The Case for South East Asia Retail Investment: Structural Opportunity vs. Trading Strategy?

Transcription

1 PREI PRUDENTIAL REAL ESTATE INVESTORS The Case for South East Asia Retail Investment: Structural Opportunity vs. Trading Strategy? FEBRUARY 13 ABU DHABI ATLANTA BEIJING CHICAGO FRANKFURT HONG KONG ISTANBUL LISBON LONDON LUXEMBOURG MADISON MEXICO CITY MIAMI MILAN MUNICH NEW YORK HENRY CHIN, PHD HEAD OF RESEARCH AND STRATEGY, ASIA PACIFIC PARIS SAN FRANCISCO SAO PAULO ALAN CHOW DIRECTOR OF RESEARCH SEOUL SINGAPORE PRUDENTIAL REAL ESTATE INVESTORS 7 GIRALDA FARMS MADISON, NJ SYDNEY TOKYO

2 Executive Summary The Asia Pacific retail market is the world s largest. The region s retail sales rose from US$3. trillion in (31 of the worldwide total) to US$3. trillion in 11 (1 of the total). 1 The rate of growth during this period was at least four times faster than in Europe or North America. When we think of the Asia Pacific region, the big economies of Japan, China, India, and Australia often come to mind first. Within the Asia Pacific landscape, South East Asia tends to be overshadowed by these bigger and more high profile players that surround it. So is there a case to be made for retail investment in South East Asia? In this paper, we tackle this question, and these are some of our findings: Strong Demographics: The five core markets of South East Asia Singapore, Malaysia, Thailand, Indonesia, and Vietnam had a combined population of 3 million in 11, more people than either Europe or the US. And the age structure in South East Asia is relatively young compared to these advanced economies. Economic Resilience: South East Asia generally weathered the recent Global Financial Crisis with less collateral damage than might have been expected. The region s economic contraction during this period was short-lived and the subsequent rebound was impressive. Over the next five years the core South East Asian economies are projected to grow by to 7 per annum, a significantly faster pace of growth than is expected in advanced economies. Tourism Potential: South East Asia s location boosts its prospects for luring tourists. First, China s 1.3 billion residents live immediately to the north. As China s affluence grows, so too will outbound tourism, possibly on a large scale. Second, Malaysia has already become a popular destination for affluent tourists from the Middle East and this suggests a strategic direction that other countries in South East Asia could emulate. Retail Market Maturity: The core markets of South East Asia offer a range of opportunities, depending on investor appetite for risk and maturity. Global markets can be categorized along a sliding scale of maturity that ranges from advanced (e.g., Australia, UK, US) to pre-institutional (e.g., Myanmar, Pakistan, Iraq). Within South East Asia, Singapore is a mature retail market with attributes that are generally comparable to Hong Kong, France, Japan, and Germany. Malaysia and Thailand are maturing, and they lag somewhat behind Singapore. Vietnam and Indonesia are still emerging. Investment Opportunities: South East Asia presents differing retail investment opportunities from country to country. Opportunities can also vary significantly within countries. In emerging markets like Vietnam and Indonesia, the focus should usually be limited to the major cities. In maturing markets like Malaysia and Thailand, urbanization and improving infrastructure bode well for the retail scene in the central and fringe areas of capital cities, and increasingly in second tier cities and resort areas outside the capitals. In mature markets like Singapore, both central city and suburban retail are considered core investments which can attract institutional investors. 1 Canadean and Market Research.com, The Future of Global Retailing to 1, June 1. 1

3 Table of Contents Executive Summary... 1 Part 1: Global Retail Trends and Structure... 3 Market Maturity and Evolution... 3 Global Retail Trends... 5 Globalization and International Retailing... 5 E-commerce... Composition and Impact of Sales Growth Trends... A Conceptual Framework of Factors Impacting Retail Property... 1 Part : South East Asia Retail Market Analysis... 1 The Macro Environment... 1 Macro Economy... 1 Demographics Labor Market... 1 Wealth Accumulation Tourism... 1 Retail Competitiveness Real Estate Fundamentals... 1 Structure of the Regional Market... 1 Supply... Demand... Pricing... Risk Considerations... Assessment of Retail Attractiveness... Part 3: Opportunities and Conclusions... 9

4 PREI PRUDENTIAL REAL ESTATE INVESTORS Part 1: Global Retail Trends and Structure Market Maturity and Evolution No assessment of a regional property market can begin without first understanding the market s context. All property markets fall along a continuum of structural progression. The least mature markets are those with a limited stock of investment grade property. These markets consist largely of small, owner-occupied shops, with few if any organized multi-store domestic retailers, let alone foreign ones. Government policies in these markets can be both confusing and confounding, with potential institutional investors deterred from even considering participation. Market information is scant, if it exists at all. This is the beginning of the maturity spectrum, the starting point for progress. In South East Asia, this is where Myanmar is today. Far away, at the other end of the spectrum are a handful of markets Australia, the UK, and the US are among them with high levels of liquidity, transparency, and organized participation by institutional investors. Retailers are sophisticated and organized, and from their head offices, they command multi-store formats that span national borders, languages, and local product preferences. Policy frameworks in these markets offer multiple, clearly-defined modes of entry. Market information providers are numerous and competitive. Modern, advanced retail centers form deep pools of investible stock in these markets. The closest South East Asia gets to this level of retail market maturity is Singapore. Other markets in South East Asia fall midway along the spectrum. Emerging retail markets in Vietnam, the Philippines, and Indonesia, for example, are ahead of Myanmar, but they lag behind the maturing markets of Malaysia and Thailand. Exhibit 1 provides a framework for understanding how South East Asian markets fit into the maturity spectrum in 13. 3

