Asia’s real estate markets are beset by an abundance of riches. Whether derived from new sources of institutional capital that continue to build across the region, or from almost six years of global central bank easing, a seemingly endless stream of money is now pointed at real estate assets across virtually all jurisdictions and asset classes, pushing up prices and further compressing yields. For now, despite the prospect of impending U.S. interest rate rises, there seems little prospect of that flood of liquidity ending. Too much capital, however, has the tendency to distort markets, and in this case there have been a variety of consequences.
- Investors are opting not to buy. Transaction volumes across Asia fell 24 percent year-on-year in the third quarter of 2014, compared with significant gains in the United States and Europe. Although much of the decline is due to lower sales (in particular, sales of land) in China, transactions have dropped in most Asian markets, with the notable exception of Australia.
- Product is scarce. The structural shortage of investment-grade assets across the region is compounded by growing volumes of capital held by local institutions and the lack of incentive to sell, given that relatively little commercial real estate is held by investment funds that will recycle their assets into the market after a few years.
- Investors seek other asset classes. With core product both expensive and hard to source, investors are looking for alternative strategies. This includes value-add deals and, in general, more-complicated asset management situations, and finding specific types of assets that may have been left behind by the market.
- Investors are wary of secondary locations and assets. Given the lack of trust in the current market, most investors prefer to remain in gateway cities, where they have more confidence in the resilience of pricing and liquidity. This applies especially in Australia. In China, many buyers are avoiding secondary locations because of a spate of overbuilding. Japan is the exception, with competition from local real estate investment trusts (REITs) forcing investors to branch out to cities other than Tokyo. Meanwhile, secondary assets such as retirement homes, self-use storage, and student housing have proved to be less investable than previously anticipated due to difficulties of working in specialist sectors. Logistics, however, remains one area where investors are unreservedly bullish. Conversion plays—for example, from office to residential—are also popular in some markets.
- Interest in emerging markets cools. Fast-growing markets such as the Philippines and Indonesia remain on investors’ radars, but the attraction has dimmed somewhat this year as investors become cautious over the potential for capital outflows in the wake of upcoming U.S. interest rate hikes.
- Investors are increasingly willing to adopt development risk. Forward-funded and build-to-core strategies are popular, especially in Australia. In Japan, however, development is less attractive given increased construction costs.
- Distressed developers provide opportunistic returns in China. As a government-mandated squeeze in debt financing for developers takes effect, small and midsized Chinese developers will seek rescue capital or other types of private equity to make ends meet.
- Strong asset prices compare with weak rentals. Occupational markets are weak in many countries, especially Australia and Japan. Many investors project that further upside will come from improving rentals rather than from more price rises.
On the financial side, Asia has seen a structural shift in the last couple of years in the role that local institutional capital (i.e., from sovereign wealth funds, pension funds, and insurance companies) is now playing in real estate, with a big increase in local money being directed into both regional and global markets. For now, much of this new capital is sourced from China and South Korea. In the future, it is likely to be supplemented by substantial amounts of pension fund capital emerging from Japan and potentially Australia.
Another major change to the capital flow scenario (and one reason transaction volumes in Asia have been lower this year) is that funds are now increasingly directed to U.S. and European markets. At the moment, this money tends to be targeted at core assets by way of direct investments in gateway cities in the United States and the U.K. New patterns are evolving, however. As more capital crowds into these cities and as Asian investors become more experienced in operating internationally, new investments are now being directed at assets in second-tier locations such as cities in Germany and France (primarily Paris) and into U.S. cities such as Atlanta, Chicago, and Houston.
Another new trend is an increase in the volume of private capital originating from Asian markets. This has been led by a group of large Chinese developers (although Singaporean, Hong Kong, and Malaysian players also are prominent) that invest mainly in residential projects both regionally and globally, whose products are aimed largely at buyers from mainland China. While these forays appear to have been largely successful so far (with a lot of activity this year in Australia), some interviewees questioned whether the migration of Chinese developers has been too large, too fast.
Meanwhile, Asia’s banks continue to provide plenty of debt capital to fund both real estate investments and development (China and India being notable exceptions). In addition, while Asia’s public capital markets remain immature compared with those in the West, issues of both bonds and equities remained surprisingly strong in 2014.
Regional REIT share prices also have proved resilient. Although REITs are not buying as actively in 2014 compared with the previous year, they remain the biggest buyers in Japan and Australia. In the case of Singaporean REITs, they are also increasingly looking to buy outside their home markets (in particular, in China).
In this year’s Investment Prospects survey, Tokyo remains the investor favorite by a wide margin, featuring as a clear winner in both investment and developer categories and followed closely by Osaka, which as recently as our 2013 report ranked next to last.
Other major survey findings include the rise of Australian cities into leading positions, reflecting the appeal of the high cap rates still offered by Sydney and Melbourne in an otherwise yield-challenged environment across Asia. They also include a fall in popularity of China. Although the two most important mainland cities—Beijing and (especially) Shanghai—continue to show reasonable strength, the three other mainland Chinese destinations featured in the survey, together with Hong Kong, have been herded into positions at the bottom of the ladder. Sentiment toward China has been affected by an ongoing slump in the residential sector, a slowing economy, and low cap rates across almost all sectors and locations.
Finally, the industrial/logistics sector remains the most popular in terms of sectoral preferences, again by a wide margin. This is testament to chronic shortages of logistics capacity in most markets and the relatively higher yields still offered by logistics plays.