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Asia Pacific
Asia Pacific Capital Markets Outlook 2018
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Asia Pacific Capital Markets Outlook 2018 3
Commercial real estate market in the Asia Pacific region looks set for an interesting, yet somewhat challenging year ahead in 2018. On the one hand, excessive liquidity has created an incredibly competitive landscape in most core markets, and we’ve continued to see some modest yield compression over the course of 2017. On the other hand, new opportunities are emerging across the region and the occupational side of the market has performed relatively well, despite facing the healthy supply delivery over the course of the year. We expect returns across the traditional asset classes to remain positive in all markets over the medium-term, however, expectations vary quite significantly across the region. Overall, our medium-term forecasts suggest unlevered total returns are likely to be below that of the preceding three years as we near the end of a yield compression cycle and development activity remains abundant.
On the capital side of the equation, core investors continue to make large commitments to the region, however, there remains limited opportunities for managers to deploy in the existing competitive environment. This is pushing core investors to sometimes redefine the definition of “core” and move into new markets, new sectors and new strategies; often further up the risk curve. Much of the new core capital is making its way into the market directly via Sovereign wealth funds (SWFs)/pension funds as well as via new REIT vehicles, open-ended funds, joint venture structures and insurance companies. Private equity capital raising has been modest throughout the year, with 2017 vintage funds raising USD 12.4 billion, down on the USD 16.8 billion raised by 2016 vintage funds. Opportunistic remains the main strategy, however, a larger share of capital raised is being allocated towards other strategies, in particular value add.
Capital outlook
Private equity (PE) capital raising by strategy
Source: Prequin, JLL
Source: REIS, 3Q16
Unlevered total return expectations (3-year CAGR 2017-2020)
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Asia Pacific Capital Markets Outlook 2018 5JLL4
Single asset sales have become increasingly difficult to source and investors are looking at new ways to deploy capital, via joint venture partnerships, portfolio deals, recaps and entity level deals. Investors have been recalibrating their strategies and looking at the alternatives sectors and the more niche asset enhancement/conversion plays. The operationally intensive nature of most alternative asset classes means there is a disconnect between capital and expertise within the Asia Pacific region. Therefore, those with strong operational capabilities in these more niche sectors are likely to experience strong demand for those expertise in 2018.
On the asset conversions, domestic market trends have played a large role in determining conversion feasibility and the strategies have been different across the region. Hong Kong has seen a number of old industrial facilities converted to data centres and Japan continues to have old office blocks in residential areas being earmarked for self-storage conversions. In China, a number of underperforming/zombie malls are being converted into several uses like coworking spaces, campus-style office buildings and various residential strategies.
Finally, investors have shown a clear shift to non-CBD markets as they seek out available opportunities and higher yields. This has been a consistent trend through a number of the larger markets in the Asia Pacific region – however, the trend seems to be reversed for Australia.
As well as capital shifting from CBDs to non-CBDs, there has been a noticeable shift into new markets. When looking at the 8 core CBDs within the Asia Pacific region (Shanghai, Hong Kong, Singapore, Seoul, Tokyo, Sydney, Melbourne and Beijing), their overall share of office transaction volumes has fallen to its lowest level on record.
Typically, the top eight CBDs would account for around 45-55% of Asia Pacific office transaction volumes, however, in 2017, these 8 core CBDs accounted for just 39% of the overall share. The non-CBD markets of these major cities generally attracted more capital in 2017, in particular Shanghai, Hong Kong, Seoul and Tokyo. Elsewhere, a number of tier 2 cities saw transaction volumes grow year-on-year. Markets like Osaka (+34%), Brisbane (+41%) and Chengdu (+104%) were standout performers.
Office market CBD vs. non-CBD transaction volumes % change 2017 vs. 2016
Major office CBDs share of total volumes
Top 8: Tokyo, Shanghai, Beijing, Singapore, Hong Kong, Sydney, Melbourne, SeoulSource: JLL, RCA
Source: RCA, JLL
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Asia Pacific Capital Markets Outlook 2018 7JLL6
Source: Thomson Reuters
Interest rates and FX concernsInvestor concerns around the medium-term interest rate outlook has lifted recently which is placing some pressure on their ability to underwrite deals in the absence of significant rental growth. Yield curves globally have flattened in line with the US, as shorter term rates have moved higher in anticipation of further monetary tightening. Economists generally agree there are likely to be another three or four rate rises in the US in 2018, which will have some significant ramifications for the Asia Pacific region.
Benchmark interbank offer rates (IBORs) have already increased in a number of markets in the final quarter of 2017, particularly in Hong Kong and Korea. Hong Kong rates are of course intrinsically linked to the US, and Korea recently raised their benchmark rate for the first time in 6 years, marking the start of a new interest rate cycle. Short-term rates in Australia look relatively stable for now, however, the next move by the Reserve Bank of Australia (RBA) is expected to be upwards – albeit probably not until 2019. China’s Shanghai Interbank Offered Rate (SHIBOR) rates have moved higher, however, this is the lesser used benchmark, with the People’s Bank of China (PBOC) 7-day repo rate being lifted by 5 bps in December following the Fed decision.
