As the downturn demonstrates the degree to which some Asian markets are coupled to the rest of the world investors are retrenching in markets that offer stability, liquidity, transparency and sound fundamentals, as Kristen Paech reports

Asia's office markets are in for a rough ride. The key drivers that buoy the sector - international financial markets and exports - are at the sharper end of economic weakness  in the global economy, and the financial crisis has triggered a steep decline in pricing that is expected to continue well into 2009.

With the cost of debt rising, developers' ability to secure debt has been tested, particularly in Japan, where over-leveraged players have crumbled under the weight of their own borrowings. Emerging economies such as Thailand have been shown up to be more volatile - and risky - than investors might think. And while they are probably more insulated on the demand side, the scale of new development is harder to predict.

Fund managers investing in the region are adopting a ‘wait-and-see' approach, assessing the opportunities with the intention of investing once the dust has settled.They are looking for core, unleveraged existing assets in large and stable markets, with sufficient liquidity and transparency to enable them to exit the market when they see fit.Richard Price, chief executive officer of ING Asia Pacific, says that, for the time being, ING's office exposure in Asia is entirely in Seoul.

ING sold most of its office assets in Singapore and South East Asian markets last year, and Price says the firm will only consider new investments after there has been further price correction, most likely in the second half of next year. "For markets like Seoul we'll also have to work out exactly how much of the development pipeline will get built given the new financing environment," he says.

"That will impact our forecasts, but at the moment the market is very tight; there's very little vacancy. Korea is one of the largest economies in the world and we think there is continued growth potential for the economy. There are some short-term challenges in the market, much like everywhere, but we think the structure of the leases in Korea helps minimise volatility and if you look at rental trends over the long term they're pretty stable."

On a risk-adjusted basis, Price's top three office markets for new investing are Japan, Korea and Hong Kong, in that order. He says these are markets with reasonably robust institutional investment demand and decent liquidity.

Price adds: "We feel that while economies are going to be challenged in the short term, if you're able to take advantage of price correction you can get hold of good-quality core assets with solid income streams that can perform well over the long term."

Likewise, Invista Real Estate Investment Management is targeting the larger, more mature real estate markets in Asia. The Invista Real Estate International Fund closed in May 2008, and while the initial focus was on Japan, Singapore and Hong Kong, Tim Francis, director, continental European research and strategy, says the fund is now predominantly focusing on Japan. 

Hugo Vere, fund manager for the International Fund, says the research carried out ahead of the fund's launch did not identify those three markets as the highest performers of the region, but on a risk-adjusted basis they were considered the most appropriate for the fund's target of a leveraged internal rate of return of 15%.

"Hong Kong and Singapore are smaller markets but are a long way ahead of most other South East Asian markets in terms of liquidity. So those markets on balance are still stacking up but, of the three, we're very much focusing our efforts on Japan," Francis says.

"Japan is almost European in its style - it's a fairly low and steady-yielding market, and on a risk-adjusted basis it's attractive in so far as the returns don't tend to move around too much. Clearly, if you start to look at the very prime end of the Tokyo office market where rental growth has been extremely strong in the last few years, your return profile will be more volatile, but the Marunouchi market is pretty much a closed shop - it's not a market we'd look to target nor do I think it's a market where many international investors will be successful, in terms of acquiring assets. The main market in Tokyo is still in the core central business district - so good locations, good-quality buildings and good-quality tenants."According to Vere, the size of Japan's economy and the ability to get positive financing also add to its appeal.

"The attraction with Japan for us is that it is the second largest economy in the world, it's the second largest real estate market in the world, so it does have a lot of liquidity and a relative degree of transparency together with the established legal and financial systems that as an investor you take comfort from," he says.

"The cost of debt is significantly less than the yield on the assets. The big caveat is whether you can secure debt in the current market."Despite seeing opportunities in Japan, Invista has made a deliberate decision not to invest right now, Vere adds.

"The market is moving towards us in terms of pricing and there's still a high degree of uncertainty surrounding the occupational outlook in some of these markets," he explains.
Jason Chew, chief investment officer of Pramerica Real Estate Investors (Asia), expects all Asian office markets to face slowdown in demand and falling rent rates in 2009.
However, he says Tokyo and Seoul are likely to offer the best opportunities for the office sector, followed by Shanghai.

He notes limited supply in the CBDs, occupancies in the low single digits, labour laws protecting employees and highly leveraged distressed sellers as some of the factors that make Tokyo and Seoul attractive.  "China continues to grow at a healthy level despite the crisis, and the ‘new' China is now able to spend its way through the crisis with massive government projects and initiatives," he adds.

"More importantly, many companies are looking at China to take up the lost demand from the US and I personally do not think there will be much downsizing of their office in Shanghai, or at least, not ahead of their other operations elsewhere."
However, HoKang Puay-Ju, head of property, Asia Pacific, at Aberdeen, says that in today's markets it is hard to pick which office markets look attractive on a risk-adjusted basis."It's very difficult to see clearly, from where we are now, where the markets are going to head," she says.

"Because they are coming off such high pricing, the returns in the developed markets will deteriorate much more sharply than the developing set. We are still going to see higher returns from the developing set but you have to measure that against the risks. From an absolute returns point of view, the developing markets will outperform but it's not easy to find good value in the current market environment."

Puay-Ju says that those markets that are traditionally less geared and that have seen more restrained supply will hold up better than others. "In terms of fundamentals we already see substantial softening in the developed office markets, like Singapore and Tokyo," she says. "Singapore is not as highly geared an investment market as Japan, though, hence repricing has not taken hold on the same scale.

"What we are seeing here is a stand-off between sellers and buyers. The sellers are holding off, trying to get prices that were easily achieved in the past, and the buyers are adjusting prices quickly so there's now a gap between sellers and buyers which I expect will close rapidly in favour of buyers in the coming months."