Economic growth in Asia is slowing but still strong. Sigrid Zialcita looks at what this means for the region’s office markets
The overall picture so far this year is of an economy growing more slowly, albeit better than the rest of the world. GDP growth for all of 2013 is expected to remain solid on the back of rising employment, supportive government policies and increased investments, as well as recovering external demand. At the same time, regional growth will hinge on a stronger Japan and US, and a still-growing China.
For the leasing market, the positive economic sentiment should support absorption in most of the 29 cities tracked, but occupancies will vary, depending on new supply. Rents will remain on a moderate upswing in most markets for the remainder of the year, and are set to pick up in Tokyo’s five central wards and Hong Kong’s Greater Central in 2014. For the investment market, activity is expected to further gain traction during the course of the year, with investors showing appetite for both core and emerging markets.
The year thus far has been marked by surprises, with momentum in the regional economy shifting to the developed world, away from the emerging economies that had led growth since the financial crisis. Notably, a resurgent Japan is driving the shift, following years of stagnation, indicating promise for prime minister Shinzo Abe’s new policies. At the same time, economic strides in the region’s powerhouses – China and India – have eased considerably. Nonetheless, most ASEAN markets continued their robust expansion, led by the Philippines. As a result, our baseline outlook for the remainder of 2013 has several changes, although regional real GDP is still forecast to advance 5-5.5% for all of 2013.
First, Abenomics – a three-pronged approach consisting of structural (economic overhauls aimed at sustaining long-term growth), monetary and fiscal policies – will cause Japan’s GDP growth to shift to a higher gear, from an annual average of nearly 1% from 2000 to 2011 to 2-2.5% this year.
Additionally, as the world’s third-largest economy, we expect Japan’s growth to have global significance. Hence, Japan’s reflation policies, combined with continuing gradual improvements in the US, will filter to its trading partners within the region and, thus, add to upside growth. Second, the slowdown in India is expected to persist with economic growth estimated at 5-5.5% for fiscal year 2013-14, especially as economic reforms have yet to pick up steam.
Third, we are lowering our outlook for China, where growth is transitioning to a new normal of 7.5% as policymakers rebalance the economy. Notably, if it posts a 7.5% GDP growth rate for all of 2013, it would be the slowest since 1990.
Lastly, the outlook in Australia has also softened on weakening sentiment in China and the retreating resources sector, although efforts are under way to balance away from mining.
On the upside, both fiscal and monetary policies in most countries have room to manoeuvre, especially given the diminished risk of higher inflation in the region.
Of course, the outlook is not risk-free. While Europe broke out of recession in the second quarter, the upturn is far from adequate to address its deep-seated problems of mass unemployment and high debt. Additionally, the recovery in the US economy is gaining traction, which in turn, has fuelled speculation that the US Federal Reserve is close to a decision to start unwinding the economic stimulus. In our view, we expect the Fed to shift its policy if, and only if, the US economy shows major improvement. In Asia Pacific, the inexorable slowdown in China and its spillover effects on the region remains the greatest risk.
Geopolitics is another source of risk. The ongoing territorial issues in Asia are fuelling diplomatic tensions and have begun to have an impact on economic ties. A case in point: Japan’s exports to China in the first half of the year fell to their lowest level in four years. At the same time, Japan’s direct investments in China for January-June this year fell 31.1% from the year before to $4.9bn (€3.7), based on data from Japan External Trade Organization.
Leasing activity to remain stable
Solid economic conditions, combined with employment gains, bode well for occupier demand across all 29 cities tracked within the region. While overall occupancies will vary, rents are still expected to advance 1-2%, on average, through next year.
Given continued rent increases in most markets for the past four years, occupiers with three-year leases reverting this year will, by and large, face higher renewal rates as grade-A rents across the region will be up by an average of 15% from 2010. Still, there will be exceptions, with occupiers likely to achieve cost savings if they renew their leases in Hong Kong’s Greater Central, Singapore CBD, Tokyo, Seoul and Hanoi and Ho Chi Minh City.
In core cities in Australia or in Beijing and Shanghai, occupiers will likely see rent increases of 10% to as much as 70% if they renew their leases in those markets. For emerging markets, rents through the end of this year will be up from a low of 4% in Mumbai, to as much 130% in Jakarta compared with 2010. A similar comparison was done for 2014 versus 2011, and yielded comparable findings – that is, cost increases will still be material for a number of markets.
Following are some key notes for each region.
GREATER CHINA Decentralisation will continue to take hold in high-cost markets such as Beijing and Shanghai. Notably, there has been a demand shift in those markets, with occupiers opting to relocate out of the CBD to adjacent emerging locations where rates are at a substantial discount and options remain more abundant. As a result, absorption has risen in those lower-cost locations and contracted in core markets and that, in turn, is partly causing grade-A rent increases to cool down in Beijing’s and Shanghai’s core markets. Nonetheless, both remain choice destinations for major global and domestic companies, so occupancies and rents should remain high.
