Senior vice president
*NAI Global’s Asia Pacific offices contributed
the information for this discussion
Chiang Ling Ng
M&G Real Estate Asia
Head of Asia Pacific investment research
PGIM Real Estate
The Asia Pacific real estate market was predicted to enter a period of slower growth in 2016. Was this the reality?
Chiang Ling Ng: In terms of rental growth, the cost-conscious occupier and the new supply of commercial space in most markets have largely kept rental levels in check, with the exception of Sydney and Hong Kong.
However, total investments (in dollar terms) into Asia Pacific real estate have not slowed much, despite the decline in the number of transacted deals for 2016.
For Asia Pacific’s real estate market, the uncertain outlook for US and European markets helped keep more capital within the region, with significant activity from Chinese investors sending assets offshore within the region.
In the latter half of the year, stricter capital control imposed by the Chinese government led to more onshore investments, and drove up capital values across the spectrum of property types in China.
There was also increased interest from overseas investors looking to the Asia Pacific to further diversify their real estate exposure globally, particularly European institutional investors.
Lindsay Fierro: In 2016, major Asian tier-one cities in China, Japan and Thailand were showing continuous growth. On the other hand, Singapore, Hong Kong and Taipei transactions were decreasing due to government regulations to cool down the market.
It is true that in mainland China, 2016 growth was slower than before. However, there was still growth and, given the already enormous size of China’s real estate market, this growth continues to be impressive. In 2016, real estate- and construction-related activities accounted for around 14 percent of China’s GDP ($1.58 trillion out of a total GDP of $11.3 trillion).
The same goes for South Korea. As the interest rate stay relatively low, investment in real estate is still attractive.
In Australia, this did not happen, in fact the commercial property sector in the larger cities is very buoyant with many new developments underway. We have seen an increase in interest and demand for commercial property investments from the US and Canada as well as the Asia Pacific region.
Interest rates remain at historical lows by Australian standards. However, we have some purchasers struggling to gain funding to complete purchases due to local funding restrictions.
New Zealand has seen a continuing strong property market. Positive migration numbers are seeing no lessening in demand for both properties for investment or for users to occupy. Local authority consent procedures can be exhaustive, causing supply to lag behind demand by a considerable time.
Cuong Nguyen: It is hard to sum up the Asia Pacific region in a single view given the dynamism of the markets it comprises. Slower growth was indeed the case for some markets such as Hong Kong, Singapore and Tokyo offices, but for other markets such as Sydney, Melbourne or Osaka, growth momentum is still very positive.
Rental growth in these markets has accelerated over the past 12 months, and we expect that this momentum will be carried into 2017.
In the investment markets, activity was a bit slow in the earlier half of the year, driven by political uncertainty following the UK’s vote to exit the EU and the US election, but in the last few months of 2016 activity picked up strongly.
Though still remaining cautious, investors appeared to start getting more confidence that Asia’s political environment was actually more stable than those of Europe and the US, and there would be proactive responses to the moving global political and economic landscapes.
How is 2017 poised to shape up? What are the levels of investment demand, given investors’ likely conservative attitude going forward?
Fierro: In 2017, we expect major cities in China to slow down due to the government increasing property tax for having more than one home.
There is still a strong demand for residential space, as well as commercial and industrial space, in China’s tier-one cities and also often in tier-two cities. Whereas in tier-three and tier-four cities, as well as in villages, there seems in many cases to be an oversupply of residential and commercial space.
Investment demand is quite high, however South Korean institutional investors will keep their approach conservative and risk-averse. In Australia, we believe the investment demand will continue to attract offshore investors and that 2017 will be stronger than 2016. Mining, one of the core industries in Australia, is again picking up with increased investment.
All indications are that property will continue to perform at least to the level of 2016. New Zealand does not see the same market fluctuations that many other countries experience, and with a strong and steady economy, stability of government and unemployment rates remaining at a reasonably low rate, there is little reason to anticipate much change.
Nguyen: We expect that investment sentiment and activity will remain strong in 2017. Surveys that seek to measure investor sentiment from organisations such as Asian Association for Investors in Non-Listed Real Estate Vehicles (ANREV) are all pointing to positive.
However, the fact that capitalisation rates are now at historic lows in most markets and the lack of motivated sellers in the market are making it challenging for investors to turn their demand into acquisitions without taking more risks or accepting lower returns.
It seems that taking on more risks through value-added investment would be the preferred strategy for investors in 2017.
This is already being seen in recent transactions in Japan, Australia and South Korea. Assets that need repositioning in terms of capital expenditure or significant leasing risks are attracting more attention from active investors.
Ng: We see ongoing demand to deploy capital outside the region. South Korean, Chinese and Japanese investors all have very different motivations and approaches to real estate investment. For South Korean investors, the motivation is largely to seek secure, direct investments. For most Japanese investors, the key is to source low risk investment via funds for long-term holds.
Chinese investors such as private wealth investors are often looking for relatively short-term hold periods with a higher-return profit motivation, whereas insurance entities are looking for longer-term capital preservation investments in iconic assets in key gateway cities.
The US has been the preferred destination to date, ahead of the UK and Europe. That may change with the sense that the US is not so welcoming of international capital, notwithstanding the exemption to the Foreign Investment in Real Property Tax Act for pension funds—much of the Asian capital is from insurance and bank balance sheets which do not qualify for the exemption and incur substantial tax and other reporting imposts. The UK and Europe may appear ‘friendlier’ destinations in the near term.
Which sectors are you seeing attract the most interest?
Nguyen: The office sector has attracted the most investor interest in recent years. However, as competition has led to significant yield compression in the sector, investors are expected to shift their interests to other sectors including alternatives such as student housing or hotels.
