PWC ULI real estate Asia Pacific outlook 2018

PWC ULI real estate outlook report asia pacific 2018

PWC and ULI have teamed up again to produce their annual report on the outlook of the real estate market in Asia Pacific in 2018.

As usual, they interview key real estate investors around Asia and gather their feedback to try to determine where the real estate market is headed.

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The report is a tome of 64 pages so here are the key points.

A lot more work required to generated returns

Increasing amounts of global and local capital are flowing into real estate across the region, and there is unprecedented amount of competition for the same amount of stock.

More buyers means higher prices and lower yields.

A fund manager said, “In the past, when we picked investments we would just say, ‘This is China, so we expect capital values will go up’.” This is no longer the case. Some investors used to target 20+% returns on opportunistic investments, driven by cap rate compression, but now they see a greater proportion of the 20% coming from current income. This means that investors have to asset manage and work each property harder.

Core buyers taking more risk

China insurance companies are happy to pay prices considered excessive by global standards.

Their thinking is reflected in their attitude of buying property now (at high prices), and not risk the opportunity to own some stuff, especially when these insurers require an income stream to give their policyholders in future.

Most institutions are also migrating up the risk curve by taking on development projects. Some of these are purely speculative builds, while other investors are building to forward sell it to institutional and sovereign funds.

Rental growth slowing

With cap rate compression harder to come by, rental growth is the next driver in providing returns.

However that is difficult to come by as the global economy is just beginning to find its feet and shed off the fears of the global financial crisis.

In this regard, asset management and hands on managing of properties is becoming a popular strategy.

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Alternative assets become popular

Alternative asset classes include data centers, affordable housing, multifamily, student housing, senior housing and coworking spaces.

The key reasons given by investors for investing in alternative assets/sectors are

  1. Demographic demand drivers 295
  2. Higher yields 24%
  3. Diversification 19%
  4. Stable income return 16%
  5. Less competition from other investors 13%

The shift to alternative assets, though not new, has become pronounced in the past year, with investors increasingly willing to take a bet in these sectors.

Only 2 years ago, such sectors were shunned because of the lack of understanding by investors in them, the greater perceived risk and a need for operational and technical expertise to manage such assets.

In the data centre sector, investors are of the view the supply/demand dynamics are positive, with shortage in capacity and an impending increase in supply as companies move to the ‘cloud’.

Investors have identified Hong Kong, China, India and Singapore as potential data centre investment destinations, with projected internal rates of returns of 13 to 15%.

Affordable housing is beginning to gain traction especially in Hong Kong, Indonesia and India.

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Many affordable housing projects are backed by the government, with them giving such projects “infrastructure status”, allowing them access to lower financing cost and tax exeptions. According to Cushman & Wakefield, the supply of newly constructed affordable homes in India increase 27% on year in the first 3 quarters of 2017 to 26,000 units.

In Indonesia, the government is slated to build 900,000 affordable housing units at an average sale price of US$33,000 each in 2017. In 2016, 700,000 units were completed, mostly in low-density projects about 25-30 km out of the city.

However, one difficulty investors have with affordable housing projects is the government’s involvement. One fund manager said he would have preferred to see the sector stand on its own rather than with the benefit of government subsidies.

With multifamily, the increase in home prices around the region is driving the need for long-term rental housing stock.

This is a sector with obvious appeal for yield-oriented investors given the long term nature of the leases that are locked in.

However, most Asian markets do not have a history of build-to-rent real estate unlike western markets. As such, fund managers interested in this niche asset class in Asia are still figuring how to operate and make money from it.

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In China, foreign and domestic developers are actively working to establish operating platforms. Their target is the younger demographic who are choosing to move away from their parents and having their own place to stay.

One foreign fund established a platform by leasing older office buildings on a long term basis of 10 to 20 years and then converting the space into studio apartments of 22 to 25 sqm. Each unit is then sublet out at US$400 to US$500.

Yields for multifamily housing in China is said to be as low as 2%. The lack of a formal legal structure also presents obstacles for investors. Nonetheless, momentum is gathering, with the chinese government seeming intent on creating a financing framework to allow developers to spin off low yielding residential assets.

Investors have been active in the student housing sector for some time now, and the focus continues to be on Australia.

International student numbers are booming and inner-city housing is popular with such students who want the convenience of living close to campus.

Money continues to flow out of China

Capital continues to flow out from Asian markets in the first half of 2017, with CBRE estimating about US$45b of outbound capital going into global property assets.

The biggest supplier of Chinese outbound capital is institutional, where the country’s sovereign wealth fund deployed much of the US$26b of China outflows in the first half of 2017.

Bidding by Chinese developers is aggressive, and their activity has caused land prices to soar in many Asia Pacific cities such as Hong Kong, Australia and Singapore. According to RCA, development site sales in the region climbed 38% on year to US$240b in the first half of 2017.

By source of Asia outbound real estate investment in the first half of 2017, China took top spot with US$26b followed by Singapore at US$6.8b, Hong Kong at US$6.6b, South Korea at US$2.9b and Japan at US$1.3b.

Asia Pacific on the radar of investors

In terms of regions targeted by private real estate investors in the next 12 months, there has been an increase in percentage of respondents saying Asia Pacific is their target market.

In 2Q 2016, 21% of investors said they are targeting Asia Pacific, and this has risen to 27% who intend to deploy money in the next 12 months.

All other regions stayed stable or fell. 40% of respondents continue to target North America in 2Q 2017, unchaged from 2Q2016, as is 5% targeting “Rest of World”.

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Investors targeting Europe (from 56% to 54%), Emerging markets (from 11% to 7%) and Global (from 41% to 38%) have all fallen.

Asia Pacific remains top of mind for most investors.

New financing options as banks retreat

With tighter bank lending regimes and ever shrinking returns from investing in conventional real estate, fund managers have begun to look at debt and mezzanine lending.

One fund manager said that there is a funding gap to provide preferred equity or mezzanine lending, just behind senior lenders. 

Senior lenders are providing a lower level of leverage, so these players can come in at the 50 to 70% LTV mark, have an equity buffer above, and still get attractive risk-adjusted returns.

One would expect that such managers would have runaway success but anecdotally, fund size of such debt providers are small, and their success has been limited.

Japan is one market that has been drawing foreign investor interest, with the focus on tenor, either in the form of long term debt or short term bridging loans.

In China, mezzanine debt is available, with reported returns in the area of 25 to 30%. India has a return range of 16 to 18% compared with standard construction lending of 12 to 13% from local banks.