asia pacific fair value q3 2012...2012/11/13 · asia pacific q3 2012 foresight 2 fair value...

DTZ Foresight Asia Pacific Fair Value Q3 2012

Monetary easing benefits markets hh

DTZ Research

29 October 2012

Contents

Fair value results 2

Required & expected returns 3

Market classifications 4

Office market forecasts 5

Retail market forecasts 6

Industrial market forecasts 7

Appendices 8

Authors

Jade Tan

Senior Analyst, Forecasting

+ 852 2250 8865

[email protected]

Kate Barrow

Head of Asia Pacific Forecasting

+ 852 2250 8864

[email protected]

Contacts

Matthew Hall

Global Head of Forecasting

+44 (0)20 3296 3011

[email protected]

Hans Vrensen

Global Head of Research

+44 (0)20 3296 2159

[email protected]

More markets in Asia Pacific became investment-attractive in Q3, based on the DTZ Fair Value IndexTM score which improved from 68 in Q2 to 75 (Figure 1). This is similar to the level seen in Q3 2009 when opportunities to take advantage of rapid re-pricing in the wake of the global financial crisis first emerged.

The number of HOT markets grew from 32 to 39 in Q3. China led the upgrades with 16 out of 17 markets now rated as either HOT or WARM, meaning that the majority of markets are expected to provide solid returns. Shanghai offices overtook Beijing to become the most attractive market in China, driven by forecast yield compression and solid rental growth. Despite the slowdown, the China growth story remains alluring, with forecast GDP growth of around 7-8% in the medium term. In addition to Beijing and Shanghai, many lower tier markets are offering investors good value at current pricing.

Australia continues to account for the largest number of HOT markets in the

region due to the large spread between property yields and government bond yields. However, there are concerns over falling commodity prices arising from the China slowdown and its effect on future growth.

Upgrades were also evident in South East Asia, where emerging markets are

delivering strong growth. Jakarta offices leapt to the top of the fair value ranking with forecast total returns in excess of 25% p.a.

Growth in Asia Pacific continues to be challenged by global headwinds.

However, borrowing costs have been lowered in line with the wave of monetary easing across the globe. This has made real estate more appealing as an asset class amid ongoing uncertainty. Nevertheless, with lack of investable product a lingering issue in many markets, seizing opportunities at the right time presents a challenge to investors.

Figure 1

Asia Pacific Fair Value Index ratings by country, Q3 2012

Source: DTZ Research

1 1 1

58

2

84

14

1414

5 639

0%

20%

40%

60%

80%

100%

Australia China India Other Asia Pacific

Cold Warm Hot

Asia Pacific index score: 75

Asia Pacific Q3 2012

www.dtz.com Foresight 2

Fair value results

Fair Value Index Q3 Overview More markets in Asia Pacific became investment-attractive in Q3, based on the DTZ Fair Value IndexTM score which improved from 68 in Q2 to 75 (Table 1). This is similar to the level seen in Q3 2009 (72) when opportunities to take advantage of the rapid re-pricing of 2010 first emerged. Whilst economic woes in Europe and the US continue to dampen sentiment, a wave of central bank stimulus – which will help reduce borrowing costs – has provided a fillip to the markets. This is making real estate increasingly attractive to global investors, and is reflected in the fact that 53 out of the 61 markets in our Asia Pacific index coverage are currently rated as either HOT or WARM. In fact, this quarter saw the number of HOT markets increase from 32 to 39 (Figure 2). The office sector leads on upgrades, with an index score of 78 – on a par with industrial. While industrial stands out on the basis of providing stable income stream during times of weaker capital growth, future office returns will be driven by capital appreciation and solid rental performance as markets enter the recovery phase.