I think that the retail sector will also soon make a comeback. Investors—particularly cross-border investors—overlooked retail in recent years given the complexity and specialty demand in managing retail assets.
However, as retail sales growth is expected to recover, together with stronger economic growth expectation (including Japan), the retail sector will attract more interest.
More stable income yields and opportunity for return enhancement through asset enhancement initiatives or repositioning are indeed key factors that long-term investors are seeking in an uncertain investment environment.
Ng: Typically, investors seek investments that require limited asset management input and hence tend to favour office over retail.
Logistics has not had substantial appeal to date, partly due to lot size. I would add that the scarcity of quality assets or portfolio of assets has led many institutional investors to be less selective on sectors, and taking on a macro view of the country’s economic potential in their investment thesis.
Fierro: According to the Chinese, hospitality attracts the most interest. Regional cross-border tourists increase heavily. For example, more than five million Chinese visited Japan in 2016.
In other areas, the sector attracting most interest is logistics. There we see a continued high demand on both the export and import side. In addition, there is an enormous demand for logistic space from the booming ecommerce sector. Demand for office space is also continuing to increase.
Physical retail space is one of the few areas where rental rates and occupancy rates are dropping. This can be attributed in part to bubble situations in recent years and in part to a shift of more and more retail taking place in ecommerce.
Properties worth $100 million and above, in all sectors, have proven to be quite popular.
For Australia, we believe the strongest interest is in the industrial sector, with continued strong growth in smaller retail units with large format retail remaining static. This is then followed by new or refurbished office space.
A shifting trend has seen a rise in the demand for shared space and co-working facilities, a step away from non-standard office environments. This has been the result of technological and communication advances.
In New Zealand, we are seeing demand across all sectors. Investors’ preference is either retail or large office structures. Local investors, owner occupiers and investment funds lean towards industrial.
How are real estate investors financing deals? Are they taking on too much debt?
Fierro: The continuation of low interest rates (for example, zero interest in Japan), which encourage investors to get cheap money from banks in order to invest in real estate. In mainland China, real estate investors tend to take on a lot of debt, often ignoring the risks.
This optimism probably stems from the fact that in the past 30 years, land and property values kept rising continuously, so that many market players developed an unhealthy confidence and perceive the Chinese real estate market to be an invincible one.
In many cases, the answer could simply be that it varies. Loan to value is approximately 50 to 65 percent. Some real estate investors are funding locally, and in some of the areas we are seeing some buyers purchasing properties with cash whereas other developments have been funded 100 percent upfront.
It is unclear if investors are leveraging in their home country or not. We very rarely have any involvement in financing, however, the majority of investors seem to be sourcing funds through Chinese banks or entities.
Nguyen: Lending conditions in Asia remain broadly favourable in most markets (particularly attractive in Japan), but investors seem to remain disciplined in their use of debt. According to data from ANREV’s fund database, the average leverage ratio (debt as a percentage of gross annual value) across the region has stayed broadly stable in the last few years at around 25 percent.
In Japan, even with the extremely low cost-to-borrow and flexibility in lending terms, average leverage was around 50 percent in 2016—much lower than the level seen in pre-global financial crisis years. Value-add and opportunistic funds that typically use high leverage in their investment have also maintained their debt level at 45 percent, on average.
Reasonable use of leverage remains a positive factor supporting real estate investors looking to soften financial risks in the case of market uncertainty, and there’s not much concern on this front currently.
Ng: Generally not. We are seeing many investors seeking core assets with long-term income characteristics with a maximum 40 percent target loan-to-value. This is a different period compared to pre-global financial crisis high-leverage deals.
What is investors’ preference for structured vehicles such as funds at the moment? And are you seeing any movement from listed to non-listed REITs, and vice versa?
Fierro: Due to the current hot market, which makes the deal transaction cycle shorter, private equity funds take more advantage because they are more aggressive and make decisions with short cycles. REITs haven’t become a widespread phenomenon in China, mostly as a result of government regulation making it difficult to operate them.
Financing is often done with a portion of private equity, in some cases including artificial private equity and bank loans.
Moving to Australia and New Zealand, funds and REITs are a different type of investment. Many investors prefer this type of investment, others prefer to directly own or manage their properties.
It’s a mix between the two—we don’t foresee any change here.
Ng: Investors are not switching between listed and unlisted REITs. Both have their roles in a portfolio, but they are very different in terms of risk exposures.
Most consider real estate to be a ‘pure play’ on the underlying real estate and prefer to avoid listed security volatility.
Are you taking any notice of the fund passporting opportunities being discussed in Asia at the moment? Will these lead to any benefits in real estate for you and your clients?
Fierro: Fund passporting opportunities do not appear to be relevant in mainland China, it seems that this initiative aims more at Australia, Japan, South Korea and New Zealand, and it will possibly also include Malaysia, Thailand and Singapore.
South Korean institutional investors such as pension funds and insurance companies don’t work directly with real estate consulting firms. Especially when it comes to international transactions, those funds need accounting firms to manage the project.
But such accounting firms don’t really have wide networks to list feasible properties. So with the strong partnership of NAI and Deloitte, we are trying to provide properties for sale to South Korean investors.
Australian and New Zealand businesses are aware of the Asian region fund passport opportunities, however it is unknown if they will see any direct benefit from this new system which is expected to commence later this year.
Many clients are either directly investing in real estate by way of direct investment rather than funds.
However, it’s expected the Asian region fund passport will create many new opportunities for investment in commercial property, whether it is development or passive investments for larger property transactions.