ASIA PACIFIC – Simon Smith

Regional Head of Research & Consultancy

Storm Clouds Gather

Asia Pacific property markets face a number of battle fronts in 2023. The first is external to the region as the war in Ukraine combined with post-COVID supply chain disruption has fueled inflation causing central banks to raise rates and in doing so cool growth. This is nowhere more apparent than in the US and Europe, the final demand markets for Asia’s exports. The second is within the region itself and concerns its largest economy, China, which accounts for 53% of the region’s GDP and almost a third of all manufactured products. A low growth and, thanks to zero-COVID policies and a more assertive political direction, more isolated China, is depriving real estate capital of a universe of investment opportunities while funds flowing out of the Mainland have slowed to a trickle. The final battle front is longer term and structural and concerns how people work and shop and how new technologies are tearing down the old boundaries between asset classes while creating new ones in an orgy of creative destruction. Something familiar to markets globally.

A Silver Lining 

Asia is not alone in facing a challenging 2023 of course, a sub-par year in terms of growth and some way from pre-COVID norms. However, measured against the yardstick of the global economy, and in particular the US and Europe, Asia’s strengths become apparent. While North America and Europe face recession in late 2022/early 2023, Asia Pacific will see modest growth in many jurisdictions, higher rates in some. Interest rates are also expected to rise more slowly as inflation fails to make the inroads it has elsewhere. Even geopolitical tensions are moderating thanks to the G20 Bali Summit. A raft of trade agreements, temporarily grounded by COVID, should also help accelerate the post-pandemic resurgence as supply chains mend and the region’s low-cost base reinforces its competitiveness. While ‘alternative asset classes’ are proliferating in the region, other disruptions such as flexible working and online retail are making fewer gains than elsewhere while large parts of Asia Pacific are still enjoying the luxury of catch-up growth, delivering outsized economic gains in, for example, Southeast Asia and parts of India. 

Rays of Light

Looking ahead into 2023, it is unlikely that any of the three battle lines will be redrawn, but this doesn’t mean a dearth of opportunities, quite the opposite. In an inflationary environment Asia’s shorter lease lengths should prove appealing while ‘index-linked’ defensive sectors such as self-storage, student housing, multi-family housing and senior living should find an audience. The ‘New Economy’ remains as fresh as ever. 

In Japan, low interest rates and a weak Yen will continue attracting overseas capital with logistics assets, and multi-family housing all being targeted while hotels should prove to be an actively traded asset class in 2023. 

Singapore meanwhile is emerging as a ‘geopolitical safe space’ in the region, building its financial services base, attracting private family offices, and benefiting from the exodus of talent from Hong Kong. Vietnam continues to benefit from its dismantling of COVID restrictions and ‘China plus one’ and is expected to post enviable growth of 4% in 2023. 

In Australia, Asia’s principal resource-driven economy, high yields, strong growth compared to major markets and a weaker Australian Dollar should attract offshore investors. Sectors to watch include logistics, core offices and a range of alternatives.

In China, as elsewhere in the region, life-sciences, data centres, logistics and cold chain investments have lost none of their allure as structural drivers remain compelling. Even with low inflation and low interest rates, debt burdened firms may deliver distressed assets, but pricing remains contentious.

And a look at 2023 wouldn’t be complete without mentioning ESG. Love it or hate it, it’s here to stay and expect to see growing ESG commitments, and more ESG initiatives as part of investment strategies across all asset classes.

 

AUSTRALIA - Katy Dean

Head of Research & Consultancy

The sharp rise in interest rates and greater uncertainty around the outlook have led to a period of price discovery. The bid-ask spread between purchaser and vendor has widened, and this has tempered deal activity. Some investors will continue to wait for the impact of higher interest rates to wash through valuations. Weaker global economic conditions will see growth in inflation peak in December 2022 and moderate in 2023 through a combination of weaker demand and easing of supply constraints.

Current market pricing is consistent with interest rates peaking in the first half of 2023. After having risen sharply over 2022, government bond yields are set to fall next year as global growth slows, inflation eases, and investors anticipate eventual cuts in central bank policy rates. Materially lower bond yields would represent a significant change in the current market dynamics, with profound implications for investment markets across asset classes including property. 

Falling bond yields in 2023 will ease the pressure on property yields with the potential to limit further widening. However, movements in yields could diverge significantly by individual asset depending on sector, quality, location, and lease length. 

Australia’s relatively strong economic growth outlook and high yields compared to many major markets, coupled with the weaker Australian Dollar, make Australia an attractive destination for offshore investors. Investment capital will chase assets with the strongest underlying demand fundamentals, specifically industrial/logistics, core office / prime grade quality, and alternative/emerging asset classes (BTR/ multi-family, student accommodation) to take advantage of tailwinds from higher migration and travel recovery.

