REALESTATE February 19 Asia Real Estate Market Outlook For Investment Professionals only Notice to investors in Australia. M&G Investment Management Limited (MAGIM) and M&G Alternatives Investment Management Limited (MAGAIM) have received notification from the Australian Securities & Investments Commission of the Class Order [CO 3/199] exemption and are therefore permitted to market their investment strategies (including the offering and provision of discretionary investment management services) to wholesale clients in Australia without the requirement to hold an Australian financial services licence under the Corporations Act 1 (Cth). MAGIM and MAGAIM are authorised and regulated by the Financial Conduct Authority under laws of the United Kingdom, which differ from Australian laws. Compass One, Singapore
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Executive summary We believe domestic drivers should sustain the APAC region s economic growth in 19 despite external headwinds to developed economies Residential is expected to deliver the highest total returns in 19 as growing institutional interest is likely to drive yields lower Logistics is forecasted to provide consistent returns of around 7 over the next three years Office demand should remain healthy, supported by a growing services sector and stable supply-demand dynamics 7.6* 8.* Singapore prime office rental growth expected in 19 9.8* total return forecasted for residential in 19 *Real estate research forecasts as shown in figure 6, page 6 and figure 8, page 7. APAC total return forecasted in 19
APAC winners and losers We believe prime logistics in Sydney and Melbourne, Tokyo and Seoul should provide relatively higher total returns of around 1 in 19, backed by a higher concentration of online retail and a sizeable domestic market to buffer against trade protectionism. Japan s residential sector, particularly in the key cities, looks attractive owing to structural changes to household composition, low construction starts and stable income streams. Australian regional retail could prove challenging as both landlords and retailers continue to cope with the disruption of online retail as well as potentially weaker consumption due to a falling housing market and rising debt levels. This will likely increase downward pressure on rents and could push up cap rates for weaker performing assets in the medium term. Within the office sector, select sub-markets within key Australian cities may still offer relatively higher return prospects. Low vacancy in key Japanese regional city office markets may still offer investors higher rental growth prospects. Domestic-based fundamentals to sustain economic growth amid mounting external challenges Positive domestic drivers, such as the strength of personal consumption and expansionary fiscal policies, are likely to sustain economic growth in the five developed APAC economies, albeit at a slower pace owing to challenging times ahead for the region in 19. The rise of service-based industries such as financial services, technology, education and healthcare will support growth; Australia s economy, for instance, is forecast to expand the strongest at.7 as non-mining sectors ramp up investment activity. In Japan, a potential relaxation in foreign employment policy could fuel economic growth; a draft bill regarding the implementation of two visa categories for unskilled and skilled labour has been proposed by Prime Minister Shinzo Abe to counter a tight labour market in industries such as hospitality, healthcare and manufacturing, in addition to an ageing population. An increase in personal consumption, ahead of a likely tax hike in Q 19, would also lend support to Japan s anticipated economic growth of 1.1 in 19. Index (Q 8 =1) Impact on Real Estate External headwinds remain the key threat to the five developed APAC economies. A prolonged US-China trade dispute, should negotiations between both countries wither, would continue to weigh negatively on global trade momentum; a resulting uncertain macro environment could affect corporate investments and magnify the impact of the trade dispute. An anticipated slowdown of the Chinese economy could also potentially hurt tourist arrivals and consumption, as well as service imports, thus placing further downward pressure on the region. Particularly export-oriented cities such as Hong Kong, Singapore and South Korea, therefore, will likely see slower growth in 19. Figure 1: Asia Pacific real economic growth for 17- () Real GDP Growth () 5 3 1 Australia Hong Kong Japan Singapore South Korea 17 18(f) 19(f) (f) Source: Oxford Economics, as of November 18. Figure : Key risks and impact assessment for Asia Pacific Early US recession (19) China credit shock - Peace in the Korean peninsula Acceleration of Fed rate hike China-led Asia trade pact Japan: foreign worker relaxation Asia Pacific 1 Probability of Occurrence 1 Positive Negative Source: M&G Real Estate, as of November 18. Japan post-olympic recession recession Prolonged US-China trade war 3