5 1: MATURITY OF RETAIL MARKETS Stage PRE- INSTITUTIONAL EMERGING MATURING MATURE ADVANCED INSTITUTIONAL Definition / Features Limited investment Lack of organized shopping formats Local owneroccupiers dominate Middle class growing Consumers aware of retail formats Shopping districts emerge Surge of wellorganized malls Domestic/foreign chains enter market Significant growth in retail sales Retail property as institutional asset class Consumer affluence; liquidity still evolving Domestic/foreign retailer sophistication High liquidity and transparency High discretionary spending High barriers to market entry (expensive) Transparency Major Formats Main Entry Method Opaque Street shops Domestic retailers dominate Difficult path to entry Low Transparency Semi- Transparent Transparent Highly Transparent Department stores Supermarkets Shopping malls Hypermarkets Online sales Mature retail formats Suburban shopping centers Big box / specialty shops Entertainment formats Competitive online sales Modern retail in prime areas Local partner needed Develop / acquire malls Local partner preferred Acquire/reposition malls Develop without partner Indirect (debt, listed stocks) Acquire malls Multiple entry options Retail Stock Noninstitutional Limited institutional grade stock Developme nt expands institutional stock Institutional grade stock Institutional grade stock Retailers Domestic retailers Domestic retailers Foreign retailers (big cities) Foreign retailers penetrate Strong retailer competition National brands emerge Chain retailers expand into secondary locations and cities High foreign retailer penetration (big cities) Countries Pakistan, Venezuela, Kazakhstan, Iraq, Laos, Myanmar Vietnam, Philippines, Indonesia, Mexico, Russia, India Malaysia, Thailand, Poland, South Korea, China, Taiwan Singapore, Hong Kong, France, Italy, Japan, Germany US, Australia, UK Source: Prudential Real Estate Investors Note: as of End 1 The pre-institutional and emerging stages of maturity are less suitable for institutional real estate investing. Even if an adequate retail opportunity can be identified, investments in these markets generally involve various risks, including illiquidity, lack of transparency, identification and vetting of local partners, unfriendly legal structures, and volatile fundamentals, especially on the supply side. But maturity is a constantly evolving concept. Of course, markets themselves move through the continuum of maturity, but even our definition of advanced maturity is a moving target. Downtown department stores once sat at the top of the retail spectrum. Then came suburban malls. Today our notion of advanced retail markets has moved toward specialty shops, retail warehouses, and entertainment-themed centers. South East Asia currently lacks markets that are recognized as advanced institutional, but fast-paced economic development is definitely pushing the region up the maturity spectrum (Exhibit ). South East Asian markets are quickly becoming more urbanized and consumers have more disposable income to spend. Organized retailers, both domestic and international, are watching South East Asia s progress closely, as are institutional investors. Incremental institutionalization is creating new opportunities. In the maturing markets, for example, where institutionalization is nascent, a convenient

6 point of entry is development of modern retail stock. In those markets that are already considered mature, optimal strategies might also include acquisition of existing malls. Advanced maturity may eventually become widespread in South East Asia, but for now the opportunities in this segment of the market things such as the development of retail big box stores remain limited. South East Asia s retail properties, both prime and suburban, are often tightly held by their owners. This translates to fewer market transactions, and thus constraints on liquidity. : EVOLUTION OF RETAILING potential for institutionalization PRE-INSTITUTIONAL EMERGING MATURING MATURE ADVANCED HIGH / MATURE Economic development Urbanization Consumer spending capacity Retail market Grocery stores Street shops High street shops Department stores domestic Shopping malls High street shops domestic & foreign Shopping malls (prime & suburban) domestic & foreign Specialty shops Retail warehouses Themed centers domestic & foreign LOW / IMMATURE domestic NECESSITIES Consumers LIFESTYLE INDEPENDENT Retailers CHAIN Source: Prudential Real Estate Investors Global Retail Trends Globalization and International Retailing More than half of the world s 5 largest retailers sell fast-moving consumer goods (FMCG). Deloitte defines these as consumer staples such as food, beverages, drugs, and general mass merchandise. The low-margin, high-turnover product mix of these retailers pulls in about two-thirds of revenues produced by the top 5 global chains (Exhibit 3). FMCG retailers are surprisingly insular, especially North American ones, and have so far been the least likely of major retailers to enter markets abroad. Those FMCGs that have stepped across borders, especially European hypermarkets, have significantly broadened their revenue streams. 3 These types of price competitive retailers dealing in basic necessities tend to do best during sluggish economic times. Other types of retailers, especially those dealing in luxury-type goods, tend to perform better when discretionary incomes are expanding. Deloitte, Switching Channels: Global Powers of Retailing 1, January 1, p. G5. 3 Deloitte, Switching Channels: Global Powers of Retailing 1, January 1, p. G. 5

