WE LIVE IN UNUSUAL TIMES
The 1997 Asian Financial Crisis was a very diffi cult period for many countries including Singapore, Malaysia and South Korea, however, the lessons learned and the resulting reforms to banking systems helped the region weather the Global Financial Crisis (GFC) comparatively well. Governments, corporations and households endured the sharp downturn and rebounded quickly thanks to their conservative balance sheets and comparatively moderate risk levels. Yet the region has not decoupled from more developed economies, especially given the importance of trade. Growth is currently below trend due to the ongoing recession in Europe and the continued slow and somewhat patchy recovery in the U.S. The effect of aggressive monetary policy in the U.S., and to a lesser extent
in Europe, has caused fl oating rates to decline and liquidity, currencies and asset prices to increase in the Asia Pacifi c region. Some of the Asia Pacifi c real estate markets have not escaped and pricing has risen as local investors target real asset investments and institutional investors seek real estate’s comparatively attractive yields.
Real estate yields have fallen in many Asian markets, yet the positive spread over both local sovereign bonds and total borrowing costs have led some investors to view the sector’s expected comparative performance favorably. This is evident in recent transaction volumes, and while much of the activity has come from domestic buyers and sellers, the region’s pension funds and insurance fi rms have increasingly become an important source of capital.
Similar to the western economies, the region’s central banks have been very accommodative. Low domestic infl ation has allowed policy makers to implement stimulatory measures, such as lower interest rates, designed to aid economic growth. But what will happen when central banks unwind these positions? Will higher short-term variable rates lead to higher cost of debt and therefore higher real estate yields? While higher variable rates may lead to a softening of property
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June 2013Asia Pacifi c Property: A Primer
yields, banks may also reduce their lending margins, which could offset the direct impact. A rise in policy rates usually signals economic growth, which in turn should generate occupier demand and NOI growth via either rent growth or lower vacancy. Additionally, some of these markets (such as Singapore, Hong Kong, China etc.) have not been priced as core markets, i.e. markets where income is expected to comprise a large portion of the total return. Rather, investors are projecting appreciation to be the biggest part of the total return, making these markets less interest-rate sensitive.
DEMAND: THE LONG AND SHORT OF IT
While it is always important to identify where markets are in the cycle, it is equally important to consider the market’s longer-term fundamental drivers. Some of the region’s long-term demand drivers for the real estate market include: high comparative growth, urbanization, the rise of the middle class and the growth of domestic businesses.
High Growth
The region’s high comparative economic growth can be attributed to a few underlying factors. First, many governments are better positioned with regard to debt than the governments of the West. This has allowed them to continue to invest in their economies, building much-needed physical infrastructure that helps generate productive capacity and competitiveness. While investment has grown faster than consumption, consumption growth should not be underestimated. For instance, in China consumption grew 8.6% per annum over the ten-year period from 2003 to 20121
. In comparison, U.S. consumption growth was only 1.7% per annum, lower than Australia (3.3% per annum), Hong Kong (4.2% per annum), Singapore (3.7% per annum), Korea (2.8% per annum) and Malaysia (7.4% per annum).
Future economic growth for many of the region’s economies is expected to be less reliant on low-level investment and the demographic dividend2
. Rather, growth in the region is expected to come from productivity improvements that will result from innovation, improved skill levels and/or competition. We have observed an increase in this type of output growth in many markets, including China, Singapore, Hong Kong and Korea.
FIGURE 1
CHINA: SLOWER RATE OF GROWTH BUT MORE OUTPUT
0 1,000 2,000 3,000 4,000 5,000 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 G D P, R M B , b illions 10.5% p.a. 5.9% p.a.
Source: Oxford Economics May 2013
1
Aggregate government and consumer consumption, Oxford Economics, June 2013 2
Demographic dividend refers to an increase in the productive labor force, a declining dependency ratio and typically coincides with improved economic growth. In India and Indonesia, for example, this long-term structural trend is an important driver.
A rise in policy rates
usually signals economic
growth, which in turn
should generate occupier
demand and NOI growth
via either rent growth or
lower vacancy.
Urbanization
Urbanization and the growth of cities have also been important contributors to the region’s development over the past few decades. Some countries such as Australia, Japan and Korea are highly urbanized, however, others including China, India and emerging Southeast Asia, are forecast to see substantial growth in their urban population; the growth of urban areas is far from fi nished. By one estimate, Chinese cities are forecast to add the population of Australia every year for the next ten years3.
