Market Perspective. Prudential Real Estate Investors. Asian Quarterly April 2007

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1 Prudential Real Estate Investors Asian Quarterly April 2007 Market Perspective Executive Summary Asia s economies are expected to see continued growth in 2007, although the pace of expansion in major industrial economies is expected to ease. The region s 2007 annual GDP growth is projected to be 7.6%, lower than 2006 s 8.3% but higher than the five-year annual average growth of 7.5% from 2002 to Inflation is forecast to be about 3.0% in 2007, lower than 2006 s 3.4%. The region s grade-a office markets generally saw firm rents and low vacancies in the first quarter, buoyed by positive business sentiment and corporate expansions. The supply of CBD grade-a office space in key financial centers such as Tokyo, Hong Kong, Singapore and Shanghai continues to tighten. A rise in headcounts increased new demand, as companies expand to capitalize on the fastgrowing region. Consumer confidence in Asia for the first half of 2007 is higher than in mid Retail sales and tourist arrivals in the first quarter saw positive growth, which supported demand for retail space, especially in prime areas. Prudential Real Estate Investors 8 Campus Drive Parsippany, NJ USA Ph Fax Web prei.reports@prudential.com Demand for logistics properties, or distribution centers, is expected to expand further this year, supported by supply chain management companies and freight forwarding firms, which are seeing fast-growing demand for their services. The region s trade activity is increasing rapidly, which has translated into stronger demand for warehouses. The Asian REIT market saw five new listings in the first quarter, bringing the count to 79, with a total market cap of US$79.0 billion. The J-REIT market composed 64.6% of total market cap, followed by Singapore (22.0%), Hong Kong (10.8%), Malaysia (1.4%) and South Korea (1.2%).

2 Asian Economies Asia s economies are expected to see continued growth in 2007, but the pace of expansion in major industrial economies will likely ease. The industrial countries expect slower growth, leading to a softening of net exports from Asia. Despite this, robust domestic demand in Asia will fill part of the growth gap. Oil prices, if they remain low this year, should help mitigate inflationary pressures in the region. The tightening measures adopted by Asia s central governments since last year will help to ensure that output grows at a more sustainable level in 2007 and that inflation remains under control. Overall, Asia s 2007 annual GDP growth is projected to be 7.6% (see Exhibit 1), lower than 2006 s 8.3% but higher than the five-year annual average growth of 7.5% from 2002 to Inflation is forecast to be 3.0% in 2007, lower than 2006 s 3.4% (see Exhibit 2). Exhibit 1: Annual GDP Growth (2007 versus 2006) 12% 10% % 6% 4% 2% 0% China India Japan Hong Kong Singapore S. Korea Malaysia Asia U.S. Euro Zone Sources: Asian Development Bank; EIU; Prudential Real Estate Investors Exhibit 2: Annual Inflation of Select Asian Markets (2007 versus 2006) 6% 5% % 3% 2% 1% 0% China India Japan Hong Kong Singapore S. Korea Malaysia Asia U.S. Euro Zone Sources: Asian Development Bank; EIU; Prudential Real Estate Investors 2

3 China s economic growth momentum remained strong in the first quarter of 2007, although growth was moderated slightly by the government s tightening monetary policy. Fixed asset investment grew by 23.4% in both January and February, albeit lower than the 26% growth for the same period a year ago. The People s Bank of China (PBOC) estimated that GDP growth in 1Q07 was 10.2%. In the first quarter, the government announced more measures to tighten liquidity and moderate growth. The PBOC announced a 50-basis-point (bps) increase in the deposit-reserve ratio requirement in January and another 50 bps in February, to 10% by the end of 1Q07. This requirement is the percentage of deposits commercial banks must deposit with the central bank. The increase in February meant about 170 billion yuan (US$22 billion) less in funds available for financing to the private sector. In March, the PBOC raised the benchmark interest rate by 27 bps to 6.39%. Also in March, the National People s Congress approved unifying, at 25%, the corporate tax for domestic and foreign companies, effective Jan. 1, Currently, the actual average corporate tax on Chinese companies is 25%, while that on foreign enterprises is 15%. The government does not expect the new tax rate will deter foreign investor interest, as other factors support investment in the mainland, such as infrastructure, science and technology, labor quality, industrial support, financing and social stability. Going forward, further