LaSalle ISA 2019: Investing in APAC real estate in an environment of rising volatility and uncertainty; Investors to stay focused, seek signs of late-cycle excesses, and temper risks with a low beta + high alpha approach
SINGAPORE, HONG KONG (February 27, 2019) — According to LaSalle Investment Management’s Investment Strategy Annual (ISA) 2019, the fundamental drivers of real estate occupier markets are likely to retain their “just right” status in 2019. However, investors should expect an eventual cyclical inflection, and watch for signs of late-cycle excesses and risk taking. In 2019, investors are expected to make investment decisions in an environment of rising volatility and uncertainty. If a recession comes, leased real estate will not be immune, but it will be a “low beta”, or less sensitive financial asset.
Jacques Gordon, Global Strategist for LaSalle, said: “In order to mitigate these potential risks, the construction of real estate portfolios that employ defensive (low beta) positioning while still dedicating a portion of investment to higher (alpha-seeking) return strategies is recommended in LaSalle’s ISA 2019.”
In Asia Pacific, investors face macro risks including the U.S.-China trade war and China’s ability to sustain economic growth. However, the latter is tempered by China’s capability to introduce monetary, fiscal and regulatory stimuli, and strengthen its trade relations with the rest of the world, particularly within trade partners in Asia Pacific to offset the negative impact of trade tariffs should the trade war escalate.
As noted in LaSalle’s ISA 2019, global economic growth is cooling. With most Asia Pacific countries at the mature stage of the economic cycle, investors also should expect the region’s pace of economic growth in 2019-2020 to be below the 2017-2018 peak levels, giving rise to some risk of investor sentiment vulnerability in the capital markets. Nevertheless, labor markets in major Asia Pacific economies are healthy. Bank, corporate and household balance sheets are generally healthier than the pre-Global Financial Crisis (“pre-GFC”) period, with a few exceptions. All of the above puts the region in a good position to handle an economic slowdown if one occurs. If a recession comes to any of the major APAC economies, LaSalle believes it will be at a much lower risk level than during the GFC.
Major central banks globally are now walking on a tightrope between loose and tight monetary policies. Key messages from major central banks suggest that rate hikes are now on the back burner, as concerns over economic slowdown or recession risks rise. As a result, the risk of rising interest rates substantially pushing up capitalization rates and reducing real estate values is low. Most importantly, Asia Pacific real estate occupier and capital markets are generally more correlated with their respective domestic macroeconomic environments than with external shocks. Rental growth in most major Asia Pacific markets in 2019–21 is expected to remain positive and mostly at or slightly below their historical averages.
Over the long term, the region is poised to grow faster than other parts of the world as it transitions from an export-led region to one based more on domestic consumption, intraregional trade and tourism, urbanization and steady rise of the middle class population. The commercial real estate markets in the region are expected to remain attractive, as the region’s large and strong domestic demand base and the relatively high growth prospects by global standards are expected to continue to attract occupiers and investors alike.
Elysia Tse, Head of Asia Pacific Research and Strategy at LaSalle, said: “Supply-demand dynamics are largely healthy in major Asia Pacific real estate markets. Nonetheless, investors should expect lower returns in 2019 than in the past few years and some divergence in strong versus weak markets/sectors and primary versus secondary asset quality. As volatility increases, quality assets and flexibility become more important. Holding period and floor plan flexibility, early loan extensions, or early lease renewals all represent the optionalities needed to survive a downturn. Most importantly, preserve some capital, when possible. Be ready to take advantage of dislocation, should it occur in the real estate sector.”
Real Estate Opportunities and Investment Themes in Asia Pacific
Industrial: The outlook for the industrial sector in Asia Pacific remains favorable as demand is supported by domestic consumption and the growth of e-commerce, which is stronger than the projected GDP growth. However, supply is generally increasing in Asia Pacific markets, which requires close local-level monitoring. Market yields for logistics remain much higher than those of office properties, although they have compressed. For low risk investors, LaSalle favors logistics properties with credit tenant leases. The attractive development yield spreads are also supportive of development or build-to-core strategies, particularly in China Tier 1 cities and their satellite cities, select China Tier 2 cities, as well as the greater Seoul area. For these higher return strategies, submarket and site selection are increasingly important to manage the supply risk.
