A look at growth sectors in the Asia-Pacific real estate market

By Jonathan Hsu / M&G Real Estate | September 3, 2018 9:00 AM SGT
Economic growth is expected to keep pace across the five developed Asia-Pacific economies — Australia, Hong Kong, Japan, Singapore and South Korea — this year, as the global trade recovery continues to gain momentum, al- though at a slower pace than in 2017.
Key downside risks still remain in the region, however, such as US and Chinese economic policies and environment. A quicker pace of rising rates in the US as well as a Chinese credit shock would have a negative impact on Asia-Pacific’s real estate market. There is also the risk of an escalation of the US-China trade war, but this needs to be considered against the possibility of a China-led Asia trade pact.
Key Asia-Pacific gateway cities such as Hong Kong, Melbourne, Seoul (pictured) and Sydney are expected to grow in the range of 2% to 5% a year on average, from 2018 to 2020 (Credit: Bloomberg)
The office market in the key developed cities in Asia-Pacific should benefit from business growth in the medium term, particularly from technology, finance and business services. The ongoing boom in the technology sector is expected to continue in the near term and serve as a key driver of occupier demand for most markets, backed by further expansion of more established tech firms, an increase in the number of start-ups and the opening of new regional headquarters by foreign firms.
Persistently tight labour market conditions in the developed Asia-Pacific markets are set to continue to drive competition for talent among corporates. As office location and building quality are key to attracting and retaining talent, prime office locations that are close to public transport infrastructure and multiple amenities — such as retail, gyms and parks — stand to benefit.
Key Asia-Pacific gateway cities such as Hong Kong, Melbourne, Seoul and Sydney are expected to grow in the range of 2% to 5% a year on average, from 2018 to 2020. Relatively lower rents in the fringe submarkets of these cities are expected to attract more cost-conscious tenants and capture some rental upside too.
The Singapore prime office market is expected to outperform the region until 2020 because of a limited supply of Grade-A office space in the CBD over the medium term and recovery of traditional, larger occupiers such as financial institutions and oil and gas companies.
Strengthening business investments in cities such as Osaka and Brisbane should help support demand for office space and rental growth. In particular, low vacancy levels in Osaka’s office market and a tight future supply pipeline could further bolster rents.
Brisbane’s office market is displaying signs of recovery as the Queensland economy transitions towards broader-based growth, diversifying away from construction and manufacturing and more towards healthcare. Vacancy rates are expected to decline over the next couple of years, and net effective rents should register higher growth by 2020. Osaka logistics and Tokyo office, on the other hand, are expected to see rental growth dragged down by an influx of supply over the next three years.
With the exception of Seoul and Brisbane, rental growth in the office markets is likely to be front-loaded, with rents in most markets expect- ed to peak by end of next year. Subsequently, slower economic growth, higher interest rates and labour constraints may dampen occupier demand for office space. In the medium term, impending supply in markets such as Tokyo and Melbourne is expected to further weigh on office rental growth.
The capital cities of the five developed Asia-Pacific markets are expected to record continued income growth as global economic power continues to shift eastwards. Tokyo, Osaka and Seoul are expected to become some of the largest global consumer markets in 2030. This underscores expectations for household wealth growth over the next decade, providing higher levels of disposable income to be spent on goods and services.
Expected higher tourist arrivals in the region are likely to provide sup- port for prime retail markets. The World Tourism Organization forecasts tourist arrivals in Asia-Pacific to in- crease to 535 million in 2030, from 331 million in 2016, which is equiva- lent to an annual growth rate of 5%.
Demand for prime retail space is thus likely to stem mainly from foreign brands seeking to raise their profile in the region with both locals and tourists, and capture potential higher-value discretionary purchases outside of their domes- tic markets. Among the developed markets, Hong Kong’s retail market is expected to see the strongest rent- al growth of 3% a year over the next three years as it continues to attract a high volume of tourists, particularly from China. Hong Kong was the most visited global city in 2017.