deposit-reserve ratio increases are expected in order to soak up excess liquidity in the market and restrain fixed asset investment. Coupled with softer external demand, China s 2007 annual GDP growth is forecast to moderate to about 10% from 10.7% in In Japan, the economy continued to show signs of recovery in 1Q07, after it grew by 1.3% in 4Q06 and 2.2% in The Index of All Industry Activity rose 0.7% in January from the previous month, more than the 0.3% expected. Japan s trade account surplus stood at US$966 million in January, as opposed to a deficit of US$1.8 billion for the same period a year ago, thanks to an 18% rise in exports outpacing an 11% increase in imports. In February, the Bank of Japan (BOJ) raised the interest rate by 25 bps to 0.5%, the first increase in seven months. The central bank believes that Japan s economy is likely to continue its moderate expansion with a virtuous circle of production, income and spending, while the uncertainties about the growth prospects of overseas economies, including the U.S., are abating. The BOJ added that it would adjust rates gradually, according to changes in the economy and prices. India expects its GDP growth to be 9.2% for the current fiscal year ending March 2007, up from 9% a year ago, the fastest expansion in 18 years. The manufacturing and services sectors, which grew by an estimated 11.3% and 11.2%, respectively, buoyed the better-than-expected performance. While high growth has lifted wages, equities and land prices, it has also caused upward pressure on inflation, which stood at a two-year high of 6.73% in March, more than the government s target zone of 5% to 5.5%. This has prompted the Reserve Bank of India to raise the key interest rate by 25 bps to 7.5% in February and another 25 bps to 7.75% at the end of March. The cash reserve ratio was also raised to 6% in February and 6.5% in March to further tighten credit lending. The ratio represents the amount of cash banks must keep on deposit with the central bank. Concerns that high inflation may persist are growing, as demand is outpacing supply, which is constrained by infrastructure deficiencies. To resolve this, the 3

4 government has raised its spending on ports, power generation and roads by 40% to about US$30 billion in the new fiscal year starting April 1, Hong Kong s economy continued to see positive signs in the first three months of The unemployment rate fell to about 4.3% in February, the lowest in nine years. In January, the retail sales index rose 9.8% y-o-y, higher than the 6.1% increase for the same period one year ago. Reflecting the robust economy, low unemployment and growing wages, the composite consumer price index rose 3.1% y-o-y in February, after a 2% increase in January. In February, the government announced the budget. While the corporate tax remained unchanged, the budget included a one-time income tax waiver of 50% and a property tax waiver for two quarters of fiscal Hong Kong s 2007 annual GDP is forecast to increase by 4.5%- 5.5% in 2007, lower than 2006 s 6.8% due to expected softer external demand. Inflation is likely to be about 1.5% in 2007 and 3.5% on average over the next four years. The Bank of Korea held the interest rate unchanged at 4.5% in the first quarter, as signs of slowing liquidity growth and housing prices appeared. In February, mortgage loans rose by billion won (US$430 million), lower than January s billion won (US$785 million). Consumers became more optimistic in general in the first quarter, according to a government survey. The seasonally adjusted unemployment rate stood at 3.2% in February 2007, the lowest since December Exports remained robust in the first quarter, as reflected by the trade surplus, which grew by 228% y-o-y in the first two months of Nevertheless, South Korea s export growth rate may ease, partly due to the expected moderate slowdown in the U.S. economy. As such, 2007 s annual GDP growth is projected to be about 4.5%, lower than the 5% growth in In Singapore, the economy grew by an estimated 6.0% y-o-y in 1Q07, based on the government s advance estimates. The manufacturing sector expanded by 6.1%, while the construction sector grew strongly by 7.0%. The service-producing industries expanded by about 6.1%, driven by financial services, and wholesale and retail trade. In February, the government announced its 2007 budget. Key highlights included the two-percentage-point reduction in corporate tax to 18%, a 1.5-percentage-point increase in the Central Provident Fund s contribution by employers and a two-percentage-point increase in the Goods and Services Tax to 7%. For the whole of 2007, the official growth forecast is 4.5%-6.5%. Private sector economists expect GDP to grow by an average of 5.4%, and they