Excess liquidity is shaping investment flows in asian real estate

01 Nov 2017 Long Read

Emerging Trends in Real Estate Asia Pacific 2018: Survey from ULI, PwC Names Sydney and Melbourne as Top Real Estate Investment Markets in APAC.

Of all the influences shaping investment flows in Asian real estate it is excess liquidity that is having the biggest effect, according to Emerging Trends in Real Estate Asia Pacific 2018, a real estate forecast jointly published by the Urban Land Institute (ULI) and PwC. Local sovereign and institutional funds bearing stockpiles of accumulated cash are buying property, both regionally and globally, creating competition for assets that is changing investment patterns in fundamental and often unexpected ways.

Changes include the realignment of traditional risk/return classifications, changing expectations over returns, the convergence of core and opportunistic investors on the value-add space, and investor migration into alternative asset classes and new markets that in the past were of little interest, including data centers, affordable housing projects, build-to-rent (or co-living) facilities and student and senior housing.

Other areas of focus include a boom in co-working facilities, concerns about how the Asian retail sector will weather e-commerce challenges, an ongoing exodus of money from Asian institutions into international markets.

This year’s investment prospect rankings reflect the growing divergence between investment strategies as buyers pursue either growth- or yield-driven approaches. Cities that are the biggest gainers in this year’s survey are those where investors seek to maximize returns via rental growth (Sydney and Melbourne), those that look for returns that are safe and low, but still higher than yields on sovereign bonds (Tokyo), or those that tap long-term secular growth in emerging markets (Vietnam). In addition, there was a resurgence in investor sentiment toward Singapore, which appears to have found a market bottom in both the office and residential sectors. In terms of prospects for individual property types, logistics assets take pole position this year, with investors showing renewed confidence in a story of long-term structural undersupply.

“The survey results for this year’s Emerging Trends in Real Estate Asia Pacific report show that Sydney and Melbourne appear at the top of this year’s rankings,” said Dr Seek Ngee Huat, ULI Asia Pacific Chairman and Chairman, Global Logistic Properties. “Both cities combine the appeal of a stable investment environment with a combination of relatively good current yields and the prospect of strong rental growth going forward.”

“The unprecedented growth in capital outflows from Asian markets in 2017 almost double the outflow witnessed during the same period in 2016, with US$ 45.2 billion in outbound capital directed into global property assets,” said KK So, Asia Pacific Real Estate Tax Leader, PwC. “While the extent of the impact of the progressive tightening of Chinese capital controls in August 20017 remains unclear, the consensus is that overall outflows may not see a meaningful decline given firstly that sovereign and state investors will probably be unaffected and secondly that there is already a substantial body of Chinese-owned capital held outside mainland China that is not subject to the rules.”

Emerging Trends, which is being released at a series of events across Asia over the next several weeks, provides an outlook on Asia Pacific real estate investment and development trends, real estate finance and capital markets, and trends by property sector and metropolitan area. It is based on the opinions of more than 600 real estate professionals, including investors, developers, property company representatives, lenders, brokers and consultants.

Top trends in the Indian real estate market:

Retail assets are now a popular play, with a number of platform or portfolio deals either already completed or in the works. The average appreciation in rentals has been anything between 8 to 10 per cent per annum, higher as compared to office space, growing 5 to 7 per cent.
The residential space continues to suffer including due to government reforms that include demonetization campaign, GST and increased regulation of real estate development practices.
High-end residential oversupply is another ongoing problem, leading most foreign investors to shy away from the sector altogether.
Most international investors in India prefer commercial property, with cap rates currently averaging in the range of 8.5 to 8.75 per cent.

While the supply of affordable homes increased in last 3 quarters, investors remain cautious about affordable housing as an asset class. The key reason being availability of land at affordable price and not so far away from the cities, no single window approvals, and time overruns.

Discussing the impact of the recent tax reforms in India, Abhishek Goenka, Leader-Real Estate Tax, PwC India, said, “The initial effects of demonetisation and GST reforms may have led to liquidity issues for the real estate sector. To an extent, the impact seems to be reflected in the investment and development prospects of the Indian cities which have moved out from the premier positions of last year. However, investment in India, specifically affordable housing, continues to be strategic in nature and offers massive scale of opportunity, a factor that makes it especially popular for funds deploying large amounts of capital.”

