictions are bad policy, particularly in light of the cultural reasons for having them.  This is merely to point out that alienation restrictions have an economic cost and tend to dampen—not eliminate, but dampen—real estate investment activity.  Real estate investors understand that no environment is perfect, and are adept at figuring out how to make an investment worthwhile notwithstanding particular challenges that may exist in any particular jurisdiction.

In addition to the maximum term of the lease, there are a number of other things that an outside investor would want to know before making a real estate investment in most parts of Micronesia:  What happens to the improvements after the lease expires?  Are there reliable ways of ensuring that the lessor has clear title to the property?  Are there strong regulatory and judicial institutions that can be relied upon enforce rights to the property, if necessary?  Can financing be obtained on the security of a leasehold interest in real property?  Are there procedures in place that would give lenders the comfort they need to provide financing, including the ability to foreclose upon and alienate real property interests in an event of default?  Are there reliable institutions to enforce the rights of lenders?  Are there foreign investment laws or other laws that impact what types of investment that outsiders can make, and how they should to structure those investments?  Can outsiders do business directly, or do they need local partners?  How do real estate restrictions affect the range of exit strategies?

The answers to these important questions vary from jurisdiction to jurisdiction.  Indeed, in addition to differences among the CNMI, Palau, the Marshall Islands and FSM on matters of real property law, each of the four states of the FSM—Pohnpei, Chuuk, Yap and Kosrae—establishes its own real property laws and there is significant variance from state to state.  I won't attempt to answer all of these questions for each jurisdiction now, but you can obtain helpful information from our website (www.doi.gov/oia), from the Asian Development Bank and from the jurisdictions themselves.  The most important form of due diligence, however, is to consult with banks, attorneys and other professionals who are actually operating in these jurisdictions.  They are the ones that can give you the best idea of how the legal and institutional framework really works in practice, and whether there are tried and tested workarounds that can be used to address particular challenges.

Throughout Micronesia, policymakers are taking a fresh look at real property laws.  A parade of consultants, including some funded by my office, has advised them on the economic costs of their current policies, and suggested ways in which Micronesian societies might better unlock the economic value of their precious land in ways that are consistent with their culture.  Thus, throughout Micronesia, legislators have recently considered and in many cases adopted proposals to increase maximum lease terms, to establish or strengthen land registration systems, to expand the ability of outsiders to invest in land and to strengthen the institutional framework in ways that would encourage financing and investment.  For many of these policymakers, land issues trigger deep-seated concerns that are difficult for outsiders to fully understand.

One of the concerns that we hear expressed over and over again is that "We don't want to become another Waikiki."  The first reaction of some outsiders might be to laugh and respond that "There's no danger that you will ever become another Waikiki."  But if one takes the time to understand what a Pacific Islander means when he says this, one can appreciate and respect the concern.  When people throughout the Pacific say that they don't want their island to become another Waikiki, they're not necessarily suggesting that their island is about to be overrun by several million tourists from around the world each year.  Pacific Islanders look at the Waikiki experience through the perspective of the Native Hawaiians, and see it as a symbol—rightly or wrongly—of the loss of one's land, the loss of one's culture, the loss of one's language, the loss of one's identity; of making outsiders rich at the expense of the indigenous people.  Reasonable people can debate whether this is best way to interpret the history of Waikiki's development, but it is certainly an impression that is widely held and deeply felt throughout the Pacific.  Outside investors should be respectful of these concerns and the culture that underlies them, and should be prepared to address these concerns.

Policies affecting real estate investment in Micronesia are in a period of flux.  Some places in Micronesia have policies and environments that are less than ideal for real estate investors, but that would not necessarily preclude a successful venture if one goes in with a full knowledge of the circumstances and a clear sense of how to work around imperfections in the system.  Could policy reform relating to land issues bring more prosperity to Micronesia, and more opportunity for outside investors?  Undoubtedly, but it is up to each society and each culture to strike the balance that it chooses to strike between culture and prosperity, or to find the best way to harmonize the two. 

Micronesians understand that change is necessary.  No culture is cast in stone.  Christianity, for example, was alien to the Pacific until the 19th Century; today, it is a fundamental part of most Pacific cultures.  We should always remember, however, that a culture exists to serve the needs of the people, not the other way around.  A culture that does not adapt to the changing needs of the people becomes irrelevant over time, leaving the people with the choice of abandoning their culture or following it into irrelevance.  People therefore do tend to adapt and evolve their cultures over time, but at a pace and in a manner of their own choosing.  How much of the value of real estate in Micronesia will be unlocked in the foreseeable future will be determined by Micronesians themselves, and that is as it should be. Even today, there are plenty of excellent real estate opportunities in Micronesia beyond Guam.  Even though the value of real estate in Micronesia is not, to again follow the theme of my remarks, completely unlocked, astute investors can still find ways to open the door in ways that will benefit themselves and benefit Micronesia.

Si Yu'us Ma'ase.