have a more upbeat view on the financial services, hotel/restaurant and construction sectors. The unemployment rate is forecast to be 2.5% by the end of 2007, slightly lower than the 2.6% in the previous year. Malaysia s economy will likely see robust growth in 1Q07 after 5.7% growth in the preceding quarter. Bank Negara Malaysia, the central bank, kept the interest rate unchanged at 3.5% in the first quarter, on expectations that inflation will continue to moderate, partly because of lower oil prices. Going forward, 2007 annual GDP growth is forecast to be 6%, after expanding 5.9% in 2006, spurred by higher investment and government spending. Private investment in manufacturing, services, oil and gas may grow 10.4% this year. Government investment is projected to expand 11.4% this year, driven by development projects and spending by state-controlled utilities. In March, the government announced that the property gains 4

5 tax, which was introduced in 1975, would be abolished on April 1, The objective is to revive the nation s real estate market to attract more foreign investment. Capital Markets The Asian REIT market saw five new listings in the first quarter. By the end of 1Q07, Asia had 79 REITs, with a total market cap of about US$79.0 billion (see Exhibit 3). The J-REIT market accounted for 64.6% of total market cap, followed by Singapore (22.0%), Hong Kong (10.8%), Malaysia (1.4%) and South Korea (1.2%). Exhibit 3: Market Cap and Dividend Yields of Asian REITs, as of 1Q07 $60 $50 Market Cap Dividend yield % 8.0% 7.0% $40 6.0% ($ Billion) $30 $ % 4.0% 3.0% $10 $ Japan Singapore Hong Kong Malaysia S. Korea 2.0% 1.0% 0.0% Sources: Various Stock Exchanges; IPO Prospectuses; Prudential Real Estate Investors One REIT was listed in Japan in the first quarter, which brought the total number of J-REITs to 41, with a total market cap of about US$51.1 billion and an average dividend yield of about 2.77%, 111 bps above the 10-year Japanese government bond yield of 1.66%. The 2.77% average dividend yield was, however, lower than at the end of last year (3.29%), as J-REIT prices rose by an average of 18% in the first quarter, based on the Tokyo Stock Exchange s J-REIT Index. The newly listed REIT was the Nomura Real Estate Residential Fund, whose initial portfolio comprises 89 residential properties valued at JPY69.58 billion (US$590 million). In Hong Kong, Regal REIT was listed in the first quarter, bringing the total number of HK- REITs to six, with a total market cap of about US$8.5 billion and an average dividend yield of 3.4%, lower than the 10-year Exchange Funds bond yield of 4.2%. Regal REIT is the first hotel REIT in Hong Kong, comprising 3,348 hotel rooms with an appraised value of about US$2.0 billion. The projected dividend yield for 2007 is 7.51%. The number of Singapore REITs stayed at 15, unchanged from the previous quarter. However, total market cap rose to US$17.4 billion in the first quarter, from US$13.9 billion three months ago, benefiting from the general price rise of equities in the March quarter. The average dividend yield at the end of March was about 3.9%, lower than the 4.3% yield a quarter ago but 100 bps above the 10-year government bond yield of 2.9%. During the first quarter, MacarthurCook, an industrial REIT, registered its preliminary prospectus for listing. The REIT s portfolio comprises 5

6 about 2.1 million square feet of factory and logistics space, with a total appraised value of about US$209 million. Toward the end of the quarter, the Monetary Authority of Singapore issued a consultation paper on the S-REIT market. The proposed amendments aim to establish measures to protect unitholders interest; provide clearer, more flexible investment guidelines; rationalize compliance guidelines; and introduce a licensing framework for REIT managers under the Securities and Futures Act. In Malaysia, three new REITs were listed in 1Q07, bringing the total number of M-REITs to 10, with a total market cap of about US$1.1 billion and an average dividend yield of 5.5%, 200 bps above the 10-year government yield of 3.5%. The newly listed M-REITs were Quill Capita Trust, Al-Hadharah Boustead REIT and Amanahraya REIT. Quill Capita Trust s portfolio comprises four commercial properties, including built-to-suit office buildings, data processing centers and business park properties, with a total of 493,118 square feet and an appraised value of RM280 million (US$81 million). Al-Hadharah Boustead REIT s portfolio consists of eight plantation sites, with a total land area of about 26,261 acres and an appraised value of RM414.3 million (US$120 million). Amanahraya REIT is a commercial REIT with eight properties valued at a total of RM341.8 million (US$99 million). Going forward, the M-REIT