7 3: DISTRIBUTION OF TOP 5 GLOBAL RETAILERS BY PRODUCT SECTOR, 1 by number of companies by sales volume Hardlines & Leisure 1. Diversified 1. Fast- Moving Consumer Goods 53. Hardlines & Leisure 15. Diversified 9. Fast- Moving Consumer Goods. Fashion. Fashion 15. Source: Deliotte (1) Note: as of Jan 1 Globalization among the world s top 5 retailers can be measured by the level of foreign market penetration. According to Deloitte, these top retailers brought in nearly a quarter (3) of their revenues from outside their domestic markets, and on average, their store operations spanned at least eight markets (Exhibit ). European retailers were among the most active in this group. They have reduced dependence on domestic markets. Given the recent economic situation in Europe, diversification across global markets is probably not a bad thing. Take Spain s apparel retailer Zara, for example. Even though Spain has recently been mired in recession, Zara operates more than 1,7 stores in 7 different countries. 5 Zara s Spanish parent company, Inditex, S.A., ranked 9 th on Deloitte s list of the top 5 retailers, with compound annual global sales growth of 13. over the 5-1 period. Zara s strategy is typical but not universal among the top 5 global retailers. At least two in five of these companies () generate no revenues outside their own domestic markets. Many of Japan s largest retailers have chosen this path. On average, the leading Japanese retailers operate in only or 3 countries and bring in just.7 of retail sales from their overseas operations. Compared to European retailers, both Japanese and US retailers have shown more reluctance to expand their footprints abroad. Deloitte, Switching Channels: Global Powers of Retailing 1, January accessed December 1. Deloitte, Switching Channels: Global Powers of Retailing 1, January 1, G31.

8 : FOREIGN PENETRATION OF TOP 5 GLOBAL RETAILERS Region/Country Number Foreign Sales () Mkts./Retailer (avg.) Domestic Only () Global North America USA Europe Germany UK France Asia Pacific Japan Latin America Africa / Middle East Source: Deliotte (1) Note: as of Jan 1 CBRE surveyed 3 major international retailers in 73 countries in 1. 7 Exhibit 5 shows 1 of the retail markets where penetration rates among international retailers were highest. Four Asian markets, including one South East Asian market, were among this group. Advanced economies like the UK and the US have among the highest shares of international retailers present. In the Asia Pacific region, China ranks highest, followed by Hong Kong, Singapore, and Japan. Relatively strong retail sales growth (and an increasing level of personal income) will continue to attract international retailers to China. Russia, Hong Kong, Turkey, Saudi Arabia, Singapore, and Poland are among the other markets with retail sales growth of at least 3 per annum during to 1. 5: LEADING MARKETS FOR GLOBAL RETAILER PENETRATION Retail Sales Growth, p.a POL CAN CZE AUT CHE JPN BEL TUR HKG SAU SGP ITA RUS CHN FRA ESP Share of Global Retailers Present () DEU USA GBR Note: Size of bubble represents disposable income per head. Asian markets are shown in blue. Source: CBRE; EIU. Note: as of Q 1 7 CBRE, How Global is the Business of Retail?, April 1. 7

9 PRUDENTIAL REAL ESTATE INVESTORS E-commerce Another force transforming the retailing sector is e-commerce. As internet access and usage has surged around the world, there has been a corresponding rise in online retail sales (Exhibit ). This does not necessarily mean that retail space along the world s high streets is shrinking, but e- commerce is forcing retailers to rethink the way they manage their traditional retail space in this new environment of cross-channel sales. Asset managers have become more aware of show rooming as a key feature of high street retail spaces. Meanwhile, structural change in retail supply-chain management has contributed to a rise in logistics demand for large, built-to-suit properties. In South East Asia, the limited capacity and quality of local logistics service in the near term has become an emerging opportunity for property investors. : ONLINE SALES IN SELECTED MARKETS USA Europe China USD (billions) EUR (billions) RMB (billions) 1 1 Source: U.S. Department of Commerce Note: as of End 11 Source: Note: as of End 11 e= estimate Source: Knight Frank, CEIC Note: as of Nov 1 Composition and Impact of Sales Growth Trends In the US, non-store retail sales this includes both online sales as well as catalog sales have outpaced the growth of traditional retail sales for many years. These non-store sales, however, tend to be more volatile than traditional sales, most likely reflecting a heavier reliance on discretionary consumer products. By comparison, US retail sales growth of foods and beverages over the same period showed greater inelasticity, with year-over-year changes rarely moving outside the narrow band of -5, regardless of economic conditions (Exhibit 7). Over the past years, a similar pattern has emerged in Japan s post-bubble environment. Sales growth for foods and beverages has held up better than more discretionary choices such as restaurants. This trend in the US and Japan is harder to discern in Singapore, where retail sales across categories have tended to move with the changing economy. In the near term, Singapore s softening economy will likely limit overall retail sales growth, as consumers temporarily become more selective. As Singapore s retail market matures, it is likely to see its structural sales patterns converge more distinctly with advanced markets like the US and Japan. In other words, necessity-driven sales

