Asia-Pacific economic outlook
Activity (especially in services) has been more resilient than expected in several markets, led by the US. This means that central banks, especially those in the western developed markets (DMs), will likely have more tightening to do in the near term. Our view remains that a recession is necessary for inflation to return to target levels. The timing of this has been pushed back to early 2024 (from the first half of 2023).
We think the overall interest rate outlook in Asia-Pacific (APAC) is more benign than in the western DMs, with Australia being a notable exception.
In China, the reopening rebound has faded fast. Unlike other markets, Chinese inflation remains muted and shows little sign of moving above target as the economy settles into endemic living. The surprise cut to the seven-day reverse repo rate in June was indicative of the authorities becoming increasingly concerned about the faltering rebound.
In Japan, consumer strength should continue to support growth in the coming months and fuel speculation over domestically generated inflation. Yet, the spillover from a US recession, that we expect to hit in early-2024, will weigh on growth. The Bank of Japan (BOJ) continues to view current inflation as transitory and has left policy settings unchanged. Our base case remains that the yield-curve-control policy will be tweaked in July, but the overall policy settings should remain accommodative.
While labour demand indicators continue to soften gradually in Australia, the labour market itself is still near record tight levels. Indeed, the Reserve Bank of Australia's (RBA) deputy governor has warned that the unemployment rate may need to rise to 4.5% (from the near 50-year lows of 3.55% as of May) to tame inflation. Following the surprise hike of 25 basis points (bps) in June, many observers expect the RBA to remain on a tightening path.
APAC economic outlook
Source: abrdn Research Institute; June 2023
Forecasts are a guide only and actual outcomes could be significantly different.
Asia-Pacific real estate market overview
Besides a relatively more benign interest rate outlook, APAC’s office occupier market also appears to be in a better shape compared with its western DM peers. With the exception of Australia, this is because of a faster return to office working post-Covid. More workers returning to offices in APAC is mostly to do with structural factors, such as smaller living spaces per person, and a more affordable and efficient office commute in Asia’s key cities. That said, our analysis suggests vacancy risk remains a threat in several office markets over the next three-to-five years. Seoul, Singapore and Mumbai may be the exceptions here.
Property yields in Australia and Korea have risen the most in APAC, especially for warehouses and offices. Investment sentiment is cautious, and prices have adjusted, especially in the case of Sydney and Melbourne’s central business district (CBD) offices, and logistics in Greater Seoul. That said, recent transactions do not suggest there is widespread distress yet. In the case of Sydney and Melbourne’s CBD offices, some of the wider discounts to book value transacted could be attributed to asset-specific issues, such as low occupancy and the building’s age. This supports our thesis that a faster price correction in secondary-grade assets will create opportunities for ESG (environmental, social and governance) upgrades.
Occupier market fundamentals continue to guide our preferences and we are most positive on certain aspects of the market. These are highlighted below.
Seoul's offices: Occupier market fundamentals remain solid, with record-low vacancy rates, limited near-term supply and robust leasing demand. Domestic information and communication technology firms have been particularly active in leasing additional space. While the supply pipeline is expected to pick up in four-to-five years’ time, we expect vacancy rates to remain tight relative to history even with conservative assumptions.
Australia's industrials and logistics: Record-low vacancy rates in many cities, at 1% or less, will continue to support rental growth, albeit at a slower pace. We also expect expanding yields to translate into more attractive entry points for investors as interest rates continue to climb.
Singapore's industrials and logistics: Limited near-term supply and robust demand for modern ramp-up facilities are supportive of further rental growth, despite a weak external environment for trade. This remains one of the few markets where the yield still offers an attractive positive carry to borrowing cost, even though it comes at the expense of a shorter land tenure.
Asia-Pacific real estate market trends
The overall rental decline across the APAC markets that we track was -2.5% year-on-year in the first quarter of 2023 (from -1% in the fourth quarter of 2022), on the back of stubbornly high vacancy rates of 11.9%. The weakness was led by the office markets in Shenzhen (-8.4%), Tokyo CBD Grade A (-6.4%), Hong Kong (-4.7%), and Beijing (-2.3%). It appears that market optimism at the beginning of 2023 for a near-term rebound in the Greater China occupier markets (following the reopening post-Covid), has now given way to more caution. Indeed, according to CBRE’s latest report on leasing sentiment in APAC, Hong Kong registered the sharpest deterioration in occupier sentiment in the second quarter of 2023, while sentiment in mainland China remained the most negative in the region.