China growth story still alluring while SEA is also on the up The majority of upgrades were in China, as four markets were reclassified from WARM to HOT. Apart from the investor favourites of Beijing and Shanghai, we believe a handful of lower tier cities are offering investors value at current pricing, underpinned by strong market fundamentals. A case in point is Chengdu, where rapid service sector growth will continue to drive office space expansion and the growing spending power of local consumers will support healthy retail sales. Meanwhile, all the South East Asian markets saw various degrees of upgrades this quarter, with Singapore offices upgraded from COLD to WARM on the back of the improved rental outlook. Despite potential oversupply in some markets, the South East Asia region has generally held up well and is believed to offer investors fair value at present. Activity hindered by lack of product The attractiveness of the Asia Pacific markets is yet to feed through to investment volumes, which fell by 15% q-o-q in Q3. Based on the historical relationship between the DTZ Fair Value IndexTM score and investment volumes (Figure 3), we would expect to see a recovery in investment volumes in 2013. However, investors remain cautious and those that are looking to deploy capital are faced with a lack of investable stock in many markets due to a mismatch between buyer and seller expectations. This can make capturing market opportunities at the right time a struggle.

Table 1

Asia Pacific Fair Value Index scores

Q2 2012 Q3 2012

Asia Pacific all-property 68 75

Asia Pacific office 67 78

Asia Pacific retail 68 70

Asia Pacific industrial 72 78

Europe all-property 53 62


Figure 2

Asia Pacific Fair Value Index ratings by country, Q3 2012


Figure 3

Asia Pacific total investment volume (USD bn) and Fair Value IndexTM


1 1 1

58

2

84

14

1414

5 639

0%

20%

40%

60%

80%

100%

Australia China India Other Asia Pacific

Cold Warm Hot

Asia Pacific index score: 75

0

20

40

60

80

100

0

10

20

30

40

50

60

2007 2008 2009 2010 2011 2012

Investment volume Fair value (RHS)



Required and expected return drivers

Growth remains challenging The Asia Pacific economies continue to be challenged by slowing global demand and regional GDP growth forecasts for 2012 have been downgraded from 4.3% to 4.2%, followed by a modest rebound (4.6%) in 2013 (Figure 4). The emerging markets have proved remarkably resilient, while the more exposed economies are feeling the chill of global economic headwinds. This is reflected in our Fair Value results, with the COLD category dominated by major financial centres, whilst the emerging markets offer better value. Meanwhile, in China, weakened investor confidence was evidenced by an uptick in government bond yields in the last few months, reflecting heightened risk aversion (Figure 5).

But monetary easing reduces borrowing costs Amidst all the dark clouds, there is a silver lining. The latest round of monetary policy easing will significantly reduce borrowing costs. In September, the European Central Bank (ECB) announced its boldest attempt yet to stabilise the single currency – an open-ended, unlimited bond-buying programme. Around the same time, the Federal Reserve in the US announced a third round of quantitative easing (QE3). Central banks in Japan, Australia and South Korea have also introduced monetary easing. Liquidity in China has also improved following several interest rate and Required Reserve Ratio (RRR) cuts. All of these measures have impacted our Fair Value findings via a reduction in required return estimates.

Limited yield-driven returns in core markets In the years following the global financial crisis (2009 and 2010), investors benefitted from strong yield compression and substantial rental uplift (Figure 6). This time round, the opportunities are harder to spot. Prices in even the most cyclical of markets, like Hong Kong, have remained firm during the latest crisis, with yields still hovering around historically low levels. This means that any increase in total returns in Hong Kong will be reliant on income growth rather than yield-driven capital growth. Meanwhile, yields in Singapore have compressed due to lower rental income. Nevertheless, with reduced borrowing costs and a lower risk premium, prospective returns are perceived to be reasonable. Shanghai, on the other hand, saw property yields soften in Q3 amid lacklustre investment activity – namely a decline in domestic State-Owned Enterprises (SOEs) buying assets for owner-occupation – and falling capital values. However, many expect market sentiment to reach bottom in Q3 and we foresee some scope for yield compression in Shanghai once buying activities are reignited.

