Why Invest in Asian Real Estate Markets?
Prime commercial real-estate assets tend to be expensive today, irrespective of geography and product. Gross initial yields (GIYs or capitalisation rates) have been converging to very low levels almost anywhere in the world (including Asia). Buying prime assets at a 3-5% GIY is the rule rather than the exception. Although prime assets are still ‘cash generators’ compared with other asset classes (e.g. stocks and investment-grade bonds), particularly in a low-interest rate environment, the key question is how capital appreciation can occur in the short period.
For investors seeking recurrent income, prime assets are still attractive because keeping a property for a lengthy period magnifies the importance of net rental income generation in the overall investment return. But for investors willing to incur a reasonably higher risk, a prime real-estate investment solution may have become obsolete.
Manifestly, we believe these investors should consider a wide range of ‘alternative’ property segments as well, in the primary and secondary markets, with a particular focus to Asia. Such investors would have less of a so-called ‘top-down portfolio approach’. Indeed, a top-down policy involves tracking a benchmark against which the property portfolio is measured using market analysis and forecasts. A bottom-up real-estate investment strategy focusses more on selecting specific assets which offer good prospects based on their individual qualities.
Obviously, the broader economic and property conditions should not be totally ignored either, and Asia Pacific is worth focussing on. Its investment market is expected to more than double every decade, driven by rapid growth in markets like Vietnam, India, Philippines, China and Indonesia. By 2026, Asia Pacific would contain nearly 35% of the world’s investable real-estate stock (1).
And the economic perspectives are also very good in Asia. We favour the Asian economies within the Emerging Markets as well as Japan. We feel China is transitioning from a top down industrial and state directed economy to a services economy. The services economy is now greater than 55% of overall GDP. The focus is increasingly on sustainable growth and corporate profitability boding well for better return on investment. China’s role as the locomotive of global growth will pass to India. However, our forecasts growth mean it will be a key driver of global growth for years to come and could be the largest economy in the world by 2030. India will be the fastest growing major emerging markets economy going forward and the No.2 economy by 2050. The country benefits from a reforms process under PM Modi, demographics, a newly energized central bank that is focused on reducing inflation, and strong foreign investment.
Areas of reform include increasing infrastructure spending, opening up sectors to foreign FDI, creating a single GST across the country vs. multiple taxes, and stamping out corruption, measures which will help to increase the tax base. It is a long-term process but prospects are rosy. Japan and Australia are developed markets with leverage both to Asian growth as well as unique domestic stories. Japan is undergoing a series of structural changes under PM Abe for example. Focus on corporate governance, raising labour participation of women, and accommodative monetary policy to boost the growth rate of the economy. In addition, the Olympics will come to Tokyo in 2020. The diversity of opportunities for property investment in Asia which will be the economic engine of global growth remains compelling for decades to come.
As a matter of fact, today, many professionally-managed portfolios focus on ‘non-core’, ‘alternative’, ‘added-value’ or ‘turnaround’ properties. Value-add strategies are higher up the risk-return chain, and a typical value-added strategy consists of acquiring property at a discount to the replacement cost, with a view to generating attractive returns even if the market stays flat. Alternatively, note that gateway cities still offer older assets, which need refurbishing and redesigning to accommodate modern tenants, hence incurring a significant capital expenditure. Project development may also be a consideration.
These investments are held through illiquid private structures (even though a degree of liquidity may be provided). The bulk of the return will come from appreciation over yield, with managers looking for the perfect exit strategy. Unsurprisingly, and in spite of the professionalism of portfolio managers, this type of investment presents more (execution) risks which should be remunerated with a higher IRR, preferably in excess of 10%.
Countless investors are concerned about nominal interest rates rising in the coming months and years. Not to mention higher real rates when adjusted for inflation. However, as interest rates climb, opportunities may arise when debt-saddled owners need to recapitalise their asset base.
Some examples of value creation in Asia today:
- India. Real-estate opportunities still exist in India, a country that has underperformed other Asian nation, performance-wise, in recent years. There’s a widespread lack of prime office and retail space and existing retail and office schemes need to be upgraded;
- China. Even though some caution is appropriate for the Chinese property markets in general, there’s a strong appetite for investments in the logistics sector (because of growing e-commerce activity). Or else, investment opportunities could arise from non-performing loans given rising debt levels;
- Japan. Japan is an economically mature country, though investment opportunities could be found, still, in the residential sector. There’s room for enhanced asset management of big property portfolios (higher rents, lower management fees). Alternatively, commercial assets could be bought by (foreign) private equity players who are capable of deciding in a speedy way (as opposed to local institutional investors who have lengthy decision procedures;
- Australia. Strong investment appetite for investments in logistics (similar to other places in Asia, Europe and North America).
(1) Source: PGIM Real Estate, a Bird’s Eye View of Real Estate Markets, March 2017.