DTZ Foresight Asia Pacific Fair Value Q Maturing and developed markets diverge

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1 DTZ Foresight Asia Pacific Fair Value Q Maturing and developed markets diverge 3 February 11 Contents Overview 1 Fair Value Index Fair Value Classifications 3 Asia Pacific market classifications Asia Pacific vs global forecasts Office market forecasts Retail market forecasts 7 Industrial market forecasts Economic Drivers 9 Authors Ben Burston Forecasting & Strategy Research + () 39 9 ben.burston@dtz.com Zubaer Mahboob Forecasting & Strategy Research + () zubaer.mahboob@dtz.com Contacts David Green-Morgan Head of Asia Pacific Research +1 () david.green-morgan@dtz.com Tony McGough Global Head of Forecasting & Strategy Research + () tony.mcgough@dtz.com Hans Vrensen Global Head of Research + () hans.vrensen@dtz.com The DTZ Fair Value Index (FVI) score for Asia Pacific has fallen from to 7 in Q (Figure 1). The office and industrial sectors have led the downgrades this quarter, with the office score falling from 7 to, and the industrial score falling from to. Yield compression in several markets reduced prospective investment returns, causing their Fair Value classifications to be downgraded. In addition, a tightening bias among the region s central bankers has led to higher government bond yields, raising the required returns on property and contributing to the lower index scores. As we pointed out in our Q and Q3 reports, pricing has been attractive in many Asia Pacific locations, and investors have responded to the attractive pricing with increased interest, and as a consequence yields have compressed. There is increasingly a divergence within the region between the maturing markets and developed ones. In maturing markets, which are still outside the scope of interest for many investors, pricing has not adjusted significantly over recent quarters, and there are many HOT markets offering strong income returns and solid capital growth prospects. In the more developed markets, investor interest has been strong and yields have tightened, with strong rental growth now priced in. This has led to broadly balanced pricing and consequently fewer HOT opportunities. In China and India, investors can access several high growth markets which are expected to perform well as values appreciate over the next five years. On the other hand, in Australia the investment market became less attractive in Q, driven by tightening yields which pushed up prices and lowered prospective income returns. Figure 1 Changes in Asia Pacific Fair Value Index scores Q3 to Q DTZ Fair Value Index Score All property Q3 All property Q Offices Q3 Offices Q Cold Warm Hot

2 Fair Value Index Asia Pacific Fair Value Index score falls from to 7 in Q The DTZ Fair Value Index score for Asia Pacific in Q stands at 7, following several downgrades in sector classifications (Table 1). Table 1 Asia Pacific Fair Value Index scores Q Q Q3 Asia Pacific all-property 7 Asia Pacific office 7 Asia Pacific retail Asia Pacific industrial Global all-property 3 3 Global office 7 1 Global retail Global industrial 3 The office and industrial sectors have led the downgrades this quarter, with the office score falling from 7 to, and the industrial score falling from to. Tighter property yields and higher government bond yields have driven the changes in the index scores. Notwithstanding the downgrade in the Asia Pacific index scores, the region remains attractive globally. The office sector in particular provides significantly better opportunities compared to global offices, with a stronger outlook for rental growth measured against the slower recovery in other regions. However, retail and industrial sectors in Asia Pacific are now seen to be less attractive compared to their global counterparts. Our Fair Value analysis concludes that there were 1 HOT markets at end Q, a decrease from in Q3, while the number of COLD markets has risen from nine to 13 (Table ). Table Asia Pacific (APAC) market classifications Q HOT markets Change since Q3 COLD markets Change since Q3 APAC allproperty 1 13 APAC office 11 Australia allproperty 3 3 China allproperty India all-property 1 Other APAC allproperty 3 7 In China and India, investors can access several high growth markets which are expected to perform well as values appreciate over the next five years. On the other hand, in Australia the investment market became less attractive in Q, driven by tightening yields which pushed up prices and lowered prospective income returns. Outside these countries, however, there remain several COLD markets where continued strong demand has driven rapid capital appreciation, and we expect some of these gains to be unwound over the next five years. Box 1: Guide to the DTZ Fair Value Index The DTZ Fair Value Index is intended to provide investors with insight into the relative attractiveness of current pricing in global commercial property markets. Fair Value Index scores reflect the proportion of HOT and COLD markets, with higher scores implying more HOT markets. Index Pages -3 Markets are categorised by comparing expected and required returns. Markets estimated to be more than under-priced are classified HOT; markets more than over-priced are classified as COLD; and, markets between this range are classified as WARM. The DTZ Fair Value Index is a forward-looking index based on econometric forecasts incorporating local economic drivers and local market knowledge. Fair Value Classifications Property Forecasts Economic Forecasts Page Pages - Page 9 For further information on the methodology used for classifying different markets and calculating Fair Value Index scores, see the DTZ Research report: DTZ Fair Value Index TM Methodology: Solid Foundations for Future Returns.