Figure 4

Economic growth slowing – GDP growth forecasts

Source: Oxford Economics

Figure 5

Five-year government bond yields

Source: Bloomberg

Figure 6

Selected prime office yields

NB: Shanghai yields are gross; all others are net


-2%

0%

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10%

Asi

a P

acif

ic

Au

stra

lia

Ch

ina

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ng

Ko

ng

Ind

ia

Jap

an

Mal

aysi

a

Sin

gap

ore

Thai

lan

d

2011 2012 2013 2014

0%

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7%

2007 2008 2009 2010 2011 2012

Singapore South Korea Hong Kong

China Japan Australia

0%

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6%

8%

2007 2008 2009 2010 2011 2012

Sydney Shanghai Hong Kong Singapore



Market classifications

All movements are upgrades In line with an increase in the overall Fair Value IndexTM score, eight markets were upgraded this quarter. There were no downgrades (Figure 7). A fall in required returns, as a result of reduced borrowing costs and lower government bond yields, drove expected returns above required returns in several markets. These include Seoul and Singapore. In addition to a lower risk premium, better than expected office space demand in Singapore in recent quarters has prompted a slight upgrade to our rental forecasts. However, rental return has already been factored into pricing and the market is consequently rated WARM. Elsewhere in South East Asia, Jakarta continues to offer the strongest prospects, underpinned by a robust rental outlook (Table 2). Looking at the COLD catogory, we believe Taipei offices to be overpriced. Cash-rich local insurance companies have driven up prices and coupled with moderate rental growth, current market yields stand at a low of around 2.8%. However, recent regulations setting a minimum requirement on property yields – no purchases allowed with yields under 2.1% – could slow investment and dampen the outlook for capital growth in the medium term. Shenzhen offices is also categorised as COLD as the outlook is clouded by oversupply concerns. Across the border, investors looking at Hong Kong retail will need to broaden their scope and look for value-add opportunities in peripheral areas as pricing in prime locations is considered too expensive.

Retail offers value in emerging markets Q3 has been an important quarter for the Indian retail sector. Following a long waiting period, the Indian government has finally decided to allow up to 51% FDI in multi-brand retail. This will have a significant impact on the sector, simulating retailer expansion. However, there are winners and losers; whilst we are forecasting double-digit returns for Delhi prime retail, high vacancy is a persistent problem in poor performing shopping malls (Figure 8) Meanwhile, favourable demographics in Kuala Lumpur, such as a young population, urban migration and rising disposable incomes, will underpin strong rental returns. But, as yields have fallen to 6.5% – a level at which rental growth is priced in – our recommendation for the sector is WARM. Nevertheless, double-digit annualised returns still make Kuala Lumpur retail an attractive investment prospect.

Figure 7

Movement in market classification – Q2 vs Q3 Q3 2012

Q2 2012 COLD WARM HOT

COLD

Hong Kong offices

Hong Kong retail

Taipei offices

Shenzhen offices

Singapore offices

WARM

Delhi offices

Kuala Lumpur retail

Bangkok offices

Shanghai retail

Beijing retail

Shanghai industrial

Seoul offices

HOT

Jakarta offices

Beijing offices

Tokyo offices

Sydney industrial

Source: DTZ Research Table 2

Selected market pricing relative to Fair Value

Q3 2012 Degree of overpricing (negative is underpriced)

Jakarta offices HOT -25%

Beijing offices HOT -22%

Tokyo offices HOT -17%

Sydney industrial HOT -12%

Bengaluru retail HOT -9%

Kuala Lumpur retail WARM -5%

Mumbai retail WARM -3%

Bangkok offices WARM -1%

Melbourne retail COLD 6%

Hong Kong offices COLD 25%


Figure 8

Required and expected returns for Delhi and Kuala Lumpur retail (over the next 5 years)


