DTZ Research sees strong rebound in Asia Pacific

Singapore's 31% growth contributes to region's spearheading the world economy out of the economic downturn.

Asia Pacific economies are experiencing a strong rebound after a short period of negative growth. Rental forecasts for the three major property sectors project a return to positive growth in 2010, according to a DTZ Research report.

Demand for prime office space is expected to recover in coming quarters, as vacancy rates fall back from 2009 peaks. Region-wide rental growth is only about 2% in 2010 but will pick up sharply from 2011 onwards to 6-8%. Rental growth will be strongest in Chinese cities and other markets that are closely tied to the mainland. India’s IT centres and major Australian cities are also expected to perform well over the period.

Yield compression in prime offices is expected to be marginally sharper than in the previous forecast. However, total returns will rely more heavily on occupier market fundamentals than in the 2005-2007 cycle.

China and India have the strongest consumer sector in the region, and their cities will dominate prime retail. In China, retail demand has been supported by stimulus and savings, and now increasingly by jobs and income growth. Indian cities exhibit good rental growth prospects as well as high initial yields.

Industrial rents are bottoming out after deep cuts in 2009. Going forward, demand will benefit from a sharp V-shaped recovery in the export sector. A pickup in trade and manufacturing, as well as the commodities cycle, will support industrial prospects over the period.

Q1 2010 was a record quarter for transaction volumes although it was heavily skewed by Chinese land deals brought forward. However, volumes are also picking up in Japan and Australia, and foreign investors are cautiously reentering the market. Core locations will be the main focus of renewed investor interest for now.

Office Markets
Regional office markets come out of the slump
Prospects for the office sector are improving steadily as Asia is leading the global economic recovery.

Average prime rents are expected to record modest positive growth of 2% in 2010 after falling by almost 20% last year. As the region gains momentum, the rental market will return to a long-run trend growth of 6-8% per year.

Rental recovery led by cities in greater China
Within the region, there is a great deal of variation in the timing and strength of the recovery. Demand for office space hit a trough in most markets during H1 2009, with China, Australia and Taiwan going first into the downturn. These are also the first markets to return to growth. The top five office markets in terms of predicted rental growth in 2010 are all located in China and Hong Kong.

Much of this strong performance in the short term can be explained by the Chinese government’s early intervention with a $585 bn stimulus package. The benefits have been apparent in sustained economic growth, and occupiers in key submarkets in Beijing, Shanghai & Guangzhou are again adding space.

Over the forecast period, the strongest rental markets are regional cities that are undersupplied (Shenyang, Guangzhou) and Hong Kong which suffers from an acute shortage of land.

Key Indian and Australian cities to deliver robust rental growth
Elsewhere, the picture is mixed. The Indian markets are less exposed to external shocks, and occupier demand has exhibited some lag. Net absorption in Delhi and Mumbai has now fallen to a fraction of 2008 figures, but IT centres Bengaluru & Hyderabad are already leading the way out of the slump.

The Singapore market, which suffered a 50% slide in rents in 2009, has to deal with a massive supply overhang. The impact of the recession on Japan’s economy has dragged down Tokyo offices but a predicted space shortage will result in strong performance towards the tail end of the forecasts. The Australian office markets will gain from the rising demand for commodities that will accompany the global recovery. But among the weaker markets, there are some that are notable for having lost their previous optimism, principally Kuala Lumpur and Bangkok. These office markets are expected to perform poorly in the medium term, as ongoing economic and political uncertainties take their toll.

Vacancy rates have peaked and are now falling
At the peak of the boom in early 2008, office vacancy rates had dropped to a region-wide average of 12%. However, during the bust arrived, vacancy quickly rose to more than 17%. Vacancy has been falling since Q3 2009 although at a rather slow pace. Vacancy problems are more pronounced in less mature markets (e.g. in India) where the quantity of new supply is very large in relation to the existing market size.

Yields move inward but total returns driven mainly by rental prospects
Yield movements have broadly followed the trends outlined above. Yields have compressed in almost all Chinese locations, as large quantities of state bank lending have created a new boom in commercial property. Yields in major Australian cities (Sydney, Melbourne) peaked in H2 2009 and are now coming in quickly as investors are drawn to a transparent market with healthy returns. Taipei, which is building closer economic ties to mainland China, will also benefit from rising investor interest.

Looking at total returns, Hong Kong, Shenyang and Bangalore will generate the highest returns over the forecast period, a reflection of their strong rental prospects during this time. Jakarta and Melbourne bring up the top five: high initial yields are allied with robust rental growth grounded in their strength in the commodities markets.

On a regional level the key driver of total returns over the forecast period will be strong rental growth. This is in contrast to the 2005-2007 boom period when steep yield compression also helped to generate exceptional total returns. DTZ expects fundamentals to reassert themselves going forward.

Retail Markets
Stimulus and household savings support retail
Prime retail in Asia is historically less volatile than offices or industrial. Even in the 2009 downturn, the retail sector performed quite creditably. Region wide rents recorded a decline of only 2.2%. The reasons for this stable performance are basically twofold – savings and stimulus. Asian households are renowned for their propensity to save, and this stock of savings helped to smooth out consumption at a time of falling GDP and employment. By the end of 2009, confidence had largely recovered as evidence of a V-shaped rebound became clearer.

Chinese and Indian occupier markets to outperform
By Q3 2009, rents had bottomed out in most retail markets. As yet they have not started increasing as high-quality new stock remains widely available. Notable exceptions are the booming Chinese markets, where robust consumer spending is driving occupier demand. Annual rental growth is currently above 10% in Shanghai, Guangzhou and Chengdu.

