Part of the M&G Group

M&G Real Estate: Asia Pacific Outlook

Dec

embe

r 201

6

3

The economic outlook for major Asia-Pacific markets

remains relatively healthy, with overall regional growth

estimates for 2017 upgraded slightly to 4.6% in the third

quarter. This was led by improved forecasts in Australasia

and India, which helped to widen the region’s expected

outperformance over North America (2.2%) and the euro

zone (1.3%). However, with the surprise victory of Donald

Trump in the US presidential elections in November, there

is now some potential for a stronger US domestic economy

at the expense of global trade.

Uncertainty over US trade policies could lead to a

re-assessment of regional performance but the actual

impact could be drawn out, so there are strong grounds

to remain optimistic, not least because of growing intra-

regional trade.

Executive summary• Asia-Pacific economic outlook healthy in

near-term, but policy uncertainty globally

poses risks.

• Regional property total returns look set to

taper as yield compression slows with lower

transaction volumes.

• Development, alternatives, and tactical

opportunities could drive next wave of

investments.

250%Ratio to GDP of China’s non-financial debt

15%+ Expected rise in Sydney effective office rents in 2016

6.5% Average annual APAC property returns expected

in next 3 years

China looks set to report GDP growth of 6.7% for 2016,

with a slight increase in commodity demand helping to

soothe nagging worries over a possible economic hard

landing. Fears of stock market and housing bubbles in

China continue to rank among the biggest risks to the

Asia-Pacific economy because of the financial system’s

escalating debt levels. Non-financial debt in China has

risen to more than 250% of GDP from 150% in 2008

and smaller Chinese banks have extremely high loan-

to-deposit ratios that put them at risk if non-performing

loans increase. Much of China’s positive economic

outlook, and perhaps the world’s, rests on the belief that

the Chinese government has the financial strength to

support any crisis.

In addition to domestic issues, recent political and

economic relations between the US and China appear

to have worsened and any negative ramifications could

potentially affect the global economy.

“Fears of stock market and housing

bubbles in China continue to rank among

the biggest risks...”

In Japan, unprecedented efforts to lift the world’s third-

largest economy out of a 20-year deflationary spiral

appear to have hit a wall. “Yield Curve Control” was

unveiled as the central bank’s latest policy to boost public

confidence and inflation. The policy aims to manage the

yield curve by keeping 10-year yields at zero and out of

negative territory.

Thus far, the loose monetary regime set by ‘Abenomics’

has supported investment assets well but, as yet, it has not

strengthened the real economy significantly, with private

capital investment and consumption spending growth

Near-term economic outlook remains healthy

Fig 1: APAC still comfortably ahead

Source: Consensus Economics.

US Euro zone APAC

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The near-term economic outlook for the Asia-Pacific region

is likely to remain uncertain following this year’s surprise

UK vote to leave the European Union as well as the

unexpected US election result. A Trump administration

could potentially be positive for the domestic US economy

but global trade now appears to be more at risk as potential

changes to trade agreements could hurt Asian exports.

More uncertainty lies ahead in 2017 with much of mainland

Europe going to the polls and Asian geopolitical tensions

on the rise. However, we remain optimistic in the long-run

and expect the Asia-Pacific region’s consumption outlook –

with the middle classes expanding rapidly in China, India,

and Southeast Asia – to continue to underpin economic

growth for the foreseeable future.

“...we remain optimistic in the long-run

and expect the Asia-Pacific region’s

consumption outlook – with the middle

classes expanding rapidly in China, India,

and Southeast Asia – to continue to underpin

economic growth for the foreseeable future.”

By country, the property market outlook remains as

divergent as their respective economic stories, with the

only common themes being strong Chinese tourism growth

and persistently low property yields. In broad terms, the

pace of yield compression seems to have tapered off as

investors become wary of the demanding valuations and

toppish rental cycles. This is perhaps best illustrated by

the continued decline in transaction volumes, which have

Divergent markets – stock withdrawals and rental rebounds the key drivers

still slow. The Japanese government’s 2% inflation goal

remains elusive with consumer sentiment and business

conditions still weak. Major retailers are also still choosing

to hold or even lower prices to draw out consumers’ wallets.