Near-term challenges for the region’s retail market centre primarily around weak domestic consumption. In Australia, this is driven by slow wage growth, tighter credit conditions, a housing market slowdown and an increase in inflation. Retailers may de- lay physical store expansion plans to invest further in omni-channel solutions. In Japan, the impending consumption tax hike in October 2019 is likely to lead to a slight downturn in the retail market in 2020.
Logistics take-up is expected to remain robust as e-commerce continues to grow in the region. Demonstrative of this is parcel delivery, one of the fastest-growing segments of the logistics industry, according to Colliers International.
Australia and Seoul are expected to be the best-performing logistics markets in the region, with average total returns of 8% to 12% a year over the next three years, according to M&G Real Estate analysis. A sustained population growth in the former would boost demand for logistics as consumption grows from a low base. Seoul’s logistics market is expected to see further cap rate compression over 2018 and 2019, as the market sector attracts more institutional investors.
The lack of available development land for new modern logistics facilities in Hong Kong should provide support for higher rental growth. With new supply expected to taper from 2018, Singapore’s logistics market is likely to recover by year-end and grow an average of 1.6% a year over the next three years. Tight supply and rising construction costs in some markets are also likely to support rental growth, such as the Tokyo Bay area.
There are, however, potential limitations to the upside for the logistics market in the next three to five years. In response to rising demand, there has been more speculative development particularly in markets where land is more readily available. Osaka exemplifies a market in which new supply is currently outpacing demand, which is expected to continue until 2019. Logistics rents in Osaka are therefore not expected to turn around until 2020.
Among logistics providers, there is a growing shift from business to consumer delivery to capture e-commerce growth. High competition in this segment places pressure on occupiers to keep costs lean, owing to the difficulty in passing costs on to consumers. Furthermore, persistently low unemployment levels could dampen expansion plans in key Asia-Pacific cities, as the logistics business is labour-intensive and facing a shortage of appropriately skilled manpower. As such, rental growth should perform in line with inflation for most markets.
Growing interest in core assets
Liquidity in the market is expected to remain elevated and 2018 should be another strong year for commercial real estate transactions, with record transaction volumes already seen in the first quarter of this year. This is despite restrictions on Chinese capital outflows, as Chinese investors have traditionally been one of the largest sources of cross-border real estate investments.
While real estate investors remain motivated by stable income streams and diversification from other assets, high property prices and historically low yields in the region are creating caution among investors. This is further heightened by expectations of rising interest rates.
Investment activity in the near term is thus likely to be more centred on markets and sectors in which higher yields can still be found, such as Australia and South Korea. The latter is expected to see more investment interest in the medium term as geopolitical tensions in the Korean peninsula subside and investors’ confidence improves. The industrial sector should continue to draw investors seeking to tap the positive structural drivers across Asia-Pacific markets.
Over the longer term, increased institutional interest in Asian real estate should continue to support investment in core assets and increased liquidity in the region. The market may also attract a more diverse base of institutional investors looking to Asia-Pacific real estate for its stable income over the long term, rather than solely for its capital value growth.
Asia-Pacific is expected to deliver a total return of around 9% in 2018, driven by expected yield compression in Australia and South Korea, alongside stable rental growth in the five developed markets across most sectors.
Capital values could fall if rising interest rates exert upward pressure on capitalisation rates. This places increasing importance on the sta- bility of property income, which can be strengthened through active asset management.
Owing to expected widening of cap rates across the market sectors, total returns for Asia-Pacific real estate are likely to dip from 2019. Among the sectors, logistics should provide the highest returns of 7% a year over the medium term, as higher yields compared with the other sectors provide a wider buffer against rising interest rates.
Given the relatively low returns, we remain more cautious on Tokyo and Hong Kong office and retail sectors, as yields have compressed to significantly low levels of 3% - the lowest in the region.
Jonathan Hsu is a director and head of research for Asia at M&G Real Estate (Credit: M&G Real Estate)