Roundtable: Managers proceed with caution in Asia-Pacific

This article is sponsored by LaSalle Investment Management and supported by CapitaLand Investment, Macquarie Asset Management and Keppel

The Asia-Pacific real estate market has had a rocky 2023, a year in which both raising and deploying capital has been challenging. However, managers taking part in PERE’s Asia roundtable say they are encouraged by a stable interest rate outlook and expect to be more active in 2024.

The heterogeneous nature of the Asia-Pacific region means the prospects and performance of its markets differ substantially. For example, while the fallout from interest rate rises has been the most significant factor affecting real estate performance and activity in Europe and North America this year, Asia-Pacific’s two largest markets – China and Japan – have seen headline rates unchanged or falling.

Another area where dynamics differ in Asia is the office sector. In Europe and North America, many CBDs are struggling to maintain office occupancy as workers favor homeworking as part of hybrid-working strategies. However, workers are back in the office across Asia’s cities. Research from The Economist this year found Japanese and South Korean workers spent the least time working from home.

These differentiating factors are part of Asia’s attraction, says Claire Tang, co-chief investment officer for Asia-Pacific and head of Greater China at Chicago-based manager LaSalle Investment Management. “Asia remains an attractive region for us and it is one of our biggest bets globally. The region still has the strongest growth outlook globally with relative lower inflation risk. The two largest economies here have interest rates which are steady or declining.

“Even in the office sector, where fundamentals have been impacted the most globally, we’re still seeing some bright spots in certain markets in Asia, particularly in Korea, as well as Japan.”

Nonetheless, Asia-Pacific has not escaped a correction in real estate values. Interest rates have risen sharply in Australia, South Korea, Singapore and Hong Kong. China has a different range of problems: it has shown signs of slipping into deflation following a weaker-than-expected recovery from the pandemic and the travails of its housing sector, best illustrated by developer Evergrande – the world’s most indebted real estate company with $325 billion of debt outstanding – which faces a winding-up hearing in December.

James Kemp, head of real estate, Asia-Pacific at Sydney-based manager Macquarie Asset Management, says: “Generally across Asia-Pacific we have seen pricing move around 5-10 percent lower since recent peaks, outside of the Japanese market. Cap rates have moved out by 50-150 basis points in some markets, with rental growth supporting pricing in sectors such as logistics and living.

“What we are seeing across our business in the US and Europe is obviously much more severe, where aggregate pricing has fallen 20 percent from early 2022 levels, though there is considerable variation by sector and location.”

Galen Lee, chief executive officer of real estate and data center funds at Singapore-based manager Keppel, adds: “We haven’t seen a lot of price movement in Japan because the financing environment has been stable, whereas in China there’s a lot of talk about distressed assets coming to market – although we find these tend to be assets with fundamental problems.

“We are seeing bids for well-located core assets [in China] at comparatively small discounts, whereas opportunistic bids for troubled assets are coming in around where the debt level is, so maybe at around 50-60 percent of book value. Those two markets bookend the region, with the rest somewhere in between.”

The variation in pricing changes has not just been across countries, but also across sectors within countries, says Patrick Boocock, CEO of private equity alternative assets at Singapore-based manager CapitaLand Investment. “If you look at a market like Australia, the office sector has been most impacted, while logistics hasn’t come off nearly as much. New economy assets, such as data centers and life sciences, have remained virtually unchanged.”

Easier borrowing

The cost and availability of debt is one of the key factors driving real estate investment and, in this regard, Asia has two markets offering something unavailable in most places worldwide.

“The only two markets with positive yield spreads are Japan and China,” says Tang. “Japan has consistently offered healthy spreads of 200-plus bps over the past years. In China, we have seen the borrowing cost for sectors with strong policy support – multifamily and logistics – fall by 200-250bps, resulting in positive spread for stabilized assets.”

She notes Japan has adjusted interest rates – while keeping policy rates unchanged – in order to deal with imported inflation. “We have already seen moderate interest rate movement for fixed loans in Japan in response to changes in Japanese government bonds. However, we have not seen any direct impact on cap rates as capital flow into Japan continues to be strong.”

