Market Perspective. Asian Quarterly. Pramerica Real Estate Investors. Executive Summary

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Pramerica Real Estate Investors Asian Quarterly Market Perspective Executive Summary The spike in oil prices and soaring inflation has become a major threat to Asian economies, most of which are net

1 Pramerica Real Estate Investors Asian Quarterly Market Perspective Executive Summary The spike in oil prices and soaring inflation has become a major threat to Asian economies, most of which are net oil importers. The impact of the global credit crunch continues to linger. Asia s capital markets are in the doldrums, illustrated by the cancellations of initial public offerings (IPOs) of two REITs. Investment sales volume dipped in the quarter, as investors remained cautious. We foresee some distressed sales in the market, creating some buying opportunities for long-term investors. The region s class-a office markets saw relatively stable occupancies and rents in the quarter. New supply in the second half will remain fairly tight, which supports prevailing rents. Asia s retail markets continue to be resilient. However, the short-term outlook is clouded by the inflationary environment, which could moderate retailers expansion plans. July 2008 Overview Asian property markets remained stable in the second quarter amid a great deal of upheaval. Concerns over inflation in general and the price of oil in particular are so acute that they are overshadowing the impact of the credit crisis on the region s economy. Oil prices rose by nearly 40% in the second quarter, which outpaced the 6% increase in the first quarter. As most Asian countries are net importers of oil, the economic impact from rising prices will be severe going forward. At the same time, food prices also have increased substantially, particularly problematic for most Asian countries, where food typically accounts for a large share (30-57%) of the consumer price index (CPI). The spike in food and oil prices will intensify the inflationary environment, which is likely to moderate the region s economic growth. Some worry that stagflation will crop up. Pramerica Real Estate Investors 8 Campus Drive Parsippany, NJ USA Tel Fax Web Meanwhile, repercussions from the global credit crunch have not dissipated. Given the continued write-downs by large global financial institutions, the credit markets are unlikely to recover anytime soon. Lenders in Asia continue to exercise caution on real estate financing, even to borrowers with a reputable track record. The difficulty in arranging debt was a factor in the drop in investment sales volume in the second quarter. Banks are much more cautious, reducing loan proceeds, increasing spreads and requiring more

2 onerous terms. A persistent bid-ask spread remains due to the less favorable financing environment and the resolve of sellers to stand by their pricing and the conviction of buyers that bargains should be available. We believe that the market environment will create opportunities to buy properties at discounts from distressed sellers, and only well-capitalized sponsors that do not need high levels of debt will be able to take advantage. This is especially so in emerging markets such as Vietnam, China and India. Economic Context Asian economies found themselves walking a tightrope in the second quarter, the result of soaring oil and commodity prices. The other culprit is high inflation, driven by rising food prices. Central banks in the region must tighten their monetary policies to keep inflation under control. Indeed, inflation in most Asian markets is already at historical highs and is expected to surpass official forecasts. To curb inflation, central banks are expected to raise interest rates or let domestic currency appreciate. Both options, unfortunately, have the potential to drag down capital investment and exports. Double Whammy for Asian Economies Rising Oil and Food Prices Historical Oil Price (US$ per barrel) Net Oil Exports/Imports by Country $150 $100 10% $125 $50 5% $100 $0 0% $75 -$50-5% $50 $25 -$100 -$150 Net export/import of oil (US$ bil, left) Share of GDP (%, right) -10% -15% $0 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 -$200 Japan China Korea India Taiwan Thailand Hong Kong Philippines Singapore Malaysia -20% CEIC; Pramerica Real Estate Investors Food Weight as a Percentage of CPI Country Share Country Share India 57.0% Malaysia 30.0% Philippines 46.6% Hong Kong 26.9% Indonesia 42.3% Taiwan 25.0% China 33.2% Singapore 23.4% Thailand 32.7% South Korea 14.0% Asian Development Bank In Japan, core inflation in June rose 1.5% over the prior year, the quickest pace in more than a decade. Household expenditures slid 3.2% in May from a year earlier, implying that Japanese households are spending less. The Bank of Japan (BOJ) kept interest rates at 0.5% as of end of the second quarter. Nonetheless, it is expected that the BOJ will be forced to increase interest rates in the near future, as the inflationary environment persists. 2