In Japan, the Quantitative Easing (QE) program remains in place, however, the Bank of Japan (BoJ) is focussing on their yield curve control rather than a fixed asset purchase volume. The stated target of 80 trillion yen per year of asset purchases has not materialized lately, with the asset purchase rate slowing quite significantly to closer to 50 trillion yen (y/y to November 2017). The BoJ, however, now owns 40% of all issued Japanese Government Bonds (JGBs) so there’s limited capacity to continue acquiring bonds at the previous rate. The end result is Japan remains a long way back in any interest rate cycle, however, recent optimism by Governor Haruhiko Kuroda has put the spotlight on the Bank of Japan’s next move.
Source: Thomson Reuters
3-month IBOR rate increases in Q4 2017
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Finance trends to watch in 2018
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JLL Asia Pacific Capital Markets Outlook 20188 9
The contrasting rate environment across the region is creating concern amongst investors around their FX exposure and consequently their returns and hedging cost. An acceleration of an interest rate cycle is likely to increase currency volatility and hedging cost in some markets. On the other hand, stable rate environments like Japan could see their currency hedging improve further as other markets’ yield curves shift higher on a relative basis. Interestingly, Australia – which has generally been an expensive market
Debt Funds and Debt InvestorsFrom another interest-rate related perspective, investors are taking a bigger look at debt strategies as returns between debt and equity continue to close. Banks continue to pull back from riskier lending practices owing to global bank sector regulation and domestic macroprudential policies. As a result, the non-bank lending sector has been growing significantly in markets like Australia, India and China to fill the void left by traditional lenders. A number of new real estate debt funds have raised capital in 2017, however, most are looking to provide mezzanine finance or last mile project finance for developers. We have yet to see too many funds providing senior debt strategies but some insurers have beefed up their efforts to provide senior loans on a direct basis.
to hedge – has seen their rate curve remain relatively stable over the past year. With upward movements in the US, the 1-year USD swap rate is now higher than the equivalent 1-year AUD swap rate – for the first time in 16 years. Other short-term rates (Bank Bill Swap Rates/USD Libor) as well as longer swaps are also starting to converge. Should this upward trend in the USD continues, there could be a notable improvement or deterioration in hedging conditions for select currency pairs in 2018.
On a global basis - the share of investors now looking actively at debt strategies has lifted quite significantly over the past few years. In fact, the share of the total investor mandates that includes debt as a strategy has doubled over the past two years – which includes Limited Partners (LPs) focussed on Europe and the US where debt fund activity is more active. In Asia Pacific, one area where there has been a high level of activity is distressed debt funds, particularly China and India. Should conditions deteriorate on the development side of things, we could expect a lot more recovery funds start to make their way into the market.
Source: Thomson Reuters, JLLSource: Prequin
Australia and USA 1-year swap 2008-2018 Investor Searches and Mandates that Include Debt Funds, Q3 2015 - Q3 2017
Asia Pacific Capital Markets Outlook 2018 11JLL10
Platform and REIT M&A With many investors now looking to improve their ability to source and execute deals in various sectors and markets, we expect more Mergers and Acquisitions (M&A) activity in 2018. Investors will be looking to shore up their expertise in target markets as well within new sectors or the development space. There is also scope for more platform consolidation where synergies may be found, as well as acquisitions undertaken with a view to providing a strong future pipeline of deals.
There is also likely to be more REIT sector M&A as well-capitalised investors look at large portfolios as a means to deploy scale. REITs in some markets like Japan have seen their unit prices fall in 2017 so their Price to Net Asset Value (P/NAV) ratios look a lot more attractive than the same period last year. Smaller single sector REITs are likely to be targeted more in 2018, particularly those with underperforming management. Those looking seriously at the Alternatives sectors are also likely to make inroads towards their operations capabilities, so opco M&A or strategic partnering could be a common theme in 2018.
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Demand for multifamily in China has been particularly strong this year, boosted by the government’s attempt to build and insentivise development of more rental housing. The Chinese housing market traditionally has been dominated by homeowners, but urbanisation trends and affordability concerns in larger cities have pushed many to look towards the rental market. These trends have already attracted a number of institutional investors, however, achieving required returns remains a challenge.
Australia is also exploring ways to develop a proper multifamily rental housing market at an institutional level. Developers will need to be creative in their product offering as domestic negative gearing tax incentives for Australian residents makes private investors very competitive on pricing. Standard apartment cap rates are relatively low in Australia, so developers will need to come up with a new rental format or work closely with the state government to help improve the economics of the sector.
The Asia Residential StoryThe rental-housing market is booming across the Asia-Pacific region, signaling a willingness among major investors to push into new real-estate sectors. Investors have piled $20.3 billion into the multifamily sector in 2017, a 61 percent increase from the same 2016 period. The surge has vaulted multifamily investment volumes over spending on the industrial sector for the first time in seven years – this sets a new record for multifamily residential in Asia Pacific.