10 PRUDENTIAL REAL ESTATE INVESTORS growth is likely to become more stable in the future than discretionary-driven sales growth. These trends should, in turn, be reflected in the retail property market. (In fact, there is some evidence that this is already happening in Singapore. This is discussed more in Exhibit.) 7: RETAIL SALES GROWTH BY FORMAT IN SELECTED MARKETS, p.a. USA Japan Singapore 3 Non-store retail (online/mail order) Clothing & accessories Food & beverages 3 Restaurants & cafés Clothes Food & beverages 3 Department stores Supermarkets Food & beverages Source: U.S. Census Bureau; Moody s Analytics Note: as of Sep 1 Source: Japanese Ministry of Economy; Japan Council of Shopping Centers Note: as of End 1 Source: CEIC Note: as of Sep 1 Retailers (and the specific products they sell) impact the success of retail properties. For owners and managers, the tenant mix is a fundamental consideration. High-margin, low-volume fashion retailers, for example, pay higher rents than low-margin, high-volume retailers like supermarkets. Property owners and managers play a delicate game of finding the right tenant mix of discretionary and nondiscretionary retailers. To stabilize incomes in sluggish economic conditions, property managers have an incentive to minimize volatility and lease up with retailers selling consumer staples. During economic booms, it may be more tempting to attract retailers of apparel or luxury goods since they can pay higher rents. These trends play out in an example from Singapore s Hougang Mall. There was a clear shift in the tenant mix between and 1 that reflected changing economic conditions. Favorable economic conditions between and 7 cleared the way for ample discretionary spending. As a result, Hougang Mall attracted more fashion stores. But after the global financial crisis in, consumer spending shifted to more necessity driven products, so leasing at Hougang Mall began tilting toward food and beverage retailers as the economy shifted. In a direct comparison of the tenant mix between and 1, both of these patterns can be observed. Food and beverage retailers held just 1 of the net leasable floor area at Hougang Mall in, but this had climbed to by 1. 9

11 Similarly, fashion retailers held just 1 of the mall s space in, but a surge of new leasing in -7 still left these tenants with more space (1) in 1 than they had before the full property cycle began in. As of 1, food and beverage retailers were the most common type of tenant at Hougang Mall. A quick comparison to CapitaMall Trust s retail portfolio in Singapore shows a similar pattern with food and beverages being the leading tenant type. In CMT s case, the tenant mix is calculated on gross rents rather than net leasable area, but the same basic pattern still prevails (Exhibit ). : EXAMPLES OF TENANT MIX IN SINGAPORE Hougang Mall (retail asset example) Distribution by net leasable area, vs. 1 CapitaMall Trust (retail portfolio example) Distribution by gross rent, 11 Other Food & beverages Other 11 Food & beverages 7 Beauty & healthcare 1 9 Beauty & healthcare 9 Department stores & supermarkets 13 1 Fashion & related 1 Lifestyle & entertainment Department stores & supermarkets 11 Fashion & related Lifestyle & entertainment 1 Source: Prudential Real Estate Investors, CMT Note: as of Q 1 A Conceptual Framework of Factors Impacting Retail Property This paper has so far focused on the structural context of global retailing. Before analyzing and assessing the potential of the South East Asian retail markets, a conceptual framework is necessary to explain the process for evaluating retail real estate attractiveness. The drivers of performance fall into three distinct dimensions (Exhibit 9): The structural drivers are normally associated with the long-term changes. This includes the macro environment as well as some retail-specific drivers of market competitiveness. Cyclical factors real estate fundamentals and performance also impact the attractiveness of retail property markets. Like other property sectors, retail real estate markets follow cyclical patterns, with periods of constrained supply tending to be followed by bursts of new construction. Before engaging in any transaction, the cautious and pragmatic investor must first understand a market s position in the current cycle, both in terms of market fundamentals (demand, supply, vacancies, and rents) as well as market performance (pricing and returns). 1

12 Beyond the structural and cyclical drivers of performance, investors must understand the risks associated with investing in different retail markets. These risks include the volatility and pricing of market performance. Institutional risks involve the economic and political maturity of sovereign markets, as well as property-specific considerations such as transparency, liquidity, income security, asset management, tenant relationships, and property positioning issues. 9: FRAMEWORK OF FACTORS THAT IMPACT RETAIL REAL ESTATE Long-term structural drivers Short-term cyclical drivers FRAMEWORK OF VARIABLES TO EVALUATE REAL ESTATE ATTRACTIVENESS The macro environment Retail competitiveness Real estate cycles Risk considerations Macroeconomy GDP Demographic factors Working population Urbanization rates Labour factors Unemployment Job growth Wealth indicators Disposable Income Tourism indicators Country risk Infrastructure Access/convenience Affordability Retail space per capita Supply New construction Demand Take up Retail sales Retailer strategies Market pricing Yields Spreads Volatility Pricing Institutional risks Country risk Political / legal risk Transparency Liquidity Retail real estate risks Asset management Positioning Retailer relationship Catchment area Trade mix Source: Prudential Real Estate Investors Note: as of End 1 The remainder of this paper includes an analysis of the South East Asian retail property market following the framework outlined above in Exhibit 9. 11

13 Part : South East Asia Retail Market Analysis The Macro Environment Macro Economy The South East Asian economies are projected to grow by to 7 per annum over the 1-1 period. This is a significantly faster pace of growth than is expected in advanced economies. Singapore s productive capacity in essence, its wealth has already pulled in line with the US, Japan, and Western Europe as measured by GDP per capita. And Malaysia's GDP per capita exceeds China and India by a relatively wide margin. Given these trends where are international retailers likely to be seeking growth opportunities in the years ahead? Clearly, a fertile environment exists for prime retail demand to grow in South East Asia in the years ahead. Add to this a surprisingly massive population base. South East Asia s 3 million residents in 11 exceeded both the US and Western Europe in size. Moreover, the region s large population base tends to be younger than either the US or Western Europe, where age cohorts are skewed in the other direction (Exhibit 1). 1: SOUTH EAST ASIA COMPARED TO THE REST OF THE WORLD GDP 11 (US$bn) GDP per capita 11 (US$) GDP growth 1-1 ( p.a.) Population 11 (millions) Population growth 1-1 ( p.a.) Urban share 11 () South East Asia Indonesia 7 3, Malaysia 79 9, Singapore 9, Thailand 3 5, Vietnam 1 1, Rest of Asia Pacific China 7,53 5,33.1 1, Japan 5,71, India 1,97 1, , Australia 1,7, Korea 1,9 1, Taiwan 7, Hong Kong 3 3, Other regions Western Europe 17,, USA 15,9, Source: EIU Note: as of 3Q 1 Indonesia and Vietnam, only marginally integrated with the rest of the world economy, have easily weathered recent external disruptions, including the global financial crisis and Europe s sovereign debt crisis. These same events had a different impact on South East Asia s more mature economies. External shocks, for example, contributed to sharp, but relatively short, corrections in Singapore and Thailand. Looking forward, recent forecasts for medium-term economic growth in South East Asia appear favorable. (Exhibit 11). 1