There will be increased appetite for prime quality industrial assets in good locations with shorter lease terms from investors seeking reversionary upside that is linked to both inflationary pressures and current rental growth performance to drive total returns from income growth.

While the Australian economy is expected to remain in expansionary territory in 2023 and avoid the worst of the global downturn, the slowdown in economic growth and deterioration in labour market conditions may increase office leasing risk in some markets.

The relative strength of the occupier market outlook for prime office assets, both from a cyclical and structural (changing work patterns since the onset of the pandemic) perspective will drive a rotation into core assets and out of non-core assets as major institutional investors reposition their portfolios towards assets that are less exposed to leasing risk.

Demand for ‘green’ will intensify, driven by growing ESG commitments and competition for talent. Additionally, there will be an increase in ESG initiatives as part of investment strategies across all asset classes, with landlords adopting green building certifications, along with energy efficiency upgrades, and investment as part of their strategies.

The number of investors targeting the Australian Build-to-Rent (BTR) sector will continue to grow, with the yield stability reinforcing how investors are attracted to the sector for the long-term income streams it generates.

There will be continued investor interest in student accommodation as an asset class, driven by the bounce back in international students, occupancy, and outperformance in rental growth during 2022.

 

JAPAN - Tetsuya Kaneko

Managing Director of Research & Consultancy

With the pandemic receding, all sectors have seen some recovery over the past year. That said, 2022 has been a year characterised by war, inflation and a high global interest rate environment, which all make the world a more uncertain place. Even Japan, a country known for its stability, has experienced a historic weakening of the Yen. Given that wage growth remains largely modest in Japan, average households have suffered.

Inflation is currently at acceptable levels of 2% to 3%+ and interest rates remain low (5-year government bonds are yielding around 0.1%). As such, while some are taking a wait-and-see approach due to concerns over a future increase in interest rates, most investors are looking to snap up opportunities and 2022 has been another busy year with multiple large transactions. On top of the JPY400bn+ deal involving Otemachi Place, the largest transaction ever in Japan, several transactions valued at over JPY100bn have taken place over the past year.

Interest rate hikes in the US are likely to slow down, and many believe that the upward pressure on rates in Japan should be manageable. Investors will likely get a clearer picture of the direction of the market by early 2023 as inflation in the US gradually slows. J-REITs are notably susceptible to changes in interest rates and their activity level depends on the interest rate environment. Given the relatively high prices of real estate, transactions volumes by J-REITs will likely be affected if interest rates were to go up.

Nevertheless, an economic slowdown is likely in 2023, which will negatively impact real estate activity. With this high level of uncertainty, investors remain cautious as well as selective in their investments. For instance, although the office sector remains stable, office location appears to be an increasingly decisive factor, especially considering the long-term impact of hybrid work arrangements.

ESG appears to be gaining further ground. According to a survey by the Development Bank of Japan, approximately half of tenants responded that they would accept some level of rental premium for ESG compliant office buildings.

Looking ahead at real estate investment prospects, the logistics sector remains sought after, although there are increasing concerns over inflation and elevated supply levels. Tenants are struggling with thin profit margins and inflation, and competition for tenants is growing. Some investors may not be able to achieve rents high enough to justify their own sharp pricing.

Multi-family also retains its popularity due to its stable cash flow even during the pandemic. There were several large portfolio transactions over 2022, and 2023 is also likely to see a high level of activity. Rental levels have almost recovered to pre-pandemic levels, and further rental hikes should follow meaningful wage growth. Student housing and healthcare facilities appear to be popular targets as well.

Office attendance has improved throughout 2022 and there has been stability in the office market. Investors have been very selective about location – poorly located offices will likely struggle to attract tenants while hybrid work arrangements are common. 

In the value-add space, urban retail still appears to have some room for growth. Indeed, bricks and mortar demand from domestic consumers has largely recovered in 2022. That said, recovery has been fragmented even in prime submarkets. High-spending inbound tourists should help change the fortunes of urban retail. 

At an opportunistic level, the hotel sector remains attractive to investors, given that inbound tourism has resumed and domestic tourism, which comprises roughly 80% of the market before the pandemic, has recovered to pre-pandemic levels. Furthermore, investors, anticipating interest rate hikes, are encouraged by the fact that hotel performance is far less linked to interest rates than other sectors. We expect more hotel transactions in 2023 since owners are now able to sell their hotels at acceptable discounts to pre-pandemic prices.

Elsewhere, luxury or branded residences might be interesting opportunities to explore, especially because stock levels remain subdued. Tokyo will see its first branded residence in 2023, provided by Aman Tokyo Residences, which will pave the way and spark new entries from other market participants.