The sector remains largely undeveloped in most markets, with Japan being the outlier in the region with a deep and liquid multifamily market. Investors, however, are seeing urbanisation and housing affordability placing increasing levels of demand on rental properties and are shifting their focus towards this segment of the market. With investors also looking at new sectors and new strategies in order to deploy capital, the timing couldn’t have been better for some of the first movers. Governments have also been supportive of the creation of an institutional rental property market, with some offering FAR concessions, tax incentives or discounted land price sales in order to boost the level of rental properties available.
Market trends to watch
Source: RCA, JLL
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Asia Pacific median age of buildings at sale (by asset class)
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Most of the increasing asset age at sale figures have been in the core established markets, with India and China median building age at sale being just 4 of 5 years old. The most “aged” market is Hong Kong with the average building age at sale being 35 years – certainly this is reflected in a lot of redevelopment/conversion plays being undertaken recently. Singapore, Japan, Australia and Korea are all clustered in a range between 20 and 25 years old. In 2013 however, Singapore, Japan and Korea all had median age at sale figures of around 13 to 15 years.
Excludes development sites and newly developed assetsIncludes office, retail, industrial, hotel and apartmentSource: JLL, RCA
Median age of buildings at sale (by country)
Excludes development deals and newly built assetsSource: JLL, RCA
Increasing focus on asset enhancementAs investors continue to move up the risk curve and look at new ways to deploy capital, there is a growing emphasis on asset enhancement/value add plays. As the Asia Pacific region matures and assets age, opportunities start to present themselves in these redevelopment strategies. This has been evident in the “median age at sale” figures which shows transactions in 2017 are typically on assets that are older at sale than any other year prior. Between 2007-2015, the median age of industrial assets sold in Asia Pacific was around 13 years. In 2017, the median age sold was 25 years. Similarly, median office buildings at sale were 24 years old in 2017, higher than any other year on record. This trend is likely to continue into 2018 as even investors are looking closer at strategies to try to manufacture core income streams as opposed to acquiring them stabilise.
Landlords will most likely start to look closer at the business model proposed by an individual coworking operator as the sector becomes increasingly competitive. On an occupancy basis, coworking tenants may have a higher downside beta than many other sectors, so landlords will want to consider the impact of Net Operating Income (NOI) volatility associated with various coworking occupiers. Perhaps landlords will look closer at what level of bank guarantees might be required to shield themselves from tenancy risk concentrated in the coworking sector, or whether or not there is a case to apply a rental premium. Furthermore, major landlords with large portfolios may also look to build up their own capability in the coworking sector in order to capture any upside benefit from coworking operations – as well as to reduce their tenants from eroding their business model of renting space.
Coworking trendsCoworking has of course been a big trend in 2017, with both large operators and smaller boutiques aggressively expanding into almost all markets around the region. The coworking/flex space model is here to stay, however, there are some concerns around the long-term viability of some operators. The service is great for corporate occupiers in that they can expand and contract quickly without taking on long-term liabilities. For many corporates, they are not seeing this flexibility; costing them a significant premium – which pulls into question the operating margin for some of these coworking spaces. The business model of course has a number of parallels to the serviced office product, which has at times been shown to be quite volatile in regards to its operational viability. It will be interesting to see how coworking operators handle a cyclical downturn, as corporate clients cut short-term liabilities and centralise remaining personnel back to their HQ. Generally, cyclical downturns are also associated with a reduction in R&D expenditure and therefore the short-term contracts for personnel and project space requirement are reduced. This would also flow through to the private individual clients of coworking operators, as freelance, IT and tech workers would experience a fall in demand for their services.
JLL Asia Pacific Capital Markets Outlook 201816 17
JLL18
The rise of alternatives One of the key growth segments around investors’ future strategies has been the inclusion of alternatives sectors. Any way you look at it, the outlook for the individual sectors all look compelling. Overarching macro trends and demographic drivers all support the need for an expansion in supply. The Asia Pacific region, in particular, looks compelling as there is an opportunity for first movers to build up their operational proficiency and take advantage of some of the sector level demand drivers.
The sectors within the Alternatives environment present a new opportunity for many investors to take advantage of long-term structural changes supporting the development of each asset class. Each market and sub-sector will mature along a different timescale, however, most remain at a relatively nascent stage. Returns look attractive at both the propco and opco level, however, getting access to product and building up scale will be the key challenge over the short-to-medium term.
Aged care The population of those aged 65 years or more will grow by over 140 million people over the next 10 years in Asia Pacific. More than the rest of the world combined.
Data centers An additional 575 million internet users in Asia Pacific over the next 10 years. Once again more than the rest of the world combined.
Education The number of international schools in Asia is expected to more than triple over the next 15 years.
Student housing A total of 109 million tertiary students in Asia Pacific (2014) and growing rapidly. 1.7 million of the students in Asia Pacific are studying abroad.
Self-storage Growth in the urban population will increase by over 400 million people in Asia Pacific over the next 10 years.
Nicholas Wilson Director, Asia Pacific Capital Markets Corporate Finance & Debt Research+65 9786 [email protected]
Stuart CrowHead of Asia Pacific Capital Markets+65 6494 [email protected]
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