Elsewhere, economic situations across individual markets

continue to diverge. In Australia, Sydney and Melbourne

are growing strongly on the back of record-low interest

rates and a housing boom. Infrastructure construction and

residential redevelopment in the Sydney and Melbourne

central business districts is driving real output growth,

along with related business and professional services

such as legal and real estate, etc. Consumer sentiment

has received a huge boost from the ongoing surge in

residential prices, up over 30% since 2013.

Meanwhile in Brisbane, and particularly Perth, economic

conditions remain soft, despite improving commodity

prices. Even as commodity demand picks up, incremental

investment from this sector appears unlikely. With some

firms still facing financial difficulties, bad loan risks are still

high, so Australian bank and sovereign credit ratings face

potential downgrades.

South Korea has also seen a gradual pick-up in growth,

driven by low interest rates and the government’s fiscal

efforts, including the latest KRW10trillion (US$8.5 billion)

stimulus package. But doubts remain over the Korean

recovery’s sustainability, given fluctuating industrial and

manufacturing output reports over the course of 2016.

Labour strike issues and the impeachment of the country’s

president have further clouded Korea’s economic outlook.

Two of Asia’s key global cities Singapore and Hong Kong

continue to face strong headwinds as they struggle

through their respective structural problems.

Singapore’s government GDP guidance fell further to the

lower end of the 1-2% official estimate after economic

data for the third quarter showed some weakness in the

manufacturing and industrial sectors. Recent defaults by

oil and gas service companies and persistent weakness

in the shipping industry have played a part in keeping

consumer sentiment muted. 2017 growth forecasts

also look soft. The government’s drive to attract higher-

value manufacturing and technology companies to help

offset weakness in the ailing financial sector faces strong

competition globally.

Slower Chinese growth plus growing competition from

mainland Chinese hubs Shanghai and Shenzhen are part

of the structural shift that Hong Kong faces. Political

uncertainty also appears to be rising again, two years

after mass pro-democracy protests erupted. Pro-Beijing

and pro-democracy camps are raising the stakes ahead of

elections in March for the Special Administrative Region’s

chief executive. The uncertainty over China’s reaction has

kept some business decisions on the side lines.

Source: Bloomberg.

Australia

South Korea US

SingaporeHong Kong Japan

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Fig 2: Property’s relative yield appeal

5

peak of the cycle with the looming supply pipeline likely to

enter the market from 2018-19. On the retail front, inbound

Chinese tourist arrival figures continue to rise at a heady

pace, though average tourist spend has declined. With

visitors spending less on luxury retail, prime retail rents

will continue to benefit from Japan’s tourism drive but are

unlikely to enjoy the huge increases seen in recent years.

Logistics-driven industrial demand remains strong,

particularly in Tokyo Bay, where vacancy remains low.

Outside of the prime industrial areas there is evidence that

the rate of absorption has slowed, although vacancy rates

remain low. Relatively stable returns in Japan’s industrial

and residential sectors are also helping to underpin

investment interest.

“Logistics-driven industrial demand

remains strong, particularly in Tokyo Bay,

where vacancy remains low.”

The office sector in Seoul continues to see high incentive

levels as the supply pipeline comes on-stream. With

domestic demand making up the majority of absorption,

the uncertainty in the Korean economic outlook is

likely to have an impact on expansion plans and rental

growth. Similar to Tokyo, the retail sector in Seoul has

been a beneficiary of Chinese tourism. Prime retail in

Myeongdong district has seen stable rental increases due

to its concentration of more-affordable cosmetics and

fashion retail shops, instead of luxury boutiques.

