Match growth and income needs with Asia real estate

The US Federal Reserve’s rate cuts were mirrored by central banks across the globe in 2019. Many announced larger-than-expected cuts and continue to stand ready to do more if required, firmly entrenching the trend of global monetary easing. These moves have heightened the ongoing quest for yield enhancing investments, and alternatives strategies such as private equity, infrastructure and real estate appear set to be beneficiaries. Between 2020 and 2025, the assets under management for real estate are forecast to almost double from USD192 billion to USD382 billion i.e. a compounded average growth rate of 13.9%.²

Investors keen on real estate can either choose to own the physical property or invest in the shares and/or bonds of property companies. The latter option, however, appeals as it more affordable, offers diversification opportunities, facilitates trading and accords liquidity. Moreover, investing in real estate via the financial markets gives a broader geographical exposure, an opportunity to diversify from a home bias and tap into the growth in the broader Emerging Asian markets.

The ongoing growth of Asia’s capital markets offers an equally compelling argument about the region’s investment potential. By 2027, Asia could become the top equity market region;³ Asia’s market capitalisation could double to USD56 trillion, overtaking the US and Canada while Asia ex Japan’s bond market could hit USD10 trillion, which is the size of Japan’s bond market.

Some of the key demand drivers of real estate are the level of economic activity, population size, demographic profile, urbanisation rate and government policies. Asia seems well placed in most of these areas.

The region, which is home to approximately 60% of the world’s population⁴, is on track to top 50 percent of global GDP by 2040⁵. Asia is also experiencing rapid urbanisation; by 2030 at least 56% of the population will be urbanised.⁶ Demographic trends vary significantly across countries, but the good news is that more than 60% of ASEAN’s population is under 35 years old.⁷

These dynamics will naturally drive the demand for infrastructure development in different real estate segments ranging from residential, office and retail to industrial, medical and hospitality. Meanwhile the rise of the new Asian super cities across China, India, Indonesia, Philippines, etc. will sustain demand for real estate for years to come.

Many Asian cities are also leading the way to transform to smart cities. Broadly speaking, a smart city is one that optimises the use of limited resources by utilising technology and information (including real-time data) to integrate systems, thereby increasing efficiencies and enhancing the quality of life of its residents.

Climate change issues are further shaping new demands on real estate i.e. green and energy efficient buildings and smarter grids. In fact, smart city projects are gaining momentum; in 2018, ASEAN countries, for example, set up a Smart Cities Network comprising 26 pilot cities across 10 countries to tackle the challenges of rapid urbanisation. Many Asian cities also have the advantage of building smart cities from scratch, unlike the developed cities of the Western world which must face the costly upgrading of archaic infrastructure.

Given the region’s population growth and urbanisation rate, Asia offers numerous and varied real estate equity and bond investment opportunities comprising property developer stocks, Real Estate Investment Trusts (“REITs”), real estate bonds and listed global infrastructure plays. Across Asia Pacific ex Japan, there are 1,117 listed property developers and 194 listed REITs.

REITs, in particular, have become popular with both investors and developers. Aside from its diversified spectrum (see Fig 1), REITs’ relatively high yields and stable dividends appeal to small investors. Meanwhile, property developers are turning into REITs of tomorrow. This is a natural consequence as many property assets in Asia are closely held and cannot be purchased outright, not to mention the tax benefits; a REIT that pays out at least 90% of its earnings to its shareholders in the form of dividends will qualify for tax exemptions.

REITs’ popularity has also spawned strong merger and acquisition (“M&A”) activity; the rationale being a bigger entity would find it easier to get a place in global benchmarks and portfolios, raise funds for expansion and tackle competition. Such M&A in Singapore has created some of the largest REITs in the region. Elsewhere, new REITs are also being launched with India listing its first REIT in 2019. China and Philippines are on track to do the same in 2020. The current market capitalisation of Asian REITs is USD383 billion, of which Japan makes up USD148 billion.⁸

Fig 1: A well-diversified Asian REITs market⁹

Furthermore, structural shifts in the economy and demographics are changing the way we live, work, play, etc. thereby creating new opportunities. Equally, disruptors such as e-commerce, co-working spaces, 5G and ride sharing are changing the investment landscape by creating a new product or service and offering fresh investment opportunities. These lifestyle shifts are creating the need for datacentres, warehousing, flexible work spaces, retirement homes and self-storage to name a few. Such niche sectors will continue to draw investors hooked on accessing these unique opportunities.

Meanwhile the real estate sector is also an important part of the Asian USD bond market, particularly the high yield market. Overall, the real estate represents 15% of the broad JP Morgan Asian Credit Index (JACI) and 42% within the JACI high yield index. While the bond market is currently dominated by China property developers, Asia’s real estate bond market continues to grow both in size and issuers, expanding the investment options (see Fig 2). The overall yield level of the sector also remains relatively attractive compared to the broad Asian bond market.

Fig 2 : A growing Asia real estate bond market¹⁰

Given the abundant real estate investment choices in Asia, how can investors capitalise on the opportunities? A simple yet effective way is to adopt a multi asset allocation approach that captures both the growth and income components; equities pave the way for growth and capital appreciation while bonds offer safety and income.

It is also evident that returns from this sector are more attractive versus the broader based equity and bond asset classes (see Fig 3). A good mix of real estate investments can offer a relatively stable income stream.

Fig 3: Asia real estate delivers relatively higher income¹¹

Once the asset allocation mix is determined, further diversification reduces any concentration or specific risk. An optimal asset allocation without sufficient diversification (and vice versa) can still result in losses. Therefore, the option to invest in the various sub segments of the real estate sector plays a vital role in risk diversification.

Each subsector is influenced by different factors; the office sector is affected by economic activity with a long-term rental reversion cycle while the hospitality sector relies on tourists and reprices frequently. This flexibility to allocate across the asset classes sets the stage for more stable returns and a higher chance of a favourable outcome over the long-term (see Fig 4).

Fig 4: A good asset allocation has a higher chance of a favourable outcome¹²

Investments in real estate are also becoming more popular. Recent data indicates that high net worth individuals (“HNWI”) are increasing their allocations to real estate. In 2018, HNWIs in Asia Pacific ex Japan invested 20% of their holdings in real estate versus 18.7% in 2017 while the rest of the world saw an increase to 17.5% versus 2017’s 14.5%.¹³

All said, Asia’s real estate sector offers many attractive, dynamic and fresh investment opportunities. However, investors need to be selective, diversify across the property spectrum and keep abreast of changing market dynamics. Besides, local market knowledge is critical as government policies can impact real estate values. Get around these challenges by investing in a dedicated real estate fund that offers extensive diversification and expertise and matches your growth and income needs.