Urbanization brings a multitude of changes to a country and its economy, not the least of which is modernization and demand from consumers for higher standards of living. There is a consequent increase in demand for all forms of modern, high-quality housing and
commercial real estate as households and businesses respond to this growth. Simply put, there are more people, which creates demand for places to live, shop and work.
In the U.S. (and other western economies), urbanization was the direct consequence of movement from an agrarian economy to a manufacturing-based economy and, later to the post-manufacturing “information economy”. At each stage there were huge increases in productivity and income/living standards.
Wealth Creation and the Rise of the Middle Class
Urbanization is closely linked to wealth creation, the rise of the middle class and the expansion of the service sector. Independent research suggests that the center of the world’s economic activity has shifted eastward and will continue to do so. Growth in China, India and Southeast Asia is shifting the world’s attention to Asia and research indicates that over 80% of both the increase in the projected size and purchasing power of the global middle class is expected to come from Asia.
FIGURE 2
GROWING CONSUMER MARKETS OF ASIA
Note: ‘Middle class’ is defi ned as those households with daily expenditures of between US$10 and US$100 per person. The black border circles and orange border circles depict the size of the middle-class population in 2009 and 2030, respectively. Source: Kharas & Gertz (2010).
3
United Nations Population Division, 2010 revision
North America 2009: 338 m 2030: 322 m Central and South America 2009: 181 m 2030: 313 m Europe 2009: 664 m 2030: 680 m
Middle East and Africa 2009: 137 m 2030: 341 m Asia Pacifi c 2009: 525 m 2030: 3228 m
The spending power of this middle class is very important. Aggregate private consumption in Asia is projected to be larger than the U.S. in just a few years. While consumption on a per capita basis in Asia is lower than the U.S. or Europe, it is expected to grow rapidly - approximately 34% through by 2017.
The rise of the middle class is expected to happen in tandem with the rise of the service sector. This is particularly true for China where rebalancing is a focus of its leadership. A bigger service sector means more demand for many goods and services, from fast-moving consumer goods (FMCG) in supermarkets or hypermarkets through to fi nancial services such as banks and insurance. This has positive consequences for demand, not only for prime real estate, but also for high-quality commercial real estate in non-prime locations, for instance local necessity shopping centers.
Business Growth
As economies grow and spending power increases it leads to an increase in the creation and expansion of domestic companies. This materializes at the local level with entrepreneurial activity creating new start-ups, which then leads to small-and medium-sized enterprises. It also occurs as large businesses grow and become national or international.
The Asia Pacifi c region has quickly developed a large corporate base. The 2012 Forbes 500 (an annual list of the 500 largest corporations by revenue) shows the Asia Pacifi c region is home to 179 of the world’s largest corporations. This is more than either Europe or the U.S. and is more than a threefold increase from 2005, when there were only 50 Asia-Pacifi c-based corporations on this list. Much of this growth comes from Chinese fi rms, but Japanese and Korean fi rms are also prominent. Similarly, trade fl ows indicate the level of economic activity and business growth in the region. In 2011 eight of the world’s ten busiest ports by TEUS volume (twenty-foot equivalent unit) were in Asia and 75% of the combined volume of the 50 largest ports in the world was from the region4
.
When more than 500 large corporations were surveyed at the end of 2012 about where they expect to see growth over the three-year period from 2012-2014, they reported the Asia Pacifi c region was expected to see the highest growth. This contrasted sharply with the U.S., which was stable, and Europe, which contracted.
FIGURE 3
GLOBAL CORPORATE EXPANSION INTENTIONS
Negative Net Portfolio Growth (<-10%) Negative Net Portfolio Growth (-10% to -1%)
Rest of Region Stability (0% Net Growth)
Positive Net Portfolio Growth (+1% to +10%) Positive Net Portfolio Growth (+11% to +30%) Positive Net Portfolio Growth (>+30%)
Source: Jones Lang LaSalle, 2013 4
World Shipping Council, 2012
The Asia Pacifi c region
has quickly developed
a large corporate base.
The 2012 Forbes 500
shows the Asia Pacifi c
region is home to 179
of the world’s largest
corporations.
