Market Outlook
2017 Mid-Year Commercial Real Estate Outlook for Asia Pacific
 
 

Market Outlook

2017 Mid-Year Commercial Real Estate Outlook for Asia Pacific

 

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.

Macroeconomic Environment

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 

 

DISPLAY 1
Forecasted GDP Growth7

By Country

 
 
 
 

Source: Morgan Stanley Research, data as of June 2017

 

 

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

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

 

DISPLAY 2
Exports Picking Up

By Country

 
 
 
 

Source: Oxford Economics, data as of June 2017

 

 

DISPLAY 3
Urbanization Continues12

Share of Population Living in Urban Setting

 
 
 
 

Source: UN Population Division, World Population Prospects, 2015 Revision, MSREI Strategy, data as of October 2016

 

 

DISPLAY 4
Number of Inbound Guests

Annual

 
 
 
 

Source: Japan National Tourist Organization, Korea Tourism Organization, Tourism Australia, MSREI Strategy, data as of January 2017

 

 

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

 

 

DISPLAY 5
Market Cycle20

Office Sector

 
 
 
 

 

DISPLAY 6
Office Rents Still Below Peak Levels
1Q 2017 Office Rents as a Percent of Prior Cycle Peak

 
 
 
 

Source: PMA, CoStar, MSREI Strategy, data as of July 2017

 

 

DISPLAY 7
Asia Transaction Volume by Capital Source

Office, Industrial, Retail and Apartment Transaction Volume

 
 
 
 

Source: Real Capital Analytics, MSREI Strategy, data as of June 2017

 

 

DISPLAY 8
Prime Office Yield Spreads to Risk Free Rate

Prime office yield over 10-year government bond yield

 
 
 
 

Source: PMA, NCREIF, Bloomberg, MSREI Strategy, data as of June 2017

 

 

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.

Capital Markets

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.

 

1 Morgan Stanley Research, June 2017

2 Japan Cabinet Office, Moody’s Analytics, as of July 2017

3 The Bank of Korea, Moody’s Analytics, as of July 2017

4 Morgan Stanley Research, as of June 2017

5 Source: Morgan Stanley Research

6 Australian Bureau of Statistics, Moody’s Analytics, as of July 2017

7 The opinions expressed herein are those of the MSREI team as of the date of the presentation and are subject to change at any time due to changes in market or economic conditions. Readers should be aware that forward-looking statements, and statements regarding MSREI’s assessment of the market are by their nature inherently uncertain insofar as actual realized returns or other projected results can change quickly based on, among other things, unexpected market movements, changes in interest rates, legislative or regulatory developments, acts of God, and other developments.

8 Morgan Stanley Research July 2017

9 Morgan Stanley Research, as of June 2017

10 Hong Kong Census and Statistics Department, Moody’s Analytics, asof July 2017

11 UN Population Division, World Population Prospects, as of December 2016

12 The opinions expressed herein are those of the MSREI team as of the dateof the presentation and are subject to change at any time due to changes in market or economic conditions. Readers should be aware that forwardlooking statements, and statements regarding MSREI’s assessment of the market are by their nature inherently uncertain insofar as actual realized returns or other projected results can change quickly based on, among other things, unexpected market movements, changes in interest rates, legislative or regulatory developments, acts of God, and other developments.

13 Morgan Stanley Research, May 31, 2017

14 Major markets include Tokyo, Sydney, Melbourne, Seoul, Hong Kong and Singapore

15 Property Markets Analysis, as of July 2017

16 Source: Property Market Analysis, as of July 2017

17 Major markets only. Property Market Analysis, Costar, as of July 2017

18 Ibid.

19 Property Market Analysis, CoStar; peak defined as the individual market’s highest point over 2007-2008, as of July 2017

20 The market cycle positioning framework is the outcome of the use of an internal tool being developed by MSREI based on a consistent set of real estate metrics available on a country-by country basis. It is aimed to help identify drivers of market performance, market positioning relative to prior cyclical peaks and troughs, turning points and implications for investing strategies. It is updated on a quarterly basis in line with the release of macroeconomic and commercial real estate data. The tool uses a mix of real estate fundamentals and capital markets metrics that are generally available in applicable countries (including rent, occupancy, cap rates and spreads and liquidity and values metrics). The majority of the metrics are based on “actuals”, versus relying on forecast data. Note that other outcomes could result if different inputs or assumptions are made. The market cycle positioning constitutes a “forward looking statement.” Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking statement.

21 Average yield compression in Melbourne, Tokyo and Seoul (2012Q4-2016Q4). Source: CBRE, PMA

22 Source: IPD, July 2017

23 Real Capital Analytics, as of July 2017

24 Property Market Analysis, as of July 2017

25 DTZ Money Into Property, as of 2015

26 Real Capital Analytics, MSREI Strategy, as of July 2017

IMPORTANT INFORMATION

These materials are being provided for informational purposes only and are not an offer, or a solicitation of an offer, to buy or sell any security or strategy. The information contained herein is highly confidential. By accepting  these materials, you agree that such materials (including any data, analysis, conclusions or other information contained herein and all oral information, if any, provided by Morgan Stanley Real Estate Investing (“MSREI”) in connection herewith) may not be photocopied, reproduced or otherwise shared or distributed to any other persons, in whole or in part, without the prior consent of MSREI.

Past performance is not indicative of future results. The views and opinions expressed in the document are speculative in nature, subject to change, may  not come to pass, and are not intended to predict the future of any investment.

All investing involves risks, including a loss of principal. The risks associated with real estate investing can include fluctuations in the value of underlying properties; defaults by borrowers or tenants; market saturation; changes in general and local economic conditions; decreases in market rates for rents; increases in competition, property taxes, capital expenditures, or operating expenses; and other economic, political or regulatory occurrences affecting the real estate industry.

The information contained herein refers to research, but does not constitute an equity research report and is not from Morgan Stanley Equity Research. Unless otherwise indicated, the views expressed are those of the research and strategy team of MSREI and may differ from those of Morgan Stanley Equity Research and other Morgan Stanley affiliates (including others within MSREI). These views may also differ from investment strategies implemented by MSREI now or in the future. The information (including facts, opinions, estimates or projections) contained herein is based on financial, economic, market and other conditions prevailing as of the date hereof. As such, it remains subject to change at any time. By providing such information, MSREI assumes no obligation to provide any update or supplement to such information following the date hereof. Although reasonable care has been taken to ensure that the information (including facts, opinions, estimates or projections) contained herein is accurate, complete and fair, no warranty, express or implied, is made as to the accuracy, completeness or fairness of such information. Certain economic and market information contained herein may have been obtained from third parties sources. While MSREI believes that such sources are reliable, neither MSREI nor any other Morgan Stanley affiliate has independently verified such information or assumes any responsibility or liability for the accuracy, completeness or fairness of such information or any omission of information.

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