14 f 15f f 15f f 15f f 15f f 15f f 15f f 15f f 15f PRUDENTIAL REAL ESTATE INVESTORS 11: GDP GROWTH 1 Indonesia History Forecast 1 Malaysia History Forecast 1 Singapore History Forecast 1 Thailand History Forecast 1 Vietnam History Forecast 1 Asia Pacific History Forecast 1 China History Forecast 1 US History Forecast Source: EIU Note: as of Nov 1 Demographics Increasing rates of urbanization bring profound structural changes across a number of fronts: Economic. Urban labor pools are larger, denser, and more diverse, something that works to the advantage of employers as well as those seeking jobs. In this environment, productivity and incomes rise and so does spending. Social. Urban areas integrate diverse groups of residents and visitors, creating a social and cultural environment that can influence fashions, entertainment, and ultimately spending patterns. Political. Urban areas also wield political power, providing a voice for concentrated public investments in infrastructure such as airports, transit systems, hospitals, and universities. All of these structural impacts stem from urbanization, and all of them economic, social, and political shape the retail property markets in one way or another. If higher urbanization, for example, translates into more retail spending, then there is likely to be an increase in demand for retail space. The urbanized share of South East Asia s population jumped from 5 in 19 to 5 today. If current population trends continue, the urbanization rate will reach 75 by 5 (by comparison, the urbanization rate in the US is currently 3). At this rate, the size of the urbanized population in South East Asia would grow by a net 3 million over the next four decades. The city-state of Singapore is already fully urbanized, but other countries within the region hold a great deal of potential for urban expansion (Exhibit 1). 13

15 f 15f f 15f PRUDENTIAL REAL ESTATE INVESTORS 1: KEY DEMOGRAPHIC INDICATORS Urbanization rates Working age population ( of total) 1 forecast forecast Indonesia Malaysia Singapore Thailand Vietnam China US Source: EIU Note: as of Nov 1 Labor Market With solid rates of job growth projected for South East Asia in the coming years (all of the markets in the region except Thailand are expected to add jobs at a faster pace than the US), retailers have reason to be considering expansion. Singapore and Malaysia are expected to lead the region s job growth over the 1-1 period. Corresponding unemployment rates are expected to be below the historical averages experienced since the mid-199s. Emerging markets like Indonesia, and to a lesser extent Vietnam, are expected to experience significant improvements in their respective unemployment rates (Exhibit 13). 1

16 11 13f 15f 13f 15f 13f 15f 13f 15f 13f 15f 13f 15f PRUDENTIAL REAL ESTATE INVESTORS 13: KEY LABOR INDICATORS Employment growth ( per annum ) Unemployment rate ( per annum ) forecast Indonesia Malaysia Singapore Thailand Vietnam Asia Pacific China US 7 Forecast Historical average ( ) Indonesia Malaysia Singapore Thailand Vietnam Source: EIU Note: as of Nov 1 Wealth Accumulation Disposable incomes provide a reasonable basis for measuring and comparing consumer spending power. Singapore s disposable income per capita (estimated by the Economist Intelligence Unit at around US$3,7 in 1) is on a scale that is out of line with the rest of South East Asia. Compare, for example, Singapore s disposable income level to Vietnam s US$ in 1. Nevertheless, the vector is the same across the entire region. Disposable incomes are projected to grow in all five major markets in South East Asia over the 1-1 period. Some markets are expected to see significant improvements in disposable income growth rates (Indonesia, Malaysia). Others will maintain steady growth (Singapore, Thailand). Only Vietnam is expected to see gradual deceleration of in the pace of annual growth (Exhibit 1). 15

17 11 13f 15f 11 13f 15f 11 13f 15f 11 13f 15f 11 13f 15f PRUDENTIAL REAL ESTATE INVESTORS 1: DISPOSABLE INCOME PER HEAD (US$) US$ 35, Singapore Disposable Income (US$ per head, LHS) Disposable Income Growth (, RHS) 1 US$, Indonesia Disposable Income (US$ per head, LHS) Disposable Income Growth (, RHS) 1 US$, Malaysia Disposable Income (US$ per head, LHS) Disposable Income Growth (, RHS) 1 US$, Thailand Disposable Income (US$ per head, LHS) Disposable Income Growth (, RHS) 1 US$, Vietnam Disposable Income (US$ per head, LHS) Disposable Income Growth (, RHS) 1 3, 1 5, 1 5, 1 5, 1 5, 1 5, 15,,,,, 15, 1 9 3, 3, 3, 3, 1,,,,, 5, 3 1, - 1, - 1, - 1, Source: EIU Note: as of Nov 1 Tourism Markets that generate increases in disposable incomes and domestic consumer spending can expect to see their retail markets grow. Adding in the extra spending from cross-border tourists is an added bonus for the tourism sector. Singapore, constrained by its size and lack of natural features, has opted for a Las Vegas-style tourism strategy that centers on casinos and the luxury resort experience. For the rest of the region, the prospects for tourism are quite solid as well. South East Asia s location boosts its prospects for luring tourists for at least two reasons. First, proximity to China will become a bigger factor in the competition for tourists in the years ahead. A growing level of affluence among China s 1.3 billion residents is already impacting tourism across the Asia Pacific region, most notably in Hong Kong. By proximity alone, South East Asia is likely to capture some of this growing market in the years to come. Second, only the Indian subcontinent separates South East Asia from the Middle East. Malaysia has already become a popular destination for affluent tourists from this region. With more than 5 million visitors annually, Malaysia is the region s top tourist destination. By capitalizing on its Islamic heritage, perhaps Indonesia is suited to capture some of this growing market in the future. (Exhibit 15). 1

