Office markets in Singapore, Sydney and Shanghai offer particularly good prospects for investors, says Charlie Huang

In the first months of 2010, most countries in Asia Pacific enjoyed a continued period of robust economic expansion, with accelerated growth particularly evident in China, Australia, Singapore and Hong Kong. The key drivers in these markets are external, but improving consumer confidence and employment prospects are also noticeably enhancing demand.

This is good news for property fundamentals and positive trends in the region's occupier markets are underpinning rising investment sentiment. Office rents are arguably near their trough in many markets, with increased leasing enquiries and declining vacancies. The rental markets in Hong Kong and Shanghai's central business district (CBD) have already entered cyclical recovery, while strong net absorption is expected in retail markets as retailers resume expansion plans. Elsewhere, an improvement in manufacturing exports is leading to stronger demand for logistics and industrial properties, although rental growth prospects are limited in this sector.

Short-term investment activity remains robust following the re-entry of well-capitalised REITs and private funds into the market are targeting the capital value recovery. However, there are undeniable challenges ahead. Inflation pressures are emerging and Australia has raised its interest rate by 100bps since October, while Vietnam, Malaysia and India have also taken the first steps to raise rates. China's government has introduced measures to curb speculative residential investment and interest rates are also expected to rise in the second half of this year.

Other challenges include uncertainty as to how economies might fare once government measures to support markets are inevitably withdrawn, while the structural imbalances in the world economy still loom large and present a longer-term risk to growth across the region. Having listed the caveats, we believe the APAC region has promising occupier fundamentals and, despite potential short-term volatility in capital markets, we are confident investors can find opportunities for good medium-term performance.

The following three office centres as particularly promising with stabilised rents and nascent value appreciation underpinned by good fundamentals.

Singapore: Capital value bottoming outSingapore is a volatile, outward looking economy whose fortunes are closely linked with those of the wider region and global trends. There has been a rapid bounce in output of late, mirrored by a swift improvement in real estate investment volumes which amounted to $4.87bn (€3.73bn) in Q1 2010, 18 times the level seen in Q1 2009. The economy is also likely to benefit from the recent opening of two integrated resorts, which alone are expected to add 1.5% pa to GDP. As in the City of London, strong leasing momentum returned towards the end of 2009 as financial and professional companies sought to take advantage of cheap prime rents on high-quality space, which had fallen by around 60%.

In its rival Hong Kong market, rents are 120% above those of Singapore. The glut of expected new completions should moderate the recovery in rental values in the short term and could scare potential investors. However, to put this into perspective, although these levels of development are the highest since the Asian Crisis, as a proportion of the overall office stock they equate to less than 2% per year, significantly below the 3.6% per year delivered in the 1990s. Headline rents have already stabilised during the earlier months of this year and we predict a return to very strong growth rates after 2011.

Sydney: Strong economy attracts increasing investments
Australia is experiencing a natural resources boom driven by strong demand from Asian countries, particularly China, which accounts for around 20% of the total exports. The unemployment rate has already dropped to 5.3% and will probably dip further by the end of 2010. The strong job market and positive net migration should fuel demand for residential and commercial property, as well as development land.

The Sydney metropolitan area was adversely affected by the global crisis and negative net absorption pushed up the vacancy rate to just under 10% in 2009. Effective rents fell 20% as occupiers sought to reduce costs and shun expensive new buildings. Demand is likely to improve quickly from the 2009 trough, and we expect the current occupier market recovery to become dynamic by 2011. In particular, new supply is mainly limited to the refurbishments of older buildings, while new developments require effective rents in excess of current market levels to become viable.

The investment market continues to improve with increasing interest from overseas investors from Asia and Europe. Domestic REITs are also in better shape and keen to seek opportunities, but the big superannuation funds have remained on the sidelines thus far. Capital values dropped by 20% from their peak in 2007 but stabilised in H2 2009 and recent prime transactions have shown a tightening of yields, suggesting that value recovery is underway.

Shanghai: Riding on the growth of the Oriental Pearl
Shanghai is the financial capital of China, and was historically referred to as the Pearl of the Orient. The government is committed to reviving Shanghai, enabling it to fulfil its legacy as the financial and commercial hub of Northern Asia. This is expected to create millions of white-collar jobs, attract wealthy consumers and underpin a promising property market.

Office jobs grew steadily throughout the recent financial crisis, although the recovery in demand for space was limited to the financial services sector. Headline rents have declined only marginally (-1.3%) since Q3 2009, after a sharp drop of 20% from their peak. Oversupply should hold the market back in the short term, with a significant hike in new completions expected. However, demand for space will be underpinned by solid economic growth and Shanghai's booming financial industry.

Domestic financial firms and big state-owned-enterprises are expanding and upgrading to higher-quality office space. In fact, about 40% of the new supply in the next two years has been pre-leased, according to JLL. Double-digit growth rates in net effective rents after 2012 can be expected.

Additionally, the Shanghai EXPO2010 is expected to attract around 70m additional visitors to the city before the end of the year, which will bring considerable long-term benefits to Shanghai's economy.

Charlie Huang, research manager, Henderson Global Investors