Moving Further Away From Capital Appreciation Strategies in 2017
CBRE is reporting that investors in Asia Pacific real estate in 2017 remain heavily focused on yield spreads when seeking assets as investment intentions, and are moving further away from capital appreciation strategies.
According to CBRE Research's newly published report, New Channels for Old Favorites, the search for yield is causing investors to direct capital towards mature regional real estate markets like Australia and Japan, but to increasingly diversify away from traditional markets including Sydney, Melbourne and Tokyo.
"The investment landscape for Asia Pacific real estate has transformed significantly in the past decade," says Robert Fong, Director of Research, Asia Pacific, CBRE. "A mix of new entrants, the emergence of first-time cross-border investors and the wider involvement of institutional investors, have not only spiked capital volumes but also changed the dynamic of this market substantially."
CBRE Research shows that the search for yield can be attributable to broader participation of institutional investors, including sovereign wealth funds (SWFs), insurance companies and pensions funds, which collectively invested US$22.5 billion into Asia Pacific real estate between 2013-2016. With the relaxation of outbound investment regulations for insurance companies in China, Taiwan and South Korea, CBRE Research also anticipates sustainable interest in high yielding, yet longer-term, returns to match liabilities.
Regionally, the search for yield is directing investor interest towards Australian real estate assets in 2017. Sydney and Melbourne continue to serve as attractive destinations for investors seeking investments with high yield spreads. Factors including solid fundamentals, robust liquidity and market transparency ensure both cities will remain appealing investment destinations, but competition for limited assets will benefit cities like Brisbane, Adelaide and Canberra, due to their lower volatility and stabilizing rental markets.
"The favorable commercial yield spreads in Australia's two largest cities confirms their status as among the most consistently sought investment markets in Asia Pacific. But given intense competition and limited available stock in Sydney and Melbourne, investors are now more willing to move up the risk curve into less familiar but stable markets like Brisbane," says Fong.
Japan also remains attractive to real estate investors in 2017 because to its high commercial yield spread. Investment demand has been heavily concentrated in Tokyo due to strong rental growth and robust liquidity, but will likely peak and correct as new supply enters the market in 2017-18, according to CBRE Research. However, given this backdrop, in interactions with investors, CBRE sees a diversification trend towards Japan's regional cities such as Osaka, Fukuoka and Yokohama, driven by factors including 150bps higher yield premiums compared to the Tokyo and lower rental vacancies.
"Japanese real estate is a well-established asset class for regional and global investors that delivers consistent yield and performs as an internationally stable investment," says Tom Moffat, Executive Director, Capital Markets, Asia, CBRE. "The combination of continued competition to invest in Tokyo real estate and positive fundamentals in regional markets is leading more investors to look closely at the regional cities."
According to CBRE Research, investors focusing on the mature Australia and Japan markets must manage the search for yield with a strong risk management framework. With more attention directed towards yield spreads versus capital appreciation in Australia and Japan investments, CBRE has identified three areas of risk facing investors in the medium-term.
Liquidity risk: Investors chasing yield in Australia and Japan are more exposed to liquidity risk, especially during periods of market downturn. To mitigate liquidity risk, CBRE Research sees investors turning to funds that have more flexible investment horizons or alternative exit strategies including converting close-ended funds to open-ended funds to avoid being forced to exit assets during low liquidity and high price volatility.
Currency risk: Freely traded currencies like the Australian Dollar and Japanese Yen are both subject to volatility and require investors to operate active hedging programs to manage the associated currency risk of investing in both markets. However, hedging movements in the Australia Dollar and Japanese Yen are generally well understood by investors, supported by a sophisticated market of liquid instruments.
Business party risk: Investors entering into mature real estate markets such as Australia and Japan, and emerging destinations like Vietnam, often opt for or are required to enter through a joint venture (JV) partnership. In order to align investment interests and views, CBRE Research observes investors scrutinizing track records of potential partners more heavily and performing more thorough due diligence to assess investment and strategic objectives.
"Irrespective of location or asset class, investors that chase an elevated yield premium understand that heightened risks are par for the course. However, the diversity of risk mitigation tactics now being used by investors in markets like Australia and Japan shows that many expect to play the yield strategy across real estate portfolios for the foreseeable future," says Fong.
Outside of Australia and Japan, markets such as Vietnam continue to hold strong appeal to investors more inherent risks and a complex and developing suite of hedging solutions available. While both yield spreads and economic fundamentals continue to reinforce appetite for real estate investment, the limited investible stock is limited, suggesting that interest is being driven more by longer-term potential than shorter-term returns.
Additional themes with the Asia Pacific real estate investment space include:
Diversity of Entry Points: Investors now have more potential entry points available to facilitate real estate investment. Direct investments, portfolio, joint venture and indirect investments through real estate funds remain popular. With greater institutional investor participation in the market, CBRE Research also sees more portfolio deals capable of capturing larger exposures.
JV Openness: More investors are focusing on establishing and deepening relationships with local developers through JVs due to the limited availability of assets in certain markets. Co-investments with other investors also continue to evolve in Asia Pacific as an alternative avenue to capture outsized exposure to an individual asset or portfolio of assets.
Benefitting from Portfolio Rebalancing: Institutional investors continue to diversify portfolios and pivot towards Asia Pacific real estate assets to offset low government bond yields and interest rates. The inclusion of direct real estate investment also continues to attract institutional investors searching for stable, risk-adjusted returns.