• The Year of Living Dangerously

    21 April 2016

    Markets will take on a familiar appearance in 2016, aping 2015, but this year there are a clutch of key issues that investors must consider.

    HONG KONG SKYLINE_2015

    Faltering economies, rising interest rates and affordability issues across broad areas of Asia’s cities are just some of the hurdles that the Asia-Pacific property market must clear this year if is to remain on a healthy growth trajectory.

    Most analysts believe this year will be defined by rising interest rates, a slowing mainland Chinese economy – the dreaded hard landing – flagging retail sales and continuing uncertainty in the finance, insurance, real estate and business services (FIREBS) sectors. However, demand by institutional investors, fuelled by outbound Chinese capital, is also likely to buoy markets in the Asia-Pacific region. Underpinned by a tight supply of investable stock with an adequate return, investors are likely to be forced to get creative.

    INVESTMENT PROSPECTS

    “Institutional investors, which have looser return requirements, will focus on prime core assets for long-term holds,” CBRE says

    in annual forecast. Those prime core assets are thought to be shopping malls and enbloc offices. “Investors seeking higher yields will increasingly turn to niche sectors such as self-storage, senior housing and student housing in 2016.”

    While international investors and funds remain committed to making inroads into under-represented Asia, Asian investors are going to stay close to home. “The cost of funding will head south in markets such as China and India, while real estate yields will likely increase,” CBRE says. As interest rates in the United States edge upward, the Asia-Pacific region will become a prime investment destination. In Australia, a weakening currency, positive demographics and a diversifying economy kept the country on the investment radar last year, and there it should remain this year. “Over the last five years the Australian dollar has fallen a very significant 36 percent against the US dollar,” says Tony Crabb, national head of research for Savills Australia. “This has had a profound impact on opportunities in Australia, including an important boost in both student and tourism numbers, and made investments across most sectors far more compelling.”

    NORTHERN EXPOSURE

    Seoul Cityscape

    Also worthy of consideration is Japan’s potential performance this year, where confidence in Abenomics is slipping, assets are limited and capital could be too cheap. Even so, “Japan continues to be a favourite target for opportunistic funds, although some of the deal-structuring strategies used are beginning to raise eyebrows,” PwC and the Urban Land Institute say in Emerging Trends in Real Estate Asia Pacific 2016. Cap rates in Tokyo are low, at about 3 percent, but even lower borrowing costs create yields that can be leveraged as high as 90 percent – the highest in the Asia- Pacific region. The result is that Tokyo – along with Osaka, Sydney and Melbourne – sits at the top of the investment location list this year.

    NEW ORDER

    Despite an economic slowdown, mainland China still leads the way in letting offices and – to a degree – selling them. Hong Kong remains the primary beneficiary of this trend. Mainland investors still looking to establish a presence in Hong have helped stave off a slide. It turned out that 2015 was strong year for letting offices in Hong Kong, “It was a good year in Central, with about 618,000 square feet of take-up. For some context, the 10-year average is about 250,000 square feet,” JLL’s head of markets Ben Dickinson said. Even so, Dickinson expects demand to moderate this year and that rents will consequently climb moderately, too – by about 5 percent overall. Chinese banks retain their focus on Hong Kong throughout the year ahead but across the region it is modern industries that are enjoying the most influence. Tech and tech firms now wield the power to affect how developers and landlords build and reconfigure properties. The core services and shifting labour demographics of these businesses have specific requirements. “Technology companies will drive growth across Asia in 2016, especially e-commerce operators,” Colliers International Asia-Pacific chief executive David Hand says. “These companies will continue to display a strong appetite for high quality space in core locations, while also expanding to new locations to attract quality talent.”

    INDIAN INFLUENCE

    The technology hotbed of India flew under the radar despite major office markets in Delhi, Mumbai and Bangalore being the best performing in the Asia-Pacific region. India was the region’s most active letting market last year and accounted for half of the region’s total gross office letting, according to JLL.

    Not surprisingly, IT, e-commerce, technology outsourcing, start-ups and consultancies led demand but new occupiers are expected to enter the market this year. “Players in many other sectors like FMCG (fast-moving consumer goods), BFSI (banking, financial services and insurance), manufacturing, telecom and pharma did not come into the market. However, this should happen in 2016 and 2017,” JLL India chairman and country head Anuj Puri says. Puri expects to “see demand for built-to-suit properties, especially from the larger IT occupiers”.

    RETAIL FLOW

    Content_Office Interior

    With the financial services sector playing it safe or expanding conservatively, new industries are likely to demand additional space. Technology, e-commerce and Internet services are expected to drive demand for industrial and logistics support. “The technology sector, especially e-commerce operators, will be one of the most active groups in Asia due to sustained growth in their business in the region,” Hand says.

    Supporting the industrial sector by association is the rising middle class, still the backbone of retail. Investors in the retail sector that have typically looked at core assets such as shopping centres are likely to wary of inflexible or ill-conceived properties, particularly in emerging markets such as Indonesia and Vietnam, and to follow the tourist dollar. That may indicate a flow into infrastructure related to mainland Chinese travellers for whom Japan is increasingly a prime destination.