Similarly, space rationalisation is widespread in Hong Kong’s Greater Central, where prime occupancy costs are the second highest in the world and command a 40-50% premium to those in non-CBD locations. Banks and insurers went on an unprecedented spending spree, particularly in Kowloon, investing more than HKD18.8bn (€1.84bn) in office properties from January 2012 to May 2013, in an attempt to manage their costs and space needs more effectively. For large occupiers, we see this trend towards Kowloon to continually be supported by a healthy supply pipeline.
However, those options in non-CBD locations do not necessarily reflect rent bargains. Rents in those markets have been rising fast. Grade-A rents have quickly recouped previous modest declines posted earlier in 2012, and have now reached new records across all non-CBD locations. And no relief is in sight; rents outside Central are expected to continue their uptrend on sustained healthy take-up and ultra-low vacancies during the remainder of the year. As such, expect rents in Greater Central to continue to stabilise and start picking up late this year through to 2014.
Meanwhile, the Taipei office market embodies the slow-and-steady ethos of the city. Given modest supply, as well as lack of new economic drivers over the near term, grade-A office occupancies and rents are expected to remain fairly stable through 2014.
NORTH ASIA The acceleration in demand in Tokyo’s five central wards will continue on the back of positive economic news. As a result, grade-A rents are set for a bounce-back after a prolonged period of stagnation, possibly rising modestly late this year and more meaningfully early next year. Even so, grade-A rents are expected to remain well below their peak levels in 2007. In nearby Seoul, opportunities abound with availabilities expected to peak in the CBD and Yeouido this year. This window will likely remain open as new construction is set to add over 6.4m sqft through 2015.
SOUTH ASIA In India, absorption so far this year has dipped to record lows amid continued challenging economic environment. Occupiers are reconsidering their positions, especially given the considerable macroeconomic headwinds facing the country. However, leasing conditions are ripe for a revival once the uncertainty of the upcoming federal elections is out of the way, and economic overhauls finally gain traction. Furthermore, a weaker rupee augurs well for India’s IT firms, which often perform back-office tasks for overseas entities and earn more than half of their revenues from the US.
Notably, a rise in the US dollar would translate to increased revenue in rupees, and in turn, have a positive impact on IT hubs such as Bengaluru. Recent amendments largely aimed at enhancing the viability of Special Economic Zones also have the potential to grow the IT/ITeS sector beyond Tier I cities. However, construction will keep apace and sustain vacancies above 20% in New Delhi, Pune, Kolkata and Ahmedabad this year.
SOUTHEAST ASIA Jakarta, Bangkok, and Manila have been a hotbed for deal activity this year. With such trends continuing on the back of favourable economic prospects, increasingly tight availabilities will pose a drag, especially in Jakarta and Bangkok. Not surprisingly, rent increases will remain at or above-average in those markets, with grade-A rents in Jakarta expected to climb another 40-50% for all of this year. In Singapore, demand from a broad range of sectors continues to gain traction, so grade-A rents appear to be on track to resume their upward trajectory, especially in Raffles Place and Marina Bay. Meanwhile, in Kuala Lumpur, demand is also expected to hold steady. However, construction will remain robust, causing office vacancies to be elevated at 25%, the highest in Southeast Asia. Similarly, development activity has remained almost uninterrupted in Hanoi and Ho Chi Minh City; consequently, vacancies will continue to rise and erode grade-A rental rates in both markets.
AUSTRALIA The office sector across all major cities tracked in Australia will continue to gradually lose steam, given the lack of any demand growth catalyst. Consequently, occupancies are likely to fall, especially in Brisbane and Melbourne, where new construction is fairly active. In addition, effective rent gains will generally be difficult to achieve in this scenario. The recent weakening of the Australian dollar against the US dollar is being watched keenly.
Investment market still has room to run
Investment activity has surged across the globe this year. For Asia, such development is credited to better investor sentiment, continued re-allocation of capital to Asia, low interest rates, supportive debt markets, and relatively attractive returns, among others. Investment activity should maintain its pace for the remainder of this year so that transaction volume in 2013, which we estimate at $1.1trn globally, is on track to be the highest since 2008.
The region will certainly benefit from such an investment run-up. First, investors’ thirst for yield will perpetuate strong competition, especially for quality assets, and will drive aggressive pricing as well as measured compression in cap rates. Second, even though cap rates might compress, spreads over the 10-year bond yield will remain wide at an average of 230-250bps in core markets, and 340-360bps in secondary or emerging markets.
As previously mentioned, we expect the interest rate environment to remain relatively benign. Notably, even as 10-year bond yields have risen modestly, rates in most markets are still extremely low in a historical context. In our opinion, this wide yield spread will continue to be a major driving force for buying in core markets, but also growing demand for higher-yielding assets and value-add investments in secondary or emerging markets. In a scenario where such investment thesis is supported by possible rising rents, the investment demand is expected to remain strong.
Furthermore, over a longer period, negative effects of rising rates should be at least offset by the region’s advantages, including healthy consumer demand and sound property fundamentals. All of these factors should keep properties in Asia Pacific attractive for regional and global investors during the course of 2013 especially as an inflation hedge and total return vehicle.
Sigrid Zialcita is managing director of research, Asia Pacific at Cushman & Wakefield