Asia Pacific property sectors: key themes Office: We believe prime Singapore office rental growth should continue to outperform the rest of the region in 19 as a limited supply pipeline and healthy demand raises landlords expectations. Retail: Prime high street retail in Sydney, Tokyo, Hong Kong and Osaka are expected to be more resilient while regional centres in Australia face more challenging times due to structural changes. Logistics: Occupier demand for inner-city locations and higher quality assets should support further rental growth across the region. Overall: Yield compression is likely to bottom out for most market sectors in 19; logistics in Sydney, Melbourne and South Korea as well as residential in Japan s key cities could see moderate compression. Sustained growth of service-based industries likely to support demand for office space The services sector has seen growth across the five developed APAC economies over the last two years, with the rise of financial and business services, as well as info-communications, media and technology industries. This has driven demand for office space in the region, particularly prime buildings in the CBD due to competition for talent, as per Australia s key cities as well as in Singapore. With the services sector expected to continue supporting growth of developed APAC economies, and potentially contributing more towards overall GDP in the medium term, demand for office space is expected to remain healthy overall. Furthermore, demand and supply fundamentals across most office markets in the five developed APAC economies should remain positive in 19 with vacancy rates below long term averages and future supply relatively moderate. Regional Japanese cities, such as Osaka and Nagoya, are expected to show relatively strong office rental growth in the next 1 months as supply has been slow to respond to growing take-up. Rising rents in the CBD, coupled with low vacancy, are likely to encourage more occupiers to consider taking up space in fringe sub-markets where costs are lower. Alternatively, occupiers may pre-commit to long term leases in speculative buildings due to more attractive lease terms offered by developers. A hub and spoke model where corporates have a head office in the CBD and a separate office in lower-cost sub-markets for some business functions is increasingly more prevalent in cities such as Hong Kong and Sydney. As such, the decentralised and fringe office sub-markets, such as Kowloon East and North Sydney, could see a further uplift in rents in the medium term as rents in the CBD are expected to hover at peak levels. Figure 3: Y-O-Y change in real services GDP () 5 3 1 Australia Hong Kong Japan Singapore South Korea Source: Oxford Economics, as of December 18. Figure : Asia Pacific office market vacancy rates () 5 15 1 5 Brisbane Melbourne - - I Source: PMA, as of November 18. 17 18(f) 19(f) (f) Perth Sydney Hong Kong - Nagoya Osaka Tokyo Singapore 17 18(f) 19-3(f) 1Y AVG 5Y AVG Seoul
Prime high street in key APAC cities to outperform other retail segments Physical retail in the region will continue to serve an important purpose, particularly those stores catering to tourism and discretionary spending as a key consumer touchpoint for marketing and engagement. Therefore, high street retail rental growth in some key APAC cities Hong Kong, Seoul, and Sydney are forecast to grow in the range of 1.5 to.5 in the next three years. High street retail in Sydney s CBD, in particular, is likely to benefit from a revitalisation of the area linked to the completion of a new pedestrian zone and light-rail line. The overall outlook for retail in Australia, however, is relatively challenging, particularly for regional shopping centres. Ongoing structural change in the market underpinned by increased diversion of retail sales from physical stores to online is expected to persist in the medium term. This would likely push more retailers to rationalise their store networks, focus on inventory management or omni-channel strategy and become increasingly cautious of where and how much space to lease. Rental growth for regional shopping centres is thus expected to moderate further in 19. Figure 5: Retail sales online share ( of total) 18 16 1 1 1 8 f-- Logistics demand to be driven by positive structural drivers Positive structural drivers, such as the growth of online retailing/consumer-oriented industries, should continue to boost logistics in the region, particularly in Australia where retailers have been slower in improving their supply chain management and retailers and third party logistics businesses are still working to improve their delivery speed. In addition, to overcome labour shortages and improve