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Colliers Radar Asia Pacific Property Research 14 November 2016 Asia Pacific: the dragons rise anew Prospects improving in China and Hong Kong; time to look again at Singapore Andrew Haskins Executive Director | Research | Asia [email protected] The outcome of the US presidential election raises challenges for Asia. However, Chinese growth remains high and a financial crisis is unlikely, while growth in Hong Kong is improving. The brighter outlook in these markets should boost office property, as firm investment demand suggests, although residential property faces risks. Singapore's longrun attractions outweigh near-term pressure in the office market. Australia's economy is buoyant, but the positive story is well-known. Global investors and occupiers should stay focused on China and look again at Singapore. Executive Summary The economic environment in Asia is improving. China's growth has beaten forecasts recently, and should remain firm. Given sound national finances and a reasonably healthy banking system, we think a financial crisis is unlikely, although a decline in the residential market is possible. In Hong Kong growth has also surprised on the upside, office rents are still rising, and Chinese interest is high. This situation explains the territory's rise to the second-ranked city investment market in Asia Pacific. In Singapore growth has been slowing, and rising supply has weighed on property markets. However, the country enjoys good governance and high transparency, and we think it will continue to attract institutional investors looking for stable long-term returns. Australia's economy remains buoyant, driving strong rent growth in Sydney and Melbourne. However, this story is well-known and in any case there is a growing shortage of property stock. Donald Trump's US election victory raises challenges for Asia, including a possible hit to confidence and growth as well as tariffs on imports. Uncertainty has risen for China in particular and this must temper our optimism about improving near-term prospects. Mr Trump's policies may prove either expansionary or contractionary for the US economy; there are arguments both ways. However, if US growth ultimately suffers under Mr Trump, US interest rates may only rise very gradually and the dollar may fall. This outcome would support Hong Kong property assets, since it would mean that negative real interest rates persist. However, dollar weakness would hurt Asian exporting nations, notably Japan where the dull economy and yen strength have already depressed property investment volumes. Real though the risks are, the US election outcome should not blind global property investors and occupiers to the fact that current economic developments in much of Asia Pacific are positive. Besides, we expect the combination of Mr Trump's victory and Brexit in the UK to serve as a reminder of the potential for shocks in developed as well as emerging markets, and so mitigate political and economic concerns about the region. From an investment perspective, Hong Kong looks good in the near term. Shanghai and Beijing have appeal if one looks past low near-term rent growth due to rising supply. Singapore's 3.5% net yield and long-run strengths outweigh falling near-term rents. India has high long-run growth potential and deserves closer attention. Figure 1: Summary of key Asia Pacific urban prime grade office property markets City Rent growth (20162019 avg pa) City avg. vacancy (end-3Q 2016) City avg. vacancy (end-2019 est.) Net oper. income yld 10 year bond yld Spread Hong Kong* 4.0% 3.3% 6.2% 3.8% (2.5%) 1.23% 2.6% (1.3%) Singapore¹ -2.1% 3.7% 8.4% 3.5% 2.11% 1.4% Shanghai 1.6% 9.8% 10.3% 4.0% 2.83% 1.2% Beijing -0.2% 7.6% 10.9% 4.5% 2.83% 1.7% Tokyo -2.4% 3.8% 6.0% 3.6% -0.04% 3.6% Mumbai (CBD)² 1.3% 7.0% 9.0% 6.4% 6.72% -0.3% Mumbai (BKC)² 2.2% 14.0% 12.0% 8.3% 6.72% 1.6% Sydney³ 7.2% 5.6% 3.9% 5.8% 2.56% 3.2% Melbourne³ 4.3% 7.0% 5.1% 5.5% 2.56% 2.9% * Average for all Hong Kong; figures in brackets are for Hong Kong Island. ¹ Singapore figures are for CBD. ² Gross and net yields are very similar in India. ³ Australia: we show gross yields unadjusted for incentives. Source: Colliers International, Bloomberg Contents Executive Summary ............................ 2 APAC economic situation .................. 5 Asia unpopular, not Asian property ............ 5 Economic prospects strong or improving across much of APAC ................................ 6 Trump's presidency threatens to hold down growth in Asia............................................. 6 China ..................................................... 8 Real GDP growth remains high and steady 8 Debt is high, but a financial crisis is unlikely ................................................................... 8 Prospects for commercial property favourable ................................................ 10 China now the second-ranked country investment market in APAC ..................... 11 Residential market remains at risk, but recent cooling is encouraging................... 12 Hong Kong ......................................... 14 Prospects turning brighter ........................ 14 Island office rents and investment market strong, Kowloon weaker ........................... 16 Hong Kong now the second-ranked city investment market in APAC ..................... 16 Risks: retail sector and long-run outlook for residential property ................................... 17 Singapore ........................................... 19 Economic growth has been slowing ......... 19 Office property market under pressure in the near term ............................................ 19 3 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International Long-run prospects brighter ..................... 