Hong Kong’s traditional gateway-to-China role for

international firms could potentially be compromised as

Tier-1 cities in China continue to develop rapidly. The

incremental demand needed to absorb the large supply

pipeline in Kowloon East also seems unlikely to come

through, as financial firms downsize. Still, office demand

in Hong Kong Central remains resilient as firms continue to

been slowing since the second quarter of 2015. The decline

would have been even more pronounced in the absence of

major acquisitions by sovereign, national insurance, and

pension funds.

As highlighted previously, the combination of population

growth, monetary stimulus, and foreign investments has

led to a surge in residential prices in Sydney and Melbourne.

Positive consumer sentiment, along with continued tourism

demand, have been supportive of retail sales and rents,

while the redevelopment of the CBD has brought about

significant stock withdrawals in the office market. These

withdrawals are the key driver of strong rental increases

given fairly flat net absorption demand levels. Sydney

office rents are expected to rise in excess of 15% in 2016,

particularly in the secondary office market where most

of the withdrawals are taking place. While office rental

incentives in Sydney are falling sharply, albeit from a high

base, in Melbourne they remain sticky due to the potential

pipeline of new supply in the Docklands area.

“We expect prime Australian real estate to

be one of the few developed sectors in

Asia-Pacific to still see some yield

compression over the next five years.”

At the other end of the spectrum, Brisbane and Perth

continue to see limited occupier demand and negative

net absorption. With vacancy rates at multi-year highs

and the rental gap with Sydney widening, investors are

increasingly looking towards these markets, particularly

Brisbane, as potential contrarian investments. We expect

prime Australian real estate to be one of the few developed

sectors in Asia-Pacific to still see some yield compression

over the next five years.

Office rental growth remained strong in Tokyo, driven by

low vacancy rates and fairly strong leasing activity. While

this growth is likely to continue in the next three years, we

expect rent increases to slow from here as we approach the

Source: PMA.

Australia SingaporeJapan (Tokyo) Hong Kong

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016F

Fig 3: Residential price index (2010=100)

Fig 4: Growth of Chinese tourists (YOY, %)

Source: Various tourism boards.

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Singapore Hong Kong Japan Australia Korea

2012 2013 2014 2015 YTD2016

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value being in Hong Kong’s premier office location, despite

the significantly lower asking rents across the water in the

new business district.

The decline in mainland Chinese luxury spending continues

to impact retail sales and the sharp correction in prime

retail rents, once the highest in the world, is expected to

be protracted.

In Singapore, pre-leasing for upcoming major office

completions has picked up at the expense of asking

rents. Older stock within the business district is likely to

be impacted the most as landlords continue to see flight-

to-quality as tenants take advantage of the soft rental

market, which could see declines extend into 2017. The

outlook for prime retail in Singapore remains similarly

uninspiring, suffering from lower average tourist spend and

competition from convenient, high-quality suburban malls.

We expect property yields to see some expansion in both

Singapore and Hong Kong over the next five years.

Top 3 for rental growth

2017 – 2019 2020 – 2021

Sydney office Perth office

Sydney secondary office Singapore office

Melbourne office Hong Kong retail

Source: M&G Real Estate.

Asia-Pacific real estate is on track to deliver some of the

highest total returns globally, averaging almost 11% in

2016, supported by continued monetary stimulus and

stronger economic expansion. Returns in recent years

have been driven by very sharp yield compression, which

we believe will now slow. With investors becoming more

cautious, we expect returns to taper to more sustainable

levels of 8% in 2017 and to average 6.5% p.a. over the next

three years. With interest rates in the region expected to

remain low over this period, these returns will still provide a

comfortable spread over bond yields.

“With investors becoming more cautious,

we expect returns to taper to more sustainable

levels of 8% in 2017 and to average 6.5% p.a.

over the next three years.”

A closer look at some regional markets reveals that high

office returns often mask significant incentives, particularly

in Australia and Korea. In comparison, we expect the

retail sector to provide stronger and less volatile effective

returns, ranging from 50 to 200 basis points above office

sector returns.

