This article is sponsored by Macquarie Infrastructure and Real Assets
Like Europe and the Americas, Asia-Pacific has been rocked by the pandemic, but China, its largest economy, is now into the recovery phase and investors are showing trust in the underlying growth prospects across much of the region. Jelte Bakker, head of Asia-Pacific real estate, and Michael Chan, senior managing director, at Macquarie Infrastructure and Real Assets, discuss how investors are approaching the region and the investment outlook with Guy Fulton, managing director at Canada Pension Plan Investment Board.
Guy Fulton: Covid-19 brought the markets to a screeching halt when it went global in mid-March and transaction volumes reflect that. We all hope the covid situation will resolve itself as quickly as possible, but the crisis aside, many of the strategic reasons why investors look at Asia, and why it is one of the preferred regions for institutional capital, still hold true. Asia-Pacific is where the growth will continue to be. It is where the increases in consumption are and it is where there is wealth creation.
Jelte Bakker: An interesting feature of this current crisis is that there has been such a divergence in the way the different property sectors have been impacted compared with, for example, the global financial crisis, which impacted all sectors pretty much equally. Logistics obviously has thrived, but the data center sector is also booming. The retail sector, by contrast, has faced further headwinds. Overall, though, the picture for the region is positive; Asia-Pacific looks attractive on a relative value basis compared to other regions. However, as always, it is tougher to transact here, so the limiting factor is being able to find deals.
GF: There are challenges to finding deals in the current environment. It’s more difficult to travel so a lot of local capital in markets like Japan and South Korea has chosen to focus more on domestic markets rather than pursue opportunities overseas. These investors still need a home for their capital, but their options are currently more limited.
Michael Chan: The technical challenges of the current environment make transactions difficult, but institutions are increasingly finding ways to adapt. For example, wider use of virtual tours, more collaboration with local partners, utilizing additional services from consultants, and having staff that are able to stay in a country for a longer period. We are continually finding better ways to work with partners on the ground in different locations.
Quality over quantity
JB: My view is that once this environment settles down, the world will not have altered dramatically; we’re likely to move back to where we were before, but with some changes at the edges. Covid-19 is effectively accelerating trends that were already afoot, and for investors and landlords, embracing those changes will be the focus going forward.
GF: The office sector will have to be monitored more closely. While we’re not going to see everyone working from home, it is unlikely to be business as it was before. And this is going to play out differently in different cities. In Hong Kong and Singapore, for example, where commuting distances are short, the centralized office model may well survive. In other cities, we may see fewer people wanting to work from offices or more people choosing to work in suburban locations. Buildings may also require larger elevators to keep people socially distanced or cleaner air conditioning systems. And tenants may choose to lease buildings on the basis of health and sanitation criteria in addition to some of the conventional metrics that have been used in the past. These are the issues we are looking at internally right now; it’s still all a work in progress and we don’t have firm conclusions yet, but things are likely going to change.
JB: Like any downturn, the biggest tangible thing we are seeing is that high-quality stock is less impacted than secondary assets, which is not necessarily unhealthy. Furthermore, high-quality modern assets are likely to be better positioned for the changes that Guy mentions.
GF: There is an inevitable flight to quality during a crisis. When you are in crisis management mode, the goal is to protect cashflow; to ensure it’s strong and stable. And better-quality buildings obviously will offer that. Prior to this crisis, we spent a lot of time stress-testing our portfolios to make sure we could manage our capital efficiently. As we come out of the crisis, though, we could start to see some interesting opportunities emerge. Investors are still waiting to see where pricing lands and are going to be looking for more opportunistic investments.
MC: One key difference between this covid crisis and the GFC is that this time nearly everyone has been directly impacted rather than just the banking sector, and accordingly governments and their institutions are more untethered in terms of the support measures they can implement. This time around, in many countries the banks themselves are playing a vital role in distributing the support to the broader economy. With low interest rates looking to be the norm for the foreseeable future, it’s hard to see banks pulling back that support, and we believe this opens up some different opportunities as a result.
