Real estate markets in Asia Pacific are moved by global economic headwinds as well as local developments. Christine Senior reports

Despite Asia's much vaunted economic resilience, it still feels the cold winds of events elsewhere. The US slowdown and the continuing debt crisis in Europe inevitably bring pressure to bear around the other side of the world. Some markets are more vulnerable, particularly those that owe their success to the finance industry - Hong Kong, Singapore, Sydney are in the front line - but amid the uncertainty there are bright spots.

In Australia, international investors have been lapping up opportunities in the real estate market, as local investors increasingly find themselves priced out of the market. DTZ reports rising international investment inflows into the Australian office market, from 36% of all investment in the second quarter to 41% in Q3, the fourth consecutive quarter of rising overseas investment. The bulk of foreign investment is from Asia, putting Asian investment at 90% of the total in Q3, the rest being from the US.

High interest rates have been deterring local investors, according to Nick Axford, head of research, Asia Pacific at CBRE. "In some cases, like the Sydney office market, it's at the bottom of the cycle and poised for a recovery in the next few years, but local investors are not being particularly aggressive in the market, and yields are quite high. That made it at one level very attractive for international investors."

But, says Axford, international investors themselves face tough conditions in financing and the strong currency. Financing through local debt is expensive and loans are not widely available, while the strength of the Australian dollar carries significant exchange rate risk.

"We have seen strong international investment, a lot from around Asia, in many cases funnelled through Singapore Real estate investment trusts (REITs), but also some European and other international funds coming in, mainly buying with equity rather than highly leveraged," says Axford. "Fundamentally they believe it's the right time in the cycle and you get relatively high yields in Australia at the moment compared to other markets in Asia. And it's seen as something of a China resource play which makes it quite attractive."

Outside the established markets of Sydney and Melbourne, other cities, particularly Perth and Brisbane, which have profited directly from the strong demand for commodities, have benefited from a broadening of interest in real estate.

"The Australian market is now a bigger investment market because the cities of Brisbane and Perth have been included in the mix," says Megan Walters, head of research, capital markets at Jones Lang Lasalle in Singapore. "Whereas five years ago international investors only bought Melbourne and Sydney, now there is a broader base of stock to look at [in terms of] investment grade locations."

But Zubaer Mahboob¸ forecasting and strategy research at DTZ, disagrees, maintaining that for foreign investors it is still the Sydney central business district (CBD) where the main interest lies. "Outside the Sydney CBD, you wouldn't be able to say the market is of much interest, particularly to foreigners," says Mahboob. "Foreign investment is going up. We have seen this trend for the last three of four quarters but at the same time overall volumes in Australia are down."

Indeed, the wider picture shows that investment activity in the Australian real estate market is in decline. According to research from DTZ, the value of transactions dipped in the third quarter to $2.5bn (€1.78bn), from $3.5bn in the previous quarter (a drop of 27%), and transactions in Q3 are only around half of the level they were at the same time last year.

Looking ahead, DTZ is rather negative on prospects for the Australian property market, given the world economic outlook. "In light of what is happening in Europe and the US, and how that could potentially impact the Chinese economy, and given Australia's dependence on the Chinese economy, the whole outlook for Australia has gone quite gloomy," says Mahboob. "The retail sector may be in recession already, and purely the strength of the commodities sector is serving to mask some of these weaknesses in the economy."

Sydney, reliant as it is on international financial corporations to underpin its office market, looks particularly vulnerable to a downturn.

Japan: office sector looks vulnerable
Developments in Japan's real estate sector have been dominated by the reconstruction planning in the wake of the earthquake and tsunami earlier this year. Tragic though the effects were (and still are for a large swathe of the population in the affected areas), there are hopes that a rebuilding programme can have some positive consequences, by potentially giving the economy a long needed kickstart.

One of the sectors that looks set to see increased activity is industrial. "Quite a few of the supply chain and logistics facilities that organisations had across Japan were quite significantly affected," says Axford.

"There is a belief that many Japanese companies will either have to establish new supply chain linkages or be looking to review the logistics infrastructure they have across the country. That could stimulate demand and change in the logistics sector."

Already the industrial sector is attracting foreign investment. Global Logistics Properties, alongside partners such as the Canada Pension Plan and Goodman Group, has invested in both completed assets and development opportunities in the Japanese logistics sector.

But for the Japanese real estate market, international investors make up a relatively small proportion of total investment. While it is a large market, access is relatively difficult for outsiders. Not surprisingly, the earthquake adversely affected investor sentiment in the spring, but things are changing, says Axford.

"Immediately following the earthquake, many international investors looking at the Japanese market thought it would be difficult to make a decision to buy in the market. Or they felt it would be a difficult sell to their investment committee," he adds. "As we came through the early and mid summer, overseas investment sentiment particularly around Tokyo and outlying areas was weaker. We have now seen that reversed with more international investors coming back into the market."

