Trump presidency weighs on Asia-Pacific real estate
Concerns over a slowdown in Chinese economic growth have receded, but the rise of Donald Trump could present challenges for Asia-Pacific real estate markets, says Sandip Bhalsod.
At the beginning of the year, most observers were agreed: the chief risk to Asia-Pacific property markets was a sharp deceleration in the Chinese economy. This hasn’t materialised: Beijing now looks set to meet its GDP growth target of 6.5-7 per cent for 2016, thanks to lavish infrastructure spending and contributions from an increasingly frothy property market.
While China’s rising debt levels may become a significant problem over the medium-term, a more pressing risk to Asian markets emanates from the other side of the Pacific. Donald Trump’s unexpected victory in the US presidential election on November 8 has sent global bond yields higher, as investors anticipate tax cuts, fiscal stimulus and higher inflation in the US.
While our central scenario for Asia-Pacific real estate has not changed significantly in the wake of the election result, the balance of risks has certainly shifted. In the short-term, the probability of a rapid rise in government bond yields has increased. This could have significant ramifications for the property markets of Hong Kong and Singapore, which are likely to import higher inflation expectations and therefore higher bond yields from the US. Tighter financial conditions could lead to accelerated pricing adjustments, while a faster than expected tightening of US interest rates poses risks to the housing sectors in both markets, given their high proportion of floating-rate mortgages.
External headwinds, coupled with sluggish domestic growth in many jurisdictions, mean attractive investment opportunities will be difficult to find in Asia-Pacific real estate over the near-term. Given there are few identifiable opportunities from a top-down perspective, discerning asset selection will become increasingly important.
Further monetary easing should support Australian real estate
Of all the real estate markets in the region, Australia offers perhaps the best value, thanks to relatively high income levels and economic stability. The Reserve Bank of Australia continues to maintain an accommodative monetary policy and a further interest-rate cut is likely in 2017. This will put downward pressure on bond yields and improve the property yield spread, although a re-pricing of fixed-income markets in the wake of the US election risks diverting foreign capital flows away from Australia.
Performance will diverge markedly across sectors and geographies. Perth’s commodity-based economy remains in the doldrums despite a stabilisation in global resource prices. Brisbane looks more promising; with underlying economic data showing signs of improvement (see Fig. 1). Despite this, positive rental growth is not expected until late 2018; we are yet to see rents bottom out and landlords continue to offer attractive leasing incentives to tenants. The Sydney office market is one of few in the region showing strong organic rental growth: competition for prime assets is fierce, however.
Fig.1. Year-on-year state final demand (%)
Source: Thomson Reuters Datastream, as of Q3 2016.
Investment activity slows in Japan
The Bank of Japan (BoJ) appears to have conceded there are limits to how much further it can expand the country’s monetary supply. Instead, BoJ Governor Haruhiko Kuroda is now aiming to raise the yield curve by anchoring the 10-year sovereign bond yield to zero. This policy shift means real estate will become relatively less attractive than would be the case if bond yields continued to languish in negative territory. However, the spread available on property still looks appealing to Japanese investors.
Nonetheless, there are signs that investor sentiment is waning in the face of extremely tight pricing. Prime Tokyo office yields have remained flat since the fourth quarter of 2015 and transaction volumes have slowed markedly during the year (Fig. 2). We have scaled back our expectations of further capital growth but still believe the sector will deliver returns of around seven per cent between 2017 and 2019.
The outlook for other sectors is more challenging. Low wage growth and weak consumption are weighing on retail property. While inbound tourism is providing a fillip to luxury retailers on Ginza high street, domestic consumers are growing more discerning in how they spend.
Fig.2. Prime office yields in Japanese cities (%)
Source: PMA, as of Q3 2016
Hong Kong and Singapore markets vulnerable
The region’s small, open economies, Hong Kong and Singapore, look most vulnerable in the current uncertain macroeconomic environment.
Donald Trump’s protectionist stance is a particular risk for Hong Kong, where exports to the US as a percentage of GDP amount to nearly 15 per cent. Our forecasts factor in negative rental growth in the logistics sector over the next twelve months against a backdrop of weak global trade, affordability concerns and soft domestic demand. Tourism from mainland China is subdued and retail sales declined 3.9 per cent in September compared with the same period in 2015. Landlords are offering significant discounts for renewals and this is part of the reason we expect annual retail rental growth to contract by six per cent this year. Mass market retail is the sector most likely to lead the cyclical recovery. Luxury retailers are expected to continue reducing their footprint in Hong Kong in the face of a structural change in demand.
Central business district (CBD) office rents should perform more strongly, however, given that vacancy rates are low and supply constrained. We expect CBD offices to exhibit strong rental growth of 5.8 per cent per annum between 2017 and 2021. Recent rhetoric from the Chinese authorities suggests we may see much tighter restrictions on offshore yuan investment. This could severely dampen Hong Kong’s office investment market given the high percentage of recent deal flow supported by Chinese capital.
The Singaporean economy expanded by an underwhelming 1.1 per cent year-on-year in the third quarter, and the government has revised its full-year growth forecasts downward. The economy is now likely to contract by as much as two per cent this year. The economic slowdown is affecting retail trading and as such the rental outlook is weak. We forecast negative returns for logistics property in 2017, given the weak rate of global trade growth and the malaise gripping the city-state’s manufacturing industry.
Investors looking for a cyclical recovery in the office market should be wary of high takeup figures; occupiers are taking advantage of a recent supply injection by relocating to better quality stock, rather than demanding more space. That said, we remain positive about Singapore’s position as a competitive business centre and expect a strong rental recovery in the office market from 2019 onwards.
Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at December 15 2016. This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.