 

SINGAPORE - Alan Cheong

Executive Director of Research & Consultancy

With the return to normalcy after two years of pandemic measures, one would have expected the local real estate market to resume firing on all cylinders. However, the rise in interest rates and regional political shakeouts have turned the market inside out.

With the Singapore benchmark interest rate at 2.8% (this is the 3-month compounded SORA or Singapore Overnight Rate Average), the all-in cost for non-recourse real estate loans is now at >4.2%. With passing yields of office buildings at 2.5%, the negative carry is too great to surmount. However, this does not mean that there are no opportunities in the core strategy space.

Inflation also appears to be peaking in the US and interest rates will soon follow the same pattern.

As with other cities in Asia, ESG appears to be gaining further ground and this is expected to become key for tenants in leasing considerations and negotiations. Opportunities will present themselves for investors who are forward looking in this regard.

A greater ESG compliance means multinational companies will consider only green rated buildings here. These are those buildings which we designate as Grade A offices as well. Although the passing yield is low now, overtime, with limited new supply and an increasing need to comply with ESG regulations in their home countries, such companies will face limited choices for their operations here except in such graded buildings. If entire buildings are not available, Grade A strata offices offer another option since supply (of good quality strata units) is limited and they can also be green rated.

Acquiring old office buildings in the CBD and redeveloping them to green buildings is a good value-add strategy. From 2021, the authorities will give points for the minimization of embodied carbon during the construction of a building. Nevertheless, there are still no compulsory standards to abide by.

Investors could also take this window of opportunity to redevelop older office buildings into mixed developments with the latest green features. In certain parts of the CBD, there are incentives for the conversion of pure offices to mixed use (office and residential) or pure hospitality. All this is subject to the payment of land betterment charges.

 

CHINA - James Macdonald

Senior Director of Research

China is faced with three significant challenges namely continuing zero COVID policies’ disruptive influence on economic activity, a distressed developer market and rising tensions with major trading partners. November 2022 nevertheless saw positive movement on all three accounts with the NHC announcing 20 policies to fine-tune COVID restrictions, meanwhile, the PBOC and CBIRC issued 16 policies to support developers and the property market, and Xi Jinping renewed dialogue with G20 leaders. While these measures by themselves are unlikely sufficient to get China back on track, they are seen as a step in the right direction and have the chance of putting a floor on deteriorating market conditions. 

Investment activity in recent years has shifted decidedly towards New Economy sectors as the fundamentals for traditional sectors weaken, the government rolls out policies to support New Economy sectors, and China’s REIT regime provides investors with greater transparency and liquidity in these markets. The broader themes are unlikely to see any meaningful change in the coming 12 months, although there may be some sectors and markets which will draw less attention in 2023 as yields reach historical lows and investors reassess their investment rationale. There may be a chance for a rebound in activity in more traditional sectors if vendors drop their valuations further and there continues to be meaningful progress on discontinuing COVID restrictions, enabling them to begin re-engaging with global trade partners. 

 

SOUTH KOREA - JoAnn Hong

Director of Research & Consultancy

Despite previous forecasts for a rebound, the South Korean economy is expected to expand by 2.5% for 2022. The economy has been largely impacted by supply-side pressures from the prolonged Russia-Ukraine crisis, ongoing high inflation, and sharp rises in domestic interest rates from further tightening of the US Federal Reserve’s policy stance leading to a weakening of both exports and domestic consumption. Looking ahead, economic growth for 2023 is projected to be below 2% on worries over a slowdown in the global economy and weakness in China.

While we predicted a rise in the Base Rate would stabilize rising inflation, we did not expect the extent of the increases witnessed during 2022, with mortgage rates doubling since end-2021. The investment market has shown little transaction activity since the third quarter of 2022 as a result. Until the market is convinced that inflation has peaked, and interest rates are unlikely to rise further, investors are expected to adopt a wait-and-see attitude.

As opposed to other major cities, Seoul prime offices have remained strong on robust tenant demand with people returning to the office after working from home and a tight development pipeline until 2025. Leasing demand in the logistics sector also remains well underpinned, while the e-commerce market has demonstrated a moderated pace of growth compared to the double-digit gains of recent years.

The Korean Won to US dollar exchange rate has appreciated significantly, up by more than 20% compared to early-2022. Though this may come as a favorable factor for offshore investors, they are also maintaining a wait-and-see attitude as transaction prices have yet to fall. For the office sector, even if leasing demand falls slightly, the decline in transaction prices is expected to be limited due to the tight supply pipeline until 2025. For logistics, the decline in rents and transaction prices may be more significant, especially in districts with a large future supply pipeline.

