This roundtable is sponsored by CBRE Investment Management • Invesco Real Estate • LaSalle Investment Management • Savills Investment Management

Storm clouds are gathering over Asia-Pacific real estate markets as they wrestle with inflation, rising interest rates, fallout from the conflict in Ukraine and major economies around the world heading into recession.

Participants at the PERE Asia roundtable agree a more difficult market is approaching but are encouraged by Asia’s current standing compared with the rest of the world and the heterogeneity of the region. For example, while interest rates have risen sharply in South Korea, they remain unchanged in Japan. Similarly, inflation is affecting the market more in Australia than in China.

Furthermore, the Asia-Pacific region continues to offer an engine for global growth, thanks to the developing powerhouses of China and India, as well as rapidly growing markets in Southeast Asia.

Data from research firm MSCI Real Assets shows that transaction volumes in the Asia-Pacific region slumped in the third quarter of this year, down 38 percent year-on-year to $32.6 billon. This has brought transaction volumes in the first three quarters of the year down 16 percent to $132 billion.

Yet, so far, there is limited evidence of falling prices or distress. These factors are expected, but not in all markets. Adrian Baker, chief investment officer, APAC direct real estate and president, APAC real estate division at Los Angeles-based manager CBRE Investment Management, says: “Most of the region is in price discovery phase at this point.”

State of play

Australia and South Korea have seen the most dramatic rises in borrowing costs in recent months and, therefore, the greatest upheaval. “Borrowing costs in those two markets have risen 150-200 basis points in the past three to six months. The effect on cost of capital means some investments no longer work. We have seen a lot of transactions fall over and from both buyer and seller,” says Calvin Chou, managing director and head of Asia-Pacific at Atlanta-based manager Invesco Real Estate.

Claire Tang, co-chief investment officer for Asia-Pacific and head of Greater China at Chicago-based manager LaSalle Investment Management, says: “Korea is probably the market reacting fastest to the changing environment. We’ve seen interest rates going up anywhere between 200-400 basis points over the last two or three months. There’s certainly repricing going on, although the bid-ask spread is fairly significant.”

Australia and Korea have seen significant deal disruption due to the changing market environment, but there is more stability elsewhere. Alex Jeffrey, chief executive officer at London-based manager Savills Investment Management, says he does not see widescale repricing of Asian assets as has been recorded in Europe, where “pricing is off 15 to 20 percent, depending on the country and the sector.”

“We have seen repricing downwards in Australia. But Singapore seems quite stable and Japan is certainly very stable,” he adds.

In 2021, capital raised from funds investing solely in APAC opportunities was recorded at $19.22 billion from 35 funds, according to PERE data. Despite a strong start in 2022, capital raised in the APAC region screeched to a halt between Q2 and Q3, raising $14.17 billion and $3.81 billion, respectively.

Tang says: “2021 was a very active year for pan-Asian capital raising. But things slowed down in 2022 as global investors became wary about geopolitical tension and the risk of recession in both the US and Europe. Investors remain positive on Asia as a driver of growth globally, however most are becoming more selective on firms and operators in the region.”

Baker is more candid: “I think the capital raising environment is terrible. Almost every pension fund in the world at this point is suffering from the denominator effect. I suspect every small, medium and maybe even large pension fund is effectively sitting on their hands currently in terms of real estate,” he says. “The only positive we see from a capital perspective is sovereign wealth funds; they are less exposed to the denominator impact than pension funds.”

He also notes that some investors may see listed real estate as more attractive as global real estate investment trust pricing has fallen more rapidly than the underlying assets.

However, the inability or disinclination to invest is not necessarily a sign of disaffection with Asia-Pacific, says Jeffrey. “We spoke to a lot of European investors at the Expo Real conference and many of them just don’t have capital to invest. Those that do see Asia as relatively attractive.”

Chou also sees the region as a comparatively sunny part of a gloomy investment world. “I think we’re probably looking at one of the toughest capital raising environments, maybe in the last decade. However, on a relative basis to North America and Europe, Asia offers a much more appealing story.

“Something that bodes well for Asia is that we are much later in on the covid clock. Some of our markets, like Japan and Hong Kong, are only just reopening and, therefore, are due a boost as people visit once again. We saw this with Australia six months ago.”

Cautious optimism

MSCI data suggests the panel’s optimism over the relative attractions of Asia is shared by international investors, as they look to capitalize on the dry powder in Asia-focused real estate vehicles. While overall transaction volumes are down this year, the percentage of transactions involving overseas investors has risen to 29 percent in the third quarter of this year, compared with 26 percent from the same period in 2021, according to MSCI data.

PERE data shows that 32 percent ($69.04 billion) of the capital raised for Asia-Pacific in 2021 was for opportunistic strategies, and managers here will now be looking for distress. So far, little distress has been seen, but the consensus is that this is set to change.

However, Invesco is inclined to be patient and wait on further price discovery for core investments, says Chou: “For value add and opportunistic investments, this is as good a time as any, when transactions are starting to fall over.”