18 11 13f 15f 11 13f 15f 11 13f 15f 11 13f 15f 11 13f 15f PRUDENTIAL REAL ESTATE INVESTORS 15: TOURIST ARRIVALS & GROWTH Indonesia Malaysia Singapore Thailand Vietnam Arrivals (millions, LHS) Arrivals (millions, LHS) Arrivals (millions, LHS) Arrivals (millions, LHS) Arrivals (millions, LHS) mils Growth (, RHS) mils Growth (, RHS) mils Growth (, RHS) mils Growth (, RHS) mils Growth (, RHS) Source: EIU Note 1: as of Nov 1 Note : It should be noted that for the consistency across various countries, we are using EIU s estimates. EIU's data source is the World Tourism section of the World Development Indicators, and international sources tend to bring in the latest data with a lag, compared to national releases. Retail Competitiveness The macro environment described in the previous section a mix of demographic, economic, labor, income, and visitor dynamics provides context for South East Asia s retail demand. All of these factors are long-term and structural. Yet there are other long-term, structural factors that can stimulate retail property growth. These are loosely connected to the macro environment, yet they do not fit neatly into that framework. For lack of a better term, we call them retail competitiveness factors in this paper. Singapore provides a good illustration of retail competitiveness. It lures tourists to its two integrated resorts, Sentosa and Marina Bay. Tourists spend their retail dollars within these resorts, but the on-site retailers have external competition. Retailers in prime high street districts like Orchard Road recognize the potential of this tourist market and move further upscale to attract a share of nonresident spending. This drives up demand for prime retail space, and over a longer period of time, it pushes rents up more than they would have increased otherwise. In this sense, a number of competitiveness factors, including infrastructure, accessibility, affordability, and retail capacity impact the structure of the retail market over the long term. Both Malaysia and Thailand are keen to emulate this entertainment-led model of retail competitiveness. A recent study of cross-border shopping patterns in the Asia Pacific region attempted to measure the competitiveness of 5 major cities across the region, including cities in South East Asia, for attracting tourists. Though the study was a comprehensive look at tourism spending, it included various retailspecific variables. Singapore, for example, ranked high in the Asia Pacific region on factors such as transport infrastructure, accessibility, and the diversity of the shopping experience but it fell short on affordability. Other cities in the region like Jakarta and Ho Chi Minh City were deemed affordable, but fell short in the areas where Singapore ranked high. Kuala Lumpur tended to rank relatively high across all categories. The cities with the highest overall scores in South East Asia (Kuala Lumpur, Economist Intelligence Unit and Global Blue, The Globe Shopper Index Asia-Pacific, April 1. 17

19 Singapore, and Bangkok) are the ones considered best prepared to compete for external tourism spending. The implication for the other cities is that broad improvements in overall amenities things like airports, transit systems, public spaces could enhance the value of local retail markets (Exhibit 1). 1: THE GLOBE SHOPPER INDEX (ASIA PACIFIC) Overall Ranking Infrastructure (Transport & accommodation) Access (Convenience) Diversity (Shopping & product mix) Affordability 1 Ho Chi Minh City Kuala Lumpur Kuala Lumpur 3 Singapore Kuala Lumpur Kuala Lumpur Jakarta 5 Singapore Singapore Bangkok 7 Bangkok Singapore Bangkok Kuala Lumpur Manila 9 Bangkok 1 Manila 11 Manila Manila Bangkok Jakarta 17 Jakarta 1 Jakarta Manila 19 Ho Chi Minh City Singapore Ho Chi Minh City 1 Ho Chi Minh City Ho Chi Minh City Jakarta 3 5 Source: Globe Shopper Index Asia Pacific (1); Prudential Real Estate Investors Real Estate Fundamentals Structure of the Regional Market The structure of a local real estate market establishes a foundation for fundamentals and performance. Emerging markets like Vietnam and Indonesia, for example, offer only marginal diversity across retail formats. There are other important clues to a retail real estate market s structure, such as property ownership (is property held by institutions or by the occupiers?) and land supply (is it tightly controlled by the government or freely traded?) and lease structures. Retail leases in South East Asia are typically shorter than in Western countries. This has an upside in that it enables property owners to exert more active management control, but it also carries the risk of quickly losing lease renewals if economic conditions deteriorate or if the property does not perform well. Another important issue is the level of foreign participation permitted in property ownership. Emerging markets tend to impose various restrictions on foreign investments. All of these issues feed into the overall maturity and structure of the market (Exhibit 17). 1

