Real estate market outlook Asia Pacific

December 2014 Real estate market outlook Asia Pacific Part of the M&G Group

Executive summary Economic outlook remains firm Leasing fundamentals improving in most Asia Pacific markets Accommodative monetary policies to boost investor interest in Japan and South Korea Strongest short term rental growth prospects: Tokyo and Singapore offices Short-term investment opportunity: secondary assets in top locations in Japan and Australia Long-term investment opportunity: Korea s maturing logistics sector 8% 7% 6% 5% 4% 3% 2% 1% Economy: strong growth outlook Economic sentiment remains strong in Asia. An improving global economy, led by the continued recovery in the United States, has helped strengthen growth in Hong Kong and Singapore. In Australia, a recovery of the housing market, coupled with stronger labour market conditions, has helped to improve consumer sentiment and household spending. To spur stronger domestic demand, central banks across the region continue to maintain very accommodative monetary policy with additional stimulus recently introduced in Japan and Korea. As interest rates remain at historical lows, credit growth and private investment are starting to recover in most economies, supporting a solid growth outlook for 2015. In Japan, the early success of "Abenomics" is being overshadowed by the negative impact of the consumption tax hike in April. This has caused a sharp decline in consumer spending, sending Japan to a technical recession with two consecutive quarters of GDP declines. However, major economic indicators - including the Tankan business sentiment survey - remain broadly positive and we expect that the additional stimulus from the Bank of Japan coupled with the recovery in the corporate sector, particularly among exporters, will offset the weakening consumer segment. This should support a resumption of GDP growth which we anticipate will average 1. p.a. over the next two years. Fig 1: Consensus GDP growth forecasts China Singapore S. Korea Hong Kong Australia Japan "As interest rates remain at historical lows, credit growth and private investment are starting to recover in most economies, supporting a solid growth outlook for 2015." A sharper slowdown in China remains a key risk to the region. However it is expected that the Chinese government will provide stimulus if economic softness accelerates. Other risks include the policy and structural adjustments in Japan, the possibility of negative spill over from economic weakness in the Eurozone and the potential volatility arising from monetary policy normalisation in the United States. However, central banks across Asia are in a relatively strong position to provide the necessary support to contain this downside. Commercial banks are also well-capitalised and profitable, cushioning them from short term volatility. This monetary capacity - coupled with progress in structural reforms, despite the downside risk - is expected to support stable growth prospects for the Asian economy. Occupational market: recovery spreading In most markets, we expect more favourable leasing fundamentals over the next few years. Office and logistics sectors are seeing stronger tenant demand thanks to improving labour market conditions and continued growth of e-commerce. "Office and logistics sectors are seeing stronger tenant demand thanks to improving labour market conditions and continued growth of e-commerce." 2014 2015 Source: Consensus Economics, November 2014. 2

Fig 2: Short-term prime occupational market drivers Retail Office Industrial Tokyo and regional Japanese cities: recovering demand and declining vacancy rates. Singapore: significant rental growth momentum in the short term. Australia: to benefit from strengthening demand. Hong Kong: tight supply underpins favourable fundamentals. Japan: demand for modern logistics space remains strong. Most markets: Rental growth prospects muted due to subdued retail sales growth outlook. Sydney and Melbourne: prime rents stabilising. Seoul: fundamental balance improving. Singapore: resilient demand but increasing supply to soften rental growth prospects in the near term. Discretionary retail beyond main cities: likely to lag the recovery in other sectors. Perth and Brisbane: continue to suffer from rental weakness. Japan and Singapore offices lead the way, Sydney and Melbourne to follow Momentum is particularly strong in Tokyo and Singapore office markets, where net take-ups have risen above the historical average. Driven by stronger demand, the rental growth rate registered double digits in both markets over the last 12 months and is expected to remain strong over the next two years. Japan s regional office markets, such as Osaka and Nagoya, have formed the second wave of the recovery, although the pace of rental growth there is more moderate compared with Tokyo. We expect Sydney and Melbourne offices to be next to rebound, with vacancy rates already declining and net effective rents on the rise. Given the relatively limited supply planned over the coming two to three years, the recovery momentum is likely to be sustained, with the improvement spreading beyond Grade A assets to lower grade properties. This is particularly the case for Tokyo, Sydney and Melbourne. To take advantage of the positive market cycle, investors may wish to consider taking on properties with selective vacancy risks or secondary assets in strong locations. "We expect Sydney and Melbourne offices to be next to rebound, with vacancy rates already declining and net effective rents on the rise." 14% 12% 1 8% 6% 4% 2% Fig 3: Office vacancy rates declining in most markets 2007 2008 2009 2010 2011 2012 2013 2014 Seoul Singapore Osaka Tokyo Hong Kong Melbourne Sydney Source: PMA Seoul and Hong Kong offices are showing a less pronounced recovery. Demand there has stabilised but remains muted, which is weighing on rental growth prospects. Rising competition between sub-markets (for example CBD versus Gangnam and Yeouido in Seoul; and Central versus Kowloon East in Hong Kong) is potentially prolonging the rental recovery cycle in these markets. 3