Jeffrey says: “Funds which acquired assets at very low cap rates and high leverage are finding refinancing challenging. We are hearing that many Korean funds are finding a number of liquidity challenges.”

Indeed, Korea is cited as the most likely candidate for distressed deals, due to rapidly rising debt costs. Tang says: “We will probably see some distress in that market, as we’ve seen a lot of lenders and domestic capital pulling back from the market. There are more opportunities on distressed credit as banks are pulling back on lending.”

Baker agrees. “I also believe a lot of developers have got ahead of themselves in price expectations,” he says, but adds that CBRE Investment Management is only “kicking the tires” in Korea currently. “We’re low-balling; bidding at where we think prices need to be to make sense.”

Failed deals

Seoul IFC complex: Brookfield’s sale of Mirae Asset Management collapsed

PERE roundtable participants are asked to choose a deal they see as significant or characteristic of the way the market is going. A sign of the times, most of the panelists picked deals that failed to close.

The headline collapsed deal of the year, cited by Claire Tang at LaSalle Investment Management, was Brookfield’s sale of the Seoul IFC complex to domestic manager Mirae Asset Management, which intended to use a real estate investment trust to hold the $3 billion asset consisting of three office towers, a Conrad hotel and a shopping mall.

However, Mirae failed to win government approval for the REIT as the Korean land ministry said it was too dependent on borrowings and would be too risky for investors. Mirae is now suing Brookfield for the return of its deposit.

The size of this deal meant it hit the headlines. But smaller deals in other markets also hit the buffers this year, often due to concerns regarding pricing and leverage. MSCI Real Assets data shows a spike in aborted deals in 2022, even when taking the IFC deal out of the equation.

Adrian Baker at CBRE Investment Management, cited GIC’s withdrawal from the purchase of Southern Cross Tower in Melbourne in June as another notable example. He said the deal was “the first this year where interest rates really changed the market, where someone threatened to pull out or seek a price adjustment because of the movement in interest rates.”

Both LaSalle’s Tang and Invesco Real Estate’s Calvin Chou cited Australia and Korea as markets seeing most distress, as they have seen the sharpest rises in interest rates.

Tang also sees distressed opportunities in China, where the economy is still laboring under ‘zero covid’ restrictions and frequent lockdowns. Growth has been sluggish this year, while the residential real estate market has slumped, plunging developers into distress. “In China, we continue to see deals out of distressed Chinese listed developers raising cash to repay offshore bonds.”

Tang sees China’s positions as unique in the region, not least because it is not raising interest rates, but also due to the level of government control over markets. “China has a different set of risks. Although the government still has sufficient tools to stimulate the market, the lack of clarity regarding covid – as well as the policy risk on the property market – presents major headwinds for the broader economy.”

Managers in China also face the problem that the region is currently out of favor with some investors due to its rocky political relations with the US and Europe. MSCI data shows that transactions in China by foreign investors fell 40 percent year-on-year to $5 billion in the first three quarters of 2022.

“The biggest constraint we have at the moment is that investors around the world are reluctant to invest in China because of the geopolitical environment,” Baker says. “I think you need to be able to tell a very strong investment story to outweigh the concerns around the geopolitical side of things.”

Despite MSCI data recording a fall in transactions by foreign investors in China from select regions, figures released by China’s Ministry of Commerce showed significant growth in overall foreign direct investment in the first eight months of 2022. Tang therefore takes a more optimistic view. “Despite all the noise, FDI has increased in China in the past year.”

Domestic capital is becoming a greater opportunity for foreign investment managers in China. LaSalle, CBRE Investment Management and Invesco are each working with domestic capital. “It’s a market that is becoming more institutionalized and needs foreign managers to professionalize what has traditionally been a single-asset, separate account-type environment,” Chou says.

Opportunities abound

Despite Japan remaining top of the list for international institutions buying Asia-Pacific real estate, the panel identified several sectors and markets where they continue to see opportunities.

The logistics sector has been an investor favorite in recent years – a trend augmented by the pandemic. The delegates support investment in the sector, albeit more cautiously. “We are still very positive on logistics, especially relative to the other asset classes,” says Tang. “However, as e-commerce penetration slows it will be more difficult and there will be more supply risk. You also need strong specialist teams to operate logistics across the region, which is something we’re trying to develop.”

Baker says CBRE Investment Management’s focus is “predominantly on developing logistics, and we still see some interesting operating opportunities in Japan.” However, he adds: “I think the cap rate compression story is really largely finished for logistics. But the occupier quality and underlying cashflow story will be a standout for logistics for the foreseeable future.”

Chou says: “I think the overwhelming capital stampede into logistics is probably slowing and the logistics super-cycle may also be over. But we are still developing logistics in Japan, Korea, and Australia. However, you can’t just build anywhere and succeed, it is all about the sub-market location.”