Finally, we are beginning to see some signs of distress amongst the domestic LP’s, which could result in increased sales activity where liquidity is required in the short-term and help expedite the pricing correction anticipated by the market. This process should then offer an opportunity for many investors, especially overseas, who have often found themselves out-priced. Regarding ESG, 2023 is expected to be an inflection year in terms of adopting ESG broadly in the real estate industry as regulations will begin to impact the commercial real estate market starting in 2023. Under these regulations, all buildings with a GFA greater than 100,000 sq m with permits to start construction after 2023 are legally obligated to receive a government-accepted rating for greenhouse gas emissions.

 

VIETNAM – Troy Griffiths

Deputy Managing Director

There are a multitude of influences playing across the Vietnam property landscape.  Not least the global slowdown and increasing interest rates, with deposits now paying 5.0% to 8.0%.  Overall, the domestic economy remains resilient, however the second half of 2023 may see the impact of manufacturing layoffs resulting from softening demand in key markets.  Inflation is relatively controlled, Retail Sale of Goods and Services are still increasing, and the VND is one of the strongest currencies in the region.  

However, local stock exchanges have fallen by up to 30%, led by property.  The ongoing anti-corruption drive, regulation of the bond market, and the cost of debt are all key contributors to the slide, which appears to have abated.   With many of the key property players now squeezed for debt, then there will be opportunities for foreign capital, favoring foreign capital. 

HCMC offices are tight at 93% overall occupancy, Hanoi less so but with consistent demand particularly for the mid-town precinct.  A consequence of ongoing investigations is that the office supply pipeline for HCMC will be disrupted, thereby ushering opportunities for repositioning of secondary assets.

Luxury retailing demand remains strong across both cities.  Luxury retailers now have confidence to enter the market as principals, forsaking previous wholesale channel arrangements.  With constrained quality supply in both CBDs, creative solutions are needed.  Discounting the pandemic retail closures, the broader market is holding up, and supermarkets trade well nationally. 

Industrial markets are strong.  Capital market activity has increased, with regional players taking positions.  FDI has been particularly strong for the higher value add industries, such as Lego and Samsung.  Ready built stock is increasing as downstream occupier demand consolidates.  Vietnam’s infrastructure spend is one of the highest in the region, and that will continue to drive opportunities.  Major ring roads, bridges, ports and regional hub airports are all under way.

 

INDIA – Arvind Nandan

Managing Director of Research & Consultancy

Indian real estate market continues to evolve across both conventional and newer asset classes including data centres and life sciences, despite global economic and geo-political challenges. Concurrently, the investible universe has expanded with REITs such as Embassy Office Parks REIT, Mindspace Business Parks REIT, and Brookfield India REIT all listed since 2019 while DRHP filed for Nexus Retail REIT in November 2022.

We expect India to clock in approximately US$4.0 billion to US$4.5 billion (INR326 billion to INR367 billion) of private equity investment in real estate in 2023 across all asset classes compared to US$2.1 billion (INR160 billion) from January to September 2022. The growth is owing to India remaining a rare bright spot in the global economy, despite the recessionary outlook in many of the world’s developed markets. In December 2022, the World Bank raised its GDP growth forecast for India for FY23 to 6.9% from 6.5% earlier, among the highest in Asia-Pacific.

We anticipate manufacturing sector expansion alongside the digitization of the economy to drive investments in industrial and warehousing, data centres and life sciences over the next few years. India is among the key beneficiaries of global supply chain rebalancing, which in turn is enhancing investment capital flows into industrial and warehousing assets. In November 2022, Apple announced plans to set up its biggest manufacturing plant in Bengaluru while Government’s digitalization drive and e-commerce growth is anticipated to increase data centre space requirements by around 15 to 18 million sq ft across the major cities over the next four to five years. 

We believe that the life sciences industry is also at an inflection point, with growth drivers such as an established pharma manufacturing base owing to India being the largest manufacturer and exporter of generic medicines, a large skilled workforce for supporting R&D research outsourcing, and cost efficiencies already in place. According to our estimates, India has the potential to create demand for around 10 million sq ft every year for R&D laboratories, up until 2030. This could provide institutional investors with ample opportunity to increase allocations to the sector, especially in the development space.

We are also witnessing increased commitments from existing investors such as Ivanhoe Cambridge, CPPIB, GIC, ADIA, Keppel Land and Blackstone. Japanese investors including Sumitomo, Marubeni and Mitsui Fudosan have also stepped up to invest in real estate across formats ranging from direct purchase to joint ventures. Further, new investors like Gaw Capital, Hillhouse Investment, Oxford Properties, Cambridge Properties, Nomura and PGIM are also exploring entry into the Indian real estate market. This will lead to increased investment activity over the next year though some may prove more cautious depending on the US economic situation and the Russian invasion of Ukraine.