    SHOPPING IN JAPAN

    In addition to hotels, the bright spot in Japan, chiefly Tokyo, is retailing. As long as the yen remains cheap, tourism will continue to surge up to the 2020 Olympic Games. PwC predicts Tokyo and Osaka will be among the top five markets for investors in retail this year, alongside Ho Chi Minh City, Manila and Jakarta. Struck from the list are Guangzhou, Hong Kong, Shenzhen and second-tier Chinese cities.

    One final hangover from last year is how technology has altered the face of retail and seen reduced demand for property in more developed markets. Industrial property remains in demand owing to the fundamentals of e-commerce. Another technology-linked cottage industry is data storage, creating demand for data centres. With security and a reliable power supply just two of the crucial requirements for data storage, Hong Kong and Singapore could see a heightened focus on industrial space – a market set for relatively strong growth, given the shortage of supply.

    NEW RETAILING REALITY

    As the flow of mainland Chinese visitors into Hong Kong slowed last year and the spending on luxury goods declined with it, the city’s commercial property market hit the front pages. It seems the story will remain there throughout this year. Colliers International predicts prices of retailing property will fall by an average of up to 24 percent this year. Savills is more optimistic, projecting rises in rents in shopping centres of up to 5 percent and falls up to 15 percent in rents for space in prime shopping areas. There may be a silver lining. As conventional  retailers exercise caution, food and beverage (F&B) outlets are stepping in to fill the void, says JLL associate director of retailing property Michelle Chiu. JLL launched a new service at the end of last year catering to these businesses, despite some dour predictions.

    Content_Retail Interior

    “F&B operators remain very aggressive despite the downturn in the retail market. Not only are we seeing a lot of new entrants into Hong Kong, we also see a lot of local operators aggressive in their expansion,” Chiu says.

    Evens as established operators and smaller outlets expand into bigger spaces, there are several factors underpin the growth in F&B. Flagging sales of luxury brands are at the top of the list, compelling landlords, particularly in shopping centres, to restore the proportion of their space occupied by F&B outlets, which had shrunk during the glory days of shopping for luxuries.

    “We’ve seen a very drastic reversal of this in the past few months as mall operators understand the importance of F&B as a key draw for bringing traffic into different malls. We also see destination retail being very popular, with F&B being the main driver, like at The Pulse in Repulse Bay and Fashion Walk in Causeway Bay,” Chiu says. Landlords are beginning to build features that attract restaurants: high ceilings and terraces to appeal to outlets usually found at street level, such as Jamie’s Italian in Causeway Bay. Establishments that serve desserts or healthy food, that offer casual dining, or that are manifestations of lifestyle concepts – all stemming from growing globalisation –round out the list. Vivienne Westwood Café, Francesco by Franck Muller and Mercedes Me by Mercedes-Benz and Maximal Concepts, among others, are using F&B to market their brands.

    The phenomenon extends beyond Hong Kong, now that fat expense accounts are shrivelling. “This is very Asia-wide. Singapore is experiencing the same market trends as Hong Kong,” says Chiu. “For example, everyone agrees that high-end dining is out. Casual cuisine is more popular.”CBRE executive director of retail services Joe Lin points to the combination of rising overheads and weakening sales. “This is an Asia-wide phenomenon,” Lin says. “This year we saw the F&B and lifestyle trends emerge with 1921Gucci in Shanghai iAPM and Café Dior by Pierre Hermé on the top floor of Christian Dior’s flagship store in Seoul,” he says. “Most major luxury retailers are now well established in Asia-Pacific, but these markets are approaching saturation point following years of rapid expansion.”

    RISING INTEREST

    Some of greatest minds spent last year parsing the words of Janet Yellen and other members of the United States Federal Reserve. On December 16, after months of wondering if or when she would raise US interest rates, a 25-basis point increase was the first in a decade.

    As 2015 gave way to 2016, interest rates in Hong Kong and elsewhere in the Asia-Pacific region were steady. While another increase in US interest rates is likely, the current approach by regulators is to refrain from disrupting markets – any market. Interest rates in the Asia-Pacific region vary widely. In mainland China and Australia they are about 5 percent or 6 percent. Official rates in Japan are negative and, in real terms, they are negative in Hong Kong. CBRE does not expect the Fed’s action in December to affect yields adversely, as almost everyone had been expecting it. But things could change when US interest rates rise again. Mainland China, with its faltering economy, has been cutting its interest rates, so the increase in US rates will narrow the difference. However, the Fed’s action may presage further depreciation of the yuan, deterring more rate cuts by the People’s Bank of China. CBRE said it expected “mild yield decompression across most asset classes (with the exception of logistics) and across most cities in 2016”. However, it attributes its expectation largely to chronic oversupply and economic challenges.

    Hong Kong and Singapore are unlikely to feel any sting anytime soon. Singapore had already factored an increase in US interest rates into the Singapore Interbank Offered Rate, the local reference rate, and yields there should remain steady, though capital values may come under pressure due to an insufficiency of occupiers. Hong Kong’s super-low interest rates will come under no pressure to rise until next year. In the commercial property market, reduced vacancy rates will reduce the threat posed by higher interest rates. Capital values and rents will remain stable, except perhaps for shops in the street, where weak demand is the threat.

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