Asia Pacific - Australia the first port of call
- Australia should benefit from economic rebalancing, with Sydney, Melbourne and Brisbane best-placed to capture upside.
- Recent RBA easing has widened the bond/property yield gap, despite strong investor demand.
- Singapore (CBD), Japan and Hong Kong are experiencing weak economic growth and could struggle to generate meaningful returns in the short-term.
A focus on the top 25 Global Cities, as defined in previous AXA IM – Real Assets research, includes many within the Asia Pacific region.
Included in the top 25 are Australian cities Sydney and Melbourne, which are liquid markets, with respected rule of law and long-term growth in office employment.1 The Australian economy is currently undergoing a transition away from a large resources and construction focus, to a more services-based economy. While Australia has made good progress to date, there is still further to go – construction employment still outweighs that of professional services.2 In Perth, the commodities hangover is still evident. As the commodities super-cycle played out, Perth and resources-rich Western Australia (WA) rode the boom. But with commodities prices and investment in WA well past their peaks, vacancy rates are high and rents are still falling.3
The Reserve Bank of Australia (RBA) has been active in its stewardship of the Australian economy, which has experienced 25 years of consecutive GDP growth. It recently began a series of interest rate cuts – the first in May 2016 after a year of flat rates. This led to currency weakness, along with lower government bond yields. The falling Australian dollar and positive market fundamentals have meant that investors have been pursuing Australian assets. Despite strong demand leading to lower yields, which are now below long-term averages in each of Australia’s main cities, the gap between prime office and government bond yields has widened.
In Sydney, vacancy rates are at their lowest in several years despite the addition of a new office submarket at Barangaroo, West of the CBD. This development has resulted in vacancy at the top-end of the quality spectrum rising.4 Among lower Grade A and B stock, vacancy rates are at historic lows. This is partially due to the construction of Sydney Metro, as office stock is withdrawn to make way for new stations. The new Metro lines connect the North-West and the South-West to the CBD. In addition, a light rail link connecting South-East Sydney to the CBD is likely to complete in 2018.
Over the next three years, office withdrawals could reach almost 600,000 sq m,5 much of which focuses on older offices in the Sydney CBD. The net effects of these changes are displaced tenants combining with strong underlying occupier demand and a shortage of space. As a result, rents have been increasing at double-digit rates across Sydney.6 This is particularly evident in Grade A and B stock, where headline rents have been increasing fastest. Incentives, which had increased in recent years, have been falling fast, and are likely to fall further.7 As a result of these strong market dynamics, Sydney offices look to offer significant upside, particularly Grade A and B buildings, where taking on asset and tenant risk appears acceptable. Melbourne is experiencing similar market dynamics, albeit not to the same magnitude as Sydney. The most recent development cycle in Melbourne appears to be ending and vacancy rates are falling. Occupier demand has remained strong and both headline and net effective rents are growing.
Yield spreads are particularly elevated in Brisbane, potentially compensating for the higher risk that this traditionally commodities-orientated market carries. Targeting premium and Grade A stock in the Queensland city could be a viable option for investors with increased risk appetite. The development cycle in Brisbane appears to be ending and vacancy is likely to peak in the near future8 but ahead of that, rent falls have already begun to stabilise.These shifting dynamics should mean that higher income and a recovery in valuations in the future compensate investors willing to take on risk.
Strong growth in both domestic and international tourist visits in Australia9 has resulted in increased demand for hotel rooms. The global growth in tourist numbers from the Asia Pacific region is a well-known secular change but Australia (and Japan) is wellplaced, particularly geographically, to benefit. In 2015, Chinese tourists accounted for 13% of all visitors to Australia, the second largest of any country, growing an average of 12% per annum over the past ten years.10
Along with other sectors, transaction volumes across Australian hotels increased in 2015, aided by the weakening of the Australian Dollar. Despite growing investor appetite, initial hotel yields remained above 2007 levels at the end of 2015, with the exception of premium assets, such as the Westin Hotel in Sydney, which traded at 4.5%, according to CBRE. Targeting investments in locations with the strongest RevPAR growth, such as Sydney, Melbourne, the Gold Coast and Cairns, should ensure the strongest returns.