0%

5%

10%

15%

20%

25%

Delhi retail Kuala Lumpur retail

Required return Expected return

WARM

HOT



Office market forecasts

Jakarta overtakes Beijing Building on strong rental growth seen in the first half of 2012, prime office rents in Jakarta grew by a further 10.3% q-o-q in Q3. We have subsequently upgraded our five-year average rental growth forecast to 15% p.a. (Figure 9 & Map 1). Combined with expected yield compression, we forecast annualised total returns in Jakarta in excess of 25% through to 2016 (Figure 11). Our rental outlook for Beijing remains robust, supported by ongoing lack of supply. However, the index score for Beijing has dropped slightly as the majority of projected rental and capital growth has already been realised. Market attractiveness has fallen sharply from the 2009 peak when investors were able to take advantage of low pricing before yield compression set in. Looking forward, we expect yields to remain relatively stable (Figure 10). Nevertheless, the market remains HOT. Despite also suffering from supply shortage, Hong Kong is set to see relatively weak rental growth going forward due to its heavy exposure to the financial sector. In fact, we have lowered our 2013 rental growth forecast for Sheung Wan/Central/Admiralty as near-term threats persist. Investors holding assets in Central should be wary of re-pricing risks in the long term, as decentralisation is likely to continue. Our outlook for Tokyo offices remains largely unchanged. Whilst the market recovery has been delayed by ongoing troubles in Europe and the US, we anticipate a return to growth in 2013 following four consecutive years of rental decline. This underpins out HOT classification. Whilst Delhi is expected to deliver similar income growth, high interest rates and lack of liquidity translate into higher required returns, hence its WARM classification.

Caution prevails in Australia despite high-yielding status We have previously advocated the attractiveness of Australian real estate due to the wide gap between property yields and falling government bond yields. Q3 witnessed a shift in sentiment, as falling commodity prices arising from the China slowdown impacted both leasing and investment activity. Those markets with abundant supply pipeline are most vulnerable, and we have consequently downgraded our rental forecasts for Melbourne. Low vacancy levels in Perth will lend some support to the rental outlook. Overall, with efforts by the central bank to shore up growth, demand is expected to recover from 2014 onwards. Assets with good covenant strength and secure income flow will provide investors with good value in the medium term, especially in light of current attractive pricing.

Figure 9

Prime office average annual rental growth (2012-16) and Q3 Fair Value classifications


Figure 10

Prime office yields in selected markets


Figure 11

Prime office average annual total returns (2012-16) and Q3 Fair Value classifications


-5%

0%

5%

10%

15%

HOT WARM COLD

0%

2%

4%

6%

8%

10%

12%

Beijing Delhi Sydney

Singapore Taipei Hong Kong

Forecast

-10%

0%

10%

20%

30%

Income return Capital value growth Total return

HOT HOT HOT WARM HOT HOT HOT HOT WARM WARM WARM COLD COLD



Retail market forecasts

Structural changes underpin rental growth in India The biggest news in the retail industry this quarter was the final ruling on the allowance of FDI into the Indian retail sector. This was already factored in to our forecasts, which remain unchanged, with rental growth of around 5% p.a. over the next five years (Figure 12 & Map 2). Six out of seven retail markets in India are rated either HOT or WARM. Shanghai and Beijing are also expected to see healthy rental growth in the medium term. Economic restructuring towards a consumption-driven economy has further increased the potential purchasing power of China. Despite slowing retail sales in line with weaker economic growth, retailer expansion and upgrading shows no signs of abating. However, some degree of future rent rises were realised this quarter as landlords lifted rents upon tenant mix adjustment. South East Asian markets offer attractive opportunities Retailer demand in other emerging markets, such as Kuala Lumpur and Bangkok, is also strong. Bangkok retail offers investors the prospect of strong income returns, driving total returns of over 10% p.a. (Figure 14). In Kuala Lumpur, capital appreciation will compensate for relatively low yields. We forecast the weakest rental growth in Singapore, where landlords are under pressure to re-position their assets and abundant new supply is limiting their ability to raise rents, despite solid demand. Total returns will be driven by future yield compression as capital takes advantage of low interest rates. But the market is nearing fair value and is currently only 7% underpriced. By contrast, total returns in the Australian retail markets are mostly reliant on income return rather than capital appreciation. Melbourne, which is yielding just 4.75%, is the only market in Australia rated COLD.

