Real estate market outlook Asia Pacific

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1 July 1 Real estate market outlook Asia Pacific Part of the M&G Group

2 Executive summary Economic recovery continues to strengthen across the region, with export-led economies set to benefit the most Office sector leads rental growth recovery, while prospects in retail and logistics remain moderate Transaction activity dominated by domestic and intra-regional investors Risk appetite is improving, leading to a compression of yields on secondary assets Best short term rental growth prospects: offices Best investment opportunity: Australian offices and logistics Market to be cautious on: and offices; retail Economy: strong growth outlook, led by exports Asia s growth outlook is strong, as exporters are set to continue to benefit from the global economic recovery. With Asian GDP growth expected to average 5.5% p.a 1., the region is well placed to continue leading global growth over the coming two years. The recovery has been slower to catch on in Australia, but there too conditions are gradually becoming more positive. Accommodative monetary policy is supporting business sentiment and labour markets. However economic headwinds remain amid declining investment in the mining sector and potential drag from the recent fiscal consolidation. Slower growth and tighter credit conditions in China may weigh on economic momentum across the region in the short term. But over the longer term, China s rebalancing towards a more consumption-led growth will be positive for the Asian economy as a whole. Japan is reaping the benefits of Abenomics a threepronged effort of monetary, fiscal and policy reforms aimed at boosting long term growth and pulling the economy out of two decades of deflation. Early successes are manifested in the more optimistic business sentiment, stronger consumption and a recovery of the labour market. The Bank of Japan s aggressive monetary policy has pushed government bond yields to historically low levels and boosted inflation expectation towards the % target. GDP growth is now above trend, and is expected to stay strong in the short term. However, the transition to stronger and sustainable growth for Japan remains uncertain over a longer horizon. If the government fails to implement the planned structural reforms, Japan risks falling back to lower growth and deflation. The reforms need to be decisive, particularly in relation to deregulation, corporate governance and the labour market, in order to maintain the momentum of early successes and to set Japan on a sustainable growth path. Exports, rolling -quarter change (%) Fig 1: Exports growth accelerating 5 6 Australia 7 Japan Source: Bloomberg, May 1 8 South Korea 9 1 China Mar 1 1 International Monetary Fund, Asia and Pacific Regional Economic Outlook, April 1.

3 Short term prime occupational market drivers Retail Office Industrial and Japan s regional office markets: recovering demand & declining vacancy rates. Australia to benefit from strengthening demand. Tight supply in underpinning favourable fundamental balance. Most markets: Rental growth prospects weakened by subdued retail sales growth outlook. and : prime rents stabilising. Seoul: fundamental balance improving. and Japan: increasing supply to soften growth outlook. Weak demand in and increased supply in to weigh on rental prospects. Occupational market: rental growth recovery spreads The economic recovery has clearly helped to strengthen leasing market sentiment and activity across the region. Occupational market fundamentals are broadly favourable and we expect that they will continue to improve, with support from a pick-up in demand and still moderate supply over the next few years. Offices lead the way Many markets, particularly offices, are at the beginning of the rental growth cycle. The office sector is leading the way, and is already experiencing very strong rental growth. The recovery in started with prime grade properties in central areas (5-kus) but has now spread to lower grade assets and sub-markets. Japan s regional markets, such as Osaka, are also showing signs of recovery. After a period of weakness, the and markets are turning the corner. Relatively low supply will be the main supportive factor for both, as we expect demand to pick up gradually. Similarly, the Seoul office sector having suffered from high vacancy and muted net demand is now showing nascent signs of a recovery. This is underpinned by the completion of the recent supply cycle and stronger take-up against the backdrop of improving economic conditions. In the medium term, we see particularly attractive prospects in secondary offices (Grade B) in selected markets, where improved fundamentals are supporting stabilising rents such as and. Net absorption (' sqm) Fig : Office net absorption to pick up further Osaka Seoul Average net absorption (-1) Average net absorption* (1-15) Source: PMA, M&G Real Estate; Net absorption estimated for CBD Grade A segment, 1/15 net absorptions are based on our forecasts Investors could also consider taking some vacancy risk in the prime segment in markets with a strong demandled recovery, such as. In the retail and logistics sectors, rental growth prospects remain generally moderate given the still subdued growth in domestic demand and retail sales across Asia. Increased supply in Australia and is also likely to limit rental growth in the short term. In the longer term, occupier demand for retail space in some countries is likely to be under pressure from the rise of online trading, as well as from the ageing populations in Japan and Korea. For this reason, we favour non-discretionary retail. The structural shifts are potentially more positive for logistics. However investors should exercise some caution, given the flexibility of supply in this sector and the relatively tight operational margins of the tenants.

