LaSalle anticipates more distressed property in Japan

Kenneth Tsang has been Asia-Pacific head of research and strategy at LaSalle Investment Management since February last year. He is responsible for the investment strategy for the company's various real estate funds.

Before joining LaSalle IM, Tsang was in charge of research and strategy at ING Real Estate Investment Management in Asia. He was also formerly head of research for Greater China at Jones Lang LaSalle, and before that, director of strategic and development consultancy for North China at US real estate services firm CBRE.

LaSalle IM, the investment arm of real estate company Jones Lang LaSalle, manages $39.9 billion of property assets, including $7.6 billion in the Asia-Pacific region, as of the third quarter of 2009. It runs seven commingled funds directly investing in real estate in Asia-Pacific.

AsianInvestor: Regarding distressed owners and lenders in the property sector, can you give an idea of what kind of deal size and returns we can expect in the coming months?
KS: After October 2008, a lot of people expected to see a lot of opportunities on the distressed side of real estate, but in reality we didn't see a lot of these deals emerge last year. That's because major Reits [real estate investment trusts] and banks recapitalised through capital raising. They were in a stronger situation than [many had expected], so they didn't have to crystallise losses by selling property.

We came across some deals in Japan, but the quantity was far below what was expected. It's difficult to forecast actual estimates, but we anticipate relatively more distressed opportunities this year. Some potential sellers may be coming out of denial mode and the market is stabilising. 

Distressed situations in Japan look particularly attractive -- why so, and what returns can be expected from such investments?
The key reason for this is that the value of Japanese properties has come down more than in other countries. In addition, Japan's economic outlook is one of the most challenging within Asia and thus there's more pressure on NOI [net operating incline] decline. For example, values of various property classes have dropped between 15% and 50% since mid-2007. We haven't seen more stressed sellers yet, but we may do.

In the annual report, LaSalle says the best higher-return opportunities in China are in mid-end residential and mid-end retail in second-tier cities - can you elaborate on this?
From a risk-return perspective, the mid-end residential and retail market in second-tier cities is a well-balanced play going forward. Our analysis suggests the middle class is emerging faster as urbanisation takes place. The newly urbanised population, estimated to be 16 million a year for the next 10 years in second-tier cities, will offer volume growth. This is already a mega-trend, but the Chinese government's proposal to relax control of the household registration system in small and medium-sized cities will certainly accelerate the pace of urbanisation.

In addition, development has relatively lagged in second-tier cities, so property prices there are more reasonable, in most cases. Demand for new housing is expected to be five million units a year in China for the next decade in both first- and second-tier cities. That's a huge number and will be a big demand driver.

Another issue is that a lot of the focus in the residential and retail sectors has been on the higher end of the property spectrum. To a certain extent, there is a mismatch between demand and supply in this segment. This creates opportunities for investors. 

LaSalle says it favours the retail sector across Asia-Pacific and the industrial sector in China, Hong Kong and Singapore. Why and how should such assets perform well?
Core investors can consider the retail sector in Hong Kong, Singapore and Australia, in the suburban retail mall or regional mall segment. In the past 12-18 months, we haven't seen much correction in that area -- retail value has held up pretty well, thanks to suburban malls being non-discretionary retail.

In China, investors can invest for the growth story, particularly in the mid-tier retail segment in second-tier cities. This segment will offer strong sustainable growth going forward.

On the industrial side, China has seen very rapid growth in warehouse occupied stock in the past five years. Exceptional export and domestic demand growth will continue to fuel demand for modern warehouse space.

Right now, the industrial sector is fragmented, and there's a lot of potential for operational-efficiency improvement and profit-margin enhancement. The rapid development of infrastructure will thus help further unleash demand for this sector and offer good opportunities.

Prime central business district (CBD) office properties in Asia will have the greatest upside, according to LaSalle. Can you elaborate on which cities look particularly attractive and why, and what returns investors can expect?
With regard to the office property market, we see a number of cities as attractive for core [institutional] investors. One is Australia, as the economy has weathered the recession very well. It has avoided technical recession in 2008/2009 and the economic outlook is positive going forward. Australia will benefit from commodity importers [such as China], and the economic benefits will cascade down into the prime office sector.

In Melbourne and Sydney, the CBD segment is very mature; there's a great investment landscape, with a lot of investment-grade office properties. Rents have stabilised in both cities after falling 20-30% from their peak in 2008. The leasing market is also increasingly active, and we see room for long-term demand growth. In addition, we don't foresee a big surge in supply. 

All these factors bode well for stable market development and potential upside for core investors. In the Australian CBD market, we expect five-year unleveraged returns of 9-11% before fees and tax.

The Hong Kong CBD is another interesting market. It has seen big corrections in rents, but prices have stabilised and started to grow in the last quarter of 2009. In the long term, it will also benefit from strong economic growth in mainland China, which will bring additional new demand. And there are no over-supply issues in Hong Kong. It's a very cyclical market, partly due to the short-lease term structure. We expect a strong cyclical rental rebound in the medium term.

What about the residential sector in Hong Kong? Prices have risen significantly in the past year in that market - is it now a good investment?
We did see a lot of mainland Chinese investment in Hong Kong, but largely into new developments and the luxury sector. Average residential prices have rebounded by 20-30% since March, but rent has gone up by a similar amount. Demand for housing has been strong and the price run-up was not driven purely by investment demand. 

Strong liquidity has certainly helped the market, and liquidity will remain relatively strong in the near term. This will help to underpin the development of the residential market this year.

LaSalle has commented that core investors should focus on stable markets and sectors. Can you cite examples of these sectors?
Apart from Australia, Japan is another low-risk market offering stable demand and income in some sectors. For example, in the warehouse sector, total occupied stock increased even in the recessionary environment. 

Other factors to note are the structural shift to higher-specification warehouse property in Japan and compliance with higher environmental standards for buildings, which will underpin demand for high-specification modern warehouses. 

Also, the impact of new supply is gradually dissipating in some areas; the demand-supply dynamics are in a more balanced situation now than they were a year ago.

When you look at the warehouse sector, investors need to pay close attention to the quality of assets, the location, and whether properties have the right infrastructure for flow of goods and transportation for workers. Right now, investors should be looking into assets with longer leases, which will help stabilise rental yields.

Are you seeing any different ways whereby institutions are accessing property exposure in Asia?
We've not seen any major shifts yet. But one emerging trend is that Asia-based institutional investors are getting more active in direct real estate investment. For example, Korea's National Pension Service has been seeking core assets within the region and recently bought prime office assets in Sydney's CBD.