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COMMENTARY

External risks remain key threat to developed Asia-Pacific economies

A prolonged trade dispute between US, China will weigh negatively on global trade momentum and affect corporate investments.

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The rise of financial and business services, info-communications, media and technology industries have driven growth in the services sector and demand for office space - particularly prime buildings in the CBD in cities such as Singapore.

POSITIVE domestic drivers such as the strength of personal consumption and expansionary fiscal policies are likely to sustain economic growth in the Asia-Pacific region, albeit at a slower pace owing to challenging times ahead for the region in 2019.

In particular, the continued rise of service-based industries such as financial services, technology, education and health care will continue to support growth. The Asia-Pacific's total return for property is projected to be 7.6 per cent in 2019.

External risks remain the key threat to the five developed Asia-Pacific economies - Australia, Hong Kong, Japan, Singapore and South Korea. Should negotiations between the US and China wither, a prolonged trade dispute between the world's two largest economies would continue to weigh negatively on global trade momentum, and a resulting uncertain macro environment could affect corporate investments and magnify the impact of the dispute.

RESIDENTIAL EXPECTED TO DELIVER HIGHEST TOTAL RETURNS

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Yield decompression for most market sectors is unlikely to take place in 2019, 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 such as Japan's multi-family residential market could even see further yield compression this year, as rising foreign institutional interest in this sector is likely to further bolster prices. Thus, total returns for the residential sector in developed Asia-Pacific is forecast to be 9.8 per cent.

The logistics sector is expected to provide around 7 per cent returns, with logistics in Australia, South Korea and Tokyo likely to experience further cap rate declines as the sector becomes increasingly institutionalised and draws more investors seeking portfolio diversification.

Total returns for the retail sector however, are forecast to be the weakest at around 4 per cent as the sector continues to be challenged by structural changes and suppressed rental growth. Rental yields are unlikely to compress and may even expand for weaker segments, such as regional retail in Australia.

The rise of financial and business services, as well as the info-communications, media and technology industries have driven growth in the services sector across the five developed Asia-Pacific economies over the last two years, supporting demand for office space in the region, particularly prime buildings in the Central Business District (CBD) due to a competition for talent as seen in Australia's key cities as well as in Singapore. This is expected to persist and potentially contribute towards overall gross domestic product (GDP) in the medium term, causing expected demand for office space to remain healthy overall.

Furthermore, demand and supply fundamentals across most office markets in the five developed Asia-Pacific economies should remain positive in 2019 with vacancy levels below long-term averages and future supply relatively moderate.

M&G Real Estate expects the Singapore prime office market to record 8 per cent rental growth, the highest among the various market sectors in the region in 2019 as a tight supply pipeline in the next 24 months should continue to boost landlords' rental expectations.

Demand for office space is likely to remain positive as Singapore continues to position itself as a business hub for foreign corporates seeking to establish an Asia-Pacific or South-east Asian head office.

Looking towards Japan, 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's regional retail rents are also likely to dip over the next 12 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.

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.

Occupiers may also 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. Thus, 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 stay at peak levels.

SLOWEST INVESTMENT MOMENTUM

Healthy occupier markets and stable domestic macro fundamentals should continue to attract real estate investment in the region in 2019 despite cyclical, geopolitical and structural challenges.

Most market sector yields are still around 200 basis points above local 10-year government bond yields, providing sufficient buffer to absorb a rise in interest rates and borrowing costs.

However, investment momentum is likely to be slower than the previous year 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.

In this environment, an increasing focus on income returns and profile will be key in investment decisions, as assets with secure and stable income streams could prove to be more defensive against upcoming macro headwinds.

  • The writer is the head of research (Asia) at M&G Real Estate