Cold storage is also an emerging and fast-growing segment in the industrial sector, whilst cold warehousing is still at an early stage of institutionalization. The location of cold storage warehouses is more important than for “dry” warehouses. LaSalle favors well-located cold storage warehouses for higher return strategies, but only when investors have a well-defined exit plan and experienced asset management capability to assist in the execution of asset-level business plans.
Office: While pricing and capital market demand for major Asia Pacific office markets are near peak levels, office occupier markets in Asia Pacific are at different stages of the occupier market cycle. Technology companies and co-working operators are boosting demand and reducing vacancy rates in major Asia Pacific office markets (e.g., Sydney, Shanghai, and Tokyo). The inflexibility of the traditional office leasing model sometimes does not align with the dynamic growth that many different firms -- both large and small -- are expecting, and LaSalle sees the co-working model likely to become a permanent option in major office markets across Asia Pacific. However, the performance of co-working operators has not been tested in a downturn. LaSalle recommends limiting the proportion of co-working and technology tenants to be a minority of an office portfolio (with variations at the asset level), and to focus on tenant credit and covenants for the majority of a property portfolio.
Retail: Investor sentiment for the retail sector is generally weaker than that of the industrial and office sectors. Domestic retail demand is expected to be more resilient in the region, while the tourist trade could be more volatile, although it remains a fast-growing segment in many gateway cities. E-commerce is contributing to the divergence between dominant, better-located and better-configured retail centers and inferior locations and outdated centers. However, in select markets, retail centers are also benefiting from online retailers who are extending their fast-growing on-line distribution channels to include brick-and-mortar stores. LaSalle is highly selective in the retail sector, with a tilt towards non-discretionary retail centers with a high tenant mix in grocery, pharmacy, food and beverage, and services located in strong residential catchment areas, particularly in Japan, Singapore, Hong Kong, and Tier 1 cities in China for core or value-add to core strategies.
Residential: Record or cyclically high residential prices in the region and the changing lifestyles of young households are driving the regeneration of multifamily markets, particularly in urban neighborhoods. For core investors, LaSalle favors urban rental apartments in Japan with excellent access to workplaces and amenities.
The for-sale residential market in Australia is particularly at risk with early signs of home price softening. Household debt in Australia is one of the highest in the region. When coupled with rising borrowing costs and tighter bank lending, home prices could correct further, particularly in the condo segment where supply is still at a record high. In Hong Kong, home prices have tripled since December 2008. LaSalle expects residential prices in Hong Kong to adjust moderately in the near term, but much less severe than the correction in 1997-98. For investors who can tolerate higher risk, LaSalle recommends monitoring the for-sale residential sectors in Australia for potential entry opportunities, if residential and land prices are adjusted.
Hotel: Asian tourists, particularly the Chinese, are the key demand drivers of Asia Pacific hotels -- particularly in Australia, Hong Kong, Japan, South Korea and Singapore. Depreciation of the Chinese yuan is unlikely to deter Chinese outbound travel to other major Asia Pacific tourist destinations. Investors with high risk tolerance could target hotel refurbishment opportunities near major tourist attractions, focusing on location selection and identifying the hotel segment that has a mismatch of demand and supply.
About LaSalle Investment Management
LaSalle Investment Management, Inc. (together with its global investment advisory affiliates, “LaSalle”) is one of the world’s leading real estate investment managers. LaSalle on a global basis manages approximately $60.5 billion as of Q3 2018 of private and public equity and private debt investments. LaSalle’s diverse client base includes public and private pension funds, insurance companies, governments, corporations, endowments and private individuals from across the globe. LaSalle sponsors a complete range of investment vehicles including separate accounts, open- and closed-end funds, public securities and entity-level investments. LaSalle Investment Management, Inc. is a wholly-owned, operationally independent subsidiary of Jones Lang LaSalle Incorporated (NYSE: JLL), one of the world’s largest real estate companies. For more information please visit www.lasalle.com.
This information is based on the market analysis and expectations of LaSalle and should not be relied upon by the reader as research or investment advice regarding LaSalle funds or any issuer or security in particular. The information presented herein is for illustrative and educational purposes and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy in any jurisdiction where prohibited by law or where contrary to local law or regulation. Any such offer to invest, if made, will only be made by means of a private placement memorandum. Past performance is not indicative of future results.