Hospitality investment was up 20 percent in the first three quarters of 2022 per MSCI data, which stirred interest from the panel. “We are acquiring a couple of hotels in Japan, which is really a bet on Japan’s re-opening,” says Baker. “You can acquire brand new hotels for 20-30 percent below replacement costs. It is an interesting opportunity. But it is quite risky, because the outcome is pretty binary.”

Beyond strategies by asset types, real estate debt also has potential, say both Jeffrey and Tang. “In an environment where interest rates are rising, banks are pulling out or calling in their loans, and there is a risk of covenant breaches. Maybe it is a good thing to be a lender rather than a borrower,” says Jeffrey. He also cites Australian non-discretionary retail as a sector with potential, due to its high yields and good cash-on-cash returns.

Among the panel, there was also enthusiasm for the office sector in the Asia-Pacific region, which has not suffered from the remote working phenomenon as much as other global markets, with the exception of Australia.

“We are still very positive on the office market in places like in Tokyo, Seoul and Singapore, because the demand fundamentals in those markets are still quite strong,” says Tang.

Chou says: “We are more negative about office markets in Australia than in Tokyo. People in Hong Kong, Singapore, Seoul, Tokyo and Shanghai are still going into the office and we don’t think the work from home trend will be as significant as in the US or Europe.”

Not all agree. Baker is one participant to oppose the view: “We’re seeing weakness everywhere in the office sector with the exception of Singapore.”

Green routes

Jeffrey believes working from home may not be a threat to the office sector in Asia. But he argues it is nevertheless vulnerable to accelerated obsolescence due to the age of office stock and the capital expenditure burden involved in bringing it up to standard, especially as tenants become more ESG-conscious.

“There is a growing bifurcation between the best and not so good, especially in terms of green certification,” he says. “There’s a rental differential of 18 percent between Grade A Singapore offices, which are green-certified, and those which are not; this gap is even larger in other markets. That means a significant challenge for owners of older assets, but also an opportunity to upgrade them.”

However, other panelists are skeptical that ESG improvements will drive returns. Chou says: “We factor ESG into all of our investments. But I don’t see ESG-driven investment ideas alone as a clear opportunity. ESG is not technically driving returns, but is a consideration to the appeal and liquidity of an asset so does impact valuation.

“It is challenging to analyze the correlation between the spend on energy savings or LEED rating and higher returns, as there is noise in the data. Buildings which are better in ESG terms tend to be newer and therefore have higher rents due to modern specs or design rather than just the ESG considerations.”

Asian, listed real estate developers and international managers have tended to lead the region’s ESG push, with Australia notably ahead of the rest in terms of GRESB scores, for example. “In this part of the world, ESG is not on everybody’s radar, but international firms are definitely trying to move things forward,” Tang says.

Besides areas like ESG, Baker notes that in the current environment, it is hard to maintain a top-down view on any market or sector, however, he says: “Because you’re starting to see the dislocation come into some markets, then I think you need to have an eye on pretty much everything, but be driven by more of a bottom-up approach.”

Further, aside from logistics and Japan, there is less consensus around this table. Chou notes that even at Invesco “our internal discussions about where to invest are as spirited as they’ve been for some time.” He adds: “Everyone needs to sharpen their pencil before presenting a deal and we’ve asked teams which have been in discussions in the past quarter to look again at pricing and to not come back until the deal looks better. We absolutely believe that we are heading into a market that is going to be much, much more challenging to navigate.”

Meet the roundtable

Calvin Chou
Managing director, head of Asia-Pacific
Invesco Real Estate

Chou joined Invesco Real Estate in 2015 from Morgan Stanley and has been based in Hong Kong since 2000. Invesco has $7.3 billion of its global assets under management total of $89.9 billion in Asia-Pacific and seven of its 21 offices are in the region.

Claire Tang
Co-chief investment officer, Asia-Pacific and head of Greater China
La Salle Investment Management

Tang is LaSalle Investment Management’s co-chief investment officer for Asia-Pacific and head of Greater China. She joined the firm in 2007 and is an executive officer of the LaSalle Asia Opportunity Fund series as well as the LaSalle China Logistics Venture. As of Q2 2022, LaSalle has AUM of $82 billion globally, of which $13 billion were in Asia-Pacific.

Adrian Baker
Chief investment officer for APAC direct real estate, president of APAC real estate                                                   

CBRE Investment Management

Baker is responsible for all direct real estate investment strategies and activities across the Asia-Pacific region at CBRE Investment Management. The firm has $146.9 billion of global assets under management and $7.6 billion of direct private real estate in Asia-Pacific. He joined in 2007 from Australian investment manager AMP Capital.

Alex Jeffrey
Chief executive
Savills Investment Management

Appointed chief executive of Savills Investment Management in 2019, Jeffrey joined from insurer M&G, where he was head of Asia Pacific, having previously headed the manager’s real estate business. Savills IM has €26.9 billion of total real estate AUM, with €1.8 billion in Asia-Pacific.