As the recent trade skirmish starts to raise its ugly head, the world is concerned that potential headwinds might derail the synchronized global growth story that has been unfolding over the last two years. This is a real issue for Asia Pacific, not only to the extent that the direct impact on trade might pose dampener on export-reliant economies in Asia, and also because the indirect consequences for domestic demand can be serious.
Trade has been a major catalyst for business sentiments in most of Asia in the last two years, and has lifted private investment levels and bolstered the job markets. These have in turn had positive spillovers on commercial real estate, and were also expected to support private consumption, further reinforcing the virtuous cycle. Admittedly, despite the last few years of strong economic performance, most of developed Asia, save for arguably China, have not yet felt the benefits accruing through wages and household spending. With the trade war looming in the horizon, there is a risk that this already elusive domestic consumption growth might be stopped dead in its tracks, before it even starts to take off.
U-turn in business sentiments to impact office take-ups
In office markets where the supply cycles have peaked or are starting to peak, such as in Singapore, Beijing and Tokyo, absorption is more important than ever. We have seen a fair amount of corporate expansion in these markets which has helped to soak up a significant level of supply coming through. Clearly, not all the excess office demand were generated from better trade conditions, and long term trends also point to the emergence of new office tenants such as from the technology sector. However, it is definitely against the backdrop of brighter business prospects which have boosted the confidence of companies to tie themselves down to office leases and to increase their employee numbers. Any drastic U-turn in business sentiments will have an impact on office absorption, and that could amplify the supply imbalance in these markets.
As corporates ramp up their capital expenditure, there is an effect on the labour markets too. The job markets in Japan, Singapore, Hong Kong and Australia, amongst others, are at their tightest in the last ten years. This situation has intensified in the last two years as companies doubled down on hiring. The only piece of the puzzle that has been glaringly missing has been the wage growth that is being expected as a result of the tight labour markets. We had been rather hopeful that the momentum from the economic expansion in recent times will finally find its way into wages. Indeed, the Japanese government also put in place policies and tax benefits to encourage companies to raise wages, in the hope of spurring the lethargic domestic consumption.
Focus on non-discretionary retail real estate
The retail sector continues to suffer, partly due to an overall slowdown in retail spending, and also from the substitution effect of online retailing. Prime retail high streets in Sydney, Melbourne, Tokyo and Hong Kong have relied heavily on tourism footfall and spending. The domestic consumer has steered clear of discretionary spending, or at least have cut back on that, making it hard for prime retail rents to see strong growth. In the absence of domestic consumption growth, investors should focus on non-discretionary retail, such as suburban malls which are supported by wide residential catchments. In fact, should the impact of a slowdown in trade dampen the already dim prospects in domestic consumption, it further makes the case for investors to play to the resilient tune of non-discretionary retail.
In the logistics sectors, the mega trends of technology and e-commerce have been the factors propelling investor interest in the last few years. Fundamentally, whether the retail spending is made online or physically, any impact on consumer confidence is likely to be felt if the trade spat worsens. Also, we tend to forget that logistics do not just serve the retailing or 3PL segments. In a market such as Japan, the manufacturing sector is a major demand source for modern logistics, and to a lesser extent, this is probably similar in China and Australia.
The cautious seldom err
We are not advocating that investors steer clear of any real estate investments until there is greater clarity on the global trade front. What we do recommend, is that investors take a closer look at the macro environment and not underwrite investments that depend heavily on capital appreciation, or significant rent growth, especially based on the economic performance we have seen in the last three years. The bottom-up perspective becomes more important for real estate investment, and the asset-level attributes of any investment has to be given more weightage.
Risk management should also include the analysis of a worst case scenario, that while unlikely, might adversely affect the outcomes of real estate investments in Asia.
While exports continue to be a key feature in most Asian economies, a few things have changed in the past decade. One, what used to be the US consumption engine driving the Asia production engine is now no longer the case. The rise of China has regionalized the export market for Asia. Two, the growth of the domestic consumer amidst higher income cannot be ignored. In turn, the corresponding growth of domestic corporate demand runs parallel. Thirdly, greater regional economic integration in Asia has significantly reduced barriers to trade, reinforcing regional demand. In a nutshell, the situation is not as dire as it seems.
As Confucius wisely said, the cautious seldom err (以约失之者鲜矣), and it definitely pays to be more vigilant and nimble, especially in the face of global uncertainties.
Head of Research and Strategy - APAC
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