20 17: STRUCTURE OF SOUTH EAST ASIAN RETAIL MARKETS SINGAPORE Dominant Retail Format Shopping malls; department stores. Ownership Local developers; S-REITs. Supply Risk (13/1) Moderate. Centrally planned by the government. Typical Lease Length Typically to 3 years. Maturity Stage Mature. Foreign Investments Yes. MALAYSIA Shopping malls; department stores; suburban malls. Developer-owned; increasingly institutional (M- REITs). Moderate to Considerable. Increasing level of supply for suburban malls in major cities. Typically to 3 years on fixed rent; longer leases must be registered with the relevant local land office. Maturing. Yes, but conditional; foreign investors would need to obtain state government approval. THAILAND Department stores; shopping malls; street shops. Predominantly retailer-owned; local developers. Moderate. Less institutional grade stock outside Bangkok. Typically 3 years on fixed rent. Maturing. Yes. VIETNAM Department stores; street shops; shopping malls. Local developers; retailer-developed and owned. Considerable. Concentrated in HCM City; significant level of new supply (double the existing stock) will enter the market over the next 3 years. Typically 3 years on fixed rent; longer term lease also available with flexible terms and market rental cap. Emerging. Yes. but conditional; the most common route is through joint ventures. INDONESIA Department stores; street shops. Local property companies; retailer-developed and owned. Minimal. Strong pre-leasing commitment for new malls in Jakarta. Developers are focusing on office and residential sectors. Typically 5 years on fixed rent; longer leases are available for negotiation. Emerging. Yes, but conditional. Source: DTZ, Prudential Real Estate Investors Note: as of End 1 19

21 Supply With the exception of prime retail space in Singapore, the pipeline throughout the rest of South East Asia ranges from adequate to abundant, depending on the market. Despite the large new supply expected in Singapore s suburban areas, demand is expected to be robust, and vacancy rates already reflect full occupancy. The retail market in suburban Kuala Lumpur faces a similar situation, i.e., ample supply but with relatively low vacancy. Pre-commitment ratios are above 7 for planned retail construction in the suburbs of both cities. 9 In the major cities of Vietnam significant supply risks loom ahead. Both Ho Chi Minh City and Hanoi are expecting to add more than one million square feet of supply in the coming four years. 1 The addition of this much modern shopping stock in cities where such space hardly exists will be a challenge for retailers to absorb, particularly in Hanoi which has been less responsive to market conditions than Ho Chi Minh City. Still, it is difficult to tell if or how much pent-up demand may exist in these markets. Vietnamese cities are different from the rest of the region because they are at such an early stage of retail investment. A surge of new supply is not uncommon when retail markets are moving up the maturity continuum. For now, Vietnamese retail vacancy rates remain far above the rest of the region (Exhibit 1). 1: RETAIL SUPPLY OVERVIEW Total New Supply 13-1 / Current Stock 1 Q Vacancy Rate Supply Risk Outlook Singapore Prime 5.5. Low Suburban 3.. Low Kuala Lumpur Prime Medium Suburban.5 5. Medium Other Malaysian Cities Medium / High Bangkok Prime Medium Suburban Low / Medium Jakarta Prime Low HCM City Prime Medium / High Hanoi Prime High Source: CBRE, JLL; Prudential Real Estate Investors Note: as of Q 1 Demand As outlined in the macro environment section of this paper, increasing levels of domestic income and inbound tourism boost the potential for retail demand. Steady growth in disposable income translates into greater volumes of retail sales over time, but in the short term, retail sales growth can be quite volatile, depending on economic issues such as job growth, inflation, and consumer confidence. Major new tourist destinations in Singapore Marina Bay Sands, Universal Studios, and Resorts World Sentosa helped to re-establish the market s retail sales growth in the wake of the global financial crisis. Despite Singapore s weaker economic outlook, its retail sales growth is expected to keep pace with past trends. 9 Jones Lang LaSalle, as of Q CBRE Research, as of Q 1.

22 PRUDENTIAL REAL ESTATE INVESTORS Malaysia was perhaps influenced by Singapore s recent success in attracting big-spending visitors. Already a major destination for Middle Eastern tourists, Malaysia has launched a new initiative to attract both investors and visitors. Dubbed Iskandar Malaysia, the mixed-use initiative is located in the southern region of the country across the border from Singapore. Liberalization of the retail sector in Vietnam and Indonesia will push retail sales growth up over the next five years. Indonesia is expected to sustain the upward momentum in sales growth over the fiveyear forecast window. Although Vietnam may lose some of its retail sales momentum in the latter years of the forecast window, it will still see some of the fastest growth in the region (Exhibit 19). 19: RETAIL SALES GROWTH () 1 Indonesia History Forecast 1 Malaysia History Forecast 1 Singapore History Forecast 1 Thailand History Forecast 1 Vietnam History Forecast Source: EIU Note: as of Nov 1 Retail rents in Malaysia, Bangkok, and Jakarta share solid prospects for growth in the near term, Over the past few years rental performance in these markets has remained relatively sheltered from external disturbances in the Eurozone or elsewhere. Recent new deliveries of retail space boosted Singapore s retail stock and provided retailers with a new array of options. In the process, the new supply also muted the market s recent rental growth. With economic conditions in Singapore looking cloudy in the near term, retailers are likely to sit on their expansion plans until prospects improve, thus delaying the retail rental recovery. A massive excess of modern supply will overwhelm Vietnamese cities in the near term. Despite an upbeat outlook on the demand side, the supply pipeline will disrupt retail fundamentals in Vietnam and send rents down in the near term. From a longer term perspective, however, this pattern is hardly unusual. When incomes and retail sales are increasing rapidly, as they are in Vietnam, large new stocks of modern space are needed for the market to transition into greater maturity. It is inevitable that some short-term imbalances in supply and demand will occur as this transition plays out. (Exhibit ). 1