Outside Australia, many investors remain focused on Japan, despite the weak economy and diminishing faith in Abenomics. The Bank of Japan (BoJ) has reviewed and changed its QE policies,11 calling into question their effectiveness. Despite this, taking advantage of low borrowing costs and aided by economic stimulus, returns in Japan have been strong.12 An expectation that this favourable environment will continue is central to the case for continuing to buy Japanese real estate assets. But an increase in borrowing costs (the five-year SWAP) has had a direct impact upon real estate valuations in the past and is likely to remain a threat to valuations in the future. While rising debt costs have impacted valuations, the potential for increased borrowing costs has had the same effect, as was the case in May-June 2016. During this period, the SWAP rate fell but despite the BoJ maintaining its monetary policy, the value of the Yen increased, hitting both equity markets and real estate valuations. Real estate valuations have tended to unwind shortterm movements but a longer-term increase in debt costs represents a risk, given that yields have moved disproportionately to a rise in the SWAP rate.
Japan’s economic performance remains weak and jobs growth is flat. Targeting Japanese offices does not appear to be an attractive strategy at present. But should borrowing costs increase and assets re-price, equity investors could take advantage of distressed sales from leveraged investors.
Singapore is experiencing its own slowdown, with GDP growth set to fall to its lowest level in decades, due to its exposure to the slowing global economy.13 The timing of a large development cycle has coincided with weak demand, leading to rising vacancy and falling rents, particularly in the CBD. Large new developments have been slow to pre-let, hitting rents, which are expected to fall around 15% in the CBD during 2016.14 Owners of CBD assets have been reluctant (and by no means forced) sellers at current prices and buyers have been unwilling to move their own valuations, leading to protracted sales processes.
However, Singapore is not all bad news. Occupier demand in decentralised areas has been stronger than that in the CBD and is more diverse. Assets tend to be smaller and more competitively priced than the trophy assets in the CBD. Higher up-front yields offer some compensation for the fact that the CBD remains favoured by many investors, despite the difficulty in completing transactions.
Hong Kong is in a similar situation to Singapore but is arguably more exposed to falling valuations, given the strong returns experienced in recent years. Hong Kong is frequently listed as the most expensive office market in the world, significantly ahead of next-placed Tokyo. A potential spike in development from 2020 onwards, as new offices are constructed at CBD2 and on the Chinese mainland could hit both valuations and rents. Against this backdrop, targeting Hong Kong now appears to be a high-risk strategy, particularly if developments complete and result in lower rents.
A place in the preferred list of 25 Global Cities does not guarantee immediately stronger returns across the board. Within the Asia Pacific region, Australian cities stand out, with several positive drivers, particularly in Sydney. For those willing to take on more risk, Brisbane appears to be a market in the early stages of recovery.
Potential re-pricing in Japan, fuelled by rising debt costs leading to weaker investor demand, could make Tokyo more appealing. Decentralised Singapore appears more resilient than the core CBD but fundamentals generally are weakening and pricing is yet to adjust. As new supply is absorbed, the window for investment in the CBD may not be open long. The potentially large supply pipeline in Hong Kong represents a risk, and clarity on this is needed before committing to the region. Put simply, Asia Pacific comprises several investment opportunities over the next 3-5 years, despite short-term headwinds in some markets.
1 JLL Global Real Estate Transparency Index 2016
2 Australian Bureau of Statistics data as at September 2016
3 PMA data as at September 2016
4 Premium vacancy in Sydney CBD increased from 5.2% in July 2015 to 11.3% in July 2016: Property Council of Australia data as at August 2016
5 Knight Frank data as at September 2016
6 PMA data and AXA IM – Real Assets forecasts as at September 2016
7 AXA IM – Real Assets forecasts as at September 2016
8 Property Council of Australia data as at August 2016
9 45% increase in visitor numbers between 2006 and June 2016: Tourism Research Australia as at September 2016
10 Tourism Research Australia data as at July 2016
11 The Bank of Japan reviewed its QE policies, announcing in September that it would target the yield curve in future, rather than focus entirely on asset purchases
12 PMA figures for 2015 and 2016 YTD
13 PMA forecasts as at September 2016 – low growth scenario
14 PMA forecasts as at September 2016
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