efficiency, occupiers are increasingly investing in more automation and technology in their warehouse space and often require higher quality buildings to accommodate this. This demand for modern logistics facilities is likely to match, or outpace, supply in the developed APAC markets, thus supporting further rental growth. This is particularly the case in Japan and South Korea where institutional-grade assets comprise a low proportion of total warehouse stock. With rising uncertainty stemming from the ongoing US-China trade dispute and protectionism hurting global trade, manufacturers and logistics-service providers have also been shifting their focus to domestic-based demand as a buffer against these headwinds. Therefore APAC countries with strong domestic markets such as Australia, Japan and South Korea are expected to see higher take-up for logistics space in inner-city areas. A slowdown in export orders could also generate short term demand for warehouse space in some markets, as occupiers seek short term leases to cope with potential inventory build up. 6 Australia Hong Kong Japan Singapore South Korea 17 18(f) 19(f) (f) 1(f) Source: PMA, as of November 18. 5
Singapore prime office continues to take the lead for rental growth The Singapore prime office market is expected to record the highest rental growth among the various market sectors in 19 as a tight supply pipeline in the next months continues to boost landlords rental expectations. Demand for office space is likely to remain positive as the city continues to position itself as a business hub for foreign corporates seeking to establish an APAC or South-East Asian head office. Similarly, Osaka s prime office market has seen a slow supply response to tightening vacancy, and new developments in the next two to three years remain limited. The Tokyo prime office market, on the other hand, is expected to see negative effective rental growth due to a significant rise in supply over the next two years. Sydney regional retail rents are also likely to dip over the next 1 months due to a more challenging retail environment, in part owing to weaker spending by consumers on the back of a fall in both house prices and savings. This has led to rising occupancy costs for tenants. Greater Osaka s logistics market currently has one of the highest vacancy rates within the five developed APAC markets as a result of an influx of supply. Thus Osaka logistics rents are forecasted to continue declining in the first half of 19 and bottom out as new supply tapers and demand continues to strengthen. Figure 6: Strongest and weakest rental growth by market sector for 19 ()* Singapore Prime Office Underlying positive real estate fundamentals to support investment activity Healthy occupier markets and stable domestic macro fundamentals should continue to attract real estate investment in the region in 19 despite cyclical, geopolitical and structural challenges. Furthermore, most market sector yields are still around basis points above local 1-year government bond yields, providing a sufficient buffer to absorb a rise in interest rates and borrowing costs. Investment momentum is likely to be slower than the previous year, however, as diminishing returns may lengthen the search for investable assets and the underwriting process. Pricing for real estate assets may have reached its peak as yield compression across most market sectors plateaus. Investors should increasingly focus on income returns and profile in their investment decisions; assets with secure and stable income streams could prove to be more defensive against upcoming macro headwinds. Figure 7: Real estate yield spreads to 1-year government bond yields 6 5 3 1 Top 3 (19) Bottom 3 (19) - - T Singapore Grade B CBD Office Osaka Prime Office Tokyo Prime Office 1y Max 1y Min 18(f) Sydney Regional Retail Source: PMA, as of October 18. Osaka Prime Logistics -1 - Sydney Melbourne Brisbane Hong Kong Tokyo Osaka Singapore Seoul Sydney Melbourne Hong Kong Tokyo Singapore Seoul Sydney 1Y AVG Melbourne Hong Kong Tokyo Singapore Office Retail Logistics - -1 1 3 5 6 7 8 9 Source: M&G Real Estate, as of December 18. *Forecast figures. 6