market is likely to benefit from government initiatives announced in the 2007 budget and should expand further. These initiatives included lowering the distribution tax on REITs to 20% (28% previously) for foreign institutional investors; individual investors (both local and foreign) will be subject to a withholding tax of 15%. At the end of 1Q07, South Korea had seven CR-REITs, unchanged from the previous quarter. Total market cap at the end of March was about US$941 million, and the average dividend yield was about 7.9%, 310 bps above the five-year Treasury bond yield of 4.8%. Property Markets Office Tokyo s grade-a office market continued to see low vacancy and rising rents in the first quarter, supported by corporate demand. Quality buildings in prime locations remained popular, and absorption of such space continued to be strong in the quarter. That said, several sizeable office moves have already occurred, and the upward pressure on rents has somewhat moderated. In 1Q07, the average grade-a office effective rent rose by 4.1% q-o-q, less than the 7.1% increase in the preceding quarter. Average vacancy remained tight at about 0.3%. The precommitment rate for 2007 s new office supply (6.14 million square feet) improved to about 90% by the end of March, from about 85% one quarter ago. Business sentiment in the banking, finance and real estate sectors in Hong Kong remained optimistic in the first quarter, as reflected in the government s quarterly Business Tendency Survey. Demand for office space among tenants in these industries focused on grade-a office buildings in Central. Nevertheless, low vacancy in these quality buildings has resulted in some spillover effect into non-grade-a office buildings. Average grade-a vacancy in Central hovered around 4.2% at the end of March, similar to that one quarter ago, while rents remained firm. Going forward, some tenants in Central could relocate to the decentralized areas for cost 6

7 reasons. Phase one of the International Commerce Centre (730,000 square feet) in Kowloon, to be completed by the end of 2007, and One Island East (1.23 million square feet) in Quarry Bay, to be completed by the end of 2Q08, could be alternatives for these tenants. Rental growth momentum in Central could experience some deceleration in the latter part of this year. While Beijing is gearing up for the Olympic Games in the summer of 2008, foreign investment continues to pour in, and the office market is undergoing a construction boom. Demand for office space in the CBD in 1Q07 came from the banking and finance sector, as well as IT. On the other hand, the substantial new supply expected this year means that tenants have many choices for expansion or upgrading. To attract these tenants, landlords must offer competitive terms, from longer rent-free periods to low rents. As such, the leasing market in Beijing will likely be a tenants market in 2007, with demand trying to catch up to new supply, which will lead to higher vacancy. Thus, downward pressure on rents will gather momentum throughout this year. The scenario is rather different in Shanghai, where new office supply in Pudong and Puxi is not excessive and demand is strong, supported by banks and insurance companies, who are typical large space occupiers. Grade-A office effective rents in Pudong remained firm in the first quarter, while those in Puxi rose by 2.8% on average. The liberalization of the banking sector in China at the end of last year will probably fuel office demand in Shanghai this year, especially in the grade-a office sector, due to a flight to quality. Rents are poised to see more upward pressure for the rest of this year. Singapore s Grade-A office sector remained active in 1Q07. Supply remained tight, and vacated space was quickly absorbed. The expanding financial and banking sectors continued to dominate leasing deals in the quarter, while some law firms and shipping companies also relocated. Average grade-a office vacancy declined to about 0.4% by the end of March from 0.8% a quarter ago. Falling vacancy pushed up effective rents by almost 26% q-o-q. Going forward, 2007 is likely to be another boom year for the Singapore grade-a office market, supported by a lack of new supply and robust demand. It would not be surprising to see grade-a office rents set a new high in In the first quarter, business activity in the financial and insurance sector remained robust in Seoul. Based on the government s Service Industry Activity Index, business volume in the financial and insurance industry rose by 7.0% y-o-y in January and by 7.4% in February. Demand for grade-a office space in Seoul remained strong in 1Q07, driven by company expansions and upgrading. That said, firms trying to expand felt a sense of