SUPPLY - PROVIDING FOR EXPECTED DEMAND
The Asia Pacifi c real estate markets have become a signifi cant part of the global investable universe and it is expected to continue to grow in both size and value. The Asia Pacifi c Real Estate Association (APREA) estimates that currently the region is about 27% of the global universe and they project that by 2021 the region’s investable universe will be larger than the combined value of the Americas and Europe today and will represent approximately 39% of the global universe. This growth is not only coming from new construction, but also value growth; a larger middle class will produce more than just demand for goods and services, it will also create a larger pension and insurance industry looking for stable long-term investments, which will be a growing source of capital for quality real estate.
FIGURE 4
PROJECTED INCREASE OF GLOBAL INVESTABLE PROPERTY MARKET
0 5 10 15 20 25 30 35 40 45 50
Asia Pacific Americas Europe
U S D t rilio n 2011 2021 2031
Source: Asia Pacifi c Real Estate Association, 2013
While the construction of new institutional-quality real estate will account for part of this supply growth, we expect demand to keep pace with the ability of developers to deliver new supply. Historically, the ability of developers to deliver supply has lagged economic growth in many markets, including land-constrained markets such as Singapore and Hong Kong, but also in Seoul and Shanghai. That said, the addition of new supply is being helped by infrastructure improvements, which includes high-speed rail in China and new urban rail lines in Hong Kong and Singapore, enhancements which open up new areas to development, improve effi ciency and create real asset value.
APREA estimates that
by 2021 the region’s
investable universe
will be larger than the
combined value of the
Americas and Europe
today and will represent
approximately 39% of the
global universe.
FIGURE 5
THE GROWTH OF REAL ESTATE MARKETS COMPARED TO ECONOMIC GROWTH INDEX 1998 = 100 100 150 200 250 300 1998 2000 2002 2004 2006 2008 2010 2012 SINGAPORE GDP Stock 100 120 140 160 180 1998 2000 2002 2004 2006 2008 2010 2012 HONG KONG GDP Stock 100 150 200 250 300 1998 2000 2002 2004 2006 2008 2010 2012 SEOUL GDP Stock 100 200 300 400 500 1998 2000 2002 2004 2006 2008 2010 2012 SHANGHAI GDP Stock
Source: Oxford Economics, Jones Lang LaSalle, May 2013
GATEWAY TO THE REGION
Gateway cities are often a favored entry point for investors as they typically provide an enticing combination of lower risk and a large base of institutional-quality real estate stock. In the Asia Pacifi c region gateway cities include Seoul, Tokyo and Taipei, as well as large fi nancial centres such as Shanghai and Sydney. Singapore and Hong Kong are two distinctive gateway markets in that the former is a city state, and the later is a self-governing region of China, but both are globally signifi cant fi nancial centres.
A common characteristic among gateway markets is liquidity. The more liquid markets are seen as desirable by investors, not only for their ability to reduce search costs, but also because price discovery aids in the valuation process and supports lenders’ decision making. As shown in Figure 6, over the past fi ve years, the key gateway markets of Singapore, Hong Kong, Seoul, Taipei and Shanghai have represented around 65% of all Asia ex-Japan real estate transaction activity.
FIGURE 6
KEY GATEWAY MARKETS’ SHARE OF TRANSACTION VOLUME
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 2007 2008 2009 2010 2011 2012 S h a re of ov e ra ll t ra n sa ct ion v o lu m e
Value of transactions (USD) Number of transactions LT Average (USD)
Source: Real Capital Analytics, April 2013. Key gateway markets include Singapore, Hong Kong, Seoul, Taipei and Shanghai
The majority of transactions in these markets are USD75 million or less, which allows most investors to satisfactorily diversify their portfolios, reduce systematic risk and improve expected risk-adjusted returns. Average transactions in these markets are a digestible size for small- to medium-sized investors, which is contrary to the perception that transactions in the region are typically large.