23 : RETAIL RENTAL OVERVIEW Source: JLL; CBRE; Prudential Real Estate Investors Note: as of Q 1 Cumulative Retail Rental Growth, Year Historical Average Retail Rental Rental Growth Rate, 3-1 Outlook Singapore Prime. Suburban 1. Kuala Lumpur Prime. Suburban 5.5 Other Malaysian Cities Bangkok Prime 1. Suburban Jakarta Prime. HCM City Prime. Hanoi Prime Cumulative Percent () Change Pricing Retail assets in Singapore and Kuala Lumpur are currently trading at the lower end of their respective historical yield bands. The historical yield bands for these markets are rather narrow, reflecting their relative maturity and stability. Contrast this with Bangkok and Jakarta, where yields have ranged much wider over time. These retail markets are still evolving and maturing. As a result, investors in Bangkok and Jakarta demand higher risk-adjusted returns. (Exhibit 1). 1: RETAIL PRICING OVERVIEW Historical yield range, 1-1 (as available) Current yield at Q Other Singapore Kuala Lumpur Malaysia Bangkok Jakarta HCM City Hanoi Prime Suburban Prime Suburban Prime Suburban Prime Prime Prime Yield Trend Source: JLL, Prudential Real Estate Investors. Note: as of Q 1

24 The previous chart (Exhibit 1) showed yield movements over time. The following chart shows yield spreads, past and present (Exhibit ). The patterns are essentially the same: only marginal historical changes to spreads in Singapore and Kuala Lumpur, but wide variations in Jakarta and Bangkok. Look closely at Exhibit and it shows that Singapore s yield spread is slightly higher than its longterm average. Low government bond yields in Singapore have more than offset the market s historically low cap rate. Ownership of Singapore s retail property is closely protected, with few transactions occurring. If and when a retail property does become available in Singapore, local institutions and S-REITs often acquire the assets with aggressive underwriting assumptions. (See again Exhibit 1, which shows Singapore as a mature market rather than an advanced institutional market. One of the features separating these two types of maturity is liquidity. In mature markets like Singapore, liquidity is still evolving. Advanced institutional markets tend to be highly liquid.) This may help to explain why, despite Singapore s modest outlook for rental growth, yields are unlikely to move out, and are instead expected to remain fairly stable. In Malaysia, the retail markets are maturing quickly. The country s M-REITs have become a major force driving cap rate stabilization. Meanwhile, yields for maturing markets like Jakarta and Bangkok are relatively healthy and the spreads are attractive. Cap rates could compress further in these markets, but the drivers will be different from Singapore and Malaysia. The Jakarta retail market is experiencing structural change in its fundamentals. Strong demand from domestic and international retailers has been met with a dearth of new modern supply. This is likely to drive cap rate compression until Jakarta s retail fundamentals can rebalance. In Bangkok, demand for retail assets is increasing, and the Thai market recently welcomed the successful launch of Tesco Lotus REIT. As the Bangkok market matures, yields are likely to compress further. : YIELD SPREADS 1 9 Long-term average spread, 1-1 Most recent 5-year spread 7 Current spread at Q Singapore Prime Singapore Suburban Kuala Lumpur Prime Kuala Lumpur Suburban Jakarta Prime Bangkok Prime Source: JLL, CBRE, Prudential Real Estate Investors. Note: as of Q 1 3

25 The outlook for unadjusted total returns on retail assets over the next three to four years varies market by market based largely on the progression of maturity in each country. In the more mature markets of South East Asia, income will be the primary driver of total returns in the near term, as cap rates in these markets currently at historically low levels are unlikely to compress significantly in the major cities of Singapore and Kuala Lumpur. The outlook for capital appreciation in Bangkok is a bit better. Solid economic growth and tourism expansion are encouraging greater institutionalization of the market, and this is likely to stimulate new tenant demand from retailers. Retail yields in Bangkok are relatively high, so the current dynamics of the market leave room for further compression. But liquidity issues complicate retail returns in the emerging markets. The lack of investment grade assets and transactions tends to amplify capital appreciation. When a transaction occurs, the yield is typically low, making it difficult for foreign investors to justify the acquisition on a risk-adjusted basis. In markets like Hanoi and Ho Chi Minh City, the infrequency of transactions and the limited stock of modern retail assets make it impractical to forecast capital appreciation in any meaningful way (Exhibit 3). 3: TOTAL RETURN OUTLOOK Income Return Capital Appreciation Annualized 13-1 Annualized 13-1 Min Max Min Max Singapore Prime 5 3 Suburban 5 1 Kuala Lumpur Prime 7 3 Suburban 7 3 Bangkok Prime Jakarta Prime Ho Chi Minh City Prime 1 1 Outlook Uncertain Hanoi Prime Outlook Uncertain Source: Prudential Real Estate Investors, JLL, CBRE Note: as of Q 1 Risk Considerations Investors face a wide range of country and political risks across South East Asia. Singapore presents a low risk environment but in countries like Vietnam the risks are much more daunting. Stable governments and sound financial and credit markets have ushered in noticeable improvements in country risks across the region, especially in Indonesia, Singapore, and Malaysia. Meanwhile, country risks in Vietnam have actually worsened over the past decade due to weaker credit markets and rampant corruption (Exhibit ).