The Asia Pacific region started the year strongly, with China and South Korea exceeding 1Q2024 GDP growth expectations due to high-tech manufacturing. However, recent data shows a slowdown in retail sales and industrial production as the initial reopening boost waned and external demand declined, affecting the labour market.
Unemployment is slightly rising in China, Hong Kong and Singapore, dampening consumer confidence. Meanwhile, Chinese and Australian consumers are cutting spending and focusing on necessities. Elevated interest rates and delayed cuts could pressure households, especially in highly indebted countries like Australia and South Korea, affecting retail trade and corporate investment. As a result, growth is expected to weaken this year, with recovery anticipated next year.
Refinancing stress presents opportunities?
The regional investment market started the year quietly, with 1Q transaction volumes down 7% y-o-y, the slowest since 2016. Domestic capital dominated, while overseas capital remained subdued due to inadequate repricing and concerns over commercial real estate fundamentals. Japan led the market, benefiting from loose financial conditions, attractive yield spreads and a weak currency. South Korea saw strong local demand for office assets to save on rising rental costs. Sectors with long-term structural tailwinds, like living and alternative sectors, remained highly sought after. Investors are seizing opportunities with greater price dislocation to mitigate risks from worsening occupier fundamentals and high financing costs. As asset owners rebalance their portfolios amid economic uncertainty, more discounted offerings are expected in Australia, Hong Kong and South Korea.
Bifurcation intensifies as office market conditions weaken
Office fundamentals are deteriorating, with most gateway markets reporting slower net absorption in 1Q2024. Occupiers are cautious about taking up new space, leading to slow expansion. Renewals and relocations to higher-grade offices dominate demand. Seoul’s office market saw 2.4% quarterly rental growth due to tight vacancies and strong local demand. Tokyo reversed its rental decline with positive 1Q2024 growth from high domestic leasing demand, lowering vacancy rates. However, new supply in 2025 is expected to push vacancy rates above historical averages, likely weakening rents. Office rents in other major markets were generally unchanged or declining, and high vacancy rates will persist as cost-saving strategies lead to low pre-commitment rates for new supply.
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Retailers turn highly selective in challenging landscape
High interest rates, living costs and labour market uncertainties dampen consumer spending, slowing regional retail sales. Retailers are cautious about leasing space, preferring key locations with high footfall and prime retail in tourist areas. In South Korea, F&B demand is strong in office arcades in major business districts due to high office attendance. In Japan, spillover demand in secondary locations arises from scarce prime retail space, widening the gap between prime and secondary assets. Prime retail in Tokyo, Osaka, Seoul, Singapore and Hong Kong shows varying rental growth, while retail assets dependent on local traffic remain subdued due to weaker domestic consumption. Despite near-term macro headwinds, investors are re-engaging with the retail sector, targeting higher yield offerings in specific segments and markets.
Maintain strict discipline for prime logistic assets
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Logistics leasing momentum is weakening as occupiers hesitate due to an uncertain macro outlook and affordability concerns. Prime facilities command higher rent premiums, while less popular ones may need rental adjustments. Despite less favourable real estate fundamentals, investors are increasing their exposure to logistics. 1Q2024 saw logistics investment volumes reach $5.4 billion, up 4.5% y-o-y. Interest in Japanese logistics remained strong, with investment activity jumping 64%. Robust capital inflow has kept logistics yields tight in Japan, while Australia and Greater Seoul face yield expansion pressure due to a sluggish investment market. High construction costs have reduced developers’ appetite for new projects, leading to smaller medium-to-long-term supply pipelines.
Fundamentals continue to favour residential
The residential leasing market in Japan remains robust, with multifamily properties in Tokyo’s 23 wards standing out. Average rents increased 4.1% q-o-q in 1Q2024, driven by strong migration to the city centre. The central five wards saw a net inflow of 7,000 people, 23% of the total. Adjacent submarkets like Taito, Sumida, Nakano, Suginami and Shinagawa also experienced significant population growth. This trend has boosted occupancy rates to 97.2%, nearing the pre-pandemic average of 97.5%.
In Australia, the residential market shows high occupancy rates, with a national vacancy rate below 1%. New developments have stalled due to high construction costs and unfavourable bank financing. This undersupply has sustained rental growth, with national rents rising 1.6% q-o-q in 1Q2024. However, affordability concerns are expected to limit future growth, a trend already seen in Melbourne.
Despite a 38% y-o-y drop in residential investment volumes to $1.8 billion, capital market interest remains strong. Investors are converting hotel properties in markets like Hong Kong and Singapore, where institutional-grade multifamily assets are scarce. Partnerships with residential sector specialists offer opportunities outside Japan, particularly in Australia and South Korea. In Japan, rising borrowing costs and narrower yield spreads make investors more selective, focusing on submarket fundamentals, lifestyle patterns, and available amenities.
Data centres at forefront of alternatives
Data centres are the top “alt” subsector for investors, driven by digitalisation and artificial intelligence (AI) applications. Investments surged over 300% y-o-y to $1.7 billion in 1Q2024, with major sales and platform transactions. This strong demand has kept cap rates between 3% and 5%. Some operators are paying premium prices, with acquisitions in Sydney and Singapore trading at a 3.5% cap rate. Platform transactions reflect tight pricing, with ebitda multiples exceeding 30 times.
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Investors are actively seeking opportunities in various living subsectors, focusing on student housing in Australia, driven by a 23% y-o-y increase in international student enrollment in the first two months, indicating robust future demand. This focus, coupled with limited supply, is expected to drive rents upward, with the positive outlook on the sector attracting international investors.
Meanwhile, Japan’s senior housing sector is attracting significant investor interest. In 2023, Japan’s elderly population (75+) surpassed 20 million, or 16.1% of the total population, enhancing the sector’s appeal. This demographic shift has drawn international investors seeking platform transactions and prompted some J-REITs to make their first investments in the sector, aiming to capitalise on the growing demand for senior housing.
For nearly 40 years until 2021, falling interest rates boosted capital values, especially since the mid-80s. During a typical seven-year hold period, declining rates reliably lowered cap rates and increased returns and exiting this era presents challenges for real estate, as commercial pricing remains below trend with tight valuation and transaction cap rates relative to interest rates.
Transaction pricing is significantly below long-term averages, often signalling a good buying opportunity, and deal volume has yet to rebound, with 2023 marking the lowest transaction volume since 2009 and a softer 1Q. Investors are no longer overweight in real estate; the rebound in equities and decline in real estate values have realigned allocations, and with values down from peaks and the denominator effect no longer a constraint, we anticipate increased investment volume in 2H2024.
Louise Kavanagh is chief investment officer and head of Asia Pacific real estate at Nuveen
