Because Asia-Pacific economies are highly interdependent, one question that investors often ask when we discuss an Asia-Pacific REIT strategy is whether a regional real estate strategy provides enough diversification.
Real estate cycles are governed by two factors, namely supply and demand. I agree that real estate demand in the various markets is linked to a certain degree, as the economies often rise and fall together across the region.
Even then, however, political and social factors are often unique to a particular economy, leading to divergence in economic and thus real estate performances. Moreover, real estate supply is a purely local phenomenon, as buildings are immovable. This adds another reason why even highly similar economies can often have different real estate cycles.
The real estate trends in the last two to three years demonstrate this idea. Since the end of 2014, for example, Hong Kong’s retail and hotel sectors have entered a correction, triggered by the fall in tourists from mainland China.
Retailers and tourist servicers then spent two years retooling their offering. For instance, high-end jewellers, watch shops and other luxury brand retailers have cut back their footprints. In some cases, they are replaced by other retailers such as sportswear retailers.
Overall, the change in tenant profile and a slight increase in vacancy rates have led to rental cuts. The busiest street shops, which have always been the most volatile indicator, saw rents falling by as much as 30 percent. However, after two years of retooling, the sector has stabilised, and rents this year is forecasted to either not move or fall by as little as five percent.
On the other hand, Singapore’s retail rent held up much better than Hong Kong in 2015 and 2016, as they did not see a similar drop in Chinese tourists.
However, the Urban Renewal Authority and other entities, which recently forecasted a continuous fall in real estate rents, seemed to confirm that Singapore’s rental down-cycle, while milder than that of Hong Kong, may last into the next one or two years. The future new supply is a major factor, but in the long run, a larger real estate stock should mean a larger economy.
In the rest of Asia-Pacific, Australia and Japan started their real estate up cycle in 2013. Australia’s economy corrected after the last mining boom ended in 2011, and Japan’s rebound after the Global Financial Crisis was slower and weaker than the rebound in Hong Kong and Singapore.
Thus, while Hong Kong and Singapore are managing a real estate down cycle, Australia and Japan are still in the middle of their real estate up cycle. The differences in the severity and length of the rental down-cycle make diversified portfolios, especially those actively managed, an opportunity to outperform.
Furthermore, different real estate sectors can also be a diversifier. While Hong Kong’s retail market faced difficulties in the last two years, its office sector has continued to see rental increases. Hong Kong’s Central district has limited future supply, and rents have reached historical record every year over the last several years.
Kowloon East, which is perhaps the biggest urban renewal project in Hong Kong’s history, can potentially offer twice the ‘Grade A’ office supply of Central, yet absorption remains healthy enough to see slow but sustained rental increases. This contrasts with Singapore’s more subdued office market, driven both by additional supply and somewhat slower demand expansion.
The newer asset classes potentially offer even more diversification. Logistics typically operate on longer lease terms. During up cycles, rental growth may be weaker than office or retail, but during down cycles, logistics may be more effective in protecting cash flow.
Data centres are still in their infancy, and we think that it may take a cycle or two to reach its equilibrium rents. Healthcare, as an industry, is growing as a percentage of most countries’ economy, and this may lead to new demand for the real estate assets that service the industry.
In short, in the last two decades, commercial real estate has diversified beyond just office and retail. An Asia-Pacific real estate strategy, perhaps implemented via a REIT program, diversifies investment risks because of the variety of geographies and asset types.