“Investors have tended in the last 12 months to be more domestically focused, but now they are curious about what’s happening in Asia”

Patrick Boocock
CapitaLand Investment

The panel also feels the environment for real estate borrowers is somewhat easier in Asia-Pacific, as banks in most jurisdictions are still happy to lend to the sector. A focus on relationship banking also means banks are more inclined to cooperate with borrowers.
“Across most markets, debt is still available for the refinancing of stabilized and performing portfolios,” says Kemp. However, he notes the cost and availability of construction financing varies from country to country.

Lee says that, while finance is available, it is harder to obtain in markets where rates have risen quickly, such as South Korea, Singapore and Australia. Available loan-to-value ratios for core assets have fallen to 45-50 percent, from 60 percent.

“This is because for many of the key markets which have experienced large interest rate hikes, the key limiting metric is now the debt service coverage ratio, which now implicitly caps leverage at these lower levels. And lenders want to see a credible asset management plan and an exit plan,” he says.

While banks are still lending to real estate, the panel believes there is room for non-bank lenders in the region to take a growing share of the market, as commercial banks prefer to support mainstream assets and strategies. The private credit market in Asia-Pacific is much smaller relative to other regions and is expected to grow.

Investor allocations subdued

Capital-raising for Asia-Pacific real estate funds has been as difficult as anywhere this year. PERE data shows only $4.8 billion was raised for private real estate funds focused on the region in the first half of this year, compared with $19.8 billion in the same period in 2022. Funds are also taking much longer to close, at an average of 13 months in H1 2023, up from nine months last year.

 

“Generally across Asia-Pacific we have seen pricing move around 5-10 percent lower since recent peaks, outside of the Japanese market”

James Kemp
Macquarie Asset Management

Boocock says: “Investors have tended in the last 12 months to be more domestically focused, but now they are curious about what’s happening in Asia and we are getting a lot more inquiries. I would say that while China remains a red line for some investors, there’s still interest from Asia-Pacific and Middle Eastern investors.”

The views of investors based in North America and Europe are influenced by the performance of those markets, says Kemp. “We have an investor set which sees the value of the fundamentals in Asia, but it is still a hard discussion to release capital for anything, let alone something in Asia, where global investors haven’t seen the same price correction as other markets.

“That will take a little bit of time to work through. We don’t think there’s some fundamental price correction to come – we’re seeing deals now that we can underwrite on a long-term view of real estate pricing – but it is going to take a little bit longer this cycle before global allocations return, including to Asia.”

The China question

Investment in China has fallen away dramatically in recent months, partly due to ongoing political concerns and now also due to the faltering economy. A number of investment managers have reported investors asking for ex-China exposure in regional funds. Earlier this year, PERE reported that Hong Kong-based manager Gaw Capital planned to create a separate sleeve in its pan-Asia fund for North American investors that do not wish to have exposure to China.

However, panel members remain keen on China as an investment destination for the long term and also as a place to tap domestic capital. “From a long-term perspective, we see China as definitely a place to continue to invest, and a place where I think that, in time, the global investment community will also return to,” says Boocock.

Keppel’s Lee says: “There are APAC investors with a longer-term investment horizon looking at China now, because foreign investors currently have access to assets of a caliber which was previously unavailable. However, like a lot of managers, we are focusing more these days on the ‘China for China’ strategy, raising onshore RMB capital to do deals in China.”

With foreign capital largely on the sidelines, liquidity in the Chinese market is coming primarily from large domestic insurers, provincial companies acquiring buildings for their own use in Shanghai or Beijing, and Southeast Asian family businesses where the family has a Chinese ethnic background and that have operating businesses in China.

Kemp points out the importance of domestic capital is not new. “Most medium-term liquidity in China comes from domestic capital, but that’s much the same as it was pre-covid. RMB investors have tended historically to have the cheapest cost of capital for stabilized assets in sectors where we have invested,” he says.

