Late cycle investing
Real estate as an alternative asset class has a key role to play in offering diversification benefits and lowering portfolio risk as its return drivers are markedly different from either equities or bonds. Especially in a late cycle environment, the pursuit of uncorrelated returns from alternative assets is imperative for investing.
Asia the epicenter of growth
Rising consumption levels and private investments continue to fuel Asia’s stance as the world’s fastest growing economic bloc, and its rapid urbanisation will see cities grow at an unprecedented pace.
To take advantage of this growth, more world-class companies will look to locate divisional and global headquarters in Asia, creating a positive knock-on effect in its commercial sector.
As Asia increases its share of global output, investors will be encouraged to increase their portfolio allocations to the region (Chart 1).
Research has shown positive correlation between GDP growth of a region and returns on office real estate investments.
All these create a compelling opportunity for Real Estate exposure, especially in the commercial space.
Chart 1: Relationship between economic growth and office returns
Source: Bank of Singapore, Jones Lang LaSalle, Oxford Economics
Megatrends behind Asia’s commercial real estate growth
Urbanisation, demographics, and resource scarcity will continue to support the value of Asia’s commercial real estate over the next five years.
Urbanisation to drive commercial space demand: Today, 1.5 billion people live in cities. In the next five years, another 500 million will become city dwellers.
This phenomenon is happening in both emerging and developed markets.
380 million more people will either be born or are migrating to the cities (Chart 2) in the next three years. From this, (i) 34 million people will be living in cities of the developed world – mostly in the second and third-tier cities - creating six cities the size of Singapore and (ii) a staggering 290 million people – 51 times the size of Singapore - will be residing in cities of the emerging world.
The housing and infrastructure needed to accommodate this spike in urban population is profound, and its cost is estimated to rise by 50% to $15 trillion annually– rivaling the size of China’s economy (Chart 3).
Chart 2: Urbanisation at a tipping point
Source: Bank of Singapore, United Nations
Demographics – rise of the middle class: The world’s population is currently at 7.6 billion and is set to grow by 500 million the next five years.
According to Brooking Institution, there are 3.2 billion people in the middle class today and this figure is expected to grow by 140 million every year. This rate is expected to accelerate to 170 million over the next five years.
Chart 3: Urbanisation to accelerate in the next three years
Source: Bank of Singapore, World Economic Forum, McKinsey
In less than five years, we could be reaching a tipping point where majority of the world’s population - for the first time ever - will be comprised of the middle class.
Currently, the world’s middle class spends $35 trillion a year. It is already the global economy’s most powerful locomotive, and it is only going to get bigger (Chart 4).
Rise of the millennials: The increasing proportion of millennials in the workforce and the growing sector of technology will drive demand for office upgrades.
The emergence of the “shared economy” business model is also shifting leasing behaviour towards flexible spaces, driving demand for co-working spaces globally which is expected to triple by 2018.
Chart 4: Demographics - the rise of the middle class
Source: Bank of Singapore estimates, Brookings Institute
Indeed, demographic shifts will affect demand for real estate fundamentally. The burgeoning middle-class urban population will require far more housing of sophisticated quality in the years to come.
The combination of rising incomes and growing population will intensify the competition for real estate, especially for scarce commercial properties.
Asia commercial opportunity – the bright spot
Urbanisation and demographics are megatrends that will transform the composition of Asia’s economy in the next decade.
The next 5 years will accelerate the region’s shift from manufacturing towards tertiary industries or services. Indeed, the service sector is expected to be a major driver of GDP growth in much of Asia Pacific economies.
There is already a shortage of good commercial spaces to house the growth of Asia’s burgeoning service sector. Grade A office space per Financial & Business Services Employee in Asian cities is relatively unmet when compared to cities like New York or London (Chart 5), therefore the demand for commercial space will continue to create a strong growth path for real estate in the years to come.
Chart 5: Grade A Office Space Per F&BS Employee
Source: Bank of Singapore, Jones Lang LaSalle, Oxford Economics, F&BS Employee” refers to financial and business service sector workforce
Low stock of investment grade assets: Today, there is a large stock of non-Grade A office in Asia due to obsolete buildings and inadequate professional management. This presents an opportunity for experienced real estate managers to buy, fix and sell (Chart 6).
This relatively underserved market provides significant upside potential for investment grade assets.
Chart 6: Composition of Asia's office market
Source: Bank of Singapore, Jones Lang LaSalle, Oxford Economics,
Rental differentials in office sector: The demand for high quality commercial spaces as driven by the burgeoning growth of Asia’s service sector has led to the phenomenon of flight-to-quality demand. This is creating rental differentials between Grade A and Grade B offices in key Asian cities (Chart 7). As a result, there is huge scope for asset managers to use Asset Enhancement Initiatives (“AEIs”) to bring about significant rental improvement to lower quality commercial spaces.
Chart 7: Grade A and B office rents in Asian cities
Source: Bank of Singapore, CBRE
Investment Strategy: Asia commercial space for portfolio diversification
Our asset allocation strategy is predicated on a diversified portfolio to deliver stronger returns over the long term.
Real estate as an alternative asset class has a key role to play in offering diversification benefits and lowering portfolio risk as its return drivers are markedly different from either equities or bonds.
The caveat is that stronger returns are mostly found with the best and most established real estate asset managers. Therefore, there is a need to source for the best-in-class property asset managers across the world, to invest with.
Additionally, an experienced real estate Private Equity (PE) manager with a clear exit strategy has the ability to enhance the value of a real estate. That said, a single investor will likely find it difficult to replicate this ability.
Value-add office strategy: Real estate value added strategies aim to generate higher risk-adjusted returns compared to REITs or core real estate strategies (Chart 8).
A typical strategy consists of acquiring property at a discount to the replacement cost, with a view to generating attractive returns even if the market stays flat. Gateway cities in Asia also offer older assets, which need refurbishing and redesigning to accommodate modern tenants.
Furthermore, the value-add strategy involves not holding a property for the long term but rather selling it at a profit after an upgrade. For example, a poorly occupied apartment building can become a fully leased office complex with higher rentals through remodelling and repositioning. Renegotiated leases and an optimised tenant mix can attract more visitors, and therefore more revenue, to an office tower with a retail podium.
Value-add looks like a promising strategy. If the locations and properties are chosen well and managed professionally, there are good prospects for a boost in development and innovation through modernisation, renovation and repositioning.
Chart 8: Real estate strategies
1. Greenfield Developments
2. Value-add real estate
3. Core real estate
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