urgency, as business plans with headcount increases are at risk if the required expansion space is not available. The market quickly absorbed new office space that came online in the first quarter, thereby keeping vacancy very low. In the CBD, average vacancy remained at about 1.5% at the end of the quarter, while it was about 1% in Yoido and 1.5% in Gangnam. Grade-A effective rents rose by 1.4% q-o-q in the CBD, 1.5% in Yoido and 1.8% in Gangnam. In the first quarter, company expansions and relocations supported leasing activity in the grade-a office market in Kuala Lumpur City Center (KLCC). Grade-A effective rent rose by about 1% in 1Q07 and is projected to rise by 4% this year, similar to last year. The vacancy rate fell in the 7

8 first quarter and is expected to be below 10% by the end of the year. The reduction of the corporate tax rate to 27% this year (from 28% in 2006) will have a positive impact on the business environment, and more companies may consider expansions, creating more new demand for office space. Residential In Japan, nationwide housing starts declined by 0.7% y-o-y in January and 9.9% in February. On the other hand, the contract ratio of new condominium units (between units contracted and units marketed) improved from 73.4% in December last year, to 74.1% in January and 77.5% in February. The number of unsold units also fell from 8,180 units in December to 7,741 in January and 7,388 in February. According to the Ministry of Land, Infrastructure and Transport, overall residential land prices rose by 0.1% in 2006, the first time in 16 years. As the Japanese economy continues to recover, home prices are likely to appreciate gradually. Housing prices in 70 Chinese cities rose by an average of 5.3% y-o-y in February, lower than the 5.6% growth in January. Average prices in Beijing, Shenzhen and Guangzhou rose by 8.8%, 12.3% and 8.1% y-o-y in February, respectively. In Shanghai, the average price rose by a mere 0.1% in February. During the National People s Congress in March, the central government agreed to monitor property prices, and more austerity measures are in the cards if the property market continues to overheat. One such measure may be the introduction of property tax, which could apply to land or existing properties, based on their appraised value. In January, the government announced the land appreciation tax (LAT), a profit tax based on the difference between the cost of land and buildings, and the sales price. The LAT was originally introduced in 1994 but was largely ignored by local authorities, who were eager to sustain economic growth figures and thus did not implement the tax policy. The central government has taken a more serious stand this time and is likely to force local officials to administer the tax regime, which ranges from 30% to 60% of profits. The hefty tax rates, if fully enforced, will likely affect developers bottom lines and reduce the attractiveness of property investment to local and foreign developers. Another impact could be that developers may opt to build cheaper housing, which is less profitable. In Hong Kong, signs indicated that the residential market was picking up in the first quarter. Residential sales and purchase agreements rose 3.2% month-on-month in January, followed by another 4.3% increase in February. Year-on-year, the agreements rose by 52.8% and 45.3%, respectively, in January and February. Meanwhile, the prime lending rate in Hong Kong remained unchanged in the first three months of 2007 at 7.75%, after it was adjusted downward by 25 bps in November last year. The luxury residential sector continued to perform strongly in the first quarter. The leasing market saw demand from additional expatriate employees brought in by multinational corporations to satisfy demand for legal, information exchange, financial and professional services. In the sales market, underlying demand is relatively less prone to the fluctuations of overall economic and income growth. Instead, liquidity and financial market performance drive it. Potential buyers are typically entrepreneurs, consulates and senior executives of large corporations. With limited new supply, the luxury residential market in Hong Kong is likely to remain resilient in 2007, with further upside in rents and prices. 8

