Market Views: Is Asia's commercial property ready to rebound?
The commercial property sector in Asia has faced significant challenges in recent times, mirroring macroeconomic headwinds experienced in major Western economies.
The impact of rising interest rates and ongoing uncertainties in the global economy have weighed heavily on real estate prices, prompting cautious capital deployment decisions by institutional investors.
As a result, commercial real estate investment activity in the Asia Pacific region witnessed a considerable 17% year-on-year decline in the second quarter of 2023, according to data and analysis from global real estate consulting firm JLL.
Investment activity in the region totalled $26.8 billion in the second quarter. While the logistics, industrial and living sectors displayed resilience, office, retail, and hotel sectors suffered a sharp contraction.
The decline was particularly pronounced in key Asian geographies such as Hong Kong, Singapore, and South Korea. Moreover, the property market in China, a major player in the region, remains shrouded in uncertainty.
In light of these developments, AsianInvestor turned to asset managers and industry experts to ask whether it's time to wade back into Asia’s commercial property market and whether the sector poised for a rebound in the near future.
The following responses have been edited for clarity and brevity.
Pamela Ambler, head of investor intelligence for Asia Pacific
JLL
The question is what’s driving owners to sell and what type of assets are buyers reallocating into?
Cash-rich, opportunistic investors are eyeing a region with the highest return to office rate and strongest net absorption readings for logistics.
Leading that charge is Japan as an outperformer amid muted transaction activity across the globe. New sources of cross border capital have been entering the market there. Income from real estate assets in Japan still exceeds the cost of debt.
South Korea’s core office trades are picking up with mega deals re-emerging. The market fundamentals of supply and demand are on solid ground.
Transactional evidence in Australia has provided greater conviction for new pricing benchmarks under the current rate environment, helping narrow the bid-ask gap.
Worth highlighting is the living sector which saw a 66% increase in Q2 volume from a year ago. Assets are trading actively given rising wage inflation that ultimately passes through to rental growth.
Accelerating activity is expected given what we see in the pipeline.
We expect motivated selling to occur in the next 12 months as investors look to maintain their gearing and liquidity position to manage the high cost of debt.
We have identified a $3.6 billion shortfall in financing for APAC tier 1 markets in 2024. But most lenders in the region remain engaged in commercial real estate loans, though being more selective, working with well capitalised sponsors.
Therefore, the default risk remains marginal and confined to some parts of office and retail. And we could see more private capital, ultra-high net worth capital being active in investing.
Louise Kavanagh, CIO and head of Asia Pacific
Nuveen Real Estate
The macro outlook for Asia Pacific for the remainder of this year remains cloudy, with consensus continuing to mark down growth forecasts for many regional economies.
Some of the drags on activity momentum – such as weaker global growth draining on trade – reflects a less sanguine business climate, capital spending as well as production.
Consumer prices have eased somewhat but remain elevated – and in turn, higher interest rates and financing costs have also drained on investment sentiment, including housing starts and sales.
That said, labour markets remain relatively robust, except in certain sectors such as financial services and tech. That has helped to support consumer spending, allowing many regional economies to avoid heading into a technical recession.
This build up in pent-up domestic demand along with more supportive monetary policy next year, should in turn drive a shallow recovery in economic momentum and growth next year before strengthening further into 2025.
Accordingly, while investment volumes are at near-decades lows this year due to the weak economic backdrop, keeping investors on the side-lines, capital market traction should start to gather pace towards the year-end. Deal flows should pick up in anticipation of improved fundamental and pricing outcomes next year.
Cuong Nguyen, head of Asia Pacific investment research
PGIM Real Estate
Asia Pacific real estate returns are expected to be under pressure over the next 12 months as pricing correction continues in a number of markets.
However, the region’s diverse condition is supporting a relatively resilient performance with regional real estate values expected to decline by less than 10% on average peak-to-trough.
Having invested in the region for three decades, history tells us that a downturn will bring opportunities, particularly in markets with significant pricing adjustment and an improved rental growth outlook.
However, in an uncertain environment, we continue to focus on resilience and quality of income as the main driver for investment strategy.
Across Asia Pacific, we favour sectors and markets that offer a resilient income profile driven by long-term structural trends – such as affordable rental housing in cities like Sydney, Melbourne and Hong Kong with strong rental growth prospects and favorable demographics, as well as logistics and data centers linked to the ongoing digitalisation of global societies.
The decarbonisation trend is also driving demand for properties with better ESG credentials.
A diversified portfolio across equity and debt can deliver less volatile outcomes than a highly concentrated strategy.
Debt typically outperforms during periods of uncertainty. This is especially the case this time round as there is a legacy of low leverage providing attractive entry points, and also – unlike in some downturns – interest rates and lending spreads have risen, boosting returns.
Investment opportunities for nonbank lenders are arising, particularly in Australia.
Kenneth Tsang, head of research and strategy for Asia Pacific real estate
JP Morgan Asset Management
The real estate sector across APAC has generally been more stable than its peers due to more sustainable growth rates and valuations in the past few years, as well as more supportive macro and local capital market environments.
