| Enough spread? Lease risk in selected Asian office markets | |||
| City | Stabilized yield | Debt | Spread (bp) |
| Tokyo | 5-5.5% | 2.25% | 275-325 |
| Seoul | 8.5-9% | 7% | 150-200 |
| Hong Kong | 6-6.25% | 4.75% | 125-150 |
| Singapore | 6-6.5% | 4.50% | 150-200 |
| Bangkok | 9-9.5% | 7.50% | 150-200 |
| Shanghai | 9-10%+ | 7.50% | 150-250+ |
| Beijing | 10.5-11.5%+ | 7.50% | 300-400+ |
| Guangzhou | 10.5-11.5%+ | 7.50% | 300-400+ |
| Source: Jones Lang LaSalle/LaSalle Investment Management | |||
Like many asset classes, Asia’s property markets have enjoyed strong growth over the past few years, compressing yields and spreads over cost of funds (see table). Yet there is little sign that the region’s real estate markets are preparing to pause for breath as demand from investors continues.
“We remain very positive about the prospects for the region,” says David Edwards, regional director at LaSalle Investment Management in Hong Kong. “Economic growth is very strong, companies are growing rapidly and sentiment is very strong.”
A member of the Jones Lang LaSalle group, LaSalle Investment Management (LaSalle) is a global real estate investor with more than $40 billion of assets under management. Early to the Asian markets, the firm is nonetheless relatively underweight Asian real estate, with $4 billion in four separate funds and separately managed accounts. Returns from the firm’s first fund, the LaSalle Asia Opportunity Fund I, have been good. Fully invested, with nearly $250 million of equity, the fund has already returned all its starting capital to limited partners and is between two-thirds and three-quarters divested, says Edwards.
Delighted
“Investors have been delighted,” he says. “When we started, we were getting cash yields of 8% to 9%, more than 20% leveraged. Capital growth from yield compression has pushed yields down now to around 5%.”
Not surprisingly, investors from LaSalle’s first fund, a mix of state pension funds, endowments and superannuation schemes, have invested into the firm’s second major fund. With $1 billion of capital to invest, the LaSalle Asia Opportunity Fund II is already actively investing in the region, aiming to acquire a diversified portfolio of office, residential, retail, hotel and industrial properties.
Finding attractive returns for the new fund is likely to be a lot more challenging than before, given the collapse in yields, a fact that Edwards acknowledges. LaSalle aims to tackle this through various strategies, including partnering in more development projects.
“There’s a risk of yield expansion because yields have already compressed to very low levels,” says Edwards. “So we’ve been investing in larger, institutional markets and stronger growth markets where upside comes from strong rental growth rather than capital value appreciation. We’ve also been developing more modern buildings. Because you take the development costs, you can get a better stabilized yield.”
The firm is also aiming to invest in more diversified opportunities to increase returns, including real estate projects in medical, education, parking facilities and transport hubs.
“They have to have a real estate component,” he says, “and these are all actively managed as real estate assets. We’re substantial hotel investors already.”
Double-edged sword
A chief contributor to the increase in capital values of Asian real estate is the growth in the region’s Reit market that has become something of a double-edged sword for the likes of LaSalle. While the growth in these vehicles has helped push up returns in its existing funds, current valuation levels make investing new funds more difficult. And despite their attraction as investment vehicle, Edwards sees limited use for Reits to provide liquidity for LaSalle’s investments.
“Reits have been very good for the region,” he says. “They’ve helped transparency and sharpened yields. We could establish a Reit for some of our portfolio, but you need to be very careful about conflicts with your investors. We’ve thought about it in Japan, but always come up with better alternatives to exit. A simple sale is usually your best option.”
In fact, LaSalle is more likely to be a buyer of Reits than a seller into the vehicles. Rapid increases in prices for many Reits in Asia, as investors have chased what is still a very narrow market, suggest that a correction might be due, especially as the market becomes more discerning. Such a correction might provide attractive acquisition opportunities, acknowledges Edwards.
“Some of the Reits are very overpriced, especially in Japan. Those that can continue to demonstrate yield growth are trading at NAV. Those that haven’t are below water. A takeover of an underperforming Reit is something we’d look at in Asia. We bought a Reit in the US last year.”
In the meantime, LaSalle continues to expand aggressively and is aiming to launch more funds, including a follow-up to its successful Japan logistics fund and a further opportunities fund as the current fund gets invested.
“We did close to $2 billion of deals last year,” says Edwards. “The volume has increased dramatically and we’ve been hiring aggressively.”
Competition is increasing: LaSalle reckons there is roughly one new Asia property fund established each week. Edwards acknowledges that the amount of capital looking for profitable assets risks pushing valuations too high. He points to certain Chinese cities, Vietnam and India as markets that look decidedly overheated already. Despite the evident risks, he remains confident that any economic fallout in the region, while clearly negative for real estate investment, will be less harmful to the region’s property markets than to the capital markets.
“The real estate market is in the lifeboat of any fallout,” he says. “People take a longer-term view.”
Have a look at Euromoney’s new publication
Euromoney Liquid real estate March 2007: Full contents
