The world's fastest changing residential real estate markets are in Asia, as Tim Bellman and Shane Taylor report

Although the size of residential markets in Asia is vast, the universe of core opportunities for institutional property investors across the region is much more modest. Dominated by owner occupied houses and apartments, there is relatively little multi-family private rental accommodation of the type suitable for institutional investors. Hence core residential product suitable for international institutional investors is dwarfed by the core office and retail product in most countries. Nonetheless, as home to well over half the world's urban population, the opportunity set is expanding and deepening and residential development strategies remain a focus for institutional investors active in the sector in the region.

The residential sector, more than any other property type can vary widely by its size, format, location and unit price points. Investors might also be mindful that in many parts of Asia, as indeed in most other places of the world, residential is the sector most heavily regulated by government and its national, state and local agencies. At this point in time when fears of (yet another) housing bubble are widespread, how might institutional investors take a circumspect view of the opportunities in Asia's residential sector? What are some of the main short and long term demand drivers for residential real estate in Asia? What are the risks?

Structurally, the economies of most of Asia's cities have been growing well and moving up the global value chain from centres of manufacturing to trade and commerce to international business and finance and other high order services. Cyclically, Asian cities have also done well in the last few years and with the main exception of Japan's regional cities, experienced recession briefly (if at all) and labour markets have grown strongly over the past year. With an aging, declining population and weak economy it is no co-incidence that new residential starts in Japan have now fallen to their lowest point since 1964. Yet elsewhere, housing markets have surged in terms of volumes traded and the values attained. In figure 1, over the past year Asia Pacific has had the four residential real estate markets exhibiting the strongest increase in prices according to the Economist House Price Indicators including Hong Kong +27.7%, Singapore +24.5%, Australia +13.6% and China +10.7%.

Might the fundamentals support this? Chief among the key demand drivers has been the impressive strength of most labour markets across the region. Currently among the world's lowest unemployment rates are to be found Singapore and Hong Kong. In no major country of the region have rates of joblessness approached the double digit figures reached in the US and Europe. With the notable exception of serviced apartments and corporate housing driven more by multinational staffing/remuneration motivations, there are demographic forces overlaid with cultural preferences and tastes which support much of the pricing. A more immediate driver is sentiment - a powerful attitudinal and behavioural variable which tends to swing quite quickly in this part of the world. Sentiment has been measurably strong this year.

Highly accommodative monetary policy is another demand factor. Lending rates were slashed in order to stimulate domestic demand and instill confidence at the height of the global financial crisis. In Singapore for example, the SIBOR (Singapore Interbank Offered Rate) fell in early 2009 to levels not seen since early 2004 - yet in contrast to the subdued supply and demand at that point of the country's history there were surging new residential launches in 2009 and in the latter half of the year, record strong levels of take-up demand. Market liquidity has also been driven by ‘hot money' or speculative capital flowing around the region and targeting residential units. Mainland Chinese targeting Hong Kong units and Indonesian and Middle Eastern capital targeting Singapore have been commonly identified.

Good economic growth, strengthening labour markets and wage rises, a higher propensity to save compared to western counterparts, accommodative lending rates, counter-cyclical stimulus and strong sentiment have thus buoyed many Asian markets to levels approaching, or even surpassing, those prior to the global financial crisis. Just as government regulations have enabled opportunities in residential markets, so too they present regulatory risk. The question mark hanging over the likely effectiveness of the rather blunt policy instruments available to dampen specific, over-heated segments of the market while not risking growth in other segments or affecting generalised sentiment remains a key risk in the year ahead. Governments across much of the region have enacted anti-speculative measures which in recent months appear, tentatively, to be achieving some of their intended effects.

Asia's economic rebound of the past year has been astonishing in its strength, yet risks remain and the most serious of them may likely emanate from outside the region. The growth rates of many key Asian economic indicators are unable to be sustained and must moderate; some of the strong growth was due to inventory re-stocking. Also, interest rates have already begun to rise across the region and a growing number of edicts and other regulations are being implemented by which to cool investment activity and stabilisation of rapidly raising residential prices which some worry are becoming new bubbles in the luxury markets in the top tier cities across some parts of Asia.

Authorities in China and the city states have been the most aggressive in rolling out these measures in the past quarter intended to cool speculation and stem the rapid pace of pricing. The Monetary Authority of Singapore has cautioned buyers over the dangers of buying into such a strong market. We have some good evidence showing a strong positive correlation between the capital values of Singapore's luxury condominium market and STI performance. There may well be considerable truth in the assertion that investors have placed their profits from other asset classes into residential real estate. Much activity in this luxury end may not be sustainable and a correction is likely at some point.

How worrying is the rapid run up in prices? As illustrated in figure 2 - also drawing on the Economist House Price Indicator - the jury remains out. Average prices in Japan and Hong Kong remain below the level they achieved in 1997 and in Singapore prices have risen only 9% since 1997. Yet prices have nearly trebled in Australia, the UK, Spain and China over the same period. At the very least such a rapid run up in prices hints at underlying challenges of affordability in these markets as and when interest rates start to increase and repayment burdens become greater. Yet of these four, only house prices in China appear to remain fairly priced when comparing the current price-to-rent ratio to its long-term trend. Due to rapid economic growth in China, rapidly rising household incomes have more than offset the rapid rise in average house prices leaving affordability little changed over the last decade (2.7% overvalued according to the Economist House Price Indicator).

Urbanisation is still the most powerful factor across residential markets in Asia. China, India and Indonesia will likely add more new urban residents to their cities in the next 20 years than all of Europe. Clearly most will not be as wealthy as the average European and only a fraction (mainly expatriates) will immediately reside in the higher-end stock more commonly and currently identified as ‘investment grade'. Yet the labour and productivity of the newcomers generates wealth for existing residents who may likely upgrade to a newer and larger premises as newcomers themselves move into smaller, older stock. One of the major challenges will be for policymakers to provide a stable long-term policy framework which helps to attract private developers and investors to meet the affordable housing needs of the pent-up demand from new economic migrants. Enabling more and more of these households to become home owners may become one of the next real opportunities for real estate investors.

Tim Bellman, global head of research & strategy. Shane Taylor, head of research & strategy, Asia Pacific, ING REIM