Yield decompression unlikely for most market sectors Yield decompression for most market sectors is unlikely to take place in 19, despite rising interest rates and tougher lending conditions, as the need to deploy capital by both existing and new funds continues to drive stiff competition for limited assets. Consequently, some sectors could even see further yield compression in 19, such as Japan s multi-family residential market, as rising foreign institutional interest in this sector is likely to further bolster prices. As such, total returns for the residential sector in developed APAC is forecast to be around 1 in 19. The logistics sector is expected to provide the highest returns of around 7 in the next three years, with logistics in Australia, South Korea and Japan (specifically Tokyo) likely to experience further cap rate declines as the sector becomes increasingly more institutionalised and draws more investors seeking portfolio diversification. Total returns for the retail sector, on the other hand, are forecast to be the weakest at around over the same period as the sector continues to be challenged by structural changes and rental growth remains suppressed. Retail yields are unlikely to compress further and may even expand for weaker segments, such as regional retail in Australia. Figure 8: Asia Pacific total returns for major market sectors 19-1 ()* 1 1 8 6 Office Retail Logistics Residential Asia Pacific 19(f) (f) 1(f) Source: M&G Real Estate, as of November 18. *Forecast figures. 7
Contact Jonathan Hsu Director, Head of Research, Asia +65 636 5353 jonathan.hsu@mandg.sg Eunice Khoo Senior Associate, Property Research Asia +65 636 536 eunice.khoo@mandg.com Richard Gwilliam Head of Property Research + () 3977 98 richard.gwilliam@mandg.com www.mandgrealestate.com Ryan Ho Manager, Investment & Product +65 636 531 ryan.ho@mandg.com Stefan Cornelissen Director of Institutional Business +31 () 799 768 stefan.cornelissen@mandg.co.uk Lucy Williams Head of Investor Relations and Business Development + () 3977 135 lucy.williams@mandg.com For Investment Professionals only. This document is for investment professionals only and should not be passed to anyone else as further distribution might be restricted or illegal in certain jurisdictions. The distribution of this document does not constitute an offer or solicitation. Past performance is not a guide to future performance. The value of investments can fall as well as rise. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and you should ensure you understand the risk profile of the products or services you plan to purchase. This document is issued by M&G Investment Management Limited (except if noted otherwise below). The services and products provided by M&G Investment Management Limited are available only to investors who come within the category of the Professional Client as defined in the Financial Conduct Authority s Handbook. They are not available to individual investors, who should not rely on this communication. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G does not accept liability for the accuracy of the contents. M&G does not offer investment advice or make recommendations regarding investments. Opinions are subject to change without notice. Notice to investors in the Netherlands: This document does not constitute investment advice or an offer to invest or to provide discretionary investment management services. Notice to investors in Singapore. This advertisement has not been reviewed by the Monetary Authority of Singapore. M&G Real Estate Pte. Ltd. (Co. Reg. No. 6118G) may distribute information/research produced by its respective foreign affiliates within the M&G Group of companies pursuant to an arrangement under Regulation 3C of the Financial Advisers Regulations. Where the information/research is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, M&G Real Estate Pte. Ltd. accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact M&G Real Estate Pte. Ltd. at (65) 6365315 for matters arising from, or in connection with the information distributed. This information/research is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should take into account your specific investment objectives, financial situation or particular needs before making a commitment to trade, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit. No representation or warranty is given as to the accuracy or completeness of this information. Consequently, any person acting on it does so entirely at their own risk. In addition to the disclaimer above, the information does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. Any views and opinions expressed may be changed without an update. M&G Investments and M&G Real Estate are business names of M&G Investment Management Limited and are used by other companies within the Prudential Group. M&G Investment Management Limited is registered in England and Wales under numbers 936683 with its registered office at Laurence Pountney Hill, London ECR HH. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority. M&G Real Estate Limited is registered in England and Wales under number 385763 with its registered office at Laurence Pountney Hill, London ECR HH. M&G Real Estate Limited forms part of the M&G Group of companies. M&G Investment Management Limited and M&G Real Estate Limited are indirect subsidiaries of Prudential plc of the United Kingdom. Prudential plc and its affiliated companies constitute one of the world s leading financial services groups and is not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America. JAN 19 / 33315