In Tokyo, the near-term outlook for CBD Grade-A office vacancy rates remains challenging on account of new supply scheduled for completion in the second half of 2023. That said, tenants’ flight-to-quality suggests vacancy risk could be increasingly concentrated in older buildings. According to Nikkei’s office rent survey for the first half of 2023, rents for new buildings increased by 4.2% – the first year-on-year rise in the first half for three years. Rents for existing buildings fell by 1% during the same period.
The industrial and logistics occupier market continues to outperform, even as economic headwinds strengthen across the APAC region. The pace of annual rental growth picked up marginally in the first quarter of 2023 to 11.8% (from 11.6% in the fourth quarter of 2022), even as the average vacancy rate expanded to 4.6% (from 3.7%) during the quarter. The market remains the tightest in Australia, where the average rental growth accelerated to 25.9% per annum in the first quarter of 2023 (from 23.6%), while the vacancy rates in Seoul, Tokyo and Singapore increased the most during the quarter.
In the case of Greater Seoul, the significant volume of speculative cold-storage completions in the near term continues to weigh on the overall industrial/logistics market. The near-term outlook remains challenging as the market digests the new supply. But the longer-term fundamentals for logistics properties in Greater Seoul remain solid, mainly because of Korea’s high adoption of ecommerce.
The prime retail rents in tracked APAC markets gained 1.7% year-on-year in the first quarter of 2023 – a faster pace compared with the 0.4% increase in the fourth quarter of 2022. The average vacancy rate also narrowed further to 7.1% (from 7.3%) during the quarter. The improved occupier performance in the first quarter was led by Tokyo and Singapore as tourism continued to recover from the pandemic. The total visitor arrivals to Singapore in May climbed further to 75% of 2019 levels (from 71% in April). In Japan, the number of international travellers who arrived in May was 72% of the pre-pandemic levels (89% if Chinese visitors were to be excluded).
We expect household spending to come under increasing pressure from the higher cost of living, which will add pressure to the outlook for retailers. This is especially the case in Australia where the outlook for interest rates appears to be more hawkish than most other key markets in APAC. That said, investment demand for non-discretionary retail assets appears to have held up. This is especially the case in Brisbane, where neighbourhood centre average yields remained relatively stable in the first quarter, compared with an increase of 20 bps nationwide.
Japanese multifamily transactions gained 13.1% in the year to March 2023, outperforming the overall Japanese market’s 1.4% loss. Japanese multifamily assets remain one of the few commercial real estate market bright spots. As competition for assets remains keen, investors are likely to move up the risk curve. Potential strategies may involve redevelopment of older apartments or offices. In June, the Legislative Councils’ subcommittee on sectional ownership law published an interim draft that could remove barriers for the redevelopment of older condos.
Australian apartment rents continued their ascent in May, albeit at a slower pace. Migration and limited supply kept vacancy rates low. We believe the outlook for the nascent Australian residential build-to-rent sector remains solid, given the favourable occupier fundamentals and recent tax changes to encourage new developments. Policy risks are on the rise, though, as policymakers come under increasing pressure to keep housing affordable.
Outlook for risk and performance
While our base case remains that the overall interest rate outlook is more benign in APAC (ex-Australia), compared with the western DMs, capital returns from real estate will continue to be challenging over the next 12 months. This is especially the case for Sydney and Melbourne’s CBD offices, and logistics in Greater Seoul where the short-term occupier market fundamentals are also poor. Beyond the immediate 12 months, we expect lower interest rates to support better capital returns. This is particularly the case for Seoul and Singapore's offices, where the occupier market outlook remains solid despite the expected recession.
Macroeconomic drivers will continue to have a bigger impact on real estate’s near-term performance. The risks to our base case include:
On the downside, a ‘no landing’ or the ‘Federal Reserve has two bites of the cherry’ scenario, whereby inflation remains elevated, and policymakers are forced to rapidly tighten again after a pause. This would imply higher interest rates for longer. Importantly, we think this could also result in a later but deeper recession.
On the upside, a more significant policy easing in China than we are currently expecting could more forcefully unlock household and market confidence. This would provide a near-term boost for assets in Greater China, Singapore and Korea. The flipside is that higher inflation suggests any upside in rents could be more than offset by lower capital values, as borrowing costs are kept higher for longer.
Asia-Pacific total returns from June 2023
Source: abrdn, June 2023
Forecasts are a guide only and actual outcomes could be significantly different