3 25% 2 15% 1 5% E-commerce impacts key for industrial and retail The retail sector has faced significant challenges due to weak domestic consumer demand in recent years. Retail sales growth across developed Asian economies overall has barely matched inflation in 2014. There are some positive signs on the horizon as improving economic conditions and recovering housing markets are expected to provide a positive boost to consumer sentiment in Australia and Korea. However, other markets such as Hong Kong and Japan are likely to see continued weakness in the short term. Not surprisingly in this environment, the retail sector is undergoing a gradual adaptation with more attention given to the non-discretionary segment, where demand has been more resilient. In most countries, rental growth in local shopping areas and convenience stores, particularly ones with strong catchment areas, is expected to outperform CBD shopping centres and department stores. By contrast, the industrial sector continues to benefit from significant growth of e-commerce. During 2007-2013 online retail sales grew by an average of 25% per annum in the Asia Pacific region, compared to 8.5% in North America and 14% in Western Europe. Japan and China have experienced significant growth of online sales in recent years and demand for modern logistics space in these markets has been particularly positive. Similar trends are also seen in Korea, Australia and Singapore. Fig 4: Growth of e-commerce Asia Pacific Latin America Eastern Europe CAGR (2007-2013); LH axis Middle East and Africa Western Europe Australasia North America Online retail volumes as of 2013 ($ billion); RH axis 200 180 160 140 120 100 80 60 40 20 0 With the established technological infrastructure in place 1, strong growth of online retail is expected to continue in developed Asia over the medium term. This offers opportunities for investors who can provide efficient warehouse and logistics spaces to meet the rising demand. Understanding the implications of this structural trend and the elasticity of new stock development will be critical, particularly for those investing in markets facing long term demographic challenges and weak domestic demand growth, such as Japan. Investment market outlook: strong weight of capital Improved leasing fundamentals are supporting strong investor sentiment across major Asian markets. Total transaction volumes in the region reached US $180 billion over the 12 months to September 2014, with investment activity equalling the peak of 2007. Japan, China and Australia remain the most liquid markets but transaction volumes in Singapore, Hong Kong and South Korea are also holding up well. Domestic investors dominate in most markets but cross-border transactions, particularly from within the region, are clearly on an uptrend. The weight of capital attracted to Asian real estate continues to rise. According to an estimate from DTZ 2, total available capital to invest in the Asia Pacific region has increased by 21% over 2014 to reach US $117 billion, registering the strongest growth globally. The still attractive value of real estate over bonds and the availability of cheaper borrowing are boosting investors interest and confidence. Japan and Australia remain preferred destinations for cross-border capital, while interest in the Korean market is rising notably, boosted by the Bank of Korea s decision to cut its base interest rate by a total 50bps in August and October. "Total transaction volumes in the region reached US $180 billion over the 12 months to September 2014, with investment activity equalling the peak of 2007." Source: Euromonitor International "Japan and China have experienced significant growth of online sales in recent years and demand for modern logistics space in these markets has been particularly positive. Similar trends are also seen in Korea, Australia and Singapore." 1 Internet and mobile penetration rates in Australia, Japan, Korea and Singapore are around 8, paralleling the levels in the US and the UK. Whilst China is lagging behind in terms of internet penetration rates, the total number of users is much greater. 2 DTZ, The Great Wall of Money, October 2014 4

