The US commercial real estate market is facing multiple challenges. In the main, property owners continue to navigate the structural shift from the rise in remote working, and are doing so amid an uncertain economic outlook, which is driving office occupiers to rationalise their needs.
With slowing leasing momentum in the US, DBS notes that overall office vacancy rates are still at close to 20% or over, a level they rose to in the first quarter of 2021. Together with this, office valuations have also been weighed down by tighter credit conditions and access to capital in the wake of US regional banking crisis earlier this year.
Reflecting investors’ concerns of further stresses in office valuations, the S&P 500 office REITs have fallen about 18% year-to-date and are down 22% year-on-year (as of late June), with office REITs trading at steep discounts to their respective net asset values.
What is Asia’s story?
While the weakness in the US commercial market remains top of mind for most investors, the story in Asia is different despite the market being similarly impacted by high inflation rates, surging interest rates, and an economic slowdown.
While the weakness in the US commercial market remains top of mind for most investors, the story in Asia is different despite the market being similarly impacted by high inflation rates, surging interest rates, and an economic slowdown
In our view, Asia’s real estate recalibration has been more modest and will likely remain so. This is for good reasons. In the main, Asia’s stronger economic fundamentals and longer-term structural growth prospects compared to the US underpin investors’ continued interest in Asia, and especially for key gateway markets that offer safe-haven status such as Singapore and Tokyo.
In addition, we believe there are key differences supporting a more constructive approach when investing in Asia’s commercial real estate market.
Asia’s resilient and growing economies
Asia’s economies are expected to continue to show resilience to continuing geopolitical and economic uncertainties. Since the start of the US regional banking crisis, for instance, we have seen that financial conditions in the Asian markets have been more stable with most Asian currencies showing strength, appreciating by 3-5% against the US dollar.
In our view, this is due to proactive monetary policy responses over the past few years and, in certain countries, robust domestic demand. In addition, we expect China’s continued re-opening trajectory to be a potential stabilisation factor in 2023 and 2024.
On growth, Asia is projected to grow by 4.2% in 2023 and 4.5% in 2024, according to DBS economists. With regional inflation rates likely turning the corner in the second half of 2023, overall monetary conditions should turn towards an easing cycle, supportive of economic growth.
While the near term business outlook remains cautious, we are positive in the medium term on the overall more stable macro conditions supporting continued improvement in job prospects. On this front, we have seen the average unemployment rate in Asia fall to 4.1% (at the end of 2022) from a pandemic-high of 4.3% in 2020 (based on World Bank data).
Higher return-to-office trends in Asia
The medium term prognosis for Asia remains positive. Indeed, we believe that multinational companies will look to grow their footprint in the region, and this is likely to generate demand for more space even though many of these companies have implemented hybrid work arrangements post-Covid-19.
Based on our discussions with various commercial landlords, physical office occupancies (or utilisation) have rebounded towards 75%-80% of pre-Covid levels. Part of the reason for this could be companies instructing employees to come back to the office. On the other side, employees are keen to socialise and collaborate in-person again with co-workers. This is supported by the high population density of many gateway cities in Asia, which means their commute to the office is not especially long and arduous.
In combination, this has boosted office in-person attendance post COVID-19 – a trend which plays into there being less pressure for office consolidation in Asia.
Compared to Asia, the average physical office occupancy in the US is only 50% to 55% of pre-Covid-19 levels, according to an index of building occupancies in ten major metro areas in the US by Kastle Systems.
While flexible work arrangements appear to be the norm there, the lower in-person office occupancy rates could be due to a longer commute time for workers in the US. This results in companies taking a more active look at their real estate footprint and requirements, leading to higher overall market vacancy rates.
Balanced office market dynamics
Supported by a lack of development completions, we note that average performance of Grade A office market vacancies in key cities in Asia has tightened, with most key gateway cities experiencing strong office take-up.
As of March 2023, based on a selected group of cities that we track, we note that Grade A office vacancies in key gateway cities of Singapore and Tokyo have recorded positive net absorption, tightening towards sub-4% levels. These levels are generally supportive of overall rent growth.
As of March 2023, based on a selected group of cities that we track, we note that Grade A office vacancies in key gateway cities of Singapore and Tokyo have recorded positive net absorption, tightening towards sub-4% levels
We remain watchful for the performance for the key cities of Hong Kong, Beijing and Shanghai, which are plagued by double digit high vacancy rates to the tune of 11%-13%. This will likely put pressure on rents and overall market performance.
Although there is optimism that a gradual re-opening of the Chinese economy will spur more confidence and firms to expand in the medium term, there is still a degree of slack to be absorbed by the market before a more meaningful recovery can take hold.
We believe that the flight to quality will persist, meaning that properties with stronger property attributes (i.e. central location, Grade A specifications and buildings that are built to high green standards) will likely see sustained demand from occupiers, supporting overall cashflows, and driving more stability in capital values despite capitalisation rate expansion due to interest rate increases.
Interest rates rises have been uneven in Asia
Alongside the sharp rise in interest rates led by hikes by the US Federal Reserve, we note that overall funding costs in Asia have increased in tandem, but by a lower extent, than levels in the US. That said, countries including Singapore, Australia and Korea have seen base interest rates rise by close to 300 percentage points.
Recent signs of easing, if continued, could lift the pressure on capital values and prompt transaction activity to return. We note that recent commercial transactions in Australia appear to suggest a downward reset in property values. However, we see less pressure of that happening in Singapore given a more tightly held market and continued interest from investors to look for asset allocation opportunities, given its safe haven status.
A more stable lending landscape
The overall lending market in Asia is also more dependent on financial institutions rather than debt capital markets. With banks across the region generally well capitalised, a more stable liquidity environment supports a healthier real estate landscape.
According to CBRE, the commercial mortgage-backed securities market in Asia is less developed when compared to the US, with higher coupon rates for real estate bonds compared to bank lending. This is one of the reasons why investors tend to prefer bank lending instead of tapping the debt capital markets.
Based on estimates for the key cities of China, Hong Kong and Singapore that DBS has a key presence in, we note that among real estate players, corporate bonds form less than 15%-30% of the overall lending landscape with a larger proportion of the overall lending with banks and financial institutions.
Summary
While not totally immune from the impact of global uncertainties, Asia’s commercial real estate markets are on firmer footing. As a bank born and bred in Asia, DBS understands the intricacies of doing business in the region’s most dynamic markets. DBS is committed to building lasting relationships with customers as it banks the Asian way.
Working with various local in-market real estate teams stationed in key cities globally, the DBS global real estate team has been able to provide seamless cross-border banking solutions that complement our clients’ international expansion plans.
As such, DBS is well-positioned to support our clients across geographies by offering market insights and also providing bespoke solutions across the capital stack, while driving the sustainability agenda in channelling financing away from high-emitting activities towards low-carbon alternatives.
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