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Value is scarce in prime Asia-Pacific real estate markets, but Australian retail could offer opportunities, says Sandip Bhalsod.*
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Economies across the Asia-Pacific region have benefited from the growth in world trade flows over the last six months. Chinese fiscal stimulus has helped revive trading activity in the region and boosted global demand for core commodities such as oil and iron ore.
The Chinese economy recorded a year-on-year growth rate of 6.9% in Q1 2017. However, growth is likely to moderate over the remainder of the year as the impact of fiscal stimulus begins to fade.
While concerns over a Chinese hard landing have receded, the country’s controlled growth slowdown and transition to a more consumption-led model will have significant implications for investors in Asia-Pacific real estate over the medium term, from Sydney to Singapore.
China: winners and losers
Assets in Chinese cities that are well placed to benefit from the growth in services industries – especially the tier-1 “super cities” of Beijing, Chongqing, Guangdong, Shanghai, Shenzhen and Tianjin, which have deep labor pools, excellent infrastructure and high internet penetration – will perform well over the medium term, while those in industrial centers such as Changchun and Shenyang are likely to suffer.
Beyond China, real estate markets in economies reliant on demand from China’s manufacturing sector – especially assets in the shipping and resources sectors – may struggle. And investors in markets dependent on Chinese capital should be mindful of Beijing’s policy stance on capital outflows. In January 2017, China imposed restrictions on cross-border capital flows to reduce pressure on the renminbi. Policymakers loosened these measures in April 2017, but investors should monitor further developments as an abrupt withdrawal of Chinese capital can have a destabilizing effect on markets that have been supported by Chinese purchasers.
For example, Sydney and Melbourne are among a cohort of global cities that have seen Chinese buyers fuel an unprecedented housing boom. Reports of Chinese buyers pulling out of transactions due to funding issues should ring as a warning bell that these streams of capital are capricious at best.
Investors in markets reliant on other forms of Chinese capital, such as tourist spending, should also be wary. We have revised downward our return forecasts for prime retail assets in Seoul in light of Beijing’s ban on group tourism to South Korea, imposed in March 2017. Tourist spending has underpinned sales growth in Korean retail in recent years and the ban is likely to have an adverse impact on the sector.
Australia bucks the trend
Based on our assessment of fair value, the majority of prime Asia-Pacific real estate markets offer poor value over both a three-year and five-year basis. The exception is Australian retail. Although return forecasts are unspectacular – we anticipate total returns of 5.5% per year in the sector over the next five years – the market is relatively stable and transparent, and therefore demands a lower risk premium than other sectors.
Capital growth is on the wane throughout the region and investors should focus on markets where supply-and-demand dynamics are fostering income growth. Prime office assets in Sydney and Melbourne have exceeded expectations in recent years and we expect rents will continue to rise, given the ongoing withdrawal of office stock. We recommend investors look at “value-add” opportunities in Sydney’s central business district to take advantage of strong appetite for prime assets.
Prime total returns, per year
Source: Aviva Investors, Q2 2017
In Japan, the unemployment rate stood firm at 2.8% in April, after falling to its lowest level in two decades a month earlier, but there is little wage growth and landlords are reluctant to increase rents. The logistics sector offers better value than prime office property in Japan, although competition for the best assets is rising and we have seen further yield compression in the sector as a result.
Singapore and Hong Kong
Singapore’s economic growth has improved in recent months but that improvement has been uneven. Trade-related sectors have picked up on the back of a healthier global economy, but growth in domestic-oriented sectors such as retail and construction remains subdued. Greater slack in the labor market is likely to reduce pricing pressure, reinforcing the already-low inflationary environment.
The picture is similar in Hong Kong, where the macroeconomic outlook is poor. As expected, the Hong Kong Monetary Authority (HKMA), the territory’s central bank, raised its base rate by 25 basis points to 1.25% in March 2017 following another interest rate hike from the U.S. Federal Reserve. With a further Fed hike in June, it is likely we will also see additional tightening from the HKMA. Local banks have thus far held off on passing higher rates onto borrowers, but are likely to do so as the hiking cycle progresses. As interest rates rise, Hong Kong landlords may become tempted to sell retail assets in order to lock in gains obtained over the past decade. However, given the weak occupier outlook, investors would need to acquire such assets at deep discounts for this to represent a viable opportunity.
Overall, prime real estate looks expensive in both Hong Kong and Singapore. Nevertheless, both cities are attracting massive demand from Chinese investors keen to diversify their property portfolios away from mainland assets. Q1 2017 saw record-setting acquisitions of development sites in both Singapore and Hong Kong, backed by Chinese capital.
Generally, it is difficult to justify such high prices given the weak returns available on office and residential property in both cities, even if rental growth is likely to make a comeback towards the end of our five-year forecast period. But these big deals show Chinese capital flows will continue to be the dominant influence on Asia-Pacific real estate markets for some time to come, and specific opportunities may still offer value.
* Investment professionals are members of AIA/AIC's Participating Affiliate, Aviva Investors Global Services Limited ("AIGSL").
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