Hong Kong retail: how much lower can yields go? Low interest rates coupled with the weak dollar is fuelling interest in Hong Kong retail, where prime yields are now below 2% (Figure 13), and yields in secondary locations are not much higher. International retailers continue to flock to the market to profit from mainland Chinese consumer spending and new entrants are outbidding each other and existing retailers to secure the best space. We expect a correction in yields towards the end of the forecast period as interest rates rise. Further capital appreciation is limited so investors would do well to focus on value-add acquisitions that require substantial tenant mix adjustment and reconfiguration.

Figure 12

Prime retail average annual rental growth (2012-16) and Q3 Fair Value classifications


Figure 13

Prime retail yields in selected markets


Figure 14

Prime retail average annual total returns (2012-16) and Q3 Fair Value classifications


0%

1%

2%

3%

4%

5%

6%

HOT WARM COLD

0%

2%

4%

6%

8%

10%

12%

Beijing Delhi Hong Kong

Kuala Lumpur Singapore Sydney

Forecast

0%

5%

10%

15%

20%

25%


HOT WARM WARM HOT WARM HOT HOT COLD COLDHOT



Industrial market forecasts

Stable income flow adds value to industrial Industrial property generally delivers smaller rental growth than the office and retail sectors, with forecast over the next five years lower than 4% p.a. for the majority of markets (Figure 15 & Map 3). Shanghai has the strongest prospects due to limited availability of land and the move towards more high value industries. The industrial sector in China is also benefitting from the growth of domestic retail. Similar to Shanghai, Singapore industrial is expected to deliver decent rental growth of around 3% p.a. to 2016. Strong investor demand in both markets is likely to drive yields down further, pushing up capital values (Figure 16). However, the relatively high yield status of both markets means that there is still room for growth and this is reflected in our HOT Fair Value classification. We expect prime yields in the other Asia Pacific markets to remain relatively flat over the forecast horizon. In some markets, such as Taipei and Hong Kong, yields are forecast to move out towards the end of the forecast period.

Double-digit returns in Australia With yields above 8%, the five Australian markets within our coverage are set to deliver strong total returns, driven by growth in the transport and logistics sector (Figure 17). The favourable status of Melbourne is being challenged by the weakening economy, but lack of supply will exert some pressure on the market in 2013. Meanwhile, demand for space has picked up in Sydney, and there has been a transition in terms of supply. Perth and Brisbane are likely to see more subdued growth compared to the last few quarters on the back of a slowdown in the resources sector. Demand is subsequently being put on hold but we foresee a return to growth next year. As our worst performer in terms of total returns, Hong Kong remains in the COLD category. As we have mentioned in previous reports, Hong Kong’s industrial market is gradually becoming obsolete as manufacturing moves to the Mainland. Investors continue to buy industrial units with the aim of converting them for residential or other commercial use and this is pushing up prices. In Taipei, local insurance companies continue to chase after industrial assets and this will hold up values in the short term. With expected total returns of 3% p.a. to 2016, we think opportunities are fully priced so upward potential is limited.

Figure 15

Prime industrial average annual rental growth (2012-16) and Q3 Fair Value classifications


Figure 16

Prime industrial yields in selected markets


Figure 17

Prime industrial average annual total returns (2012-16) and Q3 Fair Value classifications


-2%

0%

2%

4%

HOT WARM COLD

0%

2%

4%

6%

8%

10%

Hong Kong Melbourne Perth

Shanghai Singapore Taipei

Forecast

-10%

-5%

0%

5%

10%

15%


HOT HOT HOT HOT HOT HOT COLD COLDHOT



Appendix 1

Map 1

Asia Pacific prime office rents, average annual growth 2012-2016 (% p.a.)




Appendix 2 Map 2

Asia Pacific prime retail rents, average annual growth, 2012-2016 (% p.a.)




Appendix 3 Map 3

Asia Pacific prime industrial rents, average annual growth, 2012-2016 (% p.a.)




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DTZ Research Contacts

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