Government bond yields, investment-grade credit yields, and equity dividend yields have all moved higher over the past year, and real estate must offer a comparable return in order to compete for capital at the margin. Borrowing costs are also higher, restricting capital availability and limiting the amounts investors can bid for assets. These factors in combination can only mean one thing: a reset of real estate pricing to higher yields – and the adjustment process is now well underway.
The Asia-Pacific region is not exempt from this global pricing reset but the diverse condition of markets within the region is supporting a more resilient regional market environment. Overall, we expect the regional real estate values to fall by less than 10 per cent on average peak-to-trough. Asset valuations in Australia, Hong Kong, and South Korea have been declining, and capitalisation rates for assets being transacted rose sharply, i.e. registering significant discounts to valuation. However, capital values in other major markets including Singapore and Japan are holding up much better, with Japan assets bucking the trend to experience value appreciations in the past 12 months.
Market dynamics are becoming critical to investors to navigate their investment in this environment, and experience from previous cycles tells us that a downturn will bring opportunities, particularly in markets that offer a combination of pricing adjustment and an improved rental growth outlook.
In the near term, faced with an uncertainty about the rental growth outlook as global recession fears linger, investors should target sectors and markets that offer a resilient income profile driven by long-term structural trends – notably basic needs such as affordable and senior living, and logistics and data centres linked to the ongoing digitalisation of global societies. These sectors present the most attractive opportunities on a risk-adjusted basis over the next 12 months.
In the affordable housing sector, with vacancy rates falling to historical lows in major markets like Sydney, Melbourne, and Tokyo, rental growth is forecast to be strong in the next few years. However, the institutional market for rental housing remains underdeveloped in most Asia-Pacific markets outside of Japan. For income-focused core investors, rental housing opportunities will remain largely in Japan. But for investors willing to take on greater risk, the combination of favourable leasing conditions, strong rental growth prospects, and policy incentives is supporting development opportunities. Major and gateway cities of Sydney, Melbourne, Hong Kong, and Tier 1 cities in China are among the most attractive, and these markets are expected to continue growing and maturing in the coming years.
Meanwhile, driven by the secular shift towards the public cloud, demand for data centres remains robust and leasing activity has jumped up significantly across the major markets of Tokyo, Sydney, Singapore, and Hong Kong, reaching 300 megawatts in 2022. With public cloud market forecast to grow by about 30 per cent per year in the next two years, hyperscale will no doubt remain the strongest growth segment of data centres. Leasing fundamentals are improving and driving expectations of rental growth prospects, and with capitalisation rates likely to stabilise within the next 12 months, returns are expected to start improving, with income returns and rental growth being the main drivers of performance.
Looking at the logistics sector, demand remains solid but occupiers are shifting to focus on prime submarkets such as Tokyo Bay and Seoul which have recorded stronger absorption and tighter vacancy rates as compared to decentralised emerging submarkets. Similarly, prime submarkets in Sydney, Melbourne, and Singapore are also showing strong performance in both tenant demand and achievable rents over the next couple of years.
In the office leasing space, rental growth momentum will likely be uneven and diverse across major markets. A strong recovery in the past two years has brought Grade-A rents in Singapore and Seoul back to or above pre-pandemic levels. However, with a sizable amount of new supply arriving in late 2023, Singapore office leasing fundamentals are softening. By contrast, with very limited new supply, Seoul office markets remain tight, and rental growth will likely stay strong in the near term. Meanwhile, Grade-A office rents have started recovering in Australia, but like Hong Kong, rents remain 15–25 per cent below 2019 levels, making them highly affordable to tenants, and with tenants demanding improvements following the reopening, we expect Grade-A office rents in these markets to grow cumulatively 10–15 per cent in the next few years.
Lastly, the ongoing recovery of cross-border travel is creating cyclical opportunities. It is boosting demand for tourism-related real estate sectors like prime high street retail and hotels. Markets with high exposure to international tourism, such as Tokyo, Osaka, Hong Kong, and Singapore, are showing the most encouraging signs of recovery. For instance, hotel occupancy and average room rates in Hong Kong are almost back to pre-pandemic levels.
Looking ahead, Asia-Pacific real estate returns are expected to be under pressure over the next 12 months or so – and many investors will be on the sidelines until the repricing runs its course. However, the repricing is happening quickly across the board, and it is still playing out, making benchmark-driven investing difficult. Many of the opportunities above are contingent on this reset of real estate values continuing, taking pricing to levels that make sense in order for returns to compete for capital against other financial asset classes. As such, timing will be key to successfully executing structural and cyclical investment strategies.
Dr Cuong Nguyen, head of Asia Pacific investment research, PGIM Real Estate
