Macroeconomic factors – including slowing Chinese growth and expectations of rising rates in the US – are weighing on Asia-Pacific real estate, although Australia and Japan offer value in the near term, writes Sandip Bhalsod.
From the high-rise office towers of Shanghai to Melbourne’s leafy suburbs, Asia-Pacific real estate comprises a vast and diverse range of assets. But common macroeconomic trends are hampering property markets across the region. Tepid global growth, a gradual slowdown in the Chinese economy and the prospect of interest-rate hikes in the US will all have a significant influence on Asian real estate over the next five years.
We expect Asia-Pacific real estate to return 4.6 per cent per annum between 2016 and 2020. The outlook varies markedly by geography and sector, however. Australia and Japan will see the strongest performance thanks to supportive monetary policy environments. Capital growth will be the main driver of returns as robust investor appetite – coupled with a scarcity of assets – pushes valuations higher. Meanwhile, Asia’s smaller economies are likely to struggle as they are more vulnerable to macroeconomic risks.
Demand Down Under
Based on our latest forecasts, Australian property is one of few markets where value can be identified. The Reserve Bank of Australia is likely to maintain its accommodative monetary policy after cutting interest rates by 25 basis points twice in 2016. Widening spreads between real estate and other asset classes will attract more capital into the commercial property market.
Overseas investors have dominated recent purchases. This trend is likely to continue as absolute property yields in Australia remain relatively high by international standards. This holds true even with further yield compression factored into our 2016 forecast. For example, prime Australian office net yields are expected to reach 5.5 per cent in 2016, compared with an average of 4.4 per cent in mainland Europe.
Investor appetite is likely to remain focused on the prime office market. The annual return forecast for the next five years is 6.9 per cent, although this performance will be front-loaded. Occupier demand mirrors the current two-speed economy in Australia, with recovery limited to Sydney and Melbourne. Perth’s mining-dominated occupier base is struggling, despite commodity prices having stabilized this year.
The prime retail sector should outperform over the next five years, with annual returns of 6.8 per cent. Prime pitches are likely to benefit from continued demand from international retailers, trend levels of supply and buoyant tourism.
Japan offers value
In our view, Japan will be the region’s best-performing real estate market over the next five years, with annual returns of 6.8 per cent. However, investors excited by this prospect should be aware that the bulk of these returns will materialize in 2016, with returns fading thereafter. Shinzo Abe’s latest fiscal stimulus package – coupled with the likelihood of further monetary easing by the Bank of Japan in September – should create a supportive environment for property, although questions remain over the long-term effectiveness of the so-called ‘Abenomics’ program.
As in Australia, real estate yields look relatively attractive when compared with the returns available on bonds. Japanese equity market volatility – which has spiked recently – may also encourage more investors to the asset class. Investor demand will contribute to strong capital growth in 2016 and 2017. Over a five-year period, the Japanese office sector is expected to deliver average annual returns of 8.6 per cent.
The outlook for the retail sector is more mixed. Abe’s deferment of the planned hike in consumption tax to October 2019 will provide a short-term reprieve to retail tenants. Consumer wage growth remains weak, however, and any further appreciation of the yen may deter tourists, which could have negative consequences for prime Tokyo retail. Overall, we forecast returns of 6.9 per cent on Japanese retail real estate between 2016 and 2020.
Hong Kong and Singapore
Macroeconomic headwinds from a Chinese slowdown and sluggish global trade, combined with soft domestic growth, add up to a gloomy picture for Asia’s smaller economies. Five-year total-return projections for real estate in Singapore and Hong Kong are weak, with the near-term outlook particularly underwhelming.
A decline in the number of mainland tourists visiting Hong Kong continues to challenge the territory’s retailers. Landlords are offering steep incentives for new tenants and a rental recovery is not expected to begin until 2018.
Singapore’s retail sector is also suffering from a decline in tourism, as well as high operating costs due to tight labour conditions in the city-state. The recent Zika virus outbreak may also hit the number of overseas visitors. Singaporean retail property is expected to see annual returns of 1.6 per cent between 2016 and 2020.
Office sector fundamentals are healthier in Hong Kong, but a recent supply injection in Singapore will take some time to be absorbed. Given current economic conditions, tenant demand for industrial space is likely to remain subdued in both markets.
Our central case is for the Federal Reserve to increase rates at a gradual pace over coming years. If rates normalize faster than expected, then real estate markets in Hong Kong and Singapore are the Asian economies most at risk of a sharp correction in pricing.
Sandip Bhalsod is Global Real Estate Analyst at Aviva Investors.