3 Pramerica Real Estate Investors China s CPI hit 7.7% in May. The central bank responded in June by twice raising the bank reserverequirement ratio by a total of 100 basis points (bps), to a record-high of 17.5%. With the two hikes in June, the bank has raised the reserve ratio six times this year. In India, inflation struck a 13-year high of 11.89% in late June, more than double the Reserve Bank of India s target level of 5.5% for fiscal year The bank increased its key short-term lending rate by 0.5%, to 8.5%, while it kept the borrowing rate unchanged at 6%. It also raised the reserve ratio by 0.5%, to 8.75% Inflation Will Surpass Official Forecasts 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Inflation Forecasts by Country Indonesia Thailand India Philippines China Hong Kong EIU forecast Malaysia Singapore Economist Intelligence Unit (EIU), Various Governments, Pramerica Real Estate Investors Official forecast/target South Korea Taiw an Hong Kong, South Korea and Singapore were not spared from the impact of the surge in oil and food prices in the second quarter. Hong Kong s CPI rose by 5.7% in May, while in June South Korea s inflation reached an almost 10-year high of 5.5%. In Singapore, consumer prices jumped 7.5% in May, the fastest pace in 26 years. The double whammy of rising oil and food prices is threatening the growth prospects of Asian economies. Private sector economists have trimmed the region s GDP growth pace for this year and 2009 to reflect the expected lower economic activity and higher living costs. Notwithstanding, Asia s GDP growth will still outpace other regions around the globe, and the long-term outlook for investment opportunities in the region remain attractive, despite the current market turbulence. Capital Markets After a temporary rally early in the second quarter, the Asian credit markets were hit hard by inflationary fears. The J.P. Morgan Asian Credit Index ("JACI"), which measures credit risk premiums, started the quarter at 333 bps. It rallied to 275 bps by mid-may before widening 53 bps at the end of June, to 328 bps. The region s CMBS market remained in the doldrums in the second quarter. According to Commercial Mortgage Alert, CMBS issuance in Asia in the first half totaled a paltry US$1.9 billion, all in Japan. Total issuance outside the U.S. amounted to just US$9.4 billion, much lower than the US$54.9 billion a year ago. 3

4 REIT Markets The region s REIT market remained in a down mode in the quarter, with many REITs trading below their net asset values. Hong Kong REITs posted a modest gain in the second quarter and have outperformed the broader equity market in Hong Kong by a wide margin this year. However, Japanese and Singapore REITs have fallen sharply, with year-to-date total returns of 23.3% for J-REITs and 15.4% for S-REITs. Quarterly Total Returns, REITs vs. All Equities 2Q08 1Q08 4Q07 3Q07 2Q07 1Q07 REITs Hong Kong 1.6% -0.8% 0.4% -1.3% -3.5% 15.4% Japan -3.1% -20.8% -8.2% -9.3% -6.7% 25.9% Singapore -9.5% -6.5% -11.0% -4.9% 9.4% 11.0% All Equities Hong Kong -4.0% -18.2% 5.4% 19.5% 7.8% 3.3% Japan 8.6% -17.2% -8.7% -8.5% 3.6% 2.5% Singapore -1.3% -13.3% -4.7% 3.1% 12.3% 10.6% S&P/Citigroup (local currency) Weak investor demand prompted the cancellations of two REIT IPOs in June. In Japan, the Daiwa House REIT Investment Corp scrapped a US$562-million capital-raising plan, while in Singapore, India s Unitech shelved its US$600-million IPO. Only one new REIT the Indiabulls Properties Investment Trust was floated in Singapore in the second quarter. The Realty Korea Cr REIT Co Ltd was de-listed in April, which reduced the field of Korean REITs to 5. At the end of the second quarter, the total number of Asian REITs remained at 86 with a total market capitalization of US$66.1 billion, 5.3% lower than that of the last quarter. The average dividend yield rose slightly: to 5.4% from 5.3% at the end of March. Market Cap and Dividend Yields of Asian REITs, as of 2Q08 Market Capitalization (US$, bil) $45 9% $40 $37.8 8% $35 $30 $25 $20 $17.5 7% 6% 5% 4% REIT Dividend Yields and Risk-free Rates Avg div yield Risk-free rate $15 $10 $8.9 3% 2% $5 $1.5 $0.4 1% $0 Japan Singapore Hong Kong Malaysia Korea 0% Japan Singapore Hong Kong Malaysia Korea * Risk-free rate refers to long-term government bond yields Various Stock Exchanges; IPO Prospectuses; CEIC, Pramerica Real Estate Investors 4

