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MacarthurCook’s Head of Property Securities Craig Turnbull, who has 23 years’ experience in the funds management industry, recently returned from a fact-finding visit to Asia. In this e-newsletter, Craig describes the state of several key Asian real estate markets, and identifies opportunities for Australian investors seeking strong yields and capital growth. |
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> Market opportunities Diversification into Asia’s recovering real estate securities and real estate investment market is tipped to provide higher returns for investors, according to our analysis of the market. The analysis highlights the potential for superior returns from Asian real estate investments, which stem from the increasing demand for real estate in the region. This is driven by economic fundamentals, including rising personal incomes and the corresponding search for investment products, strong economic growth, and the expansion opportunities derived from the relative immaturity of local real estate securities markets. Though distribution yields are low in some markets, the spreads over local interest rates are relatively large, creating strong demand for real estate investment. |
For instance, a yield on real estate that may seem low to an Australian investor might still be attractive to a Japanese investor given the extremely low yields on Japanese Government bonds. Investors in these markets are therefore happy to buy these products, pushing prices higher. The low proportion of securitised assets compared with Australia suggests that the number of new REITs will continue to expand, enabling a profitable Initial Public Offering (IPO) strategy for real estate investment companies. Established real estate companies will continue to exploit the situation by incorporating best practices from the mature Listed Property Trust (LPT) and Real Estate Investment Trust (REIT) markets in Australia and the US. Dividend yields are similar to or lower than Europe and North America, but the capital growth potential is much higher. |
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> Recent rental market history Real estate cycles are significantly more pronounced in Asia than those generally experienced in Australia, Western Europe and North America. In Hong Kong, office rents fell by 78 per cent from their peak in 1994 because of a variety of factors, such as the handover to China, the dotcom collapse and the SARS outbreaks. The market bottomed in the middle of 2003 and has since recovered by 158 per cent. However, rents remain 44 per cent lower than 11 years ago. Market research by Macquarie Research indicates rentals will continue to grow by 40 per cent until 2007 because of unmet demand, with the vacancy rate expected to fall to 3 per cent from 5 per cent. New developments and refurbishments are unlikely to address the shortage of office space until 2008-2010. In Japan, office rents fell by 7 per cent during 2003 when new supply entered the market, but vacancy rates have subsequently halved to 4 per cent as the oversupply was soaked up. UBS estimates that asking rents in Tokyo have grown by 25 per cent from the bottom of the slump in the first quarter of 2005. In Singapore, the outlook is also improving. Rentals have picked up by 16 per cent in the year to September after a seven-year slump because of rising demand and a shortage of supply. However, a large quantity of new space in 2006 will dampen |
For instance, a yield on real estate that may seem low to an Australian investor might still be attractive to a Japanese investor given the extremely low yields on Japanese Government bonds. Investors in these markets are therefore happy to buy these products, pushing prices higher. The low proportion of securitised assets compared with Australia suggests that the number of new REITs will continue to expand, enabling a profitable Initial Public Offering (IPO) strategy for real estate investment companies. Established real estate companies will continue to exploit the situation by incorporating best practices from the mature Listed Property Trust (LPT) and Real Estate Investment Trust (REIT) markets in Australia and the US. Dividend yields are similar to or lower than Europe and North America, but the capital growth potential is much higher.  |
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> Yield Spreads While property capitalisation rates are low in most Asian markets, the spread over the cost of capital is relatively large, providing an attractive margin between dividends and interest repayments even before factoring in potential capital gains. Gearing levels for many REITS are low but they are rising to international standards. This allows acquisitions to be funded mostly by low-cost debt, making them highly accretive to Earnings Per Share (EPS). One example is the Tokyo Stock Exchange-listed Japan Retail Fund, one of the first so-called JREITs. It has enjoyed debt costs of only 0.6 per cent, yet it has been able to buy retail property on a cap rate of 6 per cent. This explains why it has expanded from four shopping centres when it was set up in 2002, to 32 in 2005. Because of accretive acquisitions, funds from operations after tax have risen from 15.6 billion yen ($178.36 million) to 22.4 billion yen, despite the fact that comparable-store sales have been flat. |