20 Slow US interest rate rises would support Hong Kong property ................................. 32 Time to look at Singapore again .............. 21 Australia.............................................. 22 USD weakness would hurt Japan and other Asian exporting nations ............................ 32 Good times keep rolling for the Lucky Country .................................................... 22 Direct implications for Asian property markets are limited ................................... 32 Office markets still very strong in Sydney and Melbourne ......................................... 24 Trump and Brexit surprises should lower concern about Asia over time ................... 32 Investment in Australia driven by Asia, especially China....................................... 25 Core markets still attractive, even if investment story is well-known ................ 25 Japan................................................... 26 Economy only ticking away ...................... 26 Weakening outlook for Tokyo office property market ...................................................... 26 Investment volumes declining .................. 27 Japanese property: dull near-term outlook, brighter in the long term ........................... 27 India ..................................................... 28 Economic outlook remains positive, supported by new policy initiatives........... 28 Office leasing market firm: focus on Bangalore and Hyderabad ....................... 29 Medium-term investment opportunities substantial ............................................... 29 Time for investors to put India on their radar screens .................................................... 30 US election: impact on Asia ............. 31 Trump's victory surprises global markets, but less so than Brexit ............................. 31 Expansionary and contractionary: different views about Trump's economic policies ... 31 4 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International APAC economic situation Asia unpopular, not Asian property As we have often observed in our research, Asian property has a problem: it has been unpopular ever since the Global Financial Crisis (GFC) of 2008-2009. As shown in Figure 2 below, based on data from Real Capital Analytics, outbound capital flows from Asia into property markets in other regions of the world surged 12x over 2008-2015 to USD66.6 billion, while inbound capital flows halved to USD12.1 billion. The pattern over the first nine months of 2016 was similar; total outbound capital flows from Asian real estate amounted to USD44.7bn – more than 6x inflows of USD7.3bn. commodities markets. However, it also reflects sharp slowdowns in emerging markets outside Asia: Russia, South Africa, Turkey and - most importantly - Brazil, which now faces its second year of recession. Reflecting the steady recovery in the US economy since the GFC and the deceleration in emerging economies, US financial assets have been in high demand. As a result, the US dollar has been strong against most Asian currencies, notably the Chinese renminbi, against which the dollar now stands at a six-year high (see Figure 3). Figure 3: USD dollar vs RMB (last seven years) 7.00 6.80 6.60 6.40 6.20 6.00 5.80 Source: Bloomberg Figure 2: Outbound and inbound real estate investment in Asia (2001-2016) Inbound Outbound $70,000 Investment Volume (US$ million) $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $0 2008 2009 2010 2011 2012 2013 2014 2015 Source: Real Capital Analytics 5 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International 2016 as of 31 Sep 2016 - Jun 2015 - Dec 2015 - Jun 2014 - Dec 2014 - Jun 2013 - Dec 2013 - Jun 2012 - Dec 2012 - Jun 2011 - Dec 2011 - Jun 2010 - Dec 2010 - Jun 5.60 2009 - Dec We believe that this divergence reflects general pessimism about emerging markets since the GFC, rather than specific problems in Asian property markets. Perhaps surprisingly (considering that the crisis started there), the US has been the chief engine of world economic growth since the GFC. In contrast, the economic performance of emerging markets has deteriorated sharply. This deterioration partly reflects the end of the period of rapid expansion in China (roughly 2005-2007) which had fuelled a global boom in Economic prospects strong or improving across much of APAC Is Asia's general unpopularity still justified? As we shall argue in detail in this report, we believe that economic prospects for many countries in the Asia Pacific region have improved recently. The two large emerging Asian economies, China and India, continue to grow at 6.57.5% p.a.; and so far this year growth has accelerated slightly in both markets. Strong secular growth is likely to continue in both countries for some years. In contrast, Japan's economy is ticking away at a very moderate pace. The economy has been impacted by weaker household consumption and the strength of the Japanese yen, which is one of the few Asian currencies to have risen against the US dollar over most of 2016. The lingering problems of weak aggregate demand, high corporate debt and deflation are starting to fade into the background. However, perhaps the biggest challenge for Japan remains its poor demographic profile: Oxford Economics projects an average annual decline in the working age population of 0.8% over the next decade. Regarding China, concerns about financial stability persist. These concerns are justifiable, considering that the country's debt/GDP ratio stands at close to 250%, and that growth in total social funding (essentially aggregate credit growth) is running at 12% per year or higher; it is 16% on some economists' definitions. Over the long run, China faces a challenge in weaning itself off a credit-driven growth model driven by