FIGURE 7
DISTRIBUTION OF AVERAGE TRANSACTION VALUE 2007 TO 2012
30% 32% 20% 10% 6% 2% 0 10 20 30 40 50 60 70 <50m 50-75m 75-100m 100-125m 125-150m >150m Numb e r of T ra n s a ct io ns <$50m $50-$75m $75-$100m $100-$125m $125-$150m >$150m
Source: Real Capital Analytics, April 2013 RETURN EXPECTATIONS
Yields in the Asia Pacifi c region have recovered from 2008 and 2009 and in some cases are surprisingly low, primarily because many investors are expecting a large part of their total return to come from appreciation as opposed to income. In particular the land-constrained, yet built out and fast growing, markets of Singapore and Hong Kong are two places where yields have fallen below 4%. That said, there is a wide variation in yields throughout the
Average transactions
in these markets are
a digestible size for
small- to
medium-sized investors,
which is contrary to
the perception that
transactions in the region
are typically large.
region. For instance, Australia has the highest unleveraged yields in the region with prime CBD offi ce yields currently between 6.0%-7.0%, while secondary yields are between 7.0%-8.5%. Regional retail shopping centres’ yields are between of 5.5%-7.0%, while smaller sub-regional centres have yields of 6.5%-10.0%. Often it is the city and trade catchment that explains the difference between the highest and lowest yields. Prime offi ce assets in Korea can trade at about a 5.0%-6.0% yield, while secondary-quality properties can transact at a 200 basis point premium to this. In Japan, Tokyo prime offi ce yields are around 4.0%-4.5% and secondary quality buildings in the central 23 wards are about 5.0%-5.5%. Outside Tokyo, regional cities, which are considerably smaller, have offi ce assets trading at about 6.0-7.0%. Yields for shopping centres in Japan are about 6.5% in Tokyo and 7.0%-8.0% outside.
Gearing from local commercial banks is available for most types of income-producing real estate. Maximum loan-to-value ratios for fi rst mortgages are typically in the 50% to 60% range and interest rates are typically quoted on a variable plus lending margin basis, with total borrowing costs ranging from 2.0% to 7.0% per annum depending on the market. This equates to leveraged income returns on acquisitions, before any rental growth assumptions, that can be as high as 10% per annum in select markets. Income growth assumptions depend largely on asset quality and location.
In Asia there are a larger number of buildings that are older and poorly maintained. For instance in Hong Kong some 60% of the offi ce stock is more than 20 years old and it is typical for local owners to spend very little on repairs and maintenance. These assets will benefi t from professional management and capital expenditure. This leaves a large opportunity for income improvement above and beyond whatever market movement there might be. To borrow a term from the hedge fund industry, many of the markets are alpha rich.
CONCLUSION
We are living in usual times at the moment. Advanced market central banks have aimed to keep interest rates low for a long time and increased monetary liquidity. Bond yields have fallen to very low levels and alternative investments, such as real estate, have seen an infl ow of capital seeking yield. The risk of this reversing continues to hang over the market, however, we believe Asian real estate markets are less interest rate sensitive and local banks could absorb some of the impact.
There are many long-term fundamental demand drivers supporting real estate markets through their cyclical ups and downs. Urbanization and the rise of the middle class are arguably the two most noteworthy, but equally signifi cant is the expected growth of both the service sector and domestic companies. On the supply side while governments have been focused on improving urban infrastructure which has benefi ted property investors and developers, historically developers have not been able to complete commercial buildings at the same rate of growth as the underlying economies.
We believe gateway markets offer investors a good risk-adjusted entry point for investment in the Asian real estate markets as they are large, liquid and transparent. While income returns or yields in some of these markets may seem low when compared with the U.S. or Europe, this is primarily because many are land constrained and investors are expecting capital gains to form a large part of their total return.
Commercial property is merely a factor of production in a local economy and, as such, will perform largely in step with the fortunes of the local economy. When tenants are earning excess economic profi t, this excess ultimately accrues to the factors that produce it. Some will go to labor, some will go to technology or other capital and some will accrue to the property itself, primarily through rising rents. Across the region, we see many instances of this happening and expect even more as urbanization moves people from lower to higher productivity activities, living standards continue to rise and global competitive differences continue to narrow.
Prepared by AEW Research, June 2013 This material is intended for information purposes only and does not constitute investment advice or a recommendation. The information and opinions contained in the material have been compiled or arrived at based upon information obtained from sources believed to be reliable, but we do not guarantee its accuracy, completeness or fairness. Opinions expressed refl ect pre-vailing market conditions and are subject to change. Neither this material, nor any of its contents, may be used for any purpose without the consent and knowledge of AEW.
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