Looking forward, the list of top performers in retail, as in offices, is dominated by China & India. Both economies are expected to keep growing at around 8-10%. In China, the authorities’ ability to control the credit boom without jeopardizing growth & jobs will be crucial for the consumer sector in future.

Indian retail is relatively less mature, with traditional formats still playing a large role in the overall market. As the population grows more affluent, modern formats (shopping centres and malls) will gain a greater share of spending, and demand for space is expected to increase. This will underpin sustained rental growth in cities like Delhi and Bangalore.

High initial yields in India underpin total returns
The top four markets in terms of total returns are all located in India. High initial yields allied with robust rental growth, averaging 4-6% over the period, mean that strong returns (in excess of 15% annually) are forecast throughout the period.

Prime yields in Australia have started coming in as investors are attracted by a thriving consumer sector that has defied all the odds. In contrast, yields in major Chinese markets such as Beijing and Shanghai have remained broadly unchanged, while Hong Kong yields, already at very low levels, keep inching downwards as retail is seen as a safe play by cash-rich investors.

Industrial Markets
Sharp recovery in exports after heavy falls in 2009
Manufacturing exports collapsed across the region in 2009 as demand from abroad dried up. Japanese exports shrank by almost 25% while China, Taiwan, Singapore and Hong Kong also suffered double-digit losses. The good news however is early evidence of a sharp recovery in exports – all the above countries are due to post strong export gains this year, ranging from 10% in Singapore to 18% in Taiwan.

Pace of rental recovery varies in different occupier markets
Rents are still falling in Hong Kong, but they appear to have finally hit bottom in Singapore after a decline of 20% or more in 2009. Industrial parks in Singapore were often used as a location for back-office operations during the boom, but this source of demand has dried up.

Key markets in China and Australia have also flattened out as the outlook for trade has improved. A sign of things to come may be seen in Taipei where rents are gradually rising again as manufacturers cope with bursting order books. Taiwanese exports have risen six months in a row, driven by economic growth on the mainland as well as global demand for Taiwanese-made electronic goods.

Manufacturing and commodities drive top markets
Over the forecast period, the industrial powerhouses of Hong Kong and Shanghai are expected to post strong recoveries on the back of growing regional trade as well as sustained domestic demand. Asian manufacturers are actively seeking to diversify away from their traditional markets in the West and to develop ties with emerging markets such as Latin America, Middle East and Africa. Australian industrial markets have experienced only shallow dips during the worst of the recession, and Perth and Melbourne are likely to see the return of robust rental growth on the back of the commodities cycle.

Relatively high initial yields (ranging from 7.50% to 9.00%) combined with strong rental growth expectations propel the Australian markets to the top of total returns rankings.

Investment Trends
A record first quarter for transaction volumes
Investment volumes have staged a major rebound since the middle of 2009, culminating in a record volume of transactions in Q1 2010. The total of $38.6 billion edges out the previous record of $36.7 billion set in Q3 2007. If the Q1 pace is maintained, 2010 could turn out to be the biggest year on record in terms of investment volumes.

Chinese developers bring forward land purchases, driving up volumes
Improving economic conditions are driving investment activity. However, volumes have also been driven up by Chinese developers in anticipation of tighter controls on bank lending to the real estate sector. Indeed, the vast majority of deals recorded in China in Q1 were land purchases by developers. This includes the sale of Games City in Guangzhou for $3.7 billion, the largest single transaction since 2007.

China, Japan and Australia account for the vast majority of activity
Thanks to such development deals, the Chinese market now accounts for almost two-thirds of all transactions in Asia. Transactions totaled $25.2 bn in Q1 2010. Among the more established economies, Japan has regained some of its attraction as an investment destination. The Q1 total of $7.2 bn is the highest recorded in two years. In Australia, positive sentiment and continued good news on the economic front drove Q1 volumes up by more than 50% to $3.0 billion.

Transaction volumes in China may dip in coming quarters as lending restrictions take effect. One mitigating factor will be the gradual return of foreign investors. North American and other international investors beat a hasty retreat from Asia in the aftermath of the credit crunch, leaving the field open to domestic and regional players. They are now set to come back, attracted by the economic resilience and the growth prospects of the region.

Economic Outlook
Asia Pacific leads the world out of recession
Asia is leading the world economy out of the downturn; while America and Europe have been debating about double dips and various letters of the alphabet, the evidence in Asia points to a sharp Vshaped recovery. In 2010, China & India are set to deliver 8-10% GDP growth on the back of sizable stimulus packages, a vibrant domestic sector as well as improving trade conditions. The ‘Asian tiger’ economies which were hit by a deep slump in exports are now roaring again – Singapore recorded Q1 growth of 32% yoy, and full-year GDP forecasts are around 6% for Taiwan, Singapore & Hong Kong. Japan too is expected to post positive growth after two years of declining GDP.

Domestic and external demand to deliver robust economic growth
The sources of strength are broad-based – domestic consumption in Asia grows steadily by 4-5% per annum, led by China & India where the annual average is closer to 8-10%. Far from denting their prospects, the aftermath of the recession finds these countries in a confident mood as they grow in importance on the global stage. Unemployment rates are set to fall everywhere (except Japan) sharply as exports grow again by double digits.

Overheating concerns gain ground
Indeed, with the downturn safely behind them, governments are becoming concerned about checking the pace before overheating occurs. Australia has raised interest rates five times since October. As inflation becomes uncomfortably high, more rises may be on the way. The same applies in India where wholesale inflation of 9.9% has the authorities concerned. The Chinese government, which helped fuel the current boom in residential & commercial property, has at last introduced measures to bring back some control over the housing market.

Subject to an orderly winding down of the credit boom, Chinese as well as regional growth should continue strongly, especially as the global economy is now moving into a growth phase.