In focus: Korea s logistics sector Korea s real estate market has seen one of the strongest structural transformations in Asia over the last decade. This has been mostly evident in the office sector but, more recently, we are also seeing progress in logistics. Looking at market fundamentals, long term demand for logistics space is healthy and is expected to continue to grow as the economy matures. Korea s retail sales have been strong with annualised growth of 7.5% for the decade to 2013, one of the strongest rates among OECD economies 3. Strong economic growth, a stable employment market, high household income and an expanding tourism industry are expected to support consumer spending. In response, demand for modern logistics and distribution warehouses is rising steadily, further boosted by growth of online retail and rapid expansion of the third party logistics (3PLs) sector. Korea s e-commerce has been one of the strongest markets in Asia, posting average annual growth rate of more than 2 over the last five years. In turn, logistics space has expanded at circa 9% per annum over the last decade, reaching 5 million sqm at the end of 2013. The advancement of Korea s transportation network and infrastructure has provided the critical foundation for the development of the logistics industry. "The advancement of Korea s transportation network and infrastructure has provided the critical foundation for the development of the logistics industry." Korean won, trillion 1,400 1,200 1,000 800 600 400 200 Fig 5: Domestic e-commerce business has grown significantly over the last decade 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Korea National Statistics, KOSIS Statistical Survey, E-commerce and Cyber Shopping Trends (2013). Leasing practices in logistics have also improved markedly with standards gradually approaching those of the office sector. Logistics assets now offer good leasing covenants and predictable cash flows, thus meeting institutional investors demand for stable income-driven returns. The increased institutional capital flows into Korean real estate, coupled with strong demand from tenants for quality and well-managed commercial space, provide ample room for significant growth in logistics sector. Despite limitations of an emerging sector - including lower transparency than the office sector, accessibility constraints, and relatively high asset specific risks - we believe that prime logistics assets offer attractive investment prospects. With the premium spread of 200-300 basis points over prime office 4, the sector is expected to deliver comparatively strong risk-adjusted returns in the medium term as it continues to mature. 3 Oxford Economics CAGR (2001-13): 2 p.a. 4 As of October 2014, prime logistics capitalisation rate is estimated at 7.25%- 7.75% as compared with 4.75% - 5.25% for prime office, according to M&G Real Estate data. We are seeing stronger risk appetite and rising interest in secondary assets, particularly in Australia and Japan, as anticipated in our June outlook. Both markets are experiencing rising volumes and compressed capitalisation rates, particularly in the office and industrial sectors. Investors are also clearly more willing to move up the risk curve, seeking higher return in value-added opportunities. With a medium term view, we expect that markets with strong cyclical rental growth prospects - such as Tokyo, Sydney and Melbourne offices - will continue to attract strong investor interest in both prime and secondary segments. Appetite for logistics assets is also expected to remain positive given the structural demand from occupiers and the accretive income yield over cost of borrowing. "Japan and Australia remain preferred destinations for cross-border capital, while interest in the Korean market is rising notably, boosted by the Bank of Korea s decision to cut its base interest rate by a total 50bps in August and October." 5