9 In South Korea, the housing market in Seoul is showing signs of a slowdown in the first quarter of Based on Kookmin Bank s housing price index, residential prices rose by 1.5% month-on-month on average in January, only half the growth rate in the previous month. Growth slowed further in February, at 0.4%. Indeed, mortgage loans in February rose by billion won (US$430 million), lower than January s billion won (US$785 million). The government expects that the mortgage loan market will continue to be slow for the rest of the year, as antispeculation measures and a credit tightening policy will continue to moderate buyers interest and therefore prevent prices from rising uncontrollably. In Singapore, the government s flash estimates show that islandwide private residential prices rose by an average of 4.6% q-o-q in 1Q07, the highest increase since 4Q99 (5.3%). For the luxury segment, prices rose by 5.6% on average in the first quarter, higher than the 4.9% increase in the preceding quarter. During the first quarter, luxury residential prices climbed as high as US$2,650 per square foot, as more projects were launched and sold. Rising home prices have fueled speculative activity, although this is still very selective and confined to projects in specific locations and with unique attributes. Foreigners or permanent residents bought 25% to 30% of new luxury units in the first quarter. Going forward, the upward momentum of pricing is likely to continue for the rest of the year, supported by robust economic fundamentals and buying interest from locals and foreigners. Retail In the first quarter, China s retail sales market continued to expand at a brisk pace. Total retail sales in the first two months of 2007 amounted to 1.45 trillion yuan (US$187 billion), representing a y-o-y increase of 14.7%. In Beijing, total retail sales rose by 12.0% and 20.5% y-o-y in January and February, respectively. In 2006, average income per capita grew by 14.8% y-o-y, higher than the 14.1% growth in the previous year. Demand for retail space in Beijing remained firm in the first quarter, underpinned by international high-end retailers such as fashion, food and beverage, jewelry, watches and sporting goods. On the supply side, new completions expected this year will more than double last year s, as developers continue to capitalize on the growing affluence of Beijing s population and the 2008 Olympics. As new supply outpaces demand in 2007, vacancy is expected to rise, which will put downward pressure on rents. In Shanghai, total retail sales rose by 12.6% y-o-y in the first two months of In 2006, average income per capita rose by 10.7% y-o-y. In the first quarter, demand for retail space was supported by luxury and high-street fashion retailers, and retail banks, due to the opening of the sector to foreign banking. Competition for prime retail space is likely to intensify throughout this year, as the new supply of retail space is expected to be less than last year. More shopping center refurbishments are likely this year, which will exacerbate the shortage of retail space. Overall, prime retail rents will see more upward pressure for the rest of the year, as vacancy continues to trend down. In Hong Kong, total retail sales rose by 11.4% y-o-y, buoyed by local consumer spending, which was supported by improving economic fundamentals and the wealth effect from buoyant stock market performance in most of February. The labor market saw the unemployment rate fall to 9

10 4.3% in February, the lowest level since However, tourist arrivals seemed to have slowed in the first quarter. For the first two months, total arrivals rose by only 8% y-o-y, lower than the 13.3% growth for the same period last year. In the first quarter, prime retail vacancy hovered around 1.5%, and rents rose by about 5.6%. No new supply of prime retail space is expected in 2007, thus providing further support for rents. On the other hand, the expected moderation of economic growth this year may somewhat mitigate the upward pressure on rents. In Seoul, total retail sales fell by 4.3% y-o-y in January 2007 but rose by 13.3% in February. A government survey shows that consumers in general became more optimistic in the first quarter. This could partly be due to the improvement in the labor market, which saw the seasonally adjusted unemployment rate reach 3.2% in February 2007, the lowest since December On the other hand, the nominal wage index in January actually fell by 8.3% y-o-y, an indication of lower household spending power. Indeed, the South Korean economy is likely to soften in 2007, as export growth will experience some deceleration. While demand for retail space should remain stable, any rental growth is likely to be countered by cautious consumer sentiment. In Singapore, the retail sales index (excluding motor vehicles) expanded by 4.5% y-o-y in January 2007, slightly higher than the same period last year. Total tourist arrivals in the first two months of the year amounted to 1.57 million, representing a y-o-y growth of 5.4%. In the first quarter, retail leasing interest was unabated, supported by fashion retailers and food and beverage operators. Several new fashion brands made their debuts in Singapore. At