Mumbai’s real estate market has benefited from recent strength of India’s capital market. Absorption has therefore been strong, driven also by demand in co-working, manufacturing and services companies. Although steadily declining, office vacancy rate (approximately 17 per cent) continues to very high and the city continues to lag behind in term of Grade-A stock. In the Indian logistics sector, US$ 2.5 billion was invested in last six months. Domestic warehousing stock in India currently equivalent to 1.5 percent of what is available in China and cap rates in the area of 9 to 10 percent.

“With most high-quality pre-existing assets already accounted for, international funds are turning increasingly to build-to-core projects, affordable housing and other opportunistic investments. There is trend which is picking up at a pace never seen before in unconventional assets classes, specifically, co-working space. Recent investment in modern logistics assets, driven by the increasing demand from e-commerce and recent tax reforms, gives something like a gold rush feel to it,” said Bhairav Dalal, Partner-Real Estate Tax, PwC India.

The top five markets for investment and development in 2018:

Sydney (first in investment, first in development) – Sydney’s appeal lies in the fact that it is a major city in a mature economy combining a reasonably deep and liquid market of core assets with a better-than-average yield.
Melbourne (second in investment, third in development) – Melbourne’s appeal is similar to Sydney’s – a mature market, high-quality core assets, and relatively good yields by Asian standards.
Singapore (third in investment, sixth in development) – After two years of declining rents caused by a sluggish economy and a glut of supply, the promise of a market bottom in Singapore’s office market has caused its ranking to soar from next-to-market bottom last year to third in this year’s table.
Shanghai (fourth in investment, fourth in development) – Shanghai is seeing an increase in transactions driven partly by surging demand from domestic buyers who are unable to export capital due to a regulatory crackdown, and partly by foreign core funds flush with new capital they need to deploy.
Ho Chi Minh City (fifth in investment, second in development) – With an economic trajectory thought to be similar to an early-day China, Vietnam is seeing large regional developers and an increasing number of private equity funds betting it will offer up a repeat of the Mainland China experience in terms of property price inflation.

Other top trends from the Emerging Trends survey include:

A stronger showing by Tokyo. Declining prospects for rental growth accounted for last year’s decline in the rankings for what had previously been a top performer. While these concerns continue, Japan has become a destination for yield investors due to the healthy spread between current yields and the country’s super-low sovereign bond prices.

Leading buy/hold/sell ratings for the various asset classes are as follows:

Office – buy Ho Chi Minh City, sell Taipei.
Residential – buy Ho Chi Minh City, sell Seoul.
Retail – buy Ho Chi Minh City, sell Taipei.
Industrial/distribution – buy Shenzhen, sell Taipei.

Emerging Trend 2018 – Key highlights of the report

Chapter 1

Global and local capital continues to pour into real estate markets
Competition to buy assets in major Asian markets
Increased appetite for risk and a growing exodus into various alternative asset classes
Past – Very macro-led strategy, Now – Harder to find opportunities which generate 20% returns
Paradox – High liquidity creates less incentive for property owners to sell.
Major markets will remain softer going forward in major Asian markets
Asia-wide theme of investment flows migrating to less-traveled areas
Signals of bottoming out of Singapore market.
Commercial sales volume lower in core market i.e. Australia and Tokyo.
China saw healthy 11 per cent increase in commercial sales volume and sales soared in HK.
Core investors opting to migrate up the risk curve in search of yield, via development projects.
For many, India is the only country to provide long term sustainable 3 to 5 per cent rental growth profile over a long period.
Investors identified India (among others) as a destination, where Data Centers are projected to provide 13 to 15 per cent IRR.
While the supply of affordable homes increased in last three quarters, Investors remain cautious about affordable housing as an asset class. The key reason being availability of land at affordable price and not so far away from the cities, no single window approvals, and time overruns etc.
The coworking juggernaut changing at a speed, not seen before.

