Real Estate Investors in Asia Pacific Seeking Better YieldHead of Research, Asia Pacific at CBRE
The search for better yield continues to motivate Asia Pacific real estate investors. On the one hand, investors are more actively focusing on higher risk assets outside of core centers and in emerging markets. On the other, they are less willing to deploy more capital year-on-year, becoming more strategic when selecting assets.
When viewed holistically, however, this strategic approach to real estate investment shows an underlying optimism present in this sector. Our conversations with clients and market participants reinforce this sentiment.
According to CBRE’s Asia Pacific Investor Intentions Survey 2017, despite Asia Pacific investors being less willing to invest more in real estate compared to last year, they do have a stronger appetite for higher risk assets due to the potential return. Survey findings reveal that 28 percent of respondents identify “chasing yield spread” or achieving higher returns as the main motivation for investing in real estate, compared to 10 percent in 2016.
In our view, investors are focusing more on yield spreads by exercising a greater risk tolerance in exchange for higher potential returns. This is similarly reflected by the shift from value-add to opportunistic strategies, as the lack of prime assets for sale prompts more investors to take on development or redevelopment risk to build high quality assets meeting their required standards.
However, investors do remain cognizant of external shocks when rebalancing real estate portfolios. For example, global and regional economic instability remains the key concern for all investors, although worries have eased compared to last year’s survey. In 2017, only 25 percent cite macroeconomic headwinds as their primary concern, compared to 46 percent in 2016.
Rates are the Concern
In contrast, a higher number of respondents identified faster-than-expected interest rate hikes as a threat—up from 6 percent to 14 percent. Investors are resigned to the fact that the zero- or low-interest rate policy era is gone for now. Overpricing returned as the second-biggest investor concern amid fears that valuations could come under pressure, either from leasing weakness or cap rate expansion.
As a result, more investors are seeking yield spread due to limited yield compression opportunities in a tightening interest rate cycle. By definition, yield compression typically occurs when rental increases move at a slower rate compared to the rate of the property price increment, a phenomenon which is limited at this juncture. Without the tailwind of further cap rate compression, capital gains will potentially be more challenging within the short-to-medium term, leading to fewer respondents from the survey citing capital appreciation as their major investment objective. Furthermore, the expectation of weaker rental growth across all sectors in most markets prompted fewer investors to focus on steady income returns.
With this backdrop, certain investor sectors have become more active in their search for yield. Specifically, sovereign wealth, insurance and pension funds (SWIPe) are more likely to invest for capital appreciation over yield spread, shifting their investment strategy toward more opportunistic investments. The majority of the SWIPe respondents indicated they plan to deploy between $2 billion and $5 billion of capital this year, while a few intend to deploy in excess of $5 billion. This indicates that many, if not most, of the large deals in the region this year will involve SWIPes.
Additionally, the pursuit for higher yield is pushing investors toward a core-plus strategy—in other words, investing in prime assets in non-core areas such as non-CBD office, or non-prime assets in core areas like hospitality. Understandably, by adopting this strategy, a greater risk tolerance is exchanged for higher potential returns. This trend is similarly reflected by the shift from value-add to opportunistic strategies, as the lack of prime assets for sale prompts more investors to take on development or redevelopment risk to build high quality assets.
Australia, Japan and China retain their status as the top three preferred cross-border investment destinations.
There is also an increase in the number of investors motivated by geographical diversification. This newer theme is mainly driven by international, and especially Asian, investors, who have traditionally held low allocations in overseas real estate due to a variety of reasons including capital regulations and lack of familiarity in offshore real estate investing. In contrast, Australian and New Zealand investors are less keen to invest abroad as they still enjoy a positive yield spread over government bonds in their home markets.
Down Under on Top
Australia, Japan and China retain their status as the top three preferred cross-border investment destinations. Australia was the top choice for the second consecutive year as investors continue to be lured by its attractive risk/return profile and substantial liquidity.
In China, investors’ interest is driven by strong economic fundamentals and the opportunity to purchase undervalued assets. However, current market conditions pose a challenge when seeking a positive yield spread.
Elsewhere, interest in Vietnam rose significantly on the back of the country’s strong macro fundamentals and higher initial yields. However, investible stock remains limited, and the typical method of entry relies on forming joint ventures with domestic developers.
On the other hand, interest in Japan faded amid worries that fundamentals might be peaking along with weaker economic growth.
Noteworthy shifts in investor preferences include stronger interest in the office sector and weaker demand for hotels. The stronger demand for offices reflects the sector’s solid liquidity and easier management compared to other sectors. Weaker interest in hotels is largely due to unfavorable supply fundamentals and pricier valuation in key markets such as Japan and Australia.
Another noteworthy trend was the stronger interest SWIPe investors displayed in the logistics and multifamily sectors. SWIPe investors have longer investment horizons and larger economic scale which enables them to select a wider range of assets to achieve their return objectives. SWIPe investors displayed a particularly strong interest in logistics and industrial assets this year. This trend is being driven by structural changes to consumer purchasing habits and the lack of modern logistics facilities. Over the past three years a number of SWIPe investors have formed partnerships with specialist logistics developers.
Investors also retain a strong interest in alternative sectors. While real estate debt remains the preferred option, very few investors without exposure to this segment are willing to invest, possibly due to the reversal of the interest rate cycle.
The biggest increase in interest was for demographically driven specialty asset classes such as retirement living/senior housing and health care, supported by an increase in the region’s elderly population and a growing number of people with health insurance. Large and small companies are increasingly creating, analyzing and storing data, driving growth in demand for data centers, particularly in Australia, Japan, Hong Kong and Singapore. Student housing in Australia has attracted strong demand from institutional investors amid rapid increase in international students. However, opportunities in Asia are yet to be explored.
Yield Spreads Driving Investment
Investors’ top three concerns remain unchanged: pricing, lack of availability and competition from other investors. Prime assets in core areas will continue to attract aggressive bids and squeeze potential returns, meaning that investors will need to be creative and flexible in sourcing assets. With so many large assets changing hands over the past 18 months, lack of availability is set to remain a key challenge for investors in the coming year.
We see clear signs that within this cycle, investment motivations are increasingly being driven by yield spreads. Given that the emphasis on capital appreciation has weakened due to the current market cycle, we expect this search for yield to be a very subjective issue for investors who will more strategically weigh the risk-reward balance when deploying capital into Asia-Pacific real estate.