5 Pramerica Real Estate Investors Property Markets Office Space market fundamentals in Asia s office markets are remarkably healthy. Vacancies remain low, and new supply in most markets is very modest. In Tokyo, demand for class-a office space continued to be firm, as supply remained tight. Vacancy rates, while inching up slightly, remain around 3%, particularly in the prime areas. On the other hand, there was anecdotal evidence that some companies have slowed down expansion plans, a reflection of the uncertain business environment. Some landlords responded by lowering asking rents. Notwithstanding the slowdown in investment sales, cap rates for class-a offices in Tokyo remained unchanged at about 4%, based on an investor survey in May by the Japan Real Estate Institute. In Hong Kong, fundamentals in the class-a office market are strong, supported by the robust labor market. The unemployment rate was 3.3% in May, a 10-year low. Newly completed buildings with vacant space in non-core areas such as Hong Kong East and Kowloon East continued to attract costconscious companies. In Central, the effective rent for class-a office space continued to increase in the second quarter, albeit at a slower pace. The average class-a rent edged up by 5.7% in the second quarter, lower than the 12.7% growth in the previous quarter. Vacancies are low, averaging just 1%. In Singapore, rents of class-a office space continued to climb upward in the second quarter, albeit at a slower pace compared to the preceding quarter. The lack of excess supply, coupled with an increase in service-sector employment, enabled landlords to boost rents. New supply will begin to pick up this year and will likely peak in 2010 or As such, rental growth momentum will continue to decelerate. Institutional investors remain on the lookout for quality office buildings, and prices remain stable. In Beijing, new office completions were delayed in the second quarter, as the government enforced a construction slowdown to prepare for the summer Olympics. All construction activities in the capital city must stop between July 20 and the end of the games. As a result, new supply will likely outstrip demand in the second half of the year. Prospective tenants appear to be deferring decisions on new space until then, figuring that they will have more choices and better bargaining power. The surplus supply situation is expected to last until 2009, which will cause vacancies to rise in the near term until demand catches up sometime next year. Rents are expected to see some downside as vacancies rise. In Shanghai, the existing class-a office supply in Puxi remained tight in the second quarter, as the location is highly sought after by quality tenants. Vacancy in Puxi is expected to remain low and rents are likely to trend up. Nonetheless, a number of cost-conscious occupiers have relocated to Pudong and Lujiazui areas, taking advantage of the large amount of new supply in those submarkets. In Seoul, new supply of class-a office space in the second quarter was limited to the Gangnam submarket. Additional spaces were either fully committed upon completion or owner-occupied, keeping the vacancy rate in the CBD below 2%. Given the tight supply of office space in the CBD, tenants increasingly are moving outside central areas. On the investment front, institutional investors both local and foreign continued to compete for quality buildings. They are trying to capitalize on the rental upside, given the supply-demand imbalance. 5