But concerns about the state of the global economy, as well as the impact of a strong yen on Japanese industry, have started to impact on sentiment more recently, according to Alastair Gillespie, global portfolio manager, Principal Global Investors.

He highlights the risk for Tokyo office investment: "With office vacancies in Tokyo at cyclical highs of around 8.6%, and high office supply in 2011 and 2012, the current weakness in leasing demand is likely to see a continued risk for downward pressure on market rents."

From an occupier perspective, the Tokyo office market is experiencing a split: a marked rise in demand for newer more earthquake-resistant property, to the detriment of the older secondary buildings.

While average rents for Tokyo look stable, this disguises a more nuanced story, according to Walters. "Average rents seem relatively stable but the gut feeling on the ground is that some buildings did much better than others in terms of rent returns. You are unlikely to see rent growth in secondary stock that doesn't meet new earthquake standards."

Tokyo is seeing a demand shift for offices. While the working population has been shrinking over the past few years, Tokyo benefited from a migration of office workers from secondary cities.

As corporations consider their location strategies, that is now changing, says Walters. "Since the tsunami and earthquake we are starting to see the beginning of a reversal of the process. Rather than occupying secondary stock in Tokyo, occupiers may go to prime earthquake-proof stock in secondary cities, for example Osaka," he says.

India: FDI rule changes could spur investment
The commercial market in India is weighed down with an oversupply of office space, with rents stable or declining. The main markets are the financial capital Mumbai, where demand for office space comes from financial services companies, corporate headquarters and from the IT industry, and Delhi, the seat of government.

In the second-tier cities of Hyderabad, Bangalore or Chennai there is less demand for corporate office space, and serious oversupply with vacancy rates into double digits. Here demand is driven by the domestic IT industry, and the future of that is to some extent dependent on events outside India.

The future direction depends largely on how the US slowdown and the European sovereign debt crisis are resolved. The IT industry is a major player in India's economy and will flourish or shrink depending on the outcome of the crisis.

"The commercial market growth has been driven by the IT market over the last few years," says Rami Kaushal, head of consulting, CBRE India. "The industry has grown 20-25% on average over the last few years, but now with US slowdown and European turmoil a clear direction has not emerged [in terms of] which way we are swinging, which will define the way IT companies are expanding or remodelling their businesses, because a lot of outsourcing comes to India. In the short term we don't see a major effect. But in the next six or seven quarters, the impact has yet to be seen in how IT budgets of corporates in Europe and the US market pan out."

India is not a real estate market that has attracted a lot of foreign money. One significant barrier is that foreign investment is only permitted in greenfield projects, and another is the level of bureaucracy.

"Every state has its own rules and regulations, which makes it cumbersome for foreign investors. We have had transparency issues in the industry. It's not an easy market to operate in, but you have had a lot of capital flowing into real estate and a lot of branded players coming in," says Kaushal.

The retail sector is underdeveloped, with a proliferation of small family-run businesses and local retailers. Foreign direct investment (FDI) is not permitted in multi-brand retail, only in cash and carry and single brand retail. But things could change if, as expected, the rules are relaxed.

China: retail opportunities outside Beijing and Shanghai
Any talk of China focuses on the overheating domestic residential market. Government cooling measures have begun to take effect on price growth, particularly in those cities where the measures have been applied most strictly.

But it's the retail sector that seems to be attracting the most attention from foreign investors. Growth in disposable income is fuelling strong growth in retail sales. Prospects for retail sector growth look good, with increasing urbanisation, and a growing middle class. "Chinese consumers are wanting to celebrate their new found wealth with material goods," says Alice Breheny, head of research at Henderson Global Investors.

Breheny sees good prospects for retail development in second and third-tier cities, rather than Shanghai and Beijing where supply of retail space is outstripping demand.

"In the second and third-tier towns we see strong rates of migration; rates of retail sales growth will be stronger than average in the second-tier cities and locations. To date these haven't been exploited too much by international developers. The supply-demand balance is much healthier in those markets."

But it's important that developers take advice locally for any development to be successful. Shopping centre development is polarised between international style projects that fail to take account of local preferences and local developers unfamiliar with the needs and demands of international retailers.

"I think US or European-based investors should look to work with local development partners to get the best of both worlds," says Breheny.

Walters too says the difference between a successful Chinese shopping centre and a failure is very dependent on location.

"It's about the skills of the developer and the investor in picking the right piece of retail," she says. "It's location specific. One mall can be doing really well while another 400 yards away is doing really badly. If people come off the underground in Beijing and the shopping centre is not on the right path from the underground to the CBD, people won't pass through the shopping centre."