Real estate markets have been seeing rising traction from institutional investors in recent years. A low-interest-rate environment has led to falling returns on fixed income, and investors have instead turned to real assets to gain an element of stable performance backed by underlying assets.
As a result, asset owners have allocated to fund managers’ real estate vehicles and also made direct property investments. This has led to a relatively high demand for assets around the globe.
At the same time, the overall global economy is late in the cycle, and many participants believe price levels are close to peaking. As a consequence, yields – the annual income from the investment, expressed as a percentage of the investment's total cost (or some cases its estimated current value) – have compressed. This has somewhat dampened transaction activity in the most sought-after sector – office buildings – in first-tier markets such as New York, London, Frankfurt and Hong Kong.
AsianInvestor reached out to five investors and experts to gain their views on the best defensive asset allocation strategy in 2020 in respect of real estate.
These contributions have been edited for clarity and brevity.
Jang Dong-Hun, chief investment officer
Public Officials Benefit Association
We are extending our overseas real estate investments. In our total alternatives portfolio, property accounts for more than 50%, so it is a really important asset class for us. As of end-November, Poba’s total AUM was W13.9 trillion ($11.7 billion), of which alternatives make up W7.5 trillion, or 54%.
We are diversifying into the real estate space by lowering domestic exposure and expanding overseas exposure. Previously, we have pretty much been focusing on office buildings; they have accounted for more than two thirds of the total investment in the real estate space. During the past couple of years, we have been diversifying into some other sectors, such as logistics and residential.
We think the office sector is more exposed to the economic cycle, which is currently in a late stage. Instead, we believe the logistics and residential sectors are less exposed to market cycles. A higher exposure to these asset types can lead to a more resilient portfolio for this asset class.
We have recently, as we announced on December 6, invested €120 million in a logistics portfolio in Europe together with the Danish pension fund PFA and German asset manager Patrizia. This is a part of our strategy to get more direct in our real estate investing. We do this to balance against the illiquid nature of private equity investments, where increased control of assets helps to mitigate the risk of the lack of mark-to-market valuations.
Other than equity investments we believe in real estate debt in the US, where yields on real estate equity investments have become unattractive (when hedging costs are included). In 2018 we launched $400 million joint ventures with the California State Teachers’ Retirement System (Calstrs) and Teacher Retirement System of Texas, respectively, to invest in US real estate debt. Poba committed $200 million to each JV. In May 2019, we doubled our investment with Calstrs.
Ng Chiang-Ling, Asia chief executive and chief investment officer
M&G Real Estate
As we are late cycle in a low-inflation and low-interest-rate environment, physical assets with defensible yield should remain more resilient in 2020. Investments with exposure to core strategies tend to be more stable as they benefit from distributed market lease reviews, low interest rates, and thus offer better risk-adjusted returns.
Within the developed real estate markets across Asia Pacific, we are excited about sectors with solid fundamental trends, accommodative macro policies, and a healthy supply and demand dynamic.
Examples would include logistics markets with sizeable consumer bases, office properties with strong occupancy rates and residential in gateway cities.
Sai Min-Chow, head of Asia-Pacific investment research
Aberdeen Standard Investments
In Asia Pacific, both real estate investment trusts (Reits) – except Hong Kong names – as well as investment grade and high yield public debt have outperformed physical assets this year. Looking ahead to 2020, we prefer physical assets to debt and listed equity in the Asia-Pacific real estate markets.
Firstly, the fund-raising environment is still favourable, which should translate into more capital deployment into physical real estate in 2020. In the first nine months of 2019, the combined new equity raised among listed Reits in Japan, Australia and Singapore was already 12.8% higher than the total raised in 2018.
Investors’ demand remains robust nonetheless, with these three key Reit markets still trading at an average premium of 16.6% to net asset value. As inflow continues in a low-yield environment, we expect capital to be deployed for more acquisitions in 2020, supporting physical assets’ capital values.
Secondly, risk-adjusted returns from physical real estate are higher than from Reits and public debt. The premium above suggests the three major Asia Pacific markets have already priced in an 11.9% increase in asset prices from the current levels. Moreover, investment grade real estate bonds in Asia were trading at an average option-adjusted spread of just 1.26% as of November, i.e. 17 basis points above the January 2018 low but 20bp below its five-year average.
On the other hand, the slide in 10-year sovereign yields has widened the spread between cap rates and risk-free rates for physical assets in Asia Pacific. While we expect vacancy to expand and rental growth to slow, we think the wider-than-average yield spreads should attract more investment capital in 2020.
Alison Chan, investment specialist in the Asia-Pacific alternative solutions group
JP Morgan Asset Management
Many sectors within real estate, are becoming increasingly fully priced with limited upside potential expected from price appreciation alone.
In a late cycle environment it is important that investors take a defensive stance in positioning portfolios. Investors concerned about risks in a downturn have traditionally relied on bonds as a source income and stability, but in a zero-to-negative rate environment, the portfolio insurance from bonds comes at a cost.
The best defensive asset allocation strategy for real estate in 2020 is to focus on conservative positioning at the core end of the risk spectrum.
We define a real estate asset as “core” if it is able to generate stable sources of income through long-dated contracts, is a quality asset in a major developed market, has a high occupancy level and is financed with low levels of debt. All of these characteristics should serve to insulate performance and dampen price volatility of the asset during periods of economic instability.
In addition to providing a stable source of income, investments into private real estate assets – either equity, mezzanine or debt – also provide a good source of diversification from public equities, which are typically the largest contributor of risk to investors’ overall portfolios.
Given higher quality bonds today are very low yielding, the potential of core real estate to achieve high income with low beta makes it attractive for both de-risking versus equities and enhancing income-driven return versus fixed income. For these reasons, private core real estate can serve a role in defensively positioning a portfolio in a late cycle economic environment.
Regina Lim, executive director for capital markets research
JLL Asia Pacific
Investment in Asia-Pacific real estate reached $125 billion in the first nine months of 2019, up 10% year-on-year and is set for another strong year in 2020. Investors continue to seek high yields and stability amid a climate of geopolitical uncertainty and slowing economic growth.
Over the next two years we expect global real estate transaction volumes to stay elevated and Asia Pacific to outperform, gaining an outsized portion of global investor interest. We expect to see strongest investor interest in the logistics sector, but as these assets are tightly held, investors are forming joint ventures with major established players, while some are taking cornerstone stakes in new listings or taking public listed vehicles private.
Real estate investment trusts (Reits) are likely to continue their strong trading performance and be highly competitive property asset buyers. In 2019, Asia Pacific Reits raised a record amount of capital at over $14 billion. We expect more Reit initial public offerings in Singapore and India. We also anticipate more consolidation in this sector going into 2020.
Asia-Pacific governments are also transforming cities to make them more sustainable, and investors can capitalise on this by acquiring or developing sustainable assets, or being a part of the city redevelopment process. Singapore, for instance, is encouraging the redevelopment of older office buildings and reducing the use of private transport. Beijing has restricted the size of commercial developments and targets to reduce the population in central districts.
Lastly, we expect office markets with sophisticated innovation ecosystems that sustain highly skilled workforce – such as Tokyo, Seoul, Shanghai, Singapore and Osaka – to outperform. JLL finds that technology firms are playing a greater role in driving up premium office rents than the financial services industry.