6 Residential Residential market fundamentals in Tokyo remained mixed in the quarter. Housing starts rose by nearly 21% in April, and then declined by 10% in May. Since January, the number of unsold new condominium units in Tokyo has been rising, a sign that potential buyers remain cautious about the market. Sentiment was weighed down by the uncertainty in the overall economy. The labor market remains tight, but unemployment has increased modestly since last year to 4% at the end of May. Housing prices in China were on the uptrend in the second quarter, but the momentum was decelerating. Prices rose by 9.2% in May, the lowest in eight months. Consumer confidence has been dampened by austerity measures implemented to curb soaring inflation. In addition, mortgage lenders tightened credit in June after the central bank raised the bank reserve-requirement ratio by 100 bps, to 17.5%, a record high. The rise in housing prices will likely slow in the short term. Over the long run, the trend toward urbanization will continue to be the key driver of the residential market. The underlying demand for housing, especially among the middle class, will provide stability to residential prices. In Hong Kong, residential transaction volume rebounded in June, after declining in April and May. However, the total number of transactions in the second quarter was still some 9% below that a year ago. The total transaction value in the second quarter fell by 4.6% from that of a year before. Several major lenders increased mortgage rates in the quarter, which had a negative impact on consumers looking to buy homes. On the other hand, if inflation remains elevated in the second half of 2008, more investors could decide to purchase residential properties as an inflationary hedge. The growth of residential prices ebbed in Seoul in the second quarter. On a month-on-month basis, apartment prices rose by 2% in April, but slowed to 0.8% in May and 0.5% in June. On a year-on-year basis, apartment prices in June increased by 7.4%, significantly lower than the 16.2% growth for the same period last year. There are roughly 132,000 unsold residential units nationwide as of the end of March, almost double the 10-year average. About 83% of these unsold units are in small cities in South Korea. In a move to prop up the residential markets in these cities, the government decided to lift the maximum loan-tovalue ratio for unsold units to 70%, from 60%, provided that the developers reduce prices by 10%. Acquisition and registration taxes will be cut by 50% in an attempt to boost sales. In Singapore, market fundamentals remained soft in the second quarter. Island-wide residential prices rose by 0.4% on average, the slowest pace in almost four years. In the first half of the year, about 6,800 residential units were sold, 70% less than the same period last year. The decline possibly is due to the exit of speculators, especially in the prime segment. Responses to some recent new sales launches in the suburban areas were positive, indicating there is still underlying pent-up demand from families looking to upgrade from public housing. Retail China s retail sales increased over the prior year by 21.6% in May, after gaining 22% in April. Leasing activities in Beijing and Shanghai remained robust as more retailers opened new stores in time for the Olympic games. Nevertheless, new supply outstripped demand, resulting in a rise in vacancy rates. This has put downward pressure on rents and will probably remain the case for the rest of the year, 6

7 Pramerica Real Estate Investors especially when retailers moderate their expansion plans in view of rising inflation, which will moderate retail sales growth in real terms. In Hong Kong, the private consumption level remained relatively high throughout the second quarter. Retail sales in May rose by 12.9% over the prior year, after April s 18.7% increase, on the back of healthy job and tourism markets. The retailing market in Hong Kong was able to tap into Macau s gaming industry, which brought additional visitors to the Special Administrative Region. Looking ahead, the tourism market in Hong Kong is expected to benefit from the Beijing Olympics, giving retailers confidence about the outlook in the third quarter. In South Korea, retail sales in April rose by 10.9% over a year ago, but moderated to 10.2% in May. Going forward, soaring inflation may dent consumer spending. The CPI rose by 5.5% in June, almost a 10- year high, and well above the Bank of Korea's target range of 2.5% to 3.5%. The BOK also reported that household debt increases in the first quarter were more than double from a year earlier. Consumer confidence fell to an eight-year low in June, and household consumption will likely decline for the rest of the year. Growth in retail rents will be limited going forward. Singapore s retailing market in the second quarter was not seriously affected by the slowdown in the global economy. Retail sales (excluding motor vehicles) in May rose 7.9% from the same period a year ago. The tourism market also remained healthy in the first five months of 2008, with some 4.3 million visitors, representing an increase of 4.3%. That said, retailers are concerned that inflation will curb consumer spending. Retail landlords appear to have taken notice and are more willing to negotiate. As such, the upward rental momentum will continue but at a more moderate pace. Industrial In the second quarter, the region s trade activity was weighed down by the economic slowdown in the U.S., which is Asia s key export market, and the soft U.S. dollar. As a result, demand for industrial space across the region has moderated somewhat. Japan s export growth has slowed along with the global economy. At the same time, the strengthening of the Japanese yen cut into exporters profit margins. In April, exports rose by 4%, while import costs surged 12% because of price increases for raw materials. Exports to the U.S. fell 9% from a year earlier, with significant reduction in core products such as auto parts. The latest Bank of Japan s tankan survey showed that confidence among large manufacturers softened to its lowest level since September Demand for industrial space is likely to be weighed down by the bearish market sentiment, prompting growth to decelerate. In China, there are signs that the upward growth in exports is tapering off. Total export growth in April and May to key markets such as the U.S., EU and Asia were 1.8% to 6.3% lower than the same period a year ago, possibly resulting from rising labor costs and raw material prices. If the decline persists, it could slow the growth of Chinese manufacturers. The trend is compounded by uncertainty in the global economy in the wake of high oil prices and inflation. Import demand for Chinese goods from other regions could turn sluggish, which could result in moderate absorption of industrial space going forward. 7

