1. Economic Update

Economic Conditions:

Having crossed over from the year 2023, investors looking at Asia Pacific might experience a sense of Déjà vu while starting off the year 2024 – uncertainty over economic growth prospects amid weakening global trade notwithstanding the normalization of supply chains, disinflation at work leading to ranging expectations over central bank policy movements and interest rate outlook. Our latest CIO views expect Asia’ economic outlook to be uneven, with China and Japan’s growth in 2024 to slow to 4.7% and 1.0% respectively, while other developed economies of Australia, South Korea and Singapore could see mild growth capped below 2.5%.

Within Asia Pacific, country-specific themes could influence the investment climate. For China, geopolitical tensions, property debt risks and slowing economic activity pose negative spillover risks to the region, given China’s position as the top export destination for many of its neighboring countries. In Japan, the key question is whether the country can see wage-led inflation finally gather strength, which could in turn lead to the normalization of The Bank of Japan’s interest rate policy and drive yen currency movements. In Australia, inflation readings remain elevated relative to other economies in the region while consumption spending appears to have slowed, leading to speculation whether the Reserve Bank of Australia is done with its interest rate hikes.

With central bank policy rates outside China and Japan at multi-year peak levels, real estate financing costs remain elevated, with senior loan rates in Australia, South Korea and Singapore staying at 5% to 6% levels. We continue to see lenders’ preferences gravitating towards higher quality assets in good locations while remaining more cautious on lower quality assets and development projects in secondary locations. The lack of development financing and higher debt returns coupled with supply constraints presents investment opportunities which we will elaborate further in subsequent sections.

2. Real Estate Outlook

Office:

The office sector remains a conundrum for investors globally, with many US and European based investors still reeling from their experiences of elevated vacancies and headlines-making price corrections in their domestic markets. Higher office attendance levels in Asia Pacific remain a key distinction factor versus North America and Europe. Current office utilization rates in Tokyo, Seoul, Singapore and China have hit at least 80-90% of their average pre-pandemic levels respectively, much more favorable than the 50% level in the U.S. Australia is the exception with lower albeit improving attendance levels.

Overall office leasing activity in the region has been mixed, influenced by uncertainties in the macro-economic outlook, as occupiers generally remain cautious while taking longer to conclude leasing deals. China and Hong Kong have seen weak leasing volumes due to poor business sentiment, near term supply pressures and rising vacancies. Japan saw a gradual recovery of pent-up office leasing demand from relocation requirements and healthy service industries, yet the office vacancy rate remained above 6% on the back of strong incoming supply, while macroeconomic headwinds cut short the office rental recovery in Singapore. Office vacancy in Australia remains elevated in the 12-14% range though incentives appear to be near a peak. Seoul is the notable outperformer in the region benefiting from strong rental growth underpinned by healthy leasing demand driven by the technology industry as vacancy remain at record lows.

Notwithstanding the overall weak picture, the divergence across office segments remains intact with tenant preferences clearly inclined towards high-quality developments with green credentials, highly efficient floor layouts and upgraded building facilities, with these developments outperforming older commodity buildings in secondary locations in terms of leasing volume and rental growth. Such flight-to-quality trends remain non-uniform across the region, being more evident in Australia and Singapore, while less so as in China and Japan facing strong pressures from new builds.

Industrial:

Prime logistics assets benefited from strong rental performance, particularly in markets with tight supply such as Australia and Singapore where a lack of available modern warehouse space drove prime vacancy rates below 2%. Structural post-COVID tailwinds of rising e-commerce retailing trends remain intact, with resilient occupier demand from third-party logistics providers (3PLs) and omnichannel retailers supporting take-up and occupancy levels, particularly in locations with good transport accessibility and low availability of prime assets.

Rising construction costs are likely to negatively impact the level of future supply across the region, while in Japan a lack of truck drivers underpins more space demand in infill locations. Other long-term structural factors remain at play: post-pandemic diversification of supply chains within Asia Pacific, increased nearshoring practices, shifts from just-in-time to just-in-case inventory management, upgrading demand away from obsolete owner occupation stock towards higher-quality leased warehousing suited for increased automation demand – all while a structural undersupply of modern facilities in the region persists. As such, we retain a constructive outlook on logistics with rental growth expectations at around 3% per annum and above across in our core location calls.

Retail:

The APAC retail sector has generally benefited from the rebound in international tourism as well as post pandemic consumption boost driving retail sales, yet the recovery remains uneven across the region. High-street retail locations with a significant exposure to inbound tourism in Tokyo, Seoul and Singapore have benefited from modest rental growth along with the recovery in leasing sentiment. On the other hand, slowing growth in discretionary spending in Australia continued to weigh on leasing with incentives remaining at record high levels, while retail rents in China have been on the decline as the recovery in domestic consumption remains uncertain.

While the retail downturn story has run its course over the past several years and rents appear to have either bottomed or near bottoming out in many places, the sector remains out of favour with investors questioning the long-term demand drivers for retail space. We remain in the same camp, that while rents and occupancy could be stabilizing, retail assets with limited rental upside yet exposed to the threat of rising ecommerce retail and shifts in discretionary spending do not seem attractive.

Residential:

The Living sector in Asia Pacific continues to gain momentum, as investors look to diversify away from the traditional main office and retail sectors, while residential assets provide more resilient cashflows closely linked to inflation and fundamental housing needs rather than cyclical economic factors. Japan’s mature multifamily sector continues to attract the bulk of institutional capital inflows looking to benefit from the ongoing urbanization and household formation around major city centers. At the same time, rising record-high prices of for-sale condominiums continue to drive first-time home buyers towards house rentals, while larger units remain popular particularly for households on hybrid work arrangements.

Increasingly, investors are looking into Built-to-Rent residential models across the region, particularly in Australia and China. Australia has experienced some of the strongest housing price pressures in the region, with nationwide housing values having climbed 31% since early 2020^[1] and hitting record highs in some capital cities. High interest rates contributed to the worsening owner-occupied housing affordability, driving unabated rental demand while rising construction costs and high interest rates have exacerbated the lack of new supply. In addition, fundamental growth drivers of high immigration numbers and relative rental affordability should help underpin rental growth over the coming years.

Hospitality: Based on IATA figures, air passenger travel in Asia Pacific continued its recovery, reaching 90% of 2019 levels in October 2023. Meanwhile, APAC hotel occupancy rates during the first 8 months of 2023 have reached about 90%-95% of 2019 levels, with RevPAR in Singapore, Hong Kong, Sydney and Tokyo estimated to have grown by 11%-18% in 2023^[2]. With Japan a major beneficiary of the tourism rebound, the upscale limited-service hotel in key Japanese regional markets could be highly sought after by investors given rising demand for upscale accommodation from travelers and higher profitability.

Rental Outlook

Our updated long-term rental growth forecasts are presented below. We believe that the residential markets (multi-family, built-to-rent) in certain locations such as Australia provide strong rental growth opportunities, particularly over the next few years. We also expect sustained growth in logistics rents, led by key logistics hubs in Australia, Singapore and regional cities on North Asia, along with rents in select office markets.