3 Fair Value Classifications Figure Regional Fair Value Index scores Q DTZ Fair Value Index Score Figure Global Europe Asia US UK Pacific Cold Warm Hot Asia Pacific Fair Value Index: change from Q3 to Q Figure DTZ Fair Value Index Score All property Q3 All property Q Offices Q3 Offices Q Cold Warm Hot Asia Pacific Fair Value by sector Q DTZ Fair Value Index Score All property Offices Retail Industrial Cold Warm Hot Pricing has risen, but Asia Pacific still an attractive region for investors Fair Value Index scores have decreased globally in Q, reflecting a generalised trend towards lower property yields even as government bond yields increased (Figure ). Property yields have been compressing as investors chase prime assets that are benefitting from cyclical recovery and associated rental uplift. Government bond yields, on the other hand, are rising due primarily to base rate increases across Asia Pacific on the back of inflationary pressures. As we pointed out in our previous Q and Q3 reports, pricing has been attractive in many Asia Pacific locations. Investors have responded to the attractive pricing with increased interest, and as a consequence yields have compressed in several markets, lowering expected returns for investors entering the market at the new higher prices. As such, there is increasingly a divergence within the region between the maturing markets and developed markets. In maturing markets, which are still outside the scope of interest for many investors, pricing has not adjusted significantly over recent quarters, and there are many HOT markets offering strong income returns and solid capital growth prospects. In the more developed markets, investor interest has been strong and yields have tightened, with strong rental growth now priced in. This has led to broadly balanced pricing and consequently fewer HOT opportunities. Office markets still lead, with industrial sector downgraded this quarter With a score of, the office sector continues to offer the highest proportion of HOT markets, although the score for this sector has fallen from 7 in Q3 (Figure 3). The industrial sector has also seen its score reduced substantially, following an uplift in pricing in the Australian markets. The score for industrial fell from in Q3 to in Q. The fair value score for retail has reduced fractionally to in Q from in the previous quarter (Figure ). Compared to global retail, Asia Pacific retail continues to be a less attractive proposition, and even Asia Pacific industrial (with a score of ) is now marginally less attractive against a global industrial score of

