The real estate investment cycle has turned. After a period of exceptional capital value growth around the world, driven heavily by ultra-low interest rates and cap rate compression, we are shifting to a period of income-driven total returns. In addition, income returns do not vary across markets and sectors as much as capital value growth, meaning top-down strategic picks become more difficult.
Investors and strategists like me are looking for drivers on which to pin their strategies for outperformance. As a result, there has been a resurgence of discussion and analysis on mega-trends like demographics or environmental change.
While overall awareness of major structural trends, including both climate change and aging populations, scored highly in an Investment Property Forum survey in December, the incorporation of such trends into strategic decisions and in particular at the asset level varied widely. Anecdotally and from my own involvement in strategic decision-making in the region, I think the UK-focused survey results would be similar, if not more polarized, in Asia-Pacific: awareness is probably very high but incorporation at the level of asset-specific decisions remains the exception and not the rule.
We can focus in particular on two long-term structural trends: demographics and environmental degradation. The issues are well-known and in fact are at the root of some key trends in the regional property industry, such as recent development projects in Singapore with stellar sustainable characteristics or the launch of a number of aged care development funds in China. However, generally across the asset management industry, the incorporation of these factors at the property decision-making level has been the exception, not the rule, and it is only gradually changing.
The slow adoption rates are perhaps understandable for a region that for decades has been focused on growth. A shortage of institutional stock in Asia-Pacific prioritizes speed of development. The ratio of institutional real estate to nominal GDP in APAC was 8 percent versus 14-15 percent in North America and in Europe, according to MSCI’s 2015 market size estimates (the latest available, in US dollars). The need to create jobs for a rapidly expanding population distracts from how quickly that population will age.
World-leading rates of growth can encourage short-term return maximization over long-term sustainability, though investment managers would not like it expressed that way. Events like the global financial crisis, China’s political transition, or the Tohoku earthquake necessarily create other priorities for the property industry.
But times are changing. Sustainable initiatives are becoming widespread, from corporate ethics programs to individual asset enhancement initiatives. For example, the Australian government’s decision to enforce minimum sustainability standards for the buildings it occupies make it necessary to incorporate environmental factors into property decisions at asset level there.
Early in the curve
On the other hand, demographics and the reality of a rapidly aging population are not yet being widely embraced. The supply of aged care facilities is short relative to future need across much of the region, or is hampered by regulation such that private sector participation is discouraged. Shopping malls are generally designed for the youth bracket, which will have less money and time to shop than retirees in the not-too-distant future.
These mega-trends will influence greatly what kind of real estate is needed and where in Asia-Pacific. Environmental factors are being rapidly embraced with respect to what is needed at the asset level, but less so in terms of which areas will be investable in future – that is, markets that will be less vulnerable to rising sea levels and desertification. With respect to the aging of the population, we are still in the early part in the adoption curve; the challenge is readily understood but we are not yet incorporating it into asset design or location.
For investment managers looking to outperform in an era of less capital value growth and lower returns, strategies tied to people and the planet are likely to be areas in which to excel.