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January 23, 2017

Commercial real estate’s inflation-hedging attributes and the continued demand from institutional investors have kept appetite for the asset class strong in Asia Pacific, says Myles Huang, a Director with JLL’s Asia Pacific Capital Markets Research.

“Real estate, as a hedge against inflation, will continue to attract investors, although some risks remain as the market adjusts from the “current environment of low interest rates and low inflation to a high interest rate and high inflation world,” says Huang.

In December 2016, the U.S. Federal Reserve raised interest rates for the first time since 2006. It raised rates again in December 2016 by 25 basis points.  Investors are expecting a continuing increase in the policy rates throughout 2017 with U.S. inflation rising as a result of a positive economic outlook and President Donald Trump’s deficit spending plan. The implied inflation rate in the United States is now at 2 percent – the highest since October 2014.

With rising rates, shifts in currencies, and therefore currency hedging costs, will have the most immediate impact on real estate markets, explains Huang. “Interest rate spreads in the region have seen less upward pressure recently and so have improved the hedging cost for USD-based investors coming into the region.” When U.S. rates are higher than the foreign rate, currency-hedging becomes a benefit, resulting in a positive cost of carry.

This trend should help boost cross border investment into these markets, particularly as many regional private equity funds are USD-based, according to Huang.

Huang notes that hedging costs (on five-year terms) for investors into Australia are the best they have been for 10 years. Meanwhile USD-based investors into Japan actually get a hedge benefit (in other words, are being rewarded for holding Yen).

While investors may buy real estate to counter inflation, risks remains if interest rates and borrowing costs were to rise faster than anticipated. “Rising cost of debt service payments may squeeze cash flows for over-leveraged investors in the short term,” says Huang.

His comments follow the release JLL’s fourth-quarter 2016 Global Capital Flows data, which shows that Asia Pacific transaction volumes for the last three months of 2016 were up 21 percent year-on-year, supported by transactions in China, Singapore and Japan. Total transaction volumes for the full-year 2016 reached US$130 billion, up five percent year-on-year from 2015.

More asset investment expected

Looking forward, further demand is seen coming from institutional investors looking to allocate more capital to real assets to meet benchmark total return, says Huang.

Based on a Preqin survey, one-third of investors plan to increase allocation to real estate in the near term and the rest will likely maintain their current allocation weightings for the longer-term, he says.

Huang also expects continued mainland Chinese demand as the country’s securitisation market expands. China’s government changed legislation in recent years to quicken the process for lenders to issue debt securities. Currently 70 percent of China’s asset-backed securities are backed by real estate, says Huang.

While there remains a general lack of good quality assets in the region, Huang says owners in markets such as Australia and Hong Kong may be tempted to capitalise on tight pricing to realise gains. Such asset disposals will provide opportunities for core investors.

New advisory services in demand

Amid expectations for continued real estate demand from Asian buyers in a rising rate environment, JLL is bolstering the firm’s capabilities in structured finance, capital raising and debt advisory.

The demand for these services comes on the heels of a growing appetite among Chinese investors for overseas property assets. According to JLL data, in the third quarter of 2016 China overtook the U.S. to become the largest cross-border real estate investor, having invested nearly US$18 billion into commercial property assets internationally in the first nine months of the year. In the fourth quarter of 2016, investment activity in China was more than double that of 2015, despite the continued devaluation of the yuan. Domestic investors had turned to investing locally following more capital outflow controls.

Myles Huang
Director, Asia Pacific Capital Markets Research, JLL

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