4 Asia Pacific Market Classifications More downgrades than upgrades in Q The fall in the Asia Pacific index score for Q was the result of the net balance of 1 changes in market classifications, with 11 of these made up of markets moving from HOT to WARM (Figure and Table 3). Four markets moved from WARM to HOT, and one moved from WARM to COLD. Five Australian markets were downgraded from HOT to WARM, including Sydney and Brisbane offices and Melbourne industrial. This was partly a result of falling yields, with Sydney and Brisbane office yields falling by basis points to.7 and 7. respectively, lowering expected returns. In addition to this, a basis point rise in the Australian government bond yield driven by higher interest rate expectations following the RBA s November rate hike raised the required return, making property investment relatively less attractive. Two Indian retail markets have been upgraded this quarter: Chennai and Mumbai. This has been driven by a large upgrade in rental growth expectations, with five-year annualised rental growth revised up to a very strong 7. and. respectively. Box : Why are Hong Kong and Taipei rated COLD? Hong Kong and Taipei are benefitting from a cyclical upswing supported by a strong occupier market as demand recovers quickly following a short, sharp downturn in 9. Over the next five years, the Hong Kong and Taipei office markets are expected to see strong rental growth, with forecast annualised growth of 7.9 and.3 respectively for the period to 1. This strong growth outlook has encouraged investors into the market, pushing yields down to very low levels. Office yields in Hong Kong and Taipei are now touching their lowest points on record at. and 3. respectively. This investor interest has also been supported by the broader global financial environment, with low interest rates in the major Western economies leading to a search for higher investment returns elsewhere. Hong Kong and Taipei have been major recipients of such inflows, which tend to raise asset prices. While we forecast strong capital growth over the next year, supported by rental growth and continued strong investor interest, investors with a longer time horizon should be wary of a potential unwinding of this asset price growth as the economic fundamentals underpinning the inflows are altered, with a likely catalyst for reversal being a normalisation of monetary conditions in the United States. This is reflected in our yield forecasts (see Figure on page ), with yields expected to rise from their cyclical lows over the full five-year horizon, placing downward pressure on capital values. Figure Selected Changes in Fair Value rating Q3 to Q Q3 COLD WARM HOT Q COLD WARM HOT Shenzhen offices Hong Kong retail Shanghai retail Taipei industrial Brisbane retail Tokyo offices Guangzhou offices Kuala Lumpur retail Auckland industrial Sydney offices Mumbai offices Beijing retail Melbourne industrial Table 3 Ranking of biggest movers: change from Q3 to Q Table More attractive Chennai retail Mumbai retail Gold Coast offices Guangzhou retail Gold Coast offices Chennai retail Mumbai retail Guangzhou retail Shanghai offices Bangalore offices Singapore retail Brisbane industrial Less attractive Chengdu offices Mumbai offices Delhi offices Melbourne industrial Asia Pacific Fair Value Index: major market classifications Under/over Sector Market Category valuation Office Markets Retail Markets Industrial Markets Bengaluru HOT -1 Singapore HOT -1 Shanghai HOT -11 Tokyo WARM - Hong Kong COLD 17 Mumbai HOT - Singapore HOT - Beijing WARM -1 Sydney COLD Shanghai COLD 1 Singapore HOT -1 Melbourne WARM -3 Sydney WARM -3 Hong Kong COLD 1 Taipei COLD

5 Asia Pacific Versus Global Forecasts Figure APAC vs Global All Property Rental Growth Asia Pacific Global Figure 7 APAC vs Global All Property Capital Growth Rental growth in Asia Pacific will outperform the world Asia Pacific all-property rents grew rapidly prior to the recession, beating global rental growth by a wide margin, even when the latter was growing by double digits (Figure ). The downturn reversed this picture, and in 9 rents fell more steeply in Asia Pacific than they did elsewhere. During the recovery in, however, Asia Pacific rents outperformed with. growth against global rental growth of.. Asia Pacific rental growth is still expected to exceed global rental growth through to 1, but the forecast numbers are weaker than the numbers for the boom years, with less volatility as well. Over the forecast period, Asia Pacific rents are forecast to grow at a yearly average of 3. against a global average rental growth of.3. Fewer capital growth opportunities going forward After two successive years of decline, Asia Pacific capital values recovered in, growing by 13. (Figure 7). This is almost double the capital growth observed globally. Going forward though, the scope for further capital growth becomes increasingly limited. While property yields keep falling, interest rates and bond yields in the region are moving in the opposite direction. In key markets such as Hong Kong, we forecast prime yields to normalise from their current cyclical lows over the course of the next five years Asia Pacific Global Figure APAC vs Global All Property Total Returns Asia Pacific Global 1 1 Average capital value growth during 11-1 is forecast to be around 3 annually, fractionally greater than global capital growth. Growth will be most pronounced in the office sector (at an annual rate of.) while industrial sector capital growth is expected to be subdued at 1. annually. Asia Pacific total returns will broadly match global returns In the future, we forecast stable positive returns in the Asia Pacific region, broadly similar to the returns available from global property. Both are expected to generate annual returns of around -9 (Figure ). Returns will be driven more by growth fundamentals than by debt-fuelled speculation. Breaking down by sector, the office sector will once again deliver the strongest returns at around annually, followed by retail and industrial both of which are expected to generate average annual returns of around.

