Wai-Fai Kok
Head of Real Estate, Research & Strategy – Asia Pacific

Resilient macro performance is likely to keep interest rates elevated. More cap rate expansions are possible but the worst is likely behind us. We see values emerging in Australia and continue to like Japan residential.

Wai-Fai Kok, Head of Real Estate, Research & Strategy – Asia Pacific

Correction cycle nearing the end

The economy

APAC macro performance has been resilient in recent quarters despite much tighter monetary conditions. Since December 2023, Oxford Economics has upgraded its 2024 growth forecasts twice and the positive revision was broad-based across most countries. 1Q24 GDP releases so far have been solid with several countries surprising to the upside. Oxford Economics now expects APAC GDP to grow faster at 3.8% YoY for the full year (from 3.5% in December). Nevertheless, this represents a slowdown from 4.4% in 2023. Singapore, South Korea and Taiwan are projected to be among the outliers from this moderation as these trade-reliant countries benefit from the bottoming out of an export slump. On a 3-month rolling basis, APAC exports rebounded 3.3% YoY in February 2024 after a 6.3% decline in 2023.

Private consumption has slowed but not collapsed despite much weaker consumer sentiment, likely thanks to the robust employment situation. The labor markets remain tight and especially so in Australia. It should loosen as growth slows, but will likely be gradual without a recessionary outlook. Inflation is sticky as a result. Price pressure has moderated significantly from the peak but the last mile to central banks’ targets seems painfully slow. This could be further exacerbated by tensions in the Middle East which have negative implications for oil prices.

An economic soft-landing is becoming a reality given the resilient macro and job markets. Consequently, there is likely little urgency for central banks to pivot in the immediate term. Interest rates could stay elevated and expectations of rate cuts have been postponed multiple times. Surprise rate hikes cannot be ruled out either as evidenced in Taiwan (+12.5bps in March) and Indonesia (+25bps in April). That is not our base case, however.

Based on UBS Investment Bank’s latest forecasts, Europe will likely be the first to deliver a rate cut in 2Q24, followed by the US in 3Q24. In APAC, South Korea could start in 3Q24 and Australia among the last in February 2025. China has already been tweaking at the margin since 2023. Meanwhile, Japan is on a completely different track due to its reviving nominal growth. Its negative interest rate policy ended in March 2024 and the overnight call rate was raised, for the first time since 2007, by 10bps. However, the Bank of Japan’s tone remained dovish for future rate hikes. Consensus expectations vary with UBS Investment Bank expecting the policy rate to reach 1% by end of 2025 while Oxford Economics thinks Japan will take 3 years to get there.

Leasing and capital markets

APAC leasing activity was generally resilient in 1Q24. According to CBRE, office net absorption improved slightly YoY with stable demand from the finance sector and signs of recovery in the tech sector. Demand in the logistics sector was steady and rental growth stayed positive. The retail sector continued to benefit from resilient household consumption and improved occupancy costs.

In the capital markets, weak investor sentiment lingers, and transaction activity stayed muted in 1Q24. According to MSCI (see Figure 1), APAC volumes for the quarter slid further by 13% YoY. Australia (-26%) and Singapore
(-56%) were key drags. South Korea (+81%) performed well albeit from a low base and its strong office sector continued to draw attention. Japan fell 15% in USD terms but grew 6% in JPY terms. It has been the only stable market in recent years. By sector, office (-23%) remains the worst performer while industrial was the best performer (+26%). Retail (-6%) has been on a steady recovery trend due to its robust tenant sales and relatively palatable yields.

Cap rates was stable in 1Q24 after expanding meaningfully last year. In 2023, the expansion was most pronounced in Australia where cap rates (retail, office and logistics) rose 50–120bps. This was followed by South Korea (20–60bps) and Singapore (20–63bps). Hong Kong’s movement was more modest at 20–30bps due to a lack of transaction evidence. China cap rates rose 10–45bps despite falling interest rates. For Japan, 1Q24 signal was mixed with CBRE showing an increase while other data providers showed stable cap rates. For overall APAC, we see further upward pressure in 2024 but at a much smaller quantum. Transaction activity should start to improve, likely gradually, as we enter a rate cut cycle in late 2024 / early 2025. 

