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Three ‘Ds’ to drive real estate investment in APAC

As part of a new initiative, FSA is talking to market participants about key trends that shape fund selection. This week, Benett Theseira, managing director and head of Asia Pacific at PGIM Real Estate, discusses opportunities in real estate.

Economic growth in Asia Pacific is expected to remain resilient in 2023, relative to Europe and the US, and the region as a whole provides a better backdrop for real estate investment. However, the wild card is China. Even with the expectation that China will take a while to fully open up, there will undoubtedly be a boost to economies in the region when it starts to relax its Covid policies. The question is when and how quickly.

As such, there continues to be potential for strong demand and growth of real estate in Asia Pacific, yet there remain ongoing pressures on cap rates given the interest rates hikes, most notably in Australia and South Korea, where interest rates have moved the most. At the same time, in many of the regional markets, and in specific sub-sectors, there is very strong rental growth, which is partially mitigating the effect of the interest rate rises on valuations.

As the global slowdown will result in slower growth across most of the major markets in Asia Pacific, it is vital to position on those thematic sectors which have strong fundamental drivers and are expected to outperform. Looking ahead, digitalisation, demographic change and decarbonisation are the key trends that present long-term opportunities and will be driving our investment strategy for the next few years.

Digitalisation, Demographic and Decarbonisation

Digitalisation is changing businesses everywhere; demand is driving growth for logistics and hyperscale data centers. This is on the back of very strong business and consumer migration to the cloud due to the accelerated adoption and pace of e-commerce, online entertainment, communications, social media and smart devices, which will no doubt continue to be a trend.

From the demographic perspective, the opportunities are two-pronged – on one hand, the young population and growing middle class is driving demand for residential housing, in particular rental housing due to the high cost of home ownership in major cities. On the other hand, the growing aging population will boost demand for senior housing, which is very much under-supplied in major markets in the region.

As for decarbonisation, more businesses and end users are shifting their thinking and preferences towards green buildings, which is driving the continued demand for properties with better ESG credentials. In turn, this is expected to provide more opportunities for upgrading older building stock and finding new ways to create higher value, green assets.

Investment opportunities still abundant

Historically, real estate has held up well in an inflationary period. Nevertheless, the scenario is different for the major regions – Europe, the US and Asia. Europe is facing more acute challenges due to the extended conflict in Ukraine and the US, because of how much the rates have moved and how quickly, faces risks on the downside for economy. Asia offers global investors the benefits of diversification from their home markets and the potential for stronger growth. Yet, it is critical to be selective and understand what is driving logistics, data centre, office and residential demand in specific markets.

Markets like Australia, Singapore and Korea are more similar to the West in terms of the interest rates and inflation environment. While this creates headwinds in the short term, the strong occupier demand and limited new supply will support rental growth in the medium term. In Japan, interest rates are likely to continue to be low for an extended period and hence offers attractive yield spreads.  China is going in the opposite direction – cutting interest rates and starting to provide more liquidity to real estate companies. Nevertheless, concern remains around the zero-Covid policy that is keeping the Chinese economy in shackles and creating a lot of uncertainty about recovery.

We are positive on hyperscale data centres and logistics assets across the region. Office space in Singapore is benefitting from the shift of some businesses from Hong Kong, while Seoul and Sydney will offer interesting opportunities in selected micro-markets. The residential sector in Japan is very well established, there is also huge potential demand for rental housing in Australia, as well as the co-living sectors in Singapore and Hong Kong. Higher interest rates and tightened liquidity have also ramped up the appeal of debt strategies in Australia.

If one looks at the resilience of real estate in Asia Pacific over the cycles, the region has typically rebounded quickly through major downturns. While we are likely to see some valuation declines to carry through until the first half of next year, specific sectors and markets are expected to be more resilient and experience a brighter outlook.

We believe that investing in the three major trends above would deliver positive returns over the mid to longer-term, and in the near term, liquidity tightening and higher costs of capital provide an interesting entry point for Asia Pacific real estate in the near term.

Benett Theseira is managing director and head of Asia Pacific at PGIM Real Estate.

Part of the Mark Allen Group.