Traditionally, foreign investors have favoured the property markets of Continental Europe. More recently, however, global investors are recognising the benefits offered by Asian property markets. Mike Reed, CEO at Standard Life Investments (Asia), discusses what is driving this trend and examines the key benefits associated with investing in Asian property.

Building on economic growth in Asia
As part of our Focus on Change investment process, we include the question æWhat is changing?Æ In a comparatively slow-moving asset class such as property, patterns may take some time to emerge. However, one thing that is becoming increasingly clear is that growing numbers of property investors are looking beyond their own domestic markets to seek attractive prospects.

Although investors have been investing in Continental European property markets for several years, we are now seeing growing interest in global real estate. This trend has been underpinned by strong economic growth in Asia, and the development of tax-transparent vehicles allowing relatively easy access to international markets. As a result, foreign property funds look likely to expand their investment universe further.

While much of the draw of investing in overseas markets is the perception that they are more attractively priced than in Western Europe, there is a more academic reason for investing globally. Economic, property rental and listed real-estate stock data across markets such as Hong Kong, Tokyo and Singapore have low, sometimes negative, correlations with West European markets. As a result, exposure to these markets can offer good diversification benefits for investors.

In addition to strong economic growth, Asian markets also offer prospects for structural change as property stock is released from owner-occupiers into the investment market. A further positive factor can be interest rate differentials. For example, the interest rate differential between the UK and Japan at the moment gives an immediate boost of 2% a year to returns for a sterling-based investor.

The recent robust economic growth of Asian markets has translated into occupational sectors, with companies taking up office space for immediate use, while also planning ahead for forecast expansion. In Hong Kong, prime rents are accelerating beyond their previous peaks, fuelled by major international banks hoping to tap into the private banking and corporate finance needs of China by expanding into Hong Kong.

Although office markets such as Tokyo and Singapore are not high yielding in absolute terms, they currently offer attractive margins over domestic bonds as well as the prospect for strong rental growth. The office markets in Hong Kong and Singapore represent an attractive demand and supply balance and show clear indicators for strong double-digit rental growth for the next couple of years.

Room for improvement in property stocks
It is not just investment in bricks and mortar property that offers growth opportunities. Property-related stocks in Asia are also making their mark on the investment radar. Unlike property markets in the US and UK, where affordability looks stretched by many measures, Asian property markets are well placed for improvement and banks still have plenty of spare capacity to lend.

For example, over the past two to three years the Philippines has witnessed falling vacancy rates. This is due to increasing demand from multi-national banks for back-office locations that offer a highly educated, English-speaking and cheap workforce. With US-qualified accountants on hand to meet the demand for tougher regulatory accounting, multi-nationals are increasingly being seduced by ManilaÆs office property market. Even some Indian software companies are finding the city a more cost-effective base.

Given the ongoing political instability in Manila, however, companies are not keen to add supply to the market and the prospect for rent increases looks strong. The market is currently failing to price in this changing market driver and is undervaluing companies such as Ayala. Looking at the residential market, SP Setia in Malaysia has been successfully exploiting growth opportunities by acquiring land next to areas where new roads are planned to open. By creating these suburbs for commuters, SP Setia has done well even as the broader market has struggled.

Why invest in property?
The arguments for asset allocations into property are compelling. Investors are increasingly adopting a more robust approach to the diversification of their asset mix, and property investment is one way of achieving this as it has a low correlation with the performance of equities and bonds. Using property can help provide steady income streams as well as the potential for capital growth.

Stability
ò Commercial property offers investors stable returns over the long term

ò These returns come in the form of rental yields received from tenants and income and capital growth

ò A large proportion of the total return from property comes in the form of income yield providing greater visibility and lower volatility for investors

ò Property is an asset that provides strong inflation hedging characteristics over the medium to long term.

Fundamentals
ò Property cycles are positively correlated with economic cycles

ò When economic conditions are positive, developers are enticed into the market to capitalise on the attractive supply and demand balance

ò If economic conditions deteriorate, lease durations provide some insulation against the effects of an economic downturn

ò There are a number of alternatives to direct property exposure that gives investors the ability to diversify not only their asset mix but also their regional exposure û these include quoted and unquoted property investment funds.

Performance
ò The potential for capital appreciation adds to the investment case for property while absolute returns are also compelling

ò Commercial property has performed strongly against both equities and bonds historically

ò Property returns have a low correlation with equities and bonds and can help improve the overall risk/return characteristics of a multi-asset portfolio.