THE confluence of economic uncertainty brought on by the deepening subprime crisis has posed a real risk of a systemic financial event and a prolonged global economic slowdown. This, coupled with another round of de-leveraging in the structured credit market has led to further pressure and deterioration in real estate prices, predominantly in the US and Europe. Given that the pendulum swung as far as it could in the direction of reckless mortgage lending, it will now swing back towards the quaint notion of buyers being lent only the amount they can reasonably be expected to pay back.
Whilst the rout has largely been confined to markets outside Asia, we see considerable softening in real estate markets with high foreign participation and in certain high-end segments. Opportunistic investors are pulling back from Asian property given more scope for acquiring distressed assets in their home markets, and loans remain elusive in Japan and Singapore, one of their favourite markets.
In Hong Kong, strong economic growth continues to support residential market. Hedge funds have stopped dabbling in property in the region, and although private equity players will continue to develop property in India and China, they are more likely to buy buildings cheaply in Western countries than in Asia.
We expect values for US commercial real estate to fall by 23% in the next five years from their 2007 peak, causing losses of about US$1,600bil, including those on commercial mortgage backed securities.
London office values have dropped 12% from a peak in the middle of last year, and will be under further pressure from forecasts of a 15% decline in rental values through 2009.
In 2007, total direct investment in Asia jumped 27% to US$121bil – a sixth of the global total – with approximately half invested in Japan and Singapore.
Real estate stock in Asia currently stands at US$9.5tril, growing on average by 6% - 7% p.a (except in China which grew by 15% p.a). China and India make up 50% and 12% of the total stock respectively while Japan constitutes 20% of the total.
The demand for real estate is dependent on the health of the economy, which in turn is affected by financial markets.
In 2008, we expect prospects for Asia’s real estate to remain lukewarm, especially in traditional FDI led markets like Singapore. The global economy still faces major uncertainties as to how a further unravelling of the credit crisis will affect the availability of credit and asset pricing.
The resilience of Asian economies and the real estate market will be truly tested in 2008. Buoyant domestic consumption is expected to help the region weather a substantial economic slowdown as weaker global demand impacts Asian exports.
Overall, despite the risks inherent in the region, we believe opportunities remain in Asia’s real estate market, mainly in grade-A office space, driven by sound GDP growth (projected at 8% y-o-y) underpinned by sustained private consumption, higher public and private investments; a re-rating of property as an asset class, sustained domestic demand and on-going infrastructure development.
We remain bullish on India and Vietnam, with a cautious view on China, Malaysia and Singapore.
Rent and value
Capital flows to the Asian region have increased tremendously since 2005, mainly into major economic sectors such as manufacturing, services and oil and gas, and opportunities remain abundant in the property sector.
The US is among the largest sources of investment inflows into the region; nevertheless, the largest increases in the availability of capital for real estate are expected to come from the Middle East, China and India. The main sources of capital for property investments in 2007 and 2008 remain private equity investment funds, institutional investors and real estate investment trusts (REITs).
Since 2006, the Asia region has experienced strong demand in the residential sector despite high interest rates that led to higher house prices. In mainland China and Hong Kong, strong economic growth continues to support the residential market. Beijing and Shanghai continued to attract high levels of foreign investment that entailed a higher number of expatriate professionals which led to higher demand for luxury residential property.
Residential real estate prices have shot up particularly in Singapore. Singapore’s residential price change in 4Q07 stood at 31.4%. Concurrently, Malaysia witnessed stable prices and rentals for 1H07. Strong demand for high-end residential units in prime cities such as Hong Kong, Kuala Lumpur and Singapore has escalated with the launch of new high-end residential units throughout 2007.
The most expensive residential segments in Asia continue to be Hong Kong, Tokyo and Singapore at over US$10,000 per sq m.
In Hong Kong, the real estate scene has not been very different from other countries in the region with house prices trending higher at 8.78% y-o-y in 2Q07 compared to 0.65% negative growth in 2Q06. The real estate market has been gradually recovering since the country’s downturn in the property market last year, following the housing slump in the US.
We expect interest rate cuts in the US to push prices up further in the residential segment. In Japan, land prices advanced 0.4% y-o-y in 2007, an indication that the Japanese residential property market is recovering from its 15-year price slump.
Moving forward, we expect the Asia’s residential market to sustain growth, albeit in the long term, underpinned by the following factors:
> Strong economic growth in most markets in Asia will support the strong performance in the residential segments.
> Rising income per capita will enhance purchasing power and therefore boost consumer spending. High economic growth, improved employment levels and positive wealth effects arising from equities in most parts of Asia Pacific have led to higher disposable incomes.
Average per capita income for the region rose to US$14,371 in 2006 from US$12,906 in 2004. Per capita income is expected to average US$15,217 in 2007 and US$15,886 in 2008 that in turn, will boost demand for residential properties.