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> Property Development There is huge demand for real estate in the region, particularly residential and retail real estate. This is being driven by commercial considerations, plus rising personal incomes and a corresponding increase in consumer spending and demand for income-producing investment products. Development activity is strong in all of the region’s emerging countries, and much of it is focused on China. Many businesses report problems and frustrations when doing business in China. Investors and developers may also have to deal with multiple levels of bureaucracy, any of which can hinder a project. However, many real estate companies based in Hong Kong, Singapore and Australia now have experience doing business in China. They have demonstrated the ability to produce solid returns from their investments, especially in Shanghai. |
Many are now diversifying into second-tier cities – China has 30 cities with more than five million people - and there are plenty of opportunities for investors, especially in office and retail sectors. Similarly, there is potential to earn strong redevelopment returns, particularly for retail property in markets such as Japan and Singapore, where assets have traditionally been owned by small, private landholders. As the big trusts buy shopping centres, they are finding ways to reallocate space and remix the tenants, which is contributing strongly to rental growth. |
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> Related Business To help fund expansion and raise return on equity, companies such as CapitaLand, Cheung Kong and Macquarie Goodman are spinning off assets for new REITS and funds. They are creating a thriving funds management business, which is creating value. Assets under management for CapitaLand have grown from S$2.1 billion ($1.68 billion) in 2002 to S$6.8 billion at September. |
It has nine funds, including the large CapitaMall and CapitaCommercial trusts, as well as new trusts with assets in Japan and China. Though financial services contribute only 2 per cent of the group’s Earnings Before Interest and Tax (EBIT), it is growing strongly. |
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> IPOs and real estate stocks A growing number of IPOs are being offered to investors through Asian stock exchanges. In the past four years, 23 REITs have listed in Japan and seven in Singapore. The next wave of supply is likely to come from Hong Kong, where two REIT offerings worth more than $2.7 billion, were recently completed. Units in one of them, the Link REIT, rose more than 15 per cent in their first few days of trade. Several more offerings are likely to follow next year, including one from Macquarie Goodman and another from Keppel Land. In Japan, the average performance for the first 10 JREITs is 62 per cent since listing about four years ago. But some of the more recent offerings (many of them residential funds) are down from the initial price. The first Singapore REIT appeared three years ago. The average first-day rise has been 9 per cent, and the average price gain from listing to date has been 57 per cent. There is also a regular supply of secondary issues to help fund expansion. Pricing of these issues is generally at a 2 to 3 per cent discount to the market price. In the year to date, the Japanese real estate stock sector has |
leaped 60.5 per cent, and Singapore real estate stocks have jumped 32.3 per cent. Other markets have also experienced strong growth – US real estate stocks are up 14.7 per cent, Australia’s are 9.5 per cent higher, and Hong Kong’s real estate sector is up 6.4 per cent.  |
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> Risks Rising interest rates are a threat to all real estate markets because they increase the cost of debt and narrow margins, making foreign investment less attractive. However, Asian markets have the advantage that real estate security yield margins over government bonds are relatively large – typically 2 to 2.5 per cent - and it is feasible that interest rates could rise without affecting property security valuations because of rent growth and yield compression. Many observers also expect global interest rates will stabilise by the middle of next year as overheated economies start to slow. The main risk is product oversupply, because rents would fall to enable excess space to be soaked up. But at this point the supply situation remains favourable in most markets. Solid demand and rising rents will stimulate new projects, but construction times offer a level of comfort for the next three years in most markets. In Singapore, a surge in supply next year relates to the 1 Raffles Quay project. However, 55 per cent of its 150,000 |
square metres is already precommitted, and hence this development is not expected to depress rents.  |
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> About MacarthurCook Limited MacarthurCook Limited is an ASX-listed specialist real estate investment manager. MacarthurCook manages a range of public real estate securities funds, private equity real estate funds and debt funds.
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MacarthurCook was listed as one of the 100 fastest growing companies in the BRW Fast 100 survey published on 13 October 2005. This survey recognises those companies with the greatest increase in revenue over the past financial year.  |
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> About Craig Turnbull: Craig has worked in the funds management industry since 1982, when he joined Bankers Trust as Assistant Economist. |
$8 billion of assets, which included Australian and international equities and property securities mandates. In 2001 he joined hedge fund manager Vertex Capital as Investment Director. |
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For further information contact: Craig Turnbull, Head of Property Securities, MacarthurCook Limited, +61 3 9660 4555 |
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MacarthurCook Limited ABN 64 009 110 463 Australian Stock Exchange Code: MCK |