Three Ds to drive real estate investment in Asia-Pacific

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. The wild card is China. But even with the expectation that China would take a while to fully open up, the reversal of its zero-Covid policy would undoubtedly boost economies in the region.

Therefore, there continues to be potential for strong demand and growth of real estate in Asia-Pacific – yet there are ongoing pressures on cap rates given the interest rate hikes, most notably in Australia and South Korea where interest rates have moved the most.

At the same time, in many regional markets and in specific sub-sectors, there is very strong rental growth which is partially mitigating the effect of rising interest rates 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 investments in those thematic sectors which have strong fundamental drivers and are expected to outperform.

Digitalisation, demographic change and decarbonisation are the key trends that present long-term opportunities and will drive our investment strategy for the next few years.

Digitalisation is changing businesses everywhere; demand is driving growth for logistics and hyperscale data centres. 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.

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From the demographic perspective, the opportunities are two-pronged.

On one hand, the young population and growing middle class are driving demand for residential housing – in particular rental housing due to the high cost of homeownership in major cities.

On the other hand, a growing ageing population will boost demand for senior housing, which is very much undersupplied 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 environmental, social and governance 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.

Historically, real estate has held up well in inflationary periods. Nevertheless, the scenario differs for the major regions – Europe, the US, and Asia.

Europe faces more acute challenges due to the extended conflict in Ukraine. The US, because of how much and how quickly interest rates have moved, faces downside economic risk. 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 such as Australia, Singapore and Korea are more similar to the West in terms of the interest rate and inflation environment. While these are headwinds in the short term, 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 it 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 its post-Covid economic recovery.

We are positive on hyperscale data centres and logistics assets across the region. Office space in Singapore is benefiting 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 the year, specific sectors and markets are expected to be more resilient and see a brighter outlook.

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

The writer is managing director and head of Asia-Pacific, PGIM Real Estate.