Weak near-term fundamentals in the Singapore and Hong

Kong office sectors, coupled with stubbornly high pricing,

are key reasons why M&G Real Estate has selectively

focused on other sectors elsewhere in the region – such as

retail property in Australia and Korea, which offers higher

returns, and Japan’s residential and logistics sectors, where

the returns are less volatile.

As some of these structural trading opportunities become

increasingly crowded and the low-hanging fruit largely

gets picked, we believe that new tactical opportunities

in currently-weak markets could drive the next wave of

transactions.

With global capital still on the lookout for diversified

real estate returns, low interest rates and pockets of

fundamental property strength are likely to keep both

prime and secondary property yields in Asia down in the

near-term. Faced with declining prospective returns and

limited availability of assets, investors are increasingly

looking outside of traditional core sectors. By carefully

balancing the risks and potential returns, we believe there

is scope for investors to continue to be rewarded in the

region. Development projects, for example, could provide

investors with exposure to closely-held sectors that are

historically difficult to access. Sourcing for deals in second-

tier cities with stable domestic fundamentals could be

another avenue for rewarding risk-adjusted returns.

“Sourcing for deals in second-tier

cities with stable domestic fundamentals

could be another avenue for rewarding

risk-adjusted returns.”Source: PMA.

Tokyo Osaka Singapore Seoul

Sydney Hong KongPerthMelbourne Brisbane

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Fig 2: Mixed picture

IMPORTANT INFORMATION: Not for further distribution. The value of investments can fall as well as rise. This article reflects M&G Real Estate’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. The distribution of this article does not constitute an offer or solicitation. It has been written for informational and educational purposes only and should not be considered as investment advice or as a recommendation of any particular security, strategy or investment product. The services and products provided by M&G Investment Management Limited are available only to investors who come within the category of Professional Client as defined in the Handbook published by the UK Financial Conduct Authority. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G Real Estate does not accept liability for the accuracy of the contents.

Notice to recipients in Australia: M&G Investment Management Limited does not hold an Australian financial services licence and is exempt from the requirement to hold one for the financial services it provides. M&G Investment Management Limited is regulated by the Financial Conduct Authority under the laws of the UK which differ from Australian laws.

Notice to recipients in Hong Kong: The contents of this document have not been reviewed by any regulatory authority in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice.

Notice to recipients in Singapore: This document has not been registered as a prospectus with the Monetary Authority of Singapore. Accordingly, this document and any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of shares may not be circulated or distributed, nor may shares be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor pursuant to Section 304 of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”) or (ii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.

M&G Investments and M&G Real Estate are business names of M&G Investment Management Limited and are used by other companies within the Prudential Group. M&G Investment Management Limited is registered in England and Wales under numbers 936683 with its registered office at Laurence Pountney Hill, London EC4R 0HH. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority. M&G Real Estate Limited is registered in England and Wales under number 3852763 with its registered office at Laurence Pountney Hill, London EC4R 0HH. M&G Real Estate Limited forms part of the M&G Group of companies. M&G Investment Management Limited and M&G Real Estate Limited are indirect subsidiaries of Prudential plc of the United Kingdom. Prudential plc and its affiliated companies constitute one of the world’s leading financial services groups and is not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America. DEC 16 / 174801

Yip Kai Research Analyst

+65 6349 9000

kai.yip@mandg.sg

Lucy Williams Director, Institutional Business UK and Europe, Real Estate

+44 (0)20 7548 6585

lucy.williams@mandg.com

Christopher Andrews, CFA Head of Client Relationships and Marketing, Real Estate

+65 6436 5331

chris.j.andrews@mandg.com

Richard Gwilliam Head of Property Research

+44 (0)20 7548 6863

richard.gwilliam@mandg.com

Stefan Cornelissen Director of Institutional Business Benelux, Nordics and Switzerland

+31 (0)20 799 7680

stefan.cornelissen@mandg.co.uk

www.mandg.com/realestate

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