Cap rates in many APAC markets have adjusted to higher interest rates, but rental growth in certain sectors, particularly industrial, has partially mitigated this impact; return-to-office in APAC is well ahead of other regions, with Seoul continuing to perform strongly and green shoots emerging in Australia. Conversely, Japan real estate remains attractive due to significant yield spread, stable monetary policy, and favorable currency, particularly the multi-family sector.
Most retail markets in the region have stabilized with some markets starting to see recovery in sentiments on the back of returning domestic and international visitation.
It may still be early to call for a strong near-term recovery in global real estate, but the downside risk in APAC appears to be limited. The recent decline in APAC transaction volume has been more reflective of global capital market conditions rather than local market fundamentals, which generally remain attractive, and APAC will likely continue to outperform as the investors remain underweight to this region.
Scott Kim, CEO Asia Pacific
PIMCO Prime Real Estate
Given the current cyclical headwinds in the commercial real estate market in Asia, dynamics are likely to worsen before they brighten, as we currently see a substantial liquidity shortage and heightened volatility.
Gradual improvement is expected to happen in the second half of 2024 and onto 2025, when market fundamentals are likely to become more favourable.
Against this backdrop, we see attractive tactical opportunities emerging from market dislocations in sectors like life-science and logistics which are underpinned by secular trends. I
In terms of market dynamics, Japan remains competitive backed by relatively low interest rates, a weak yen against the dollar and a stable economy.
Capital flight from Hong Kong and China has benefited Singapore which has bolstered its office market – particularly for smaller size tickets – with more family offices setting up in the city.
We also favour transitional lending, particularly in Australia and Korea.
China’s real estate market is undergoing structural change driven by deleveraging, and we will maintain our cautious approach until the market has stabilised.
Having said that, we are monitoring opportunities across sectors, particularly those benefitting from policy-supported factors and e-commerce-driven development.
Koichiro Obu, head of real estate research for Asia Pacific
DWS
The disparity between reported asset valuations and transacted pricing remains wide in most APAC markets, though this has started to narrow as demonstrated by appraisal devaluations undertaken by listed REITs (real estate investment trusts) in Australia and other markets.
Nevertheless, drawing inference from recent buyer bidding patterns and market observations, we believe that actual transacted pricing for prime assets in Australia and South Korea may have already been corrected by circa 10% (from end-2021 levels).
We expect possible further correction in office pricing in Australia for the rest of 2023, bringing the cumulative depreciation to circa 10%-15% in some assets.
Meanwhile, although Japan continued to benefit from a stable cap rate, a price divergence trend could occur as Tokyo offices undergo a mild price correction due to weakening rents, while asset prices in regional cities hold firm due to stronger demand-supply balances.
By property type, the industrial sector has shown more resilience in this cycle, driven by strong rental growth which helped offset rising yields. We are looking for logistics prices to stabilise during the second half of 2023, with the potential for pricing upside next year onwards.
The institutional residential sector is also likely to benefit from potential pricing upside due to strong demand drivers and continued rental growth, particularly for Australia where the urgency for more rental housing stock and favourable tax changes is expected to drive the institutionalisation of the BTR sector.
Min-Chow Sai, head of Asia & North America real estate investment strategy
abrdn
It is probably too early to declare that the worst is over, given that there is still much uncertainty around borrowing costs and where they are trending.
However, on the whole, we think the APAC commercial real estate market is likely in a better place, compared to its peers in the US and Europe, principally on account of two reasons: a) a more benign policy outlook (China is on course for more easing while Japan’s policy settings remain accommodative notwithstanding the recent YCC adjustment), and b) less stress on the office sector given higher return to office among workers (excluding Australia), especially in the North Asian markets.
In other words, if the global real estate market is going through a tunnel, the tunnel for APAC is likely shorter.
We expect investors to remain cautious and selective until the next easing cycle is underway, which we expect to take place in the first half of 2024.
That said, sellers’ expectations are becoming more realistic, resulting in narrower bid-ask spreads which should help in promoting transaction activity.
This is especially the case in Korea where occupier fundamentals in sectors such as Seoul offices remain robust while rising project financing stress could present some attractive opportunities.
Matt Nortcliff, partner
Goodwin
There appears to be a distinct split in sentiment between investors from North America and Europe and those from APAC and the Middle East.
North American and European investors now see significant re-pricing of assets in their home markets and are generally less inclined to increase their exposure to APAC real estate when they may find better risk-adjusted returns closer to home.
Whilst APAC investors are also looking to those markets, they typically have longer track records and stronger relationships on the ground in key markets such as Japan, Australia, Korea and China.
They are also naturally inclined to take a longer-term view on the APAC growth story.
As a result, we still see strong pockets of interest from APAC funds and investors, often through joint ventures or club funds, to invest opportunistically in sectors such as logistics and living (including hospitality) in specific markets.
Middle Eastern investors are also increasingly active.
China is still on the table for those investors that can navigate the current headwinds, but buyers need a clear exit plan at the point of investment. More investors may now look to domestic capital (e.g. insurers and, potentially, C-REITs) for their exit strategy.