8 In Hong Kong, export activities remained robust in the second quarter. Increasing exports to Asia and the EU more than weaker exports to the U.S., which fell by 1.8% in April and 2.3% in May from a year ago. The leasing market was primarily driven by the warehouse sector, where expansions of third-party logistics operators are driving demand. Warehouses that are located near the container terminals in Kwai Chung remain highly sought after. The robust demand, coupled with the low vacancy in the warehouse market, helped rents to rise by about 4.6% in the second quarter, more than the 2.9% in the preceding quarter. Singapore s high-tech industrial properties and business parks continued to see robust demand in the second quarter, as the government s long-term strategy to develop the nation into research and development, biomedical and science hubs continued to attract manufacturers. In the quarter, high-tech industrial rents rose by 6.8%. On the other hand, concerns over inflation, the strong Singapore dollar and soft export demand dampened tenant demand for factories and warehouses. Factory and warehouse rents each rose by about 3.3% in the second quarter. Looking ahead, industrialists will face more challenges given the rising raw material costs and declining profit margins. Expansion plans will probably be reviewed and new demand will be more gradual. Closing Thoughts From the macroeconomic standpoint, Asia is bracing itself for a perfect storm the global credit crunch, spiking oil prices and soaring inflation which is almost certain to decelerate the region s economic growth, probably into next year. Rising prices in particular have become an imminent problem for central banks to tackle, as uncontrollable inflation will deflate private consumption and economic growth and delay recovery when oil prices ease and the credit crunch impact begins to recede. After riding a cyclical upturn that began five years ago, the region is headed for a period of slower growth in rents and property values. On the leasing side, the uncertain business environment may cause tenants to delay their expansion plans. Although demand will likely moderate in the near term, we do not foresee a drastic contraction in the space market, as there are still long-term growth opportunities for businesses in the region. With the credit crisis still looming over the capital markets, market sentiment is gradually turning against sellers, which will limit opportunities for short-term gains. 8

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12 The Investment Research Department of Pramerica Real Estate Investors publishes reports on a range of topics of interest to institutional real estate investors. Individual reports are available free of charge in hard copy or via the Web at Reports may also be purchased in quantity for conferences and classes. To either receive reports, update contact information or to be removed from our distribution list, please us at research.reports@pramericarei.com, or telephone our New Jersey office at Pramerica Real Estate Investors 8 Campus Drive Parsippany, NJ USA Tel Fax Web research.reports@pramerica.com Copyright 2008, Pramerica Real Estate Investors Pramerica Real Estate Investors is the real estate investment management business of Pramerica Investment Management. Both Pramerica Real Estate Investors and Pramerica Investment Management are trading names of Prudential Investment Management, Inc. the principal asset management business of Prudential Financial, Inc. ('Pramerica Financial') of the United States. Prudential Financial, Inc. is not affiliated in any manner with Prudential plc, a company incorporated in the United Kingdom. Pramerica, Pramerica Financial and the Rock Logo are proprietary service marks and may not be used without the written permission of the owner. Copyright All rights reserved.

Market Perspective. Asian Quarterly PREI. Executive Summary

Market Perspective. Asian Quarterly PREI. Executive Summary PREI Asian Quarterly April 2011 Market Perspective Prudential Real Estate Investors 8 Campus Drive Parsippany, NJ 07054 USA Tel +1 973.683.1745 Fax +1 973.734.1319 Web www.prei.com Executive Summary Notwithstanding