6 Office Market Forecasts Buoyant economy to fuel rises in office rents The outlook for the office sector continues to be positive. Companies throughout the region are expanding workforces and taking advantage of relocation opportunities. In terms of rental growth, over the next five years our top three markets are Bengaluru, Hong Kong and Singapore. On average prime office rents in the region are expected to increase by. in 11, following 9.3 growth in as the economy rebounded (Figure 9). In the weaker performing markets, office rental growth is forecast to be sub- pa. Following a 1. increase in, prospects for further sharp rises office rents in Shenzhen are limited. Like Seoul, Shenzhen has a significant amount of new supply scheduled to be delivered 13. Office rents in both markets are expected to show modest falls in 13 as a result. Rental prospects are also poor in Tokyo, with rental growth of just 1.7 pa forecast over the period. Prime yields to compress in China and India There is a clear distinction between yield forecasts for the more developed markets in the region and the developing markets. In Hong Kong, Singapore and Taipei, by 1 office yields are forecast to edge up from their current lows. The rises reflect increases in global interest rates and bond yields in the second half of the forecast period (Figure ). In India and China yields are still high compared to both developed markets in the region and also Western markets. Consequently, as these markets become more liquid and established over the next five years, we expect yields to edge lower. Double-digit returns forecast for most markets Total returns over the period 11-1 are forecast to be in double digits in the majority of Asia Pacific office markets. In part this reflects higher liquidity and risk premiums compared to developed markets. Even in Sydney though, a mature, developed market, total returns are forecast to be 1.3 pa over the period as falling yields boost capital values (Figure11). The markets with the highest forecast returns, topped by Bengaluru and Chennai, are expected to receive strong tail winds from capital value appreciation as rents rise and yields decline. By contrast, in markets such as Hong Kong and Seoul, capital value appreciation is forecast to be minimal. The impact on capital values from rises in rents is forecast to be offset in large part by rises in yields. Figure 9 Prime Office Rental Growth 11-1, Best and Worst pa 1 Figure 11-1 Prime Office Yield Forecasts, Selected Markets Figure 11 Beijing Bengaluru Chennai Hong Kong Singapore Taipei Prime Office Total Returns 11-1, Best and Worst pa 1 Income Return Capital Value Growth Total Return

7 Retail Market Forecasts Figure 1 Prime Retail Rental Growth 11-1, Best and Worst pa Figure Prime Retail Yield Forecasts, Selected Markets Figure 1 Bengaluru Chennai Delhi Hong Kong Melbourne Shanghai Prime Retail Total Returns 11-1, Best and Worst pa Income Return Capital Value Growth Total Return Indian cities top retail rent forecasts The outlook for prime retail remains robust thanks to strong labour markets, rising wages and higher equity prices which are boosting household wealth. Going forward, consumer spending is forecast to grow by - pa in most of South East Asia. Even stronger consumption growth of - is predicted in the rising economies of China and India. The top five retail markets in terms of rental growth over the period 11-1 are all in India, with rents forecast to rise at pa and higher. Prime retail is still a relatively new format in India, and although the total stock of prime is increasing, the market has tended to be undersupplied. New malls continue to be developed which push prime rents higher. Rental growth in the weakest markets is forecast to be much more subdued, not even reaching pa (Figure 1). Yields diverge in developing and developed markets Yield forecasts show divergent trends between developed and developing locations in Asia Pacific. The combination of strong rental growth prospects and increasing market maturity leads us to forecast retail yields in India and other developing markets to fall over the next five years. Increased liquidity should also push yields down (Figure 13). In some of the mature retail markets in the Asia Pacific region, such as Hong Kong, Melbourne and Shanghai, we expect yields to edge higher over the forecast period. This follows falls in yields to very low levels in, and mirrors the expected increases in global interest rates and bond yields. We expect higher bond yields to feed through to property yields. Indian retail markets to deliver the highest returns Unsurprisingly, the auspicious combination of high, but falling yields and strong rental growth mean that the Indian retail markets also top the total returns league. Total returns in all of the top five markets are forecast to be above 1 pa, with capital value appreciation accounting for around half of the returns over the forecast period (Figure 1). In the markets at the bottom of the total returns table, capital value appreciation is expected to be much more subdued, with returns being largely reliant on rental income. In Hong Kong, where yields reached at the end of, rises in yields are expected to hit capital values hard, to the extent that their impact will not be offset by rises in rents. With capital values forecast to fall, total returns in Hong Kong are also expected to be negative. 7