the same time, food and beverage outlets continued their expansions, either as standalone restaurants offering a unique ambience or in malls. Some older malls are being refurbished to enhance their competitiveness or redeveloped into more upmarket shopping centers. Prime retail space remained almost fully occupied by the end of the first quarter, while rents rose by about 1%. Going forward, demand for prime retail space should be strong in 2007, supported by limited supply, robust economic growth and domestic consumption. In Kuala Lumpur, tourist arrivals in January were 1.58 million, which implied an annualized rate of about 19 million, close to the 20.1 million targeted by the government. The nation s unemployment rate was 3.0% at the end of last year, the lowest since These factors supported the demand for prime retail space in the first quarter of 2007, from both domestic and international retailers. For example, Tesco, a U.K.-based hypermarket, invested about RM2 billion (US$580 million) for expansion in Malaysia, including its acquisition of a local retail chain. New supply of retail space in KLCC is projected to rise significantly in 2007 due to the completions of a few major shopping centers. That said, overall average prime retail vacancy is unlikely to rise significantly this year, as the precommitment rates of these new malls were more than 50% by the end of last year and are expected to improve further this year. Prime retail rents remained firm in the first quarter and will likely see a modest increase this year, by about 2%. Industrial In Japan, large manufacturers became slightly less optimistic in 1Q07, based on BOJ s tankan survey, probably due to the 25-bps increase in the local interest rate. Despite this, the industrial production index for the manufacturing sector expanded by 2.9% and 4.0% y-o-y in January and 10

11 February 2007, respectively, which was better than the same period last year. Export growth in the first two months of 2007 was about 14%, lower than the 17% growth for the same time last year. Demand for mid-size to large distribution centers of over 1,000 tsubo (35,500 square feet) continued to grow in Tokyo in the first quarter. However, rental growth was restricted by the strong development pipelines and price-conscious occupiers. In China, total industrial sales in the first two months of 2007 amounted to about 4.97 trillion yuan (US$642.5 billion), representing a y-o-y growth of 28.5%, higher than the 27.1% growth for the same period in Total exports in the first two months expanded by 41.7% y-o-y to US$168.7 billion. On Jan. 1, 2007, China set minimum prices for industrial land to prevent the sale of industrial land below cost and therefore provide stability to prices. In Beijing, demand for industrial space remained firm in the first quarter. Industrial supply chains associated with the companies in the Beijing Economic and Technological Development Area (BDA), a key industrial area, drove demand for industrial space in the BDA. Another key source of demand is the automobile industry and associated supply chains. In Shanghai, demand for warehouses and logistics properties was strong in the first quarter. Industrial rents continued their uptrend in the first quarter, after edging up slightly in the previous quarter. Hong Kong s total exports grew by 9.2% and 11.6% y-o-y in January and February 2007, respectively. In 1Q07, warehouse space continued to be in the spotlight, as demand from logistics businesses remained strong. For example, Federal Express announced plans to relocate and expand its Express Distribution Center as part of its local service enhancement. Warehouse vacancy fell to 2% on average at the end of March, an all-time low. While Hong Kong s logistics industry continues to expand, the rapid economic and infrastructure development of Guangzhou and other cities in the Pearl River Delta may offer strong competition to Hong Kong s industrial market. Small to medium-size logistics companies in Hong Kong may face pressure to lower their storage and transportation costs. They could in turn lower their occupation cost expenditure for warehouse space to help sustain their profit margins in the long term. In Singapore, demand for high-tech industrial space remained firm in the first quarter, as some companies continued to look to the segment as an alterative to the limited supply of traditional office space. Some companies turned to high-tech and business and science park space to meet the need for back-up recovery offices. On average, prime industrial rent rose by 5% in 1Q07. At the same time, private developers showed a marked interest in industrial land, as the government sold four sites in 1Q07, more than half the number of sites sold in Looking ahead, industrial rents, especially for high-tech and business and science park space, are likely to see more increases over the rest of the year, supported by the robust business sentiment in the manufacturing sector. Conclusion Asian economies were off to a good start in the first quarter of 2007, led by China, Japan and India. Both exports and domestic demand continued to expand and fueled economic growth in the first quarter. Business confidence remained high, and multinational corporations expanded 11