Figure 1: Asia Pacific transaction volume (USD billion)

Asia Pacific transaction volume with stable cap rates in 1Q24

This graph illustrates how according to MSCI APAC volumes for the quarter slid further by 13% YoY.

Values emerging Down Under?

Signs of bottoming in Australia

Investor optimism seems to be returning to the Australia real estate market if the listed market is anything to go by. So far this year, Australia REITs (AREITs) have outperformed relative to both regional peers and its national stock index. Year-to-April, AREITs’ share prices have increased 7%, trumping APAC REITs (Japan 0%, Singapore -12% and Hong Kong -25%) and S&P/ASX 200 (flat). While the index heavyweight Goodman Group (+25%) drove bulk of this outperformance, we note the underlying performance was still commendable (-1% excluding GMG) in the context of 50bps higher 10-year government bond yields. Is there finally light at the end of the tunnel?

In the unlisted market, investment activity remains relatively quiet. Australia’s transaction volume was among the worst hit in 2023 (-50%) and stayed subdued in the first quarter of 2024. Nonetheless, the bid-ask spread is narrowing fast, and sellers are becoming more realistic with pricing. Australia cap rates expanded aggressively and rose the most in APAC. Since mid-2022, prime yields have risen 120bps for office, 170bps for industrial and 60bps for retail (see Figure 2). At these levels, more deals are starting to offer reasonable returns.

While further cap rate expansions are likely in the coming quarters, we think the worst of this correction cycle is likely behind us. We believe the second half would likely offer a better entry point. By sector, we think industrial offers the best risk-reward ratio with fundamentals still solid. Residential build-to-rent could continue to see tight cap rates given a strong rental outlook and investor interest. However, core assets are not readily available and likely to limit the pool of buyers. Retail in the right segment could potentially offer strong returns given improved occupancy costs. Retail sales are tracking at 20–30% above 2019 levels, significantly above rental increases since then and offer reversion potential.

Office remains a challenging sector despite the sizeable correction thus far (-12% appraised valuations, -15% to -20% recent transactions). Stock picking is important given the market bifurcation. Among the big three cities, Brisbane is performing the best, followed by Sydney. Within Sydney, the flight-to-quality trend is keeping the best stocks desirable. In core CBD, premium grade valuation (-10% since mid-2022) was more resilient than the 30% decline for B grade assets, according to CBRE data. Singapore’s Keppel REIT, for example, took a plunge at an A grade office in this location at mid-6% cap rate or 17% discount to peak valuation in 2022. Melbourne remains a tough market to underwrite given its record high incentive levels of 47% on the back of a low utilization rate.

Japan in transition

Japan has historically been a relatively easier market to underwrite due to its stability. Growth in the last few decades was uninspiring but its low and steady finance costs kept the market interesting. That dynamic is now changing as the country transitions into a new era with modest inflation and higher interest rates. It is not straight forward, but we think overall policy setting is likely to stay supportive. If successful, this environment could rekindle animal spirit and boost investment activity.

Mitsui Fudosan’s recent announcement of reinvesting in growth under its new business strategies is a case in point. The plan includes recycling JPY 2 trillion (USD 13 billion) of real estate assets over the next three years. According to Bloomberg, more activist investors are participating in a push for Japanese companies to unlock values in their real estate holdings. All this could lead to improved liquidity for the market. After all, Japan’s transaction volume only ranks fifth after the US, UK, Germany and China despite it being the second largest real estate market in size globally.

We continue to like the market but would be selective on real estate sectors that are able to deliver income growth in mitigation of potential cap rate pressure. Policy errors could be a risk and the weak JPY may be a trigger. The central bank’s dovish stance remains at odds with the global higher-for-longer mantra. The authorities have a tough job to tread, a fine line between stabilizing the currency and seizing the golden opportunity to reinvigorate Japan.

Figure 2: Australia prime yields (%)

Australia prime yields have risen

This graph illustrates that since mid-2022, prime yields have risen 120bps for office, 170bps for industrial and 60bps for retail.

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