Investors should take a closer look at commercial property in Tokyo, Seoul and Melbourne
- Investors need to embrace an active strategy in the search for submarkets under transformation in selected cities
- Commercial property is worth a look in cities where active management and the repositioning of buildings can add value
The prolonged low interest rate environment has created challenges for investors in deploying money in financial markets, as higher return opportunities are hard to find. However, active real estate strategies can thrive under such circumstances and should play a more prominent role in investment portfolios.
Real-estate strategies can be broken down into three categories: core, value-added and opportunistic. Core strategies are relatively low risk, with returns mainly being generated by long-term leases. Opportunistic strategies are high-risk investments with the extensive use of leverage or the taking development risk and they have higher uncertainty on returns.
Value-added investors take the middle route. As in the opportunistic strategy, they aim to generate higher returns through stronger capital growth. Active management, such as leasing of vacant space, the optimisation of leases and repositioning buildings through refurbishments or renovations are typical characteristics of value-added strategies.
We believe value-added strategies are supported by both the macro environment and the specific trends in the real estate market. A successful investor should also adapt his or her strategies relative to the real estate cycle.
Prime Hong Kong office rents have seemed to defy the laws of gravity, especially in Central where monthly rents have increased from HK$20 (US$2.56) per square foot in 2003 to almost HK$140 per square foot. In the first quarter, rents were up 6 per cent from a year ago due to supply shortages.
Nevertheless we believe that the potential for further core returns is limited, as we are late in the real estate cycle.
However, we see two potential strategies that could still yield upbeat returns. The first is to apply active management and reposition buildings. As discussed earlier, the spread between average quality and prime buildings is at all time high, and by renovating older buildings investors can earn additional returns. Meanwhile, locations further out from Central are looking increasingly interesting for new tenants due to their lower rents.
The second alternative is diversification. While over recent years the focus of Hong Kong investors have been overwhelmingly to diversify to Europe, we believe the time is ripe for global diversification.
Continuing shortages of office spaces can be seen in US cities such as Boston and Seattle, as well as European cities such as Berlin, Munich, and Paris.
Meanwhile three Asia-Pacific cities that we follow rank highly as a market story as well as from an improving submarkets perspective.
Firstly Tokyo. Office vacancy rates in the Japanese capital are only slightly above 1 per cent, the lowest level seen in decades, due to limited construction and strong demand for quality space. Demand for repositioned properties should therefore be strong and we project further rental growth and an ongoing zero interest rate environment. The Shibuya submarket in particular could benefit.
Secondly Seoul. Office properties in the South Korean capital are enjoying strong investment demand from both domestic and international buyers. We believe that there is an opportunity to execute on value-added strategies. The Gangnam submarket is an area that has garnered our focus.
Thirdly Melbourne. Driven by favourable demographics and a diverse base of industries, we project sustainable growth of office rents in the city over the next five years. From our perspective, Melbourne has the strongest prospects of any Australian city over a 10-year horizon. An anticipated uptrend in rents should provide fertile ground for investor strategies focused around the repositioning of buildings. We believe in the benefit of global diversification. Better risk-adjusted returns can be achieved by combining different strategies in different regions than by investing in individual niches.
Zoltan Szelyes is head of global real estate research at Credit Suisse Asset Management Global Real Estate