One of the post-pandemic economic themes has been the redrawing of the global supply chain map, with manufacturers moving away from siting production entirely in China. Some have adopted a ‘China plus one’ strategy, diversifying to Asian markets such as Vietnam or India. Others have chosen ‘nearshoring’ closer to home, which has benefited Mexico in particular, or ‘reshoring’ by bringing manufacturing back to domestic markets.

“Like a lot of managers, we are focusing more these days on the ‘China for China’ strategy, raising onshore RMB capital to do deals in China”

Galen Lee
Keppel

“Capital which had been looking at China is definitely looking at markets like India and Vietnam because that’s where the supply chains are moving to,” says Boocock.
Lee seconds this, adding: “However, I would caution that Vietnam is a much smaller market, much less liquid than China.”

Indeed, the size of ‘China alternative’ markets is a significant barrier for real estate investors, says LaSalle’s Tang. “We monitor Southeast Asia, but scale is a concern as the aggregate GDP of the five or six key markets is still a fraction of China’s.”

Rebalancing exposures

The type of vehicles and sectors investors favor for their Asia-Pacific exposure represents another shift in sentiment this year.

Boocock says: “Although I’m a big proponent of raising regional, if not global, funds to get scale, I think investors are now looking at more thematic and niche strategies. An investor said to me recently, ‘I’m not looking at macro strategies, I’m only looking bottom up. Those strategies could be regional or could be country specific.’”

Investors are looking specifically for industrial and residential strategies, especially the former. PERE data shows 95 percent of capital raised for Asia-Pacific-focused sector-specific private real estate funds in the first half of this year was for industrial funds, the remainder for multifamily.

This reflects the changing nature of institutional portfolios, says Tang: “Opportunistic and high-return funds are trying to produce assets for the core portfolios of the future and those portfolios are reallocating from office and retail into sectors such as multifamily and logistics.”

“Even in the office sector, where fundamentals have been impacted the most globally, we’re still seeing some bright spots in certain markets in Asia”

Claire Tang
LaSalle Investment Management

Macquarie’s Kemp suggests the various living sectors – multifamily, co-living, student accommodation and retirement housing – could be a focus for international capital in the future.

“It will be interesting to see how the living sectors play out across the region, when global capital returns. There are different dynamics from logistics, the other big regional play. Living is very country specific in terms of the asset type and target tenants. However, the fundamentals support the sector and the question will be how to scale in or across markets,” he says.

There is also a lot of investor interest in niche sectors such as life sciences and data centers for which, as noted, pricing has held steady even in markets with rising interest rates.

Data centers are often seen as a natural step for industrial and logistics developers, but investors are looking for a complete solution, says Lee, “which means having the megawatts capacity to cater to the customers’ expansion needs, plus efficient cooling capabilities and green energy capabilities to supply the assets.”

While industrial and logistics, private credit and multifamily residential were the preferred strategies among the panel, there is still interest in the office sector. Tang says: “As a contrarian bet, we still like selective office opportunities. We still like the reposition strategy in markets with stronger fundamentals, especially in Japan and Korea.

“There is also a tremendous opportunity to build or reposition to greener, better office space as tenants look to reduce their carbon footprint.”

Slim pickings for deals

Investor uncertainty, rising interest rates and a significant bid-ask spread in a number of markets mean 2023 has been a tough year to deploy capital in Asia-Pacific.

This is reflected in MSCI Real Assets’ transaction data for the first three quarters of the year. The $25.7 billion of deals recorded in the third quarter was the region’s lowest tally since 2010, and 28 percent lower than volumes in the second quarter. The first nine months of 2023 saw $95 billion of deals in the region, down 37 percent from the same period in 2022.

PERE roundtable participants are asked to name the most significant deals of the year, which proves a struggle for 2023 – itself indicative of a difficult market for deployment.

One notable deal mentioned was Singaporean sovereign wealth fund GIC’s October sale of a 49 percent stake in Chatswood Chase, a suburban mall in Sydney, to Vicinity Centers for A$307 million ($198 million; €183 million).

