Real estate transactions research firm Real Capital Analytics’ latest data on Asia-Pacific volumes in 2018 does not look promising for those wanting to deploy capital into one of the region’s most important markets: Japan.
Annual transactions for income-producing properties in Japan dropped 26 percent last year to $28.8 billion, the biggest year-on-year decline seen among the region’s 10 most active countries. According to RCA, Tokyo experienced the slowest activity since the global financial crisis, with a 10 percent year-on-year drop in transaction volumes. And with only four cross-border transactions completed in Tokyo, 2018 was also the year that recorded the lowest international deal count since 2009.
As Asia has evolved from being largely perceived as an opportunistic investing region to one presenting a variety of lower-risk strategies, Japan and Australia have arguably been the two countries global investors have consistently felt most comfortable when locating core assets. The fact both these markets face headwinds in today’s late-cycle environment will therefore register high on their radar.
In Japan, many sectors are yielding record low yields. According to research by global advisor CBRE, the average expected yield for office, retail and industrial in Tokyo was as low as 3.43 percent, 3.4 percent and 4.49 percent, respectively, as of Q4 2018. Dovetailing with high asset prices, investors also have to deal with a pullback in lending by Japanese banks. The property lending-to-GDP ratio in Japan was reportedly 14.18 percent at the end of 2018, higher than the long-term trend, raising questions about whether the market has overheated. According to a Nikkei report, outstanding real estate financing from Japanese banks was 78.9 trillion yen ($710 billion; €620 billion) at the end of 2018, the highest on record.
Meanwhile, commercial office property values in both Sydney and Melbourne have already surpassed the previous cyclical peak of 2008. According to CBRE’s estimates, the values in Sydney for instance are 50 percent higher than 2008. This, coupled with slow rental growth and conservative property lending by banks, has made office investments a tough bet in these two prime Australian cities. Office investment volumes touched $19.5 billion in 2018, as per JLL’s estimates, but the real estate services firm expects a 10-20 percent drop in volumes this year. Some investors have already hit pause in Australia: Allianz Real Estate, for instance, did not invest in the country’s offices in 2018. The investor continues to be selective about the sector this year as well, as PERE reported late last year.
While it is getting harder to find assets within a price range to satisfy the lower risk and return requirements of classic core investing in these markets, it is not that hard to raise core capital. Asian core strategies have returned satisfactory numbers too. In Q2 2018, core funds outperformed value-add and opportunistic funds, returning 2.62 percent, compared with 2.28 percent and -1 percent respectively, ANREV’s data shows.
Indeed, core continues to be a preferred strategy in the region. According to the latest Investment Intentions Survey published by industry bodies ANREV, INREV and PREA, 54.1 percent of the global investors surveyed said they plan to invest in core, versus 44.3 percent for value-add and 27.9 percent for opportunistic. The percentage is even higher for Asia-Pacific investors, with an overwhelming 81.3 percent advocating for core.
To meet this demand, some investors are letting managers be creative: build-to-core strategies in cities such as Seoul have been qualified as core, for example. Others have stretched the core definition in other ways, including secondary Japanese or Australian cities in the thesis or even adding alternative assets like student accommodation into the mix. But if the markets best expected to provide core real estate become prohibitively difficult to engage, it would not be a leap to imagine investors which have been including Asian core in their property portfolios putting these plans on ice until that situation changes.
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