9% Fig 6: Capitalisation rates strengthen Conclusion 8% 7% 6% 5% 4% 3% 2% 1% Sydney Melbourne Tokyo Seoul Singapore Hong Kong Yield (Q3 2014) Source: PMA, M&G Real Estate. Yield (Q1 2014) Sydney Melbourne Tokyo Singapore Hong Kong Sydney Melbourne Tokyo Singapore Hong Kong Office Regional Retail Industrial Historical average (10 years) However, the tighter spreads between prime and secondary assets and between sectors are making it more difficult for investors to identify relative value as fundamental differences are being priced in. Capitalisation rates for both prime and secondary assets are already at or close to historical lows in most areas. The plentiful capital waiting to enter the areas is likely to lead to further price appreciation but investment risks are also rising as the risk premium declines. This is particularly true for markets where rental growth prospects remain weak. In this environment, it would be important for investors to look beyond the short term to assess the intrinsic value of their investments. Whilst increasing exposure to higher yielding assets or sectors can provide additional returns in the near term, investors should remain highly aware of the specific risks associated with lower asset quality, higher tenant default risk and potentially higher sensitivity to rising interest rates. For investors willing to bid for prime assets, it is important to maintain the investment discipline to avoid over-stretched valuations and over-paying for access, particularly when leverage is employed. In the near term, we see strong prospects for both investment and occupier demand in most Asia Pacific real estate markets, supported by strengthening economic conditions and positive risk appetite. Offices are at the forefront of the recovery, led by Tokyo and increasingly followed by Melbourne and Sydney. Relatively weak retail sales growth is likely to weigh on rental prospects in the retail sector, whilst logistics will benefit from significant growth of ecommerce. Over the medium term, we expect comparatively strong performance from Seoul and Hong Kong logistics, Sydney and Melbourne office, and Singapore regional retail. Increasing exposure to higher yielding assets or sectors can provide additional returns in the near term but investors should remain highly aware of specific risks associated with lower asset quality. As risk premium has become tighter, portfolio composition should play an even more critical role in assessing investment opportunities and diversifying specific risks. In this environment, we believe that portfolios with a wider opportunity set (i.e. multi-country or multisector) will be in a strong position to improve risk-adjusted performance over the medium term. "The plentiful capital waiting to enter the market is likely to lead to further price appreciation but investment risks are also rising as the risk premium declines. This is particularly true for markets where rental growth prospects remain weak." 6

For more information Cuong Nguyen Associate Director of Research and Strategy, Asian Real Estate +65 6436 5329 cuong.nguyen@mandg.sg Richard Gwilliam Head of Property Research +44 (0)20 7548 6863 richard.gwilliam@mandg.com Christopher Andrews, CFA Head of Client Relationships and Marketing, Real Estate +65 6436 5331 chris.j.andrews@mandg.com Lucy Williams Director, Institutional Business UK and Europe, Real Estate +44 (0)20 7548 6585 lucy.williams@mandg.com Stefan Cornelissen Director of Institutional Business Benelux and Nordics +31 (0)20 799 7680 stefan.cornelissen@mandg.co.uk www.mandg.com/realestate IMPORTANT INFORMATION: Not for further distribution. The value of investments can fall as well as rise. This article reflects M&G Real Estate s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. The distribution of this article does not constitute an offer or solicitation. It has been written for informational and educational purposes only and should not be considered as investment advice or as a recommendation of any particular security, strategy or investment product. The services and products provided by M&G Investment Management Limited are available only to investors who come within the category of Professional Client as defined in the Handbook published by the UK Financial Conduct Authority. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G Real Estate does not accept liability for the accuracy of the contents. Notice to recipients in Australia: M&G Investment Management Limited does not hold an Australian financial services licence and is exempt from the requirement to hold one for the financial services it provides. M&G Investment Management Limited is regulated by the Financial Conduct Authority under the laws of the UK which differ from Australian laws. Notice to recipients in Hong Kong: The contents of this document have not been reviewed by any regulatory authority in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. Notice to recipients in Singapore: This document has not been registered as a prospectus with the Monetary Authority of Singapore. Accordingly, this document and any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of shares may not be circulated or distributed, nor may shares be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor pursuant to Section 304 of the Securities and Futures Act, Chapter 289 of Singapore (the SFA ) or (ii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. 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 EC4R 0HH. 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 3852763 with its registered office at Laurence Pountney Hill, London EC4R 0HH. 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. DEC 14 / W52169