Fed tapering in US will send chill across Asian property markets
Winding down of Washington's loose monetary policy will raise bond yields globally, and put pressure on property prices in most regions
The winding down of the US Federal Reserve's quantitative easing (QE) programme is expected to result in rises in long-term interest rates around the world, and we believe this will have significant repercussions on Asia-Pacific property markets.
Indeed, initial talk of "tapering" of the programme during the first half of last year triggered a significant widening of government bond yields.
Across the Asia-Pacific region, bond yields increased by as much as 80 basis points over the year, with changes most evident in emerging markets amid concerns over capital outflows and the increased cost of funding.
Due to the increase in bond yields, the spread between prime property yields and government bond yields has narrowed in many markets, reducing the risk premium for investing in property relative to government bonds.
Conventional wisdom suggests that gradual rises in bond yields will put upward pressure on property yields in the medium term, and thereby place downward pressure on prices.
This is especially the case when growth in rents is not sufficient to outweigh the effect of yield decompression.
In some markets, such as Hong Kong, Taipei, and Singapore, property yield spreads were at or very close to five-year lows at the end of last year, indicating that pricing momentum on prime property has become more strained. Currently the spread is less than 1 per cent in Hong Kong, 1.6 per cent in Taipei, and 2.3 per cent in Singapore.
Narrowed yield spreads mean we expect yield decompression to start earlier in the region's two financial gateway cities of Singapore and Hong Kong, where property markets are sensitive to hot money flows and where historically there has been a high correlation between bond and property yields.
With its currency pegged to the greenback, Hong Kong has imported the United States' loose monetary policy, which has pushed bond and property yields down to historic lows. Rising yields triggered by interest rate hikes will likely outweigh any gain in rents, and we expect will result in a price correction of 15 to 20 per cent in Hong Kong over the next two years.
By contrast, sustained office demand in Singapore is supporting rental growth, with prime rents having risen 3 per cent in the second half of 2013. The positive outlook for rents will serve to balance the negative effect of a mild yield decompression, and lead to modest rises in capital values over the next couple of years.
We expect yields to stay low for longer in Japan and Australia, given the continuing accommodative monetary policy in these two countries and a relatively wide spread between bond yields and property yields.
The property market in Japan is benefiting from Prime Minister Shinzo Abe's reflationary policies, which are essentially a continuation of QE. Against this backdrop, we expect yields to compress slightly further in the short term, making Japan the most attractively priced market in the Asia-Pacific region.
We are cautiously optimistic on the outlook for Australia, where the commodity supercycle has run its course on the back of slowing demand from China. As a result, the office market is seeing higher vacancy and tenant incentives.
Similar to Japan and Australia, yields in China are less exposed to tapering in the US. However, five-year government bond yields surged to a 16-year high of about 4.5 per cent last month, reflecting a note of heightened caution on the strength of the financial market in China.
Rapidly rising bond yields have squeezed the income spread to less than 1.5 per cent for prime properties in tier-one cities like Beijing and Shanghai. Considering an onshore borrowing cost of seven to 8 per cent, investors actually face a negative carry for investing in prime core assets in China.
Sharp increases in bond yields, the declining income spread on property, and a weaker capital-growth outlook as a result of tighter credit have combined to make Chinese property markets less attractive to investors.
As a whole, going forward we expect the pricing of property markets in Asia-Pacific will become less attractive on a risk-adjusted basis to investors as QE in the US is unwound.
Although global interest rates are expected to stay low in the foreseeable future, investors should prepare themselves for a gradual increase in the cost of funding. This means they will need to move up the risk-curve to achieve higher returns on property as yields decompress core property markets.
Dennis Fung is Head of Asia-Pacific Forecasting and Strategy at DTZ