8 Industrial Market Forecasts Industrial rent forecasts strongest for Singapore Exports remain a key driver of growth in Asia Pacific and the region still depends heavily on goods markets in the US and Europe. However, intraregional trade is also getting stronger. China posted export growth of 31 in, while Singapore, Taiwan and South Korea all recorded export growth rates between 11 and 1. Future growth in exports is expected to be more moderate, in the low double digits. Singapore, a traditional powerhouse in trade and logistics, is expected to be the best industrial performer over the forecast period in terms of rental growth, forecast at 3. pa (Figure 1). Benefiting from the commodities boom, both Melbourne and Brisbane are expected to outperform, with rents rising at more than 3 pa due to Australia s status as a key supplier of raw materials to Asia Pacific manufacturers. Prospects for Hong Kong, on the other hand, have been revised downwards because demand for mixed industrial/office space is expected to weaken. Mixed prospects for yields In most of Australia and New Zealand, industrial yields are forecast to show modest falls over the next five years. This reflects relatively attractive pricing at the moment compared to the office and retail sectors. (Figure 1). Hong Kong and Taipei are differentiated from the other markets by the fact that we expect industrial yields in these cities to rise over the next five years. In Taipei, yields have reached exceptionally low levels, while in Hong Kong, rental growth prospects are only lacklustre. Both these factors are expected to result in yield rises in these markets. Australian markets lead the total returns tables The five Australian markets top the total returns league for the next five years, with returns above pa forecast in all of them (Figure 17). Brisbane is the market with the highest forecast returns, at 13. pa. In all of these markets returns are boosted by uplifts in capital values. At the bottom end of the performance table are Hong Kong and Taipei. Not only do both locations suffer from low levels of income returns due to their low yields, but rises in yields are forecast to knock capital values as well. As such, total returns in Hong Kong are forecast at 3.9 and in Taipei at.3 pa. Figure 1 Prime Industrial Rental Growth 11-1, Best & Worst pa 3 1 Source: Oxford Economics Figure Prime Industrial Yield Forecasts, Selected Markets Figure 17 Brisbane Melbourne Sydney Hong Kong Shanghai Taipei Prime Industrial Total Returns 11-1, Best & Worst pa Income Return Capital Value Growth Total Return

9 Economic Drivers Figure 1 Asia Pacific Inflation 7 9 Australia China India South Korea Thailand Source: Oxford Economics Figure 19 Asia Pacific GDP Growth Forecasts China India Singapore Hong Kong Australia Japan Source: Oxford Economics Figure Asia Pacific Consumer Spending Forecasts Rising inflation a worry across Asia Pacific During inflation picked up across the Asia Pacific region (Figure 1). Price pressures were stoked by strong growth in the economy as it bounced back from the downturn in 9. In particular, strong growth fuelled sharp rises in commodity and food prices, which account for a very high share of household spending and inflation in developing countries. In an effort to curb inflation, policymakers across the region raised interest rates. In China, additional tightening measures were also used, with the reserve ratio having been tightened eight times. We expect the authorities to continue to focus on containing inflationary pressures in 11, which risk overheating if left unchecked. This is particularly true given that the oil price has hit $ amid rising tensions in the Middle East. Economic growth to remain robust in 11 The Asia Pacific region grew very strongly during. However, the pace of expansion is expected to slow during 11 as the bounce-back in industrial activity following the crisis fades and authorities act to check growing inflationary pressures. The region is still expected to outperform other regions of the world and record growth of.9 in 11, compared to. in. The strongest growth is forecast in emerging giants China and India, at 9. and. respectively (Figure 19). Elsewhere, the slowdown is expected to be more pronounced. Major exporters like South Korea and Taiwan, which benefitted strongly from the resurgence of global trade and industrial production, are expected to slow to around trend growth. In Japan growth is expected to slow from. in to 1.1 this year. Chinese and Indian consumers lead the way pa Source: Oxford Economics 11-1 Growth in consumer spending is expected to vary greatly across the region (Figure ). Mirroring their high overall growth rates, China and India are also expected to see the biggest advances in consumer spending as their markets continue to mature. In both countries, consumer spending growth is forecast to be above pa over the next five years. However, across the majority of Asia Pacific countries, consumer spending is forecast to rise in the range of to pa over the next five years. In Australia and New Zealand, growth is forecast to be weaker and below 3 pa, reflecting their status as advanced economies. In Japan consumer spending is expected to be lacklustre. 9

10 Disclaimer This report should not be relied upon as a basis for entering into transactions without seeking specific, qualified, professional advice. Whilst facts have been rigorously checked, DTZ can take no responsibility for any damage or loss suffered as a result of any inadvertent inaccuracy within this report. Information contained herein should not, in whole or part, be published, reproduced or referred to without prior approval. Any such reproduction should be credited to DTZ. DTZ February 11