The global macroeconomic landscape continues its shift away from highly accommodative monetary policy, deflation and the low-growth environment seen over the past five years, towards fiscal stimulus, reflation and a higher-growth environment. Against this backdrop, Asia Pacific’s economy is gaining momentum, benefiting from stronger global growth as well as more aggressive fiscal stimulus packages. In addition, structural trends, such as demographic and technological shifts continue to influence growth patterns and investment strategies in the region. Morgan Stanley Real Estate Investing (MSREI) believes these factors continue to create a very favorable environment for real estate investing across Asia.
Global GDP growth is expected to accelerate to 3.6 percent in 2017 and 3.8% in 2018, from 3.0 percent in 2016, led by private sector demand and increased business investment. The Asia Pacific region is expected to grow by 5.7 percent in 2017 and 5.6 percent in 2018, 2.5 times the rate of growth expected in the United States and Europe1. In Japan, Morgan Stanley Research has upgraded GDP growth from 1.3 percent to 1.6 percent (2017) and 0.9 percent to 1.1 percent (2018) primarily because of stronger export growth (which reached 6.1 percent in 1Q 20172 emanating from a weaker yen. Household consumption remains modest because wage growth has yet to meaningfully accelerate. Morgan Stanley Research expects the Bank of Japan (BoJ) to maintain their 0% yield target on the 10-year government bond in the near term, which should continue to support the economy. The potential exists, however, for rate hikes starting in 2018. South Korea is also benefiting from the recovery in global trade, with exports rising at an annualized pace of 8.7 percent in the first quarter, contributing to a strong first quarter, GDP growth of 2.9 percent.3 Morgan Stanley Research has upgraded GDP growth from 2.4 percent to 2.8 percent (2017) and 2.3 percent to 2.6 percent (2018), despite lingering concerns over North Korea.4 Under the newly appointed President, Moon Jae-in, Morgan Stanley Research anticipates that South Korea will adopt a more proactive approach to foreign policy which could lead to a more conciliatory tone toward North Korea and improved relations with China, potentially mitigating some of the geopolitical concerns5.
In Australia, first quarter GDP growth slowed to 1.7 percent year-over-year and further moderation is likely due to the slowdown in the housing market and personal consumption.6 Rising inflation and housing risks likely will allow the Reserve Bank of Australia to maintain the current policy rate at 1.5 percent. China’s growth surprised on the upside
Forecasted GDP Growth7
in the first and second quarters, accelerating to 6.9 percent year-over-year, ahead of the government’s annual target of 6.5 percent, suggesting a hard landing remains a low probability8. Further moderation is expected throughout the remainder of the year, however, as a calibrated monetary policy tightening slows credit growth and fixed investment. With its high export orientation, Singapore is well positioned to benefit from stronger global growth, GDP growth has been upgraded from 1.5 percent to 2.7 percent (2017) and 1.8 percent to 2.9 percent (2018).9 Hong Kong has also benefited from the global synchronous recovery, with year-over-year GDP growth rising to 4.3 percent in the first quarter.10 Given the expectation of only a moderate slowdown in China, growth in the Asia Pacific region should remain strong over the next two years.
Structural trends continue to play an increasingly important role in economic growth patterns and investment strategies across the region. Demographic trends, including aging populations, the rise of millennials, the growing middle class and urbanization are contributing to different living, spending and working preferences which are creating attractive opportunities in the retail and office sectors. Asia has the highest share of millennials (33 percent) versus the Americas (31 percent) and Europe (25 percent) and this has contributed to continued urbanization particularly in markets such as China and India.11 Driven by currency depreciation and surging demand from China, international tourism has rapidly increased, particularly in Japan and South Korea. This has created attractive opportunities in the retail and hotel
Exports Picking Up
Share of Population Living in Urban Setting
Number of Inbound Guests
sectors. Lastly, e-commerce penetration and growth rates are higher in several countries in Asia (13 percent in Korea and 17% in China) than in the United States (10 percent)13, creating opportunities in the logistics sector.
Real Estate Implications
The real estate environment in Asia Pacific continues to remain attractive, with steady fundamentals and cap rate compression evident in most major markets, leading to robust regional returns. Across the region’s major office markets, year-over-year rent growth averaged 3.3 percent in first quarter 2017, down from 3.6 percent in fourth quarter 2016 and 4.3 percent from year-ago levels14, 15. Melbourne and Sydney witnessed particularly strong rent growth of 7 percent and 14 percent, respectively. Office rent levels remain below prior peak levels, allowing additional room for rent growth. In Tokyo, for example, office rents are 30 percent below the prior peak, Singapore rents are 55% below peak, while Seoul rents are at the prior peak.16 With regional economic growth expected to remain stronger than European and the United States growth, and new supply expected to remain below the historical average, office rent growth for primary markets is expected to average 2.3 percent over the next five years compared with 2.2 percent in the United States and 1.3 percent in Europe.17 Office cap rates across the region compressed on average by 20 basis points, contributing to price growth of 4 percent over the past year through first quarter 2017.18 This price growth exceeded major markets in the US and Europe (2 percent and -4 percent respectively), which is not surprising given the real estate cycle in Asia generally has lagged the U.S. and Europe (Asia’s office real estate values are still 5 percent below their prior peak, compared with 15 percent above peak for the United States. and 6 percent above for Europe).19
Strong labor markets are contributing to higher income growth, helping boost personal consumption levels in the region. This, combined with the rapid rise in tourism and continued urbanization, is benefiting the retail sector, as well as the logistics sector, which continues its transition from an alternative asset class to a core, institutional asset
Office Rents Still Below Peak Levels
1Q 2017 Office Rents as a Percent of Prior Cycle Peak
Asia Transaction Volume by Capital Source
Office, Industrial, Retail and Apartment Transaction Volume
Prime Office Yield Spreads to Risk Free Rate
Prime office yield over 10-year government bond yield
class. Logistics cap rates have compressed at a faster rate than traditional asset classes (e.g., 250 basis points over the past=five years versus 150 basis points for the office sector) and may continue to compress further over the coming years21. Lastly, continued urbanization and affordable housing challenges in the region are continuing to drive investor interest in the for-lease residential sector, particularly in markets such as South Korea, China and Australia, in addition to Japan where the sector has been generating stable returns of 6.9 percent per year since 201022.
In general, interest rates and borrowing costs remain very low, providing attractive spreads for investors and encouraging strong market liquidity. Global investors are increasingly=attracted to the region with global capital flows increasing fourfold since 2009 and now accounting for 25 percent of the region’s investment activity, which remains robust at US$130 billion per year.23 Global capital inflows largely have targeted primary markets in the region, where capital values have increased by 72 percent since the trough versus 26 percent for secondary markets.24 As the Asia-Pacific region grows and develops, it is increasingly a staple in global real estate portfolios. Whereas five to ten years ago, investors— particularly foreign investors—would only venture to the region for opportunistic returns or development plays, the opportunity set today has grown to include more cash-flow or core-oriented strategies. The invested stock over the last ten years has grown by a multiple of three, to more than $5 trillion.25 Vast amounts of capital formation in the region have made the top eight markets in Asia as active and liquid as the top eight markets in Europe or the United States.26
The Path Ahead
MSREI expects the investing environment in Asia Pacific will remain attractive over the next several years driven by strong regional growth and a favorable capital markets environment. MSREI believes asynchronous growth drivers, real estate markets at different cyclical points and shifting structural trends may continue to provide attractive risk-adjusted returns across the major sectors and countries within the Asia Pacific region.