4 Investment market: domestic players dominate Capital markets remain positive, as evidenced by investment volumes in Asian real estate rising to US$17 billion in 1, close to the peak of 7. Sentiment remains strong and transaction flows so far in 1 have been buoyant, with continued improvement in risk appetite evidenced by the demand for a wider range of assets and with larger deals being completed. Given that the yield spread between prime and secondary assets remains relatively attractive and occupier demand is generally robust, it is likely that yields will compress further. We expect the move to be most notable in Australia s office and logistics and in Japan across all sectors. Deal flows in smaller markets such as and have moderated. These economies have monetary policies which are more closely tied to that of the US, and therefore face higher uncertainty from the expected normalisation in US interest rates. Investors would therefore be justified in taking a more cautious approach to and in the short to medium term, particularly in the value-stretched office sector. Prime yield (%) We anticipate that this trend will continue over the medium term given the still attractive values of real estate over bonds and accretive debt-supported acquisitions across sectors. Activity continues to be dominated by domestic and intra-regional investors, which is likely to play a critical role in mitigating the uncertainty of capital flows, particularly during monetary policy normalisation. Historically, domestic investment tends to be more long term and is therefore less likely to be subject to sudden outflows. In addition, most Asian pension funds and insurance companies expect their assets and capital bases to grow over the coming decades, supporting the capital base for real estate over the medium to long term. We expect that interest in secondary assets will continue to grow. Fig. : Property yields vs. 5-year loan interest Seoul Office Retail Industrial Outlook spotlight: Japan continues to lead the real estate market recovery in Asia, with investors attracted by the significant yield spread over government bonds and by a strong recovery in the rental outlook. Competition for access to investment opportunities has pushed property yields towards historic lows, particularly in central. Despite a supportive economic outlook, prices appear to have run ahead of fundamentals, particularly in the prime segments. In this environment, the markets seem priced to deliver returns that are not commensurate with intrinsic risks, particularly when the sustainability of Japan s economic recovery is still dependent on structural reforms that have yet to be delivered. The momentum in both the capital market and the economy will likely continue to drive property investment performance in the short term but we expect that returns will be front-loaded and growth-driven, making it a less attractive proposition for medium to long term investors. In this environment, Japan s regional markets and nonprime segments look more interesting given their higher income yield and the prospects for a more wide-spread rental recovery. Good quality Grade B office assets in attractive locations or non-discretionary retail assets within a strong catchment will likely deliver more stable and attractive returns. Yield (Q1 1) Source: JLL Cost of debt (5 years) Real Capital Analytics, figure excluding land transaction in China. Domestic and intra-regional capital accounted for circa 9% of overall transaction volumes in 1.

5 Conclusion Overall, the growing economic strength in Asia Pacific is supporting a continued recovery in the region s real estate market. Rental growth prospects are improving, albeit at varying rates. The cyclical momentum appears to be the strongest in the office sector, particularly in, and is more moderate in retail and logistics sectors. In the investment market, transaction volumes hit a six-year high in 1, and are expected to be similarly strong this year. There is still buoyant demand for prime properties but investors are also starting to move up the risk curve. As downside risks to economic growth continue to subside, we believe that non-prime assets offer more attractive value on account of their higher income yields and improving rental prospects. However, with specific risks typically higher in lower quality assets, investors need to focus on stock selection and portfolio construction. The diversity of the Asian market provides investors the depth and breadth of investment opportunities to suit varying investment strategies across time horizons and levels of risk tolerance., and offices continue to offer strong potential for growth but these markets are also subject to pricing uncertainty, and are therefore considered to be riskier over the medium term. By contrast, industrial and office sectors in Australia or logistics in are likely to deliver attractive incomedriven returns, given their improving fundamentals and current yields above the historical average. In Seoul, the continued focus of domestic capital on central business district (CBD) offices has led to a minor recovery in the sector, and in future may help soften the potential risks from interest rate rises over the medium term. Looking over the longer horizon, the Asia Pacific real estate market continues to offer attractive long term fundamentals and structural advancement. Accounting for over a third of the world s real estate universe and growing at a fast pace, Asia is securing its position as a strategic market for global investors. Fig. : Regional dynamism offers broad range of opportunities Annualised rental growth forecasts % (1-18) Growth driven markets Osaka Seoul Income driven markets Yield (Q1 1, %) Office Retail Industrial Source: M&G Real Estate Graham Newell, The significance of real estate in Asian pension funds", APREA, 1. 5

6 For more information Chris Nash Director of Institutional Business Real Estate, UK + () Stefan Cornelissen Director of Institutional Business Benelux and Nordics +1 () Chris Andrews Head of Client Relationships and Marketing For Addressee only. The value of investments can fall as well as rise. This article reflects M&G Real Estate s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. The distribution of this article does not constitute an offer or solicitation. It has been written for informational and educational purposes only and should not be considered as investment advice or as a recommendation of any particular security, strategy or investment product. The services and products provided by M&G Investment Management Limited are available only to investors who come within the category of Professional Client as defined in the Handbook published by the UK Financial Conduct Authority. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G Real Estate does not accept liability for the accuracy of the contents. Notice to recipients in Australia M&G Investment Management Limited does not hold an Australian financial services licence and is exempt from the requirement to hold one for the financial services it provides. M&G Investment Management Limited is regulated by the Financial Conduct Authority under the laws of the UK which differ from Australian laws. Notice to recipients in The contents of this document have not been reviewed by any regulatory authority in. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. Notice to recipients in the Netherlands This document is not addressed to or intended for any individual or legal entity in the Netherlands except individuals or legal entities who qualify as qualified investors (as defined by section 1:1 of the Act on financial supervision (Wet op het financieel toezicht), as amended). Notice to recipients in This document has not been registered as a prospectus with the Monetary Authority of. Accordingly, this document and any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of shares may not be circulated or distributed, nor may shares be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in other than (i) to an institutional investor pursuant to Section of the Securities and Futures Act, Chapter 89 of (the SFA ) or (ii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. M&G Investments and M&G Real Estate are business names of M&G Investment Management Limited and are used by other companies within the Prudential Group. M&G Investment Management Limited is registered in England and Wales under numbers 9668 with its registered office at Laurence Pountney Hill, London ECR HH. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority. M&G Real Estate Limited is registered in England and Wales under number 8576 with its registered office at Laurence Pountney Hill, London ECR HH. M&G Real Estate Limited forms part of the M&G Group of companies. M&G Investment Management Limited and M&G Real Estate Limited are indirect subsidiaries of Prudential plc of the United Kingdom. Prudential plc and its affiliated companies constitute one of the world s leading financial services groups and is not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America. JUL 1 / 978 6

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