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Asia-Pacific cities in Tomorrow's World: Investability is key

Asia-Pacific cities in Tomorrow

In the fifth installment of our Asia-Pacific cities research series, we discuss investment opportunities for the office sector within the Asia-Pacific region.

The rapid development of Asia-Pacific over the years, and in particular, the rise of China over the past decade, have provided global institutional real estate investors with diversification and growth benefits, as well as a wider universe of assets to invest in. As previously discussed, the region is the epicentre of global megatrends and potential future opportunities. As regional growth continues to outpace world averages, the weight of economic dominance will continue to tilt towards the East, placing Asia-Pacific at the forefront of the many investment opportunities available to real estate investors.

This strong macro backdrop should, in turn, translate into better and more interesting investment opportunities for the commercial real estate market. As a factor of production in the local economy, commercial real estate values are inextricably linked to economic growth. Strong business performance translates into excess corporate profit which may drive higher rental income and ultimately, capitalise into rising values. Although still only accounting for 17% of the global total, the level of investable stock across Asia-Pacific has risen by 23% between 2010 and 2016, accounting for 64% of growth in global office stock during the period. This trend of Asia-Pacific accounting for the largest source of most of the increase in the global property universe, is set to continue in the coming years (Fig.1).

Fig.1: More interesting opportunities

Source: Real Capital Analytics, 2017

However, beyond a wider net of assets to choose from, structuring a global real estate portfolio through a robust strategic or tactical allocation, also requires an in-depth understanding of the opportunity set in each of the selected markets. For example, in Tokyo, the level of Grade-B office stock accounts for roughly 75% of the investable universe. This is a result of the much earlier industrial development of the Japanese economy and a more diversified nature and scale of the city. It comes as no surprise that modern, high Grade-B Tokyo offices form a substantial proportion of a typical global or domestic institutional real estate portfolio, given the liquidity, investability and smaller scale of the assets. While many large-scale office projects in the development pipeline, in the Toranomon and Shinagawa districts are likely to lift the percentage of Grade-A office stock higher in the coming years, much of it will be held privately in developers' balance sheets and is not likely to broaden the Grade-A investment universe significantly.

Similarly for other mature core cities, such as Seoul and Singapore, the Grade-B investment universe ratio stands at around 60% and 70%, respectively. However, in Seoul’s case, the dominance of the large chaebols and a relatively less transparent market means that private domestic investors are more active in the Grade-B segment. By contrast, in the more recent emerging growing office markets, such as Shanghai, Beijing and Melbourne, the rapid development of new, large-scale office buildings in recent years has allowed global institutional investors to more actively deploy capital into the Grade-A space. In Shanghai and to a lesser extent Beijing, newer office stock built by local developers is often sold into the market in order to recycle cash flows, particularly in the more decentralised districts. By contrast, Central Grade-A office assets in Hong Kong are held closely by the developers. Regardless of the price cycle, the investment ticket size in Chinese cities, such as Hong Kong and Seoul, tends to be much bigger than in the Australian cities (Grade-A) and Tokyo (Grade-B) (Fig.2).

 

Fig.2: Not just when, but also what to buy

   

Source: Real Capital Analytics, 2017

 

The growth of the investable market across Asia-Pacific will provide global investors with a wider pool of options. Beyond the size of the opportunity set, however, investors will also need to consider the depth of the market i.e. liquidity and the typical size of transactions, in order to make the most meaningful capital allocation to achieve the best risk-adjusted returns.

 

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