The sale price was a 45 percent discount to the A$562.3 million price at which GIC acquired the stake in 2017. A major investor prepared to exit at a loss suggests the potential for a more liquid market going forward, and a dissipation of bid-ask spreads as investors become more realistic about the prospects for their investments and more inclined to free up capital to invest elsewhere.

Looking to 2024, the panel suggests a gradual easing of market congestion, motivated in part by a more stable interest rate environment. Kemp says: “There is a feeling that interest rates across Asia-Pacific are close to peaking. That’s not to say that we expect interest rates here to be reduced in the short term, but we do think interest rate policy is doing the job of moving inflation back toward target levels.”

Managers are still proceeding with care, however. Boocock says: “We are being very cautious in our underwriting. It’s market by market, it’s deal by deal. We see a lot of bid-ask spreads but we are hopeful this will improve in 2024.”

Tang says LaSalle will remain “patient and disciplined” with capital, based on learnings from recent cycles, but is optimistic about the near term. “We do think that, as repricing continues, for those of us that have dry powder and seasoned teams, the next 12 to 18 months should be a great time to deploy capital.”

Investors turn to real estate debt

Debt strategies are attracting interest from investors that see a gap in the market and seek downside protection

Private debt makes up close to 40 percent of all commercial real estate lending in the US, and approximately 10 percent in Europe. Similar data is not available for Asia-Pacific as the market is small at present, but it is expected to grow as a number of managers move into the space.

CapitaLand Investment’s Patrick Boocock says: “The commercial banks have healthy balance sheets but, for assets and borrowers which are just off the fairway, they are starting to back off a little. This is especially the case in Australia and so we are seeing a lot of interest from private credit platforms. We think there’s huge opportunity for private credit in APAC real estate.”

Even in favored real estate sectors, there is more demand for private credit, says Keppel’s Galen Lee: “A lot of data center and logistics operators cannot raise equity as easily today, so a lot of them are starting to turn to private credit as an alternative for expanding their business.”

 

Opportunities in ESG

Sustainability remains one of the major themes in real estate investing and there are significant opportunities for ESG-boosting strategies in the region

The opportunity set for ESG real estate investment in Asia-Pacific is “enormous,” says CapitaLand Investment’s Patrick Boocock. Potential strategies include “brown-to-green repositioning, distributed power generation associated with buildings, or investing in companies which are trying to decarbonize the built environment,” he adds.

LaSalle Investment Management is investing in repositioning offices to provide greener space, says Claire Tang. “You would be surprised how limited the options are for multinational companies seeking suitable space to meet their decarbonization goals.”

JLL research released in October suggests low-carbon office space is substantially undersupplied in Asia-Pacific cities. Major CBDs around the region are 43-84 percent undersupplied with low-carbon office space compared with demand to 2027.

The opportunity is region wide. Galen Lee of Keppel says: “We are also looking to invest in China with a decarbonization strategy, repositioning buildings to make them futureproof.
“The green economy is a very big topic in China, for which we see a lot of government support and attention.”

 

Meet the roundtable

Patrick Boocock
CEO, private equity alternative assets
CapitaLand Investment

Boocock is responsible for growing alternative assets such as digital infrastructure, renewable energy, transition and sustainability investments and private credit. CLI had S$134 billion ($99 billion; €92 billion) of AUM as at June 30, 2023. He joined CLI in 2021 from Brookfield Asset Management.

Galen Lee
Chief executive officer, real estate and data center funds
Keppel

Keppel has $10 billion of AUM in its real estate and data center private equity funds. Lee’s previous senior roles include stints with City Developments Ltd, UBS Investment Bank and DBS Bank.

James Kemp
Head of real estate, Asia-Pacific
Macquarie Asset Management

Kemp joined MAM in 2007 and leads the business across Asia-Pacific, where the firm has an opportunistic strategy with a focus on investing in and partnering with specialist operators. As at September 30, 2023, MAM had A$892 billion of AUM with A$33 billion of real estate AUM.

Claire Tang
Co-chief investment officer for Asia-Pacific, head of Greater China
LaSalle Investment Management

Tang 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 Q1 2023, LaSalle had AUM of $78 billion globally, of which $14.2 billion is in Asia-Pacific.