This article was sponsored by MIRA Real Estate. It appeared in the Global Investor 50 special section alongside the November issue of PERE magazine.
Major investors in Asia-Pacific real estate remain confident about the region’s prospects, driven by long-term mega-trends, continued economic growth and growing sophistication. While agreeing that the market is in the latter stages of the cycle, they believe the fundamentals underpinning the Asian real estate story remain strong.
“It seems as though people have been calling this market ‘late cycle’ for the last six years,” says Graeme Torre, managing director and head of private real estate, Asia-Pacific, at APG. “But overall I think it’s still a strong regional market. There is a great deal of capital looking for, unfortunately, fewer assets.
“If you take a step back and look at real estate simply as another asset class, it appears still relatively good value. On a relative basis, real estate looks fairly priced, with a 200-250 basis point spread between bond and average property yields in most markets.”
For large pension, insurance and sovereign funds, the cost of being uninvested is substantial, notes Michael Chan, managing director at MIRA Real Estate. “The sense that everything is expensive has been here for a long time but, at current rates, we believe spreads are fair and the cost of staying out of the market is high. In general, capital is being realistic regarding potential returns in Asia-Pacific real estate.”
However, he adds: “We certainly feel we’re closer to the next downturn than the previous one.”
With the US-China trade war and the UK’s exit from the EU still unresolved, geopolitics appears to be the one significant external headache for investors. Tjarko Edzes, director, Asia-Pacific at Bouwinvest Real Estate Investors, says: “While long-term fundamentals still are very appealing, there is some nervousness around geopolitical situations, such as we are currently seeing in Hong Kong and the US-China trade war. At the same time, it is difficult to steer our investment strategy based on geopolitical events. Longer term portfolio positioning is more important.”
A significant change in the market this year has been the sense that interest rates – previously considered to be at the start of an upward trend – are once more predicted to remain low for the foreseeable future. US interest rates had risen slowly to 2.5 percent but the Federal Reserve Bank introduced rate cuts in July and September, bringing the headline rate down to 2 percent.
“The key trend for 2020 will be the extension of the low rate outlook over the medium term and how investors position their asset allocation in that environment,” says Kate Herfort, managing director MIRA Real Estate.
Investors have nonetheless been repositioning to insulate their allocations against a possible downturn. Edzes says: “Over the last two or three years we have increasingly focused on investments we feel are more cycle-proof, due to resilience of their cashflow profile and quality, as well as how they are driven by longer term trends, which make them less vulnerable to market shocks in terms of demand. Also, the historical track records of certain sectors, such as Japan residential, are more stable. So, that is more of a defensive position.”
Long-term trends are crucial to the Asia-Pacific investment thesis and apply across cycles. Investors cite demographics, urbanization, continued economic growth and the impact of technology as profound demand drivers for property. As a consequence, two sectors have gained traction among investors. Logistics taps into Asia’s continuing urbanization, the growth of its consuming middle classes and the technological change which has shifted shopping from the store to the web. It is also undersupplied, says Torre.
“One of the fascinating data points we use when we’re looking at logistics opportunities is the percentage of the national logistics stock considered to be modern. In most countries around the region, that percentage is single figures. It’s quite staggering how dated some of the logistics facilities are around the region, which suggests a good opportunity for redevelopment.”
A newer sector – still niche in Asia-Pacific – is multifamily residential. “Multifamily and rental residential is the largest sector in the US REIT index, but in most of Asia it doesn’t exist,” says Chan. “Governments here are increasingly recognizing the sector’s importance, and are taking steps to actively support it.”
Bouwinvest has invested in multifamily residential across Asia-Pacific and is also heavily invested in the sector in its home market, the Netherlands. “We believe that residential-for-rent will quickly establish itself as a more institutional product throughout the region,” says Edzes.
Alongside logistics, rental residential is also a “major conviction” for APG, says Torre. APG together with MIRA Real Estate invested in an Asia-Pacific residential platform run by Greystar, a global leader in the sector. APG has also made additional investments in Japan multifamily.
“There are different constituents in different countries, but remarkably, in nearly every country in Asia, there is a case for rented residential,” he says.