> In most Asian markets (China, India, Singapore, Malaysia) the high-end residential property market has witnessed increased demand spurred by the influx of expatriates and skilled professionals, the region's increasing attractiveness as a second home (retirement) and higher rental yields.
> The demographic profile of Asia is relatively young. Asia’s young population (aged 15 to 59) continues to increase, creating strong demand for housing for ownership occupation and rental increases. India’s population is expected to increase from 1.1 billion to almost 1.5 billion by 2025. In 2006, the working age group of those aged between 15-64 years stood at 64.3% and expects to increase moving forward.
The Asian real estate market capitalisation stands at approximately US$4.9tril, mainly dominated by Japan followed by China and the rest of Asia. We expect this ratio to alter moving forward with strong growth in Asian markets. Apart from Japan, real estate activities are focused in Singapore and China.
A common practice that is picking up in the region is the number of sale and leaseback transactions particularly in Singapore and Japan. We expect this trend to spread across the region over the medium term.
Real Estate Trends
The real estate industry has seen rapid growth across Asia post-crisis, with varying stages of development within each country. Nevertheless, we have identified several similar trends/patterns, unique throughout the region, as follows:
> The real estate sector in Asia is driven mainly by rapid and dynamic growth in the offices and high-end residential segments.
> Prices for residential and non-residential properties in many major cities and smaller cities continued to rise, despite higher interest rates across the region.
> Asia’s REITs markets continued to grow with many companies converting their assets into REITs. The total number of Asian REITs at the end of 2007 stood at 86 with a total market capitalisation of US$74.8bil.
> The overheating property markets in many countries across the region led governments to enforce stricter rules to cool down the situation.
The Chinese government further tightened measures by increasing taxes, requiring developers to build more low-cost houses and tightening rules on property purchase by foreigners. South Korea and India also tightened rules in relation to borrowing.
> In most markets (Singapore, Hong Kong, Malaysia, China, India) demand for office space is highest followed by hotel/resorts, retail, industrial/distribution, homebuilding and apartments residential.
> The strong capital inflow into Asia real estate particularly China leads to the problem of demand exceeding supply. Although the Asia market has unparalleled potential for growth, in most cases, it lacks depth. The lack of a solid investment base to absorb current levels of incoming capital lead to the reflection of the current scenario, therefore increasing the risk of overheating.
Looming subprime issue
We expect the US subprime issue to continue to rear its ugly head well into the year as write downs continue.
However, we expect the impact on Asian markets to be minimal (safe the export sector) given that the region’s financial institutions have relatively limited direct exposures to US subprime mortgages.
In the region, China is the largest overseas holder of US mortgage-backed securities, at around US$260bil, which is held mostly through its international reserve holdings and through holdings of commercial banks.
We take the view that Asia remains relatively insulated from the US subprime issue for the following reasons:
> Asia’s huge pool of international reserves at US$3tril (including Japan and China)
> Asian banks’ exposure to subprime debt instruments is minimal and manageable
> Asian corporate sector leverage is very low
> The banking system has been strengthened and is strongly capitalised
> The financial sector’s direct exposure to equity markets also appears relatively limited
> Asian central banks have taken steps to improve the regulation of high-leveraged activities
> Asian economies have become more resilient to shocks to their capital accounts as external vulnerabilities have been reduced
> Companies depend less on the more risky capital inflows
As such, we expect the contagion from the US subprime crisis to be limited to the capital markets. An indirect effect of the subprime crisis on the region is that it has increased the cost of raising capital for banks, corporate and investment bodies.
New bond issues will have to be priced slightly higher to reflect rising credit market volatility and the anticipated temporary decline in investors’ demand for these products both globally and in the region.
Liquidity on capital markets in Asia remains vast although a re-rating of risk will see some liquidity being sapped out of equities/real estate in the medium term.
Credit market spreads that reached record low levels pre-subprime crisis are likely to widen and remain high into 1Q08, both in the region and for emerging markets as a whole. In the medium to longer-term, as deals get bigger in size and more complex, access to cheap international capital is becoming more important.
The crisis will continue to affect the region indirectly in that it has heightened uncertainty and resulted in a reassessment of risk, as reflected in the periodic declines seen in stock market in 2007.
We expect frequent and large reassessments of risk and high volatility in asset prices to figure largely in Asian economies for the most part of 2008.
Inflation poses a key challenge for the region, which has enjoyed robust expansion in the last few years amidst muted price pressures. Oil prices, which are expected to remain firm in 2008, have raised the spectre of global inflation trending even higher this year.
This poses a key threat to the region’s inflation outlook. We expect oil to trend higher this year to average at US$80 per barrel, vs US$72.4 per barrel in 2007.
A different set of rules will apply moving forward as policy makers strive to balance the need for tighter monetary conditions to rein in rising costs even as growth weakens.
Navigating the storm: Asia’s real estate
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