Will investment in Asia Pacific real estate markets rebound and how should investors be positioned?
Total commercial property investment transactions in Asia Pacific (APAC) totalled US$92.3 billion in the first half of 2022, equivalent to a 11% decrease year-over-year, according to the MSCI Real Capital Analytics (MSCI RCA). Transactions in the second quarter of 2022 dropped by 22% year-over-year, reflecting increased risk aversion in financial markets since the start of the Russia-Ukraine conflict, rising inflation and interest rates, lockdowns in mainland China, and strict Covid-19 restrictions in the Hong Kong Special Administrative Region (HKSAR).
The steepness of the decline is exaggerated by comparison with a record first half of 2021, and the current weakness of many APAC currencies against the US dollar. Adjusting for the currency effect, the decline in the second quarter of 2022 would have been about 16%. In any case, not all APAC markets saw lower activity: notably, Singapore saw a 54% increase in transactions in the first half of 2022.
What key long-run factors should support APAC real estate markets?
In our view, APAC real estate offers investors a long-run structural growth opportunity. APAC represents approximately 36% of global GDP, 50% of global large city population, and 45% of Fortune Global 500 companies. However, APAC represents only about 24% of global property market index value and 16% of global investment property transactions.
Key trends in APAC include continuing urban migration, the emergence of “megacities” across the region, increasing technological leadership, and location by enterprises of manufacturing and assembly operations in new markets to complement operations in China – a shift which is boosting economic activity in the east and south of the region. These trends represent strong tailwinds which offer ample headroom for sustained increases in property investment levels and valuations over time.
Is a flight to safety happening among APAC real estate investors?
For now, APAC real estate investors are generally waiting and are being more selective about deals. This is understandable given geopolitical tensions, the ripple effects of slowdown in China, and upward pressure on inflation and interest rates in many markets. Higher interest rates increase the required return from all asset classes including property. However, in APAC’s two largest commercial property markets, Japan and mainland China, interest rates should stay stable or decline over 2022.
Over the next year or so, we expect cross-border investment flows to target principally the more mature and liquid APAC property markets such as Japan, Australia and Singapore. Developers with longer time horizons and Value-Add investors may still find opportunities in mainland China and Hong Kong (including purchase of distressed assets), but activity in these markets are likely to be constrained in the near term.
How will the various property markets perform over the second half of 2022 and beyond?
Prime-grade Japanese property assets look attractive relative to the world’s lowest interest rates and bond yields, the broad range of opportunities available in Tokyo – APAC’s largest urban commercial property market – and other big cities should continue to attract investors. Compared to the 2021 average, the Japanese yen has weakened by about 21% against the US dollar so far in 2022, presenting an appealing buying opportunity for foreign funds. Investment transactions in Japan may therefore strengthen over the rest of 2022, at least in yen terms.
Singapore is popular with multi-national corporate occupiers despite rising rents, and has attracted some relocation from Hong Kong. Investors have so far followed occupiers’ lead. However, cap rate compression and rising interest rates suggest that transaction volumes will not rise so strongly in the second half of 2022. South Korea should also stay firm, with foreign capital potentially supporting strong domestic demand.
Investment activities by domestic investors in mainland China ought to pick up now that major lockdowns have eased. However, economic slowdown and financial stresses among residential property developers will probably hinder a strong rebound. Investment volumes in Hong Kong will also be constrained by the fastest-rising interest rates in developed APAC markets – a consequence of the territory’s US dollar peg which effectively ties Hong Kong interest rates to US rates.
What about the APAC property market outlook from a sector perspective?
Looking at the data for the first half of 2022, office transactions recorded a 5% increase across APAC. This number looks set to stay reasonably firm for the remainder of the year. We expect continued demand for offices in Singapore, Japan and Australia from Core investors seeking income, but also Value-Add investors seeking repositioning opportunities.
Industrial and logistics transactions in the region fell by 41% in the first half of 2022, albeit from a very high base. There has been substantial yield compression in this sector, so a rapid rebound in activity is unlikely. Structural challenges mean a strong rebound is also unlikely in retail real estate, although the sector may be starting to offer value in certain markets.
Looking ahead, we believe that prospects for investment are brightest in the smaller and less traditional property sectors in APAC. Given increasing demand for rented homes, the multi-family apartment sector offers stable income in Japan (the most mature markets), and growth potential in Australia and mainland China.
Post-Covid-19 recovery is also beckoning in hospitality, starting with domestic, urban and business travel in Japan, South Korea and Australia. As a smaller market which has completely relaxed travel restrictions, Singapore should benefit first from a revival of foreign tourism. Hotel transactions are rebounding in many markets, notably Australia, and this trend is expected to continue.
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