It is currently an ideal time for investors to position their portfolios in the Asia Pacific real estate market as it is poised to benefit from healthy asset yields, secular growth trends and unique market dynamics. This comes after 2-3 years of rising interest rates that caused capital values to fall, and property yields to rise according to Regina Lim, Head of Property Research Asia, M&G Real Estate.
"During the last 15 years, gains were made during a time when rates were low, capital values rose, and capitalisation rate compression was a huge factor in overall performance," says Lim during a media briefing on July 18. "We think that it's a good opportunity to think about the normal state prior to this period [of rising yields and falling capital values]. In the last 15 years, the low interest rate environment was a special period and won’t be repeated."
Lim believes the second half of 2024 is set to mark the bottom of the rising rate, and declining capital values cycle. In a report dated July 18, M&G Real Estate notes that real estate yields across many parts of developed Asia Pacific regions are at their highest levels in a decade, providing attractive income returns.
During past property cycles, yields comprised 50% of returns, followed by income growth and a measure of mild yield compression. However, in the last 15 years, yield compression has been the main contributor to real estate returns due to a sustained low interest rate environment. In the past two years, following “higher for longer” interest rates, M&G expects income yields to be the dominant driver of total returns.
As a result of the accelerated rate hike cycle by the Federal Reserve, and the subsequent downward pressure on capital values, prime assets now offer income yields that are 15%-35% higher compared to two years ago, M&G says, as asset values have reset lower. This is the case in developed Asia, except in Japan.
The M&G report points out that economic growth is recovering with key real estate sectors in the Asia Pacific region experiencing robust rental growth driven by strong economic fundamentals, limited supply and healthy inflation. Among these, logistics is experiencing strong income returns as e-commerce penetration, re-shoring and friend-shoring. The region’s GDP growth forecast for key exporters has also been upgraded in the last few months, supported by a rebound in global demand for semiconductors.
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Additionally, inflation rates stood around 2% across the region supporting inflation-linked leases, enhancing rental growth prospects. Tokyo has seen an uptick in office rents for the first time in 13 quarters, with multifamily rents growing by 5.4% y-o-y in 1Q2024.
The living sector, purpose-built student accommodation and necessity-based retail are other sectors that M&G favours. “This GDP growth and healthy inflation support rental growth amid low supply, making real estate investments more lucrative in our view,” says M&G in its report.
Among the challenges, banks have scaled back their appetite for new loans and become more conservative in their loan-to-value ratios, and environmental, social and governance (ESG) criteria. M&G adds: “Even if rates do start to come down over the next few years, we expect funding gaps to widen, potentially resulting in forced sales of properties at discounts, a need for equity injections by new owners, or bridge financing from non-bank lenders.”
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On the ESG front, companies in the Asia Pacific region are increasingly committing to net zero carbon emissions as corporate occupiers are beginning to gravitate towards high-quality, environmentally sustainable offices in highly accessible locations. Other challenges include economic uncertainties such as fluctuations in global dynamics; geopolitical tensions and regulatory changes; and potential supply chain disruptions.
“Investors should remain vigilant about potential risks and incorporate them into their strategies, while leveraging on positive dynamics in the real estate market to optimise returns in the coming months,” says M&G.
During the briefing, Lim says: "We are taking a view the market has bottomed, but there are risks that capitalisation rates could expand."
In Singapore, M&G and its funds own Compass One, Cycle & Carriage's industrial property and the Surbana Jurong campus with which M&G signed a develop-and-lease agreement based on a transaction value of $400 million.