12 their operations in Asia. Labor markets continued to tighten, and wages are expected to see further improvements this year. All this should lead to another year of high economic growth for the region, with 2007 s annual GDP forecast to grow by 7.6%. Although this will be lower than 2006 s 8.3%, it is still respectable growth, considering that the five-year annual average GDP growth was 7.5% between 2002 and Inflation is projected to moderate to about 3.0% this year, from 3.4% last year. China and India are expected to use interest rates to tighten their monetary policies further in 2007, if the economic growth pace is deemed excessive. For the rest of the region, the downward pressure on interest rates is gathering pace, partly because of the abundant liquidity in the region and partly because no immediate threat exists that the U.S. federal-funds rate will see any upward adjustment, in view of the weakness in the housing market and moderate inflation. The region s grade-a office markets generally saw firm rents and low vacancies in the first quarter, buoyed by positive business sentiment and corporate expansions. The supply of CBD grade-a office space in key financial centers such as Tokyo, Hong Kong, Singapore and Shanghai continues to tighten. At the same time, the rise in corporate headcounts is increasing new demand, as companies expand their operations to capitalize on the fast-growing region. Based on the MasterIndex of Consumer Confidence by MasterCard, consumer confidence in Asia for the first half of 2007 is higher than that in mid Retail sales and tourist arrivals in the first quarter saw positive growth, which supported demand for retail space, especially in prime areas. China s retailing market is likely to see further growth this year, buoyed by rising household incomes and the continued urbanization trend. Thus more international retailers will be attracted to China s 1.3 billion consumers. Overall housing prices in China remained on the uptrend in the first quarter of However, the price increase in February was lower than that in January, which could signal that the residential market is decelerating. At the same time, the central bank has raised the interest rate and tightened banks liquidity. This could cause mortgage financing to slow further in the next few quarters, thus restricting housing prices from rising excessively. In Seoul, the housing price index grew moderately in the first quarter, while mortgage loan growth also slowed, which could signal a soft landing for the housing market. In Hong Kong, after a lull in the second half of 2006, sales activities in the first quarter of 2007 showed signs of revival, while prices remained stable. Singapore s prime residential market saw a 5.6% average price increase in 1Q07, better than the previous quarter. Record sale prices were achieved in the quarter, as investor confidence levels remained high. Demand for the region s logistics properties, or distribution centers, is expected to grow further this year, supported by supply chain management companies and freight forwarding firms, which are seeing surging demand for their services. The region s trade activity is intensifying rapidly, and this has translated to stronger demand for warehouses. China, which saw annual exports and imports grow by an average of 30% and 27%, respectively, for the past five years, will remain the linchpin of the region s warehouse market growth. 12

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16 The Investment Research Department of Prudential 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, by or via the Web at Reports may also be purchased in quantity for use in conferences and classes. To receive our reports, change your contact information or to be removed from our distribution list, please us at prei.reports@prudential.com, or telephone our New Jersey office at Prudential Real Estate Investors 8 Campus Drive Parsippany, NJ USA Tel Fax Web prei.reports@prudential.com Copyright 2007, Prudential Real Estate Investors Prudential Real Estate Investors is a business unit of Prudential Investment Management, Inc., a registered Investment Adviser and indirect wholly owned subsidiary of Prudential Financial, Inc., Newark, New Jersey.