Ranking

Sentiment in Bangalore has declined relative to last year
Survey ranks Ho Chi Minh City among the highest in terms of rental and capital value growth, although size of opportunity tend to be relatively small.
India continues to attract strong flows of institutional and sovereign wealth-type capital.
Investment in India continues to be strategic in nature and offers massive scale of opportunity, a factor that makes it especially popular for funds deploying large amounts of capital.
Most international investors in India prefer commercial property, with cap rates currently averaging in the range of 8.5 to 8.75 per cent.
With most high-quality preexisting assets already accounted for, international funds are turning increasingly to build-to-core projects.
India logistics sector has recently been the target of an investment boom, largely due to tax reforms.
Retail assets are now a popular play, with a number of platform or portfolio deals either already completed or in the works. The average appreciation in rentals has been anything between 8 to 10 per cent per annum, higher as compared to office space, growing 5 to 7 per cent.
The residential space continues to suffer including due to government reforms that include demonetisation campaign, GST and increased regulation of real estate development practices.
High-end residential oversupply is another ongoing problem, leading most foreign investors to shy away from the sector altogether.
Investors still bullish on retail and remain sanguine about the ability of conventional retail to fend off online challengers.

Chapter 2

India remains the real bright spot for new REIT markets. There now seems a real prospect that Indian maiden REIT will be listed by the end of the first quarter of 2018.
Regulatory logjam is not a problem, but rather the question of how to price real estate assets at a level that will appeal to both sponsors and REIT shareholders.
300 to 400 basis points above the ten-year government bond (6.6-6.7 per cent) may be attractive, however, question is whether the above returns are enough, when price in the private market is equally or more attractive.
Currently, direct investment in residential side is looking very stark and in absence of quality alternatives, it’s likely that people could consider investing in office space through REIT route, even if it’s expensive by industry norms.

Chapter 3

Leading Buy / Sell ratings

Action	Office	Residential	Retail	Industrial/Distribution
Buy	HoChi Minh City	HoChi Minh City	HoChi Minh City	Shenzhen
Sell	Taipei	Seoul	Taipei	Taipei

Japan – Stronger show by Tokyo. Japan is sought after destination (notwithstanding the concerns on rental growth) for yield investors due to healthy spread between current cap rates and country’s super-low sovereign bond prices.

Singapore – The resurgence mainly as a result of investors betting the markets have bottomed after several years of weakness.

Top investment / development destination ranking

City	InvestmentRanking	DevelopmentRanking
Sydney	1	1
Melbourne	2	3
Singapore	3	6
Shanghai	4	4
HoChi Minh City	5	2
Shenzhen	6	5
Tokyo	7	13
Guangzhou	8	10
Auckland	9	7
Osaka	10	15
Beijing	11	17
Mumbai	12	8
HongKong	13	14
Jakarta	14	12
Bangalore	15	16
Bangkok	16	16
China’ssecond-tier cities	17	17
Manila	18	19
Seoul	19	22
NewDelhi	20	18
KualaLumpur	21	21
Taipei	22	20

Mumbai –

Benefited from recent strength of India’a capital market.
Absorption has therefore been strong, driven also by demand in coworking, manufacturing and services companies
Although steadily declining, office vacancy rate ~ 17 per cent continues to very high
Mumbai continues to lag behind in term of Grade-A stock
Retail sector drawing increasing interest from foreign investors.
However, given the commute time to visit malls, leading to a belief that e-commerce has to pick up. This means logistics as a sector – and especially with the tax reforms currently going on in India – could be more interesting.

Bangalore

Operators of BPO facilities in Bengaluru have reported rental growth of around 8 to 9 per cent annually, together with healthy new tenant demand.
BPO story may now be tapering off as the emergence of automation and AI technologies create a long-term drag on demand for back-office and customer service functions globally.

New Delhi

New-Delhi remains relatively unpopular compared to other Indian cities, mainly due to emphasis on residential development, which has recently seen downtrend. While this has created opportunity to supply bridging finance, not many foreigners have persued this option.
Delhi residential space continues to suffer due to oversupply, long delays and reputational issues of some developers.
Delhi to benefit the most the moment residential markets turns.
Overall uptake of office space has been slow, leaving vacancies at an elevated 30 per cent. However, rentals have been holding up.

Feels like gold-rush in Indian logistics sector – US$ 2.5 billion invested in last 6 months. Domestic warehousing stock in India currently equivalent to 1.5 per cent of what is available in China and cap rates in the area of 9 to 10 per cent.
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