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Research - FEBRUARY 12, 2018

“Goldilocks” global economy to broadly support Australia real estate in 2018, according to LaSalle Investment Strategy Annual

by Andrea Zander

Plentiful capital, a Goldilocks economy, and reasonably balanced supply-demand fundamentals usher in 2018.  However, capital market volatility, lingering geopolitical tensions, and economic risks could potentially disrupt these “just right” macroeconomic conditions, according to LaSalle Investment Management’s Investment Strategy Annual (ISA) 2018.

According to the report, the general macro outlook for Asia Pacific in 2018 is expected to be anchored by the rising middle class in Asia, the younger demographics of Southeast Asia, and most importantly, the political stability and positive economic momentum of the two largest economies in the region, China and Japan.

Australia extended its 26-year streak of avoiding a recession in 2017. Going into 2018, Australia looks set to continue to enjoy its own “Goldilocks” economic conditions on the back of a recovery in China and the generally positive global environment, which will give it more room to manage its domestic challenges.

Combined with “Goldilocks” economic conditions, in the form of gradual increases in interest rates/inflation and the relatively healthy real estate fundamentals, a range of build-/lease-to-core and value-add opportunities in Australia and across the region are favorable to investors.

However, real estate investors should remain mindful of and be prepared for the “three bears” scenarios Asia Pacific generally could face: geopolitical threats, financial system threats and the side-effects of a “hyperstimulus” scenario. Within the region, China’s debt problem, Japan’s challenge in stimulating inflation, low housing affordability in major countries across the region, and the threat from North Korea, all have the potential to disrupt the region’s economic outlook.

“For Australia, the government’s infrastructure investments’ domestic and continued growth in Asia Pacific will likely extend the country’s growth story in the near term,” said Elysia Tse, head of Asia Pacific research and strategy at LaSalle. “This domestic growth environment is expected to remain a supportive backdrop for improving real estate occupier market fundamentals, but bifurcation between markets and sectors is expected to continue. The country’s banking sector’s reliance on wholesale debt, making up one-third of bank funding and mostly raised overseas, could push up borrowing costs further, acutely affecting the real estate sector, as central banks tighten monetary policies. Property yields in Australia are susceptible to upward pressure and pricing risk is tilted to the downside. Additionally, the country’s housing sector, one of the most risk-exposed in Asia Pacific, is primarily driven by high housing prices. A liquidity crunch or pockets of weakness, though unlikely in the near team, could create an attractive  risk-return profile for the country and offer more attractive investment opportunities in Australia than the current market environment.”

Despite the positive economic outlook, key risks to Australia’s outlook remain the imbalanced economic structure, the health of the domestic housing market and banking sector liquidity, with the country’s high underemployment rate and high household debt also weighing down consumer spending.

Tse added, “At the moment, capital markets remain sanguine in Australia. Despite the strong property yield compression over the past few years and rises in the 10-year bond rate, Australian property yield spreads to risk-free rates remain at near their historical average spreads and compare favorably in the global context. As a result, Australia remains a destination for global capital, barring no sharp increases in the interest rate environment globally. From a long-term perspective, Australia’s economic outlook remains positive, underpinned by the strongest population growth among major developed economies in the world. Australia remains attractive to domestic and cross-border investors as one of the most transparent and liquid markets in the world.”

According to the report, Asia Pacific is expected to continue its solid growth trajectory relative to the rest of the world in 2018. LaSalle remains cautiously optimistic on Asia Pacific economies and real estate fundamentals over the next two to three years. However, regional and global geopolitical risks could interfere with the region’s growth, trade and investor confidence. There could be short-term volatility if these risks are combined with pockets of supply/demand imbalance. Interest rates in major Asia Pacific countries are expected to remain largely accommodative in 2018, although rates will eventually head towards “normalization”. While the probability of significant yield expansion in most Asia Pacific markets over the near term remains low, there could be pockets of weaknesses or repricing. If that occurs, it is likely to offer attractive investment opportunities.

The real estate markets and sectors in the region that will offer growth potential or higher returns in 2018 include the following:

  • Office: Major regional office markets are currently at different stages of the rental cycle. Build-to-core and value-add-to-core strategies in highly selective decentralized areas of large or mature office markets in the region, such as Sydney, but also Hong Kong, Shanghai and Tokyo, could be attractive to higher-return investors with flexible or long investment horizons.
  • Industrial: Prospects for the still-maturing logistics sector remain positive in most parts of the region. The expansion of e-commerce in Australia and in the region generally will be reliant on state-of-the-art logistics facilities, creating logistics development or value-add opportunities near key population centers. While a lack of modern warehouses is driving occupier demand, increasing supply suggests that market/submarket selection will be increasingly important.
  • Retail: The threat of an e-commerce impact on retail malls varies by market and retail segment. Investors should focus on non-discretionary retail malls with a high tenant mix in grocery, pharmacy, food and beverage, and services located in strong residential catchment areas due to the defensive position they offer and various government stimulus programs. E-commercewill also further contribute to the ongoing bifurcation between dominant, better-located, and better-configured shopping centers, and worse-located, less-convenient, and outdated shopping centers. Investors should also look out for opportunities where e-commerce could be a positive growth driver of brick-and-mortar stores.
  • Residential: Demand and supply dynamics are mixed among residential markets across the region. Although signals suggest that Australia and Hong Kong for-sale residential markets are at particular risk, substantial corrections are unlikely in the short term. We recommend avoiding these segments at current pricing, yet being ready to invest if pricing declines.
  • Hotel: Across the region, the rise of intra-regional tourism and growth of middle-income households are expected to drive demand for hotels in the long term. Japan and Australia are expected to benefit the most over the next few years. In 2018, investors should focus on location selection, managing supply risk, and exit timing.

Globally, the ISA finds that an investment in stabilized, leased real estate is the most direct way to get the asset class characteristics that make real estate a valuable multi-asset portfolio diversifier. At the same time, investors should seek a balance of core and value-add strategies while also setting aside capital for opportunistic and debt strategies.

The report further notes that investors will need to consider the implications of wider geopolitical instability, as well as threats to the world’s financial system, including rising levels of sovereign and household debt, high and rising asset prices, financial market deregulation in the US, regulatory and policy changes in financial markets, emerging-market financial instability, and asset price bubbles created from the growing pool of surplus savings.

“We are focusing on the importance of taking a long-term view for real estate. Investors will need to proceed with caution, as they tend to over-rely on past experiences or take consensus views when face with an uncertain economic environment,” said Jacques Gordon, global head of research and strategy at LaSalle. “In order to realize their portfolio’s target returns, investors must confidently execute their strategic plans and make tactical adjustments when unforeseen events occur.”

Gordon added, “The growth of real estate as an asset class is still underway. The professional management of new sectors across the built environment opens up new ways to create dependable income streams to help meet financial needs. In the past 10 years, logistics, self-storage, market-rate rental housing, student housing and healthcare-related real estate all grew in terms of their contributions to the real estate options available to investors. Over the next 10 years, this expansion will continue as data centers, vocational and specialized training facilities and augmented/virtual reality entertainment or educational venues all become more commonplace.”

 

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