Asia Pacific markets have experienced impressive economic growth over the past few years and the region's long-term prospects remain compelling. However, each market presents its own opportunities and challenges.
A key consideration when assessing the current investment opportunities in the region is the potential impact of government policies on real estate markets, especially residential. Currently, those policies include China's efforts to rein in housing prices; Japan's desire to stimulate its economy, which was sluggish even pre-tsunami; and Hong Kong and Singapore's attempts to stabilise their residential markets, after a period of substantial capital appreciation. Against this backdrop, we believe there will remain good opportunities within Asia Pacific commercial real estate, and would like to highlight three investment themes of particular interest.
Hong Kong: Hong Kong is uniquely situated as a financial conduit between China and the rest of the world, and it is directly benefiting from strong growth on the mainland. It is our view that the market's retail and office sectors are in the midst of a multi-year growth phase. We observed the first part of the current cycle with a robust acceleration of property values. We saw positive momentum build in rental growth, with the city's healthy economy and low unemployment driving solid demand for prime offices amid a relative lack of new supply. Strong retail fundamentals are driven by growth in consumption from visitors and domestic residents, along with new international brands seeking to establish a presence in Hong Kong.
Where could commercial property values head from here? Still higher! Unlike in New York and London, transactional evidence is limited, but we believe the market will be surprised by how much buyers will pay as rental growth exceeds expectations.
Japan developers: Japan may not have the growth profile of the region's smaller markets, but it remains the world's third-largest economy and a source of frequent opportunity in our view. We have recently seen some attractive points of entry, particularly among real estate developers that have traded at heavy discounts to fair value. In particular, although the recent disaster has amplified concerns regarding Japan's broader demographic trends, such pessimism should not be reflected on Tokyo property valuations. While population growth in the country as a whole is tepid, Tokyo draws in people from across the region, and has an above-average growth rate in the working-age demographic.
With respect to J-REITs, we are monitoring office companies for opportunities, but our on-the-ground observations suggest that the market could be muted over the next year or two as the country focuses on rebuilding and conservation efforts. Tenants will continue to seek rent reductions into 2012, but this should reverse course as confidence improves. In due course, we expect higher-quality buildings across all sectors to do relatively better as earthquake resistance becomes a bigger factor in tenants' decisions.
Meanwhile, J REITs have been able to raise debt and equity capital to fund acquisitions that should stabilise distributions in the future—and also help developers with their capital recycling plans.
Indonesia: Indonesia's market declined in early 2011 when inflation worries drove investors away from emerging markets in general. This resulted in some compelling valuations in a market where real estate fundamentals are benefiting from booming commodity prices and positive consumption trends as GDP and wages accelerate. We have a favourable view on the market's developers, especially those that are positioning their land banks for increased sales volume. They have relatively low leverage due to historical grandeur, low payout ratios and professional management teams - characteristics that support the means and ability to create value over time.
From a demand standpoint, residential pricing is affordable. Moreover, there is a nascent mortgage financing industry that should fuel personal credit growth and home ownership to the benefit of residential developers. For our part, we believe we have identified well-positioned companies with relatively good corporate governance - an important feature, given that this risk tends to be elevated in emerging markets.
In conclusion, what unites these themes is the potential to benefit from a natural progression in commercial real estate fundamentals relatively free from detrimental or unpredictable policies. With a broader focus on countries and property types with macro factors working in their favour, we believe Asia Pacific property markets offer potential for long-term investors to benefit from the growth of these economies.
First time for everything
The Finnish state pension fund Valtion Elakerahaston (VER) has begun to build up an exposure to the Asia-Pacific real estate markets by investing in two fund of funds vehicles. The commitments to the Franklin Templeton Asian Real Estate Fund and the CBRE Asia Alpha Plus fund are the pension fund's first property investments outside Europe.
VER chose to invest in Asia over the US, because it offers a greater level of diversification and the potential for an additional component of return through local-currency appreciation. "Additional benefits of diversifying outside Europe to the US would be quite small [compared with] the benefits over the coming decades of investing in Asia or emerging markets with appreciating currencies," says Timo Löyttyniemi, managing director at VER. "We have two components in our return expectations, one being the attractiveness of the diversified markets [in Asia], and secondly the appreciation of certain Asian currencies."
The pension fund prefers to invest directly in single real estate funds - a strategy it employs for Europe - but it opted for the fund of funds model for its initial move into Asia.
"We are firstly looking at the fund of funds solution. Later we might take individual funds as well, but it is too early to say what," Löyttyniemi says. "We know there are some embedded costs in that structure, but all in all we feel it is the best way to enter."
VER is looking into making additional investments to the Asia-Pacific region but has not yet decided on a timeframe.