Despite the attractions of newer sectors, offices remain the most popular choice for buyers of Asian property, according to Real Capital Analytics data, which show 57 percent of purchases in the first half of 2019 were in the sector.
Herfort says: “It is often the first sector investors go into when entering a new geography. In the Australian market, we continue to see strong appetite for the sector with investors focused on accessing high-quality office assets, which they intend to hold for the long-term. The continued lower global interest rate outlook and the falls in long-term Australian rates mean some investors, which had been waiting on the sidelines, are reconsidering their position – accepting they can’t be out of the market too long.”
The positive supply and demand equation in Australia’s major office markets has seen it outperform in recent years. Edzes says: “We’ve been expecting lower returns but, for example, the office sector in Australia has continued to perform fairly strongly, better than we expected, over the last couple of years.”
Strong demand for offices has been seen throughout the region. “In China, Tier 1 cities continue to attract broad interest, especially as these cities play an ever-growing role in the global real estate portfolio” notes Chan.
However, an environment in which returns are low has seen investors allocate more capital to new niche sectors such as data centers and student housing. Something they have in common is a more significant operating element compared with traditional real estate sectors, which can bring risks as well as returns.
Torre says these specialist sectors do not always provide returns commensurate with the risks involved but adds: “I think these specialist sectors are here to stay and some will emerge properly priced to become institutional. Particularly, something like data centers, I can only see growth in that sector. But for APG it is not just a case of building a data center and sitting back and collecting the rental.”
There are other inherent difficulties in newer sectors, says Chan. “A challenge we often face is the small absolute size of these sectors, which makes them susceptible to large pricing swings due to supply and demand imbalances.”
Retail has assumed the unwanted mantle of least popular in many markets around the world, as thousands of malls have become redundant due to the rise of internet shopping. But what is true in mature markets in North America and Europe is not always true in Asia, says Torre. “In the US and Australia, the outlook for physical retail assets is worse than it has been for some time. But in markets such as India, Indonesia and Vietnam, for example, there is strong demand for traditional physical retailing. There are communities with a growing middle class and an under-provided retail offering.”
Asia-Pacific has many attractions for investors, but also holds challenges for them. Its sheer size is a factor, which makes operations more difficult, as is its heterogeneity: there is a multitude of legal systems, languages, cultures and currencies.
“One of the biggest challenges is pricing the relative risk in such a heterogeneous region,” says Torre.
Edzes adds: “Asia-Pacific is a varied region, with big differences, especially between the more developed markets and the developing economies. So we’ve mainly focused on more developed markets plus China. Another thing that stands out is leaseholds for property; it is more common in Asia-Pacific to have this, which is a negative for property investment and sometimes difficult to overcome, especially if you want to take a longer term view. There are markets in the region where you can buy freeholds, of course, such as Australia and Japan.”
Edzes also notes that many governments in the region intervene more often in the real estate markets than in Europe or North America. This is especially the case for the residential market and where, as in China or Singapore, the government controls the supply of land.
There is a certain irritation among Asia real estate veterans about how the region is perceived. “It can be frustrating that many outside Asia still do not appreciate how sophisticated the real estate market is across much of the region. China is a leader in many areas,” says Chan.
He also remarks that private real estate investing in Asia-Pacific can be through a variety of investment structures, and mixing and matching features between the different types of investment structures is very commonplace.
This flexibility suits a global investor such as APG, which has the resources to allocate toward research and partnership-building in the region. Torre says: “Our preference is certainly not to do funds. With the experience in our team, globally and in Asia, we now feel we get better governance, transparency and economics in club deals and JVs. However, if we cannot find an operator or partner that would allow us direct access to a sector we like, we may look at a fund.”
Looking ahead to 2020, investors are cautiously upbeat about the prospects for Asia-Pacific real estate. Torre says: “I think there will be more money put into data centers and other niche sectors. I think we’ll see the rented residential sector take a stronger foothold over the next 12 months around the region.”
Chan says: “No matter what the environment in 2020, the relevance and the weighting of Asia-Pacific in the global portfolio is likely to grow and the region should continue to be a focus for capital.”