08 May 2017
Results from our Q1 Global Commercial Property Monitor indicate that the dispersion in sentiment across Asia Pacific markets increased in the first quarter. The majority of markets continue to respond to domestic supply and demand conditions, rather than a broad regional trend.
Respondents indicated that they expect markets such as Sydney, Auckland, and Tokyo to continue to outperform, while greater China remains highly nuanced. Although downbeat sentiment surrounding ASEAN markets moderated, respondents indicated that the bottom of the cycle is yet to be seen.
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Core markets looking expensive
Interestingly, feedback from chartered surveyors indicated that capital valuations forecasts may have become detached from views on valuations and the phase of the property cycle. The majority of respondents in Sydney, Tokyo and Auckland all view the property market as expensive and say the market is at its peak, but also forecast that these markets would see the largest capital value forecasts for any market in Asia-Pacific ex-India.
These markets have also seen a substantial deterioration in office yields. Data from Real Capital Analytics shows that yields on office space in Sydney have declined from 8.4% in Q1 of 2012 to 5.8% in the first quarter of this year, while those in Tokyo have fallen from 5.3% to 4.5% over the same period.
Investors wary of risks
Participants at our recent Global Investment Risk Management Forum in Singapore, which included some of the top investors across Asia-Pacific, aired concerns that a combination of yield compression across Asia-Pacific and higher yields on US fixed income driven by tighter monetary policy could spell the end of the recent bull-run for commercial property. Although this outcome is by no means deterministic, this is a risk that remains on investors’ radars.
Participants at the Forum did note that it the supply of prime properties in core markets remains inadequate for the levels of capital that need to be deployed. Evidence from other surveys throughout the region suggests that investors who have seen significant appreciation in capital values in recent years, remain hesitant to sell properties and lock in capital gains, despite the yield compression that has occurred. Real Capital Analytics data also supports this view, as volumes were down 13% and 59% for Q1 in Japan and Australia, respectively. Anecdotally, this is explained by investors having few other options in how to deploy their capital.
This is particularly true for the Japanese market, where the Bank of Japan’s (BoJ) Negative Interest Rate Policy has made real estate one of the only investable assets for investors such as pension funds and insurers which need to manage long-term liabilities. These investors would normally hold fixed income assets, but yields at zero percent for Japanese Government Bonds means that this is no longer viable. Moreover, tight US dollar funding markets have pushed up swaps premiums paid by Japanese investors and act as a barrier to moving capital to foreign markets.
Policymakers across Asia-Pacific are becoming more cognisant of the potential for froth in commercial property markets. The BoJ noted in its most recent financial stability report that although banks’ willingness to lend is the highest it has been since the early 1990s, almost all new lending has been absorbed by REITs. This suggests that credit is not being channelled to the more productive areas of the economy that is able to support long-term growth.
Data from our commercial property monitor supports this thesis. Since the BoJ launched its Quantitative and Qualitative Easing programme in 2013, momentum in the office sector has significantly outperformed that in the industrial sector as shown by both the RICS Occupier and Investor Sentiment index. This suggests that manufacturers in Japan remain reluctant to increase investment in domestic facilities.
Downside risks remain
This is by no means a purely Japanese phenomenon. The Reserve Bank of New Zealand (RBNZ) has also warned on risks surrounding credit to commercial property investors in its most recent financial stability report. The RBNZ noted that commercial property inflation had continued to be supported by low interest rates, and characterised it as one of the three main risks to financial stability.
So although respondents remain bullish on a number of markets, the outlook remains fragile for a number of Asia-Pacific markets. Namely, markets remain exposed to the risk of a faster-than-expected monetary policy normalization policy by the US Federal Reserve contributing to a reversal in sentiment across core markets in Asia-Pacific.
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