GF: CPPIB has retail exposure in China for example and the market has come back pretty solidly there. The structural tailwinds supporting retail property in China still ring true – per capita, there is an undersupply of space and consumption will continue to grow, and the people will always want somewhere to socialize, even post-covid. The other interesting factor about retail in developing Asia and China is that it came of age at the same time as e-commerce, and therefore the sector has managed to avoid many of the obsolescence issues that US retail has suffered where assets were built 20 to 30 years ago and may no longer be sustainable given current consumer trends.
MC: Multifamily residential in general has shown quite a bit of resilience during this and previous downturns but, outside of Japan, it is still a relatively new sector for Asia-Pacific. We think the underlying drivers for the sector are not going to change though, given the region’s demographics and the affordability issues that exist with for-sale residential in so many markets. It’s a new sector, but one in which we believe the fundamental drivers remain and continue to make it an interesting opportunity going forward.
GF: We would concur that the fundamentals are very much there for multifamily residential and Japan demonstrates how the sector has proven to be resilient through different cycles. However, it’s also a challenging sector because yields are fairly tight on those portfolios at the moment, making it tough to buy them. Perhaps investors might think about a develop-to-core strategy. And China obviously represents a big opportunity in this sector too. We are still assessing the opportunities in multifamily real estate. The sector needs to institutionalize a bit more and attract some big players, but the macro opportunity definitely exists.
JB: Data centers are providing new opportunities and we’ve spent a lot of time educating clients on the potential of this sector. There are now groups in Asia serving hyperscale data center users and harnessing this to build scale quickly and develop huge, valuable assets. And in the longer term, when you factor in the demographics in Asia, healthcare should be another area of opportunity. It’s a sector that will likely require a lot of capital and government is not going to provide all of it.
GF: Location-wise, we can expect to see the top-tier cities in China continuing to perform well and offering investment potential. The government stimulus package is significant and is being invested in hard infrastructure and the 5G build-out. This will benefit major hubs like Beijing, Shanghai and Shenzhen, and create growth opportunities in logistics, data centers and other sectors. Those three cities continue to excite me.
JB: MIRA is also focused on China and the other developed markets across Asia-Pacific at the moment. In this climate, investors are probably a little more risk averse, and favor stable and safer locations. So, we believe it will take a while for developing cities and markets to come back.
Asia’s logistics sector is a firm favorite
Already buoyed by e-commerce and growing consumption in many Asian markets, covid-19 has boosted the sector further. But logistics is not without its challenges
“One of the things that has happened through the covid situation is that consumer habits have changed,” says CPPIB’s Guy Fulton. “Firstly, the older demographic has become more comfortable with ordering and purchasing online, out of necessity, which was not the case before. Secondly, more people have been purchasing fresh food and groceries online. That is two big areas of growth, which require logistics and the facilities to service it. This really boosts last-mile delivery facilities; the right strategic locations next to urban centers, and I think that’s where the end users want to be.
Jelte Bakker of MIRA Real Estate says: “It’s probably fair to say that not so long ago, there was no distinction between manufacturing and logistics, or business parks. The institutionalization of the sector changes that and I believe the changes we are seeing now will lead to more distinction, or more understanding of the distinction, between the subclasses of industrial.
“But logistics pricing means it is hard to make returns stack up unless you take on more risk, and so we have seen a lot of develop-to-core strategies and development strategies being undertaken in the logistics sector across Asia-Pacific markets.”
“With so much capital interest in the sector there is a significant supply and demand challenge with logistics,” says MIRA Real Estate’s Michael Chan. “In China, for example, we remain focused on regions around the tier-one cities where tenant demand is deep and resilient, and it takes a disciplined approach to avoid the temptation to quickly build out a portfolio across lower-tier cities where land may be more easily accessed. However, the bigger challenge for institutional capital is finding suitable partners. Indeed, that remains a challenge across the region – Asia is a very complex market, and compared with the US and Europe, there are far fewer suitable partners for global investors.”