Adding value in Asia-Pacific

Investors in the Asia-Pacific region have changed their stance on risk and return dramatically in the past year, with a substantial majority now favoring value-add strategies. Real estate member funds body ANREV’s Investment Intentions Survey 2024 shows value-add is the preferred style for 63 percent of investors, up from 33 percent last year. The preference for value-add investment is now the strongest in more than a decade, according to the Asian not-for-profit organization.

David Fassbender, senior portfolio manager for the Asia-Pacific value-add fund series at PGIM Real Estate, the real estate investment management business of Prudential Financial, says: “A couple of years ago we had a lot of capital in the market and very cheap debt, so we saw investors being willing to take more risk for less return. Today, however, we have less capital in the market and more expensive debt.

“Furthermore, investors are not expecting cap rates to compress back to where they were, so they understand you need to do something, you need to add value to an asset to generate returns.”

A fragmented region

Asia-Pacific remains far more heterogeneous than North America and Europe, so generalizations about market trends are difficult and blanket investment strategies unwise. For example, interest rates have risen only marginally in Japan and not at all in China, while the market in India is accustomed to higher rates.

Meanwhile, in Australia, Korea, Singapore and Hong Kong, interest rates have risen sharply, impacting real estate values.

And in some sectors, such as Australian logistics, the impact on cap rates has been balanced by rising rents. In others, such as the Hong Kong office sector, rising cap rates have been coupled with oversupply.

Pamela Ambler, head of investor intelligence and strategy, Asia-Pacific, with global brokerage JLL in Singapore, says: “Investors are moving out of the risk curve because core stabilized assets are too costly to acquire under the high-rate environment. The spread between cap rates and risk-free rates is at a decade low.

“From a portfolio standpoint, allocations to real estate need to be justified in the context of higher fixed income returns.”

“Rental growth across most major markets and asset classes has shown resilience”

Pamela Ambler
JLL

The various shocks to hit global real estate markets in recent years also mean investors are more risk averse and inclined to demand more from their money if it is to be invested outside their home region.

Calvin Chou, managing director and head of Asia-Pacific at manager Invesco Real Estate, says: “I think that investors’ risk premium has gone up, it is as simple as that. Given the state of the world, people are looking for a return premium when investing internationally. Investors coming to Asia are looking first for higher returns.”

Investors looking to boost returns have two main options for adding value: buying at a keen price and then adding value through capex or leasing work.

Caleb Shen, senior managing director at Hines, a private real estate investor and manager, says: “In my opinion, 50 percent of the IRR is from finding the asset at the right price and 50 percent is from what you do to that asset. It is so important to generate alpha through active asset management.”

Sector performance

Pricing opportunities vary across markets. However, investors tend to agree that there has been little genuine distress so far, and that it is likely to be fairly limited in near term.

Nonetheless, there have been a number of trades in Australia and Hong Kong, mainly in the office sector with substantial repricing, while Korea is expected to offer more later this year.

Chou notes: “Higher interest rates have put pressure on some borrowers, who are running out of time to complete their business plan. They may now be underwater on LTV because values have come off.” However, like most investors in the region, Invesco is not just looking at pricing, but for assets “where we feel like we can add value.”

“Asia has outsized GDP growth [and] its investable real estate is forecast to grow from being the smallest market today relative to the US and Europe to the largest by 2032”

Caleb Shen
Hines

Investors in Asia-Pacific regions have not changed their sector preferences, with the logistics and living sectors remaining popular.

“There are opportunities to add value to industrial and logistics assets in Japan, for example, to make it attractive to tenants struggling with a tight labor market,” Fassbender explains. “This means assets need to be as efficient as possible, ready for automation and with facilities for staff.”

Developed cities in the region continue to suffer from expensive housing, so a number of investors are looking to strategies that look to meet demand. For example, Australian manager Marquette Properties bought Mineral House at 41 George Street, a Brisbane CBD tower, for $120 million with plans to convert it into student housing. Meanwhile, PGIM has invested alongside Weave Living, which has repositioned several Hong Kong assets into rental apartments.

Furthermore, many investors are seeing opportunities in sectors disregarded elsewhere, including both office and retail. The office sector, well out of favor with investors in the US in particular, is attracting the interest of investors in Asia-Pacific, not least because it offers so many opportunities to add value – for example, by upgrading the ESG characteristics of assets. In addition, demand drivers and usage levels remain elevated in many Asia-Pacific markets.

The fundamentals of the most developed Asian office markets are strong. Hines research shows that net absorption in the developed Asia office sector in 2023 was back in line with long-term averages. Shen says: “This suggests these markets are now being driven by fundamentals of supply and demand, as opposed to any structural shift related to work-from-home trends.

“The average age of offices in Tokyo is around 35 years and I think there’s a real opportunity here for upgrading their ESG characteristics. We are seeing the first generation of tenants in Japan for whom ESG is becoming important. However, non-professional Japanese real estate asset owners may prefer not to take this on.”

PGIM is also keen on the opportunity in upgrading Japanese offices, says Fassbender, because there are many assets – often owned by corporates or other non-real estate specialists – which are undermanaged. “There is a lot of potential to take great assets, upgrade them and try a different approach to managing them.”

However, both Fassbender and Shen express caution about the blanket viability of ESG upgrades. “There is an opportunity for ‘brown to green’ upgrades across the region. However, it would be very different in each location,” says Shen.

Fassbender adds: “The core theme is that regulation will eventually make it more difficult to lease or sell certain assets, which creates opportunities to upgrade assets to be in line with expected regulation or tenant demand. This is another element to the buy/fix/sell strategy, however it is complex and expensive work. Furthermore, the pace of regulatory change and demand varies widely across the region; Australia and Singapore are pushing hard, while Japan and Korea are somewhat lagging, so the ESG upgrade strategy does not necessarily add value in every market.”

Regional resilience

It is hard to justify capex in a market where investors are unlikely to be rewarded with increased rents. However, one of the key factors underpinning value-add strategies in Asia-Pacific is the prospect of strong rental growth. “Rental growth across most major markets and asset classes has shown resilience,” notes Ambler.

Shen adds: “Asia has outsized GDP growth compared with other regions, and its investable real estate is forecast to grow from being the smallest market today relative to the US and Europe to the largest by 2032, according to our research.”

The days of investors being able to significantly juice returns with leverage may be over for now, and value-add investors are mainly focused on equity investment with modest leverage, but there are some opportunities to gain higher returns from looking elsewhere in the capital stack.

Chou explains: “Every market is different but there is clearly a lot less leverage available, which means there may be opportunities to provide rescue capital in the form of mezzanine or preferred equity. It doesn’t necessarily mean those assets or owners are distressed, but there is a real need to find new capital.”

“Every market is different but there is clearly a lot less leverage available, which means there may be opportunities to provide rescue capital”

Calvin Chou
Invesco

Investor interest in Asia-Pacific, especially for investors from outside the region, is concentrated in its developed markets: Japan, Australia, Korea, Singapore and Hong Kong.

Markets such as India, China and Vietnam are seen as destinations for more opportunistic capital, although Hines will consider investing in both India and Vietnam in the later stages of the investment period of its Asia value-add strategy. Even within these developed markets, there is considerable variation.

Shen adds: “I think that Asia’s complexity actually plays to our strategy. Not only can markets be in different cycles, but different asset classes in the same market can be in different cycles as well. That complexity allows us to hunt for the most attractive risk-adjusted returns around the region.”