The Covid-19 pandemic has contained real estate supply growth in Asia throughout 2020. As life is continuing to return to normal, demand for real estate space is also improving. We asked David Fassbender, Senior Portfolio Manager and Head of Southeast Asia, PGIM Real Estate, about the major upcoming structural changes in the sector and the opportunities for investors.
AsiaFundManagers.com: How has the growth of real estate supply in Asia developed over the past few years?
David Fassbender: For many years now, the West has looked almost enviously at the extremely dynamic growth rates in the Asia-Pacific region. Led by a rapid recovery in China, the region’s economy is already back in expansion mode and is expected to record fast growth in 2021. In a recent estimate, the International Monetary Fund (IMF), for example, believes that Asia will experience a comparatively strong economic recovery. According to this, economic growth in the region is likely to be 7.6 percent this year, with a plus of 5.4 percent expected for 2022.
As life is continuing to return to normal, demand for real estate space is also improving. In the office sector, for example, demand is on the rise, especially for high-end space, even as office tenants remain cost-conscious.
After property values have basically developed very positively in the past years, we could also observe only a very moderate decline in property prices in 2020. In the course of the recovery, interesting investment opportunities will arise in the region due to both cyclical trends (recovery of demand and rents) and established structural trends, such as demographic change.
AsiaFundManagers.com: What impact did the pandemic have on the Asian real estate sector?
David Fassbender: The Asia-Pacific region, which was the first region to be affected by the pandemic, saw a huge upswing in sentiment in the first quarter and is expected to return to strong growth during 2021. The effectiveness of national policies on stringent containment measures is now paying off in many countries, which should lead the Asia-Pacific region to lead the global economic recovery. In recent months, however, rising infection rates have been recorded again in some markets. Due to comparatively low vaccination rates, this trend should be closely monitored.
Logistics remains an attractive sector for investors due to the continued structural rise of e-commerce in Asia-Pacific markets. In addition, the acceleration in online spending triggered by the pandemic has increased demand and created a sense of urgency for the expansion of space among retailers and logistics operators.
The rising demand for modern logistics through e-commerce and logistics providers is increasing and the growing interest of investors has created an unprecedented surge in the development activity, which in many countries – particularly in China, Japan, and South Korea – has led to a significant increase in the supply. Since it is comparatively easy to quickly create new logistics space, this does, however, limit rental growth which has averaged “only” 1.5% p.a. since 2016.
Given the fast-growing supply, investors should remain disciplined and become increasingly selective within the sector – particularly in markets as Tokyo and Seoul, where completions will remain at record levels over the next two years. We expect performance to become increasingly divergent and the selection of the right submarkets and subsectors to increasingly gain importance. Logistics real estate in established submarkets, that are located close to major population centers such as the Bay Area in Tokyo and satellite cities around Shanghai, or those at transport hubs with strong connectivity such as Icheon near Seoul, we consider as rather defensive and highly desirable – especially given consumer expectations of shorter delivery times.
Residential market should remain interesting
David Fassbender: Another sector that has developed well in the last few years and has gained importance in the last year is the market for residential property for rent. In almost all countries in the Asia-Pacific region, housing is primarily built for sale and not for rent. The exception here is Japan, where we find an established residential rental market. We have invested heavily in this segment in recent years, particularly with our core and core-plus strategies.
Yet, we also see the potential for the development of an institutional housing market in other countries. In this context, the markets of Australia and China are particularly noteworthy. In both markets, the affordability of residential property has declined significantly in recent years. Combined with a desire for greater flexibility, especially among a younger demographic of the population, increasing demand for rental housing can be assumed. In China, this market is also being actively promoted by the government. This is definitely a development that should be closely watched.
The office sector offers an attractive cyclical investment opportunity as the economic recovery takes shape. This opportunity is underlined by an improvement in net absorption, which turned positive in a number of cities in the last quarter of 2020 and the first quarter of 2021 after a period of tepid demand. In addition to improving economic conditions, office fundamentals in the Asia Pacific are expected to be boosted by employment growth in the tech sector and rental demand from global and regional tech players – particularly fast-expanding Chinese companies. As the pandemic health risks subside, we expect especially high-quality offices in central business districts (CBDs) – with good transport connections, good availability of services, amenities as well as proximity to clients and business partners to remain attractive and resilient.
AsiaFundManagers.com: You mentioned that the office sector in Asia has grown despite corona in 2020 – how can this be explained?
David Fassbender: Unlike in past cycles, real estate supply growth was contained before the downturn and is expected to remain subdued in 2021 and beyond.
The most recent cycle was unusual in that supply growth never really picked up. Unlike previous downturns, where growth was usually either high or accelerating at the end of the recovery phase, falling demand in 2020 was matched by only a very modest increase in total supply growth. To some extent, the downward trend is to be expected over time. As global real estate markets have grown significantly in recent years with more space added to meet the demands of an expanding economy and labor market, new additions are becoming smaller in comparison to the existing stock. Decreasing space requirements per worker or per unit of production further constrain the demand generated by the expansion of user activities.
The growth for space has barely accelerated in recent years and the near-term development pipeline suggests that low levels of supply will continue. Postponements, construction delays, and cancellations of projects not yet underway due to the pandemic point to downside risks to supply change projections in the near term.
In Asia-Pacific, the office sector saw supply increase to 3.1% in 2020, compared to an average of 1.7% per annum over the previous five years. Beijing, Shanghai, and Tokyo experienced comparatively high completions of new projects in 2020, but even in these markets, the pipeline will remain limited over the next few years.
AsiaFundManagers.com: As more economies reopen, which real estate sectors are likely to show increased demand next year?
David Fassbender: A further push towards online trade due to the pandemic means that secular demand for logistics remains strong. Interestingly, rent is only a small component of the total operating costs of a logistics company, especially compared to transport costs. This could mean greater scope for landlords to impose rent increases in well-located submarkets that allow a logistics operator or retailer to strike a balance between delivery speed, warehousing, and transport costs.
Several sub-sectors within the logistics market, such as air-conditioned logistics facilities, could be particularly attractive. Online grocery penetration is forecast to double in the region’s major economies over the next few years, driving demand for climate-controlled and cold chain logistics facilities, which remain undersupplied in many markets.
As mentioned previously, the residential market should also remain interesting, especially if the current growth in this segment in markets such as Australia and China continues and the respective governments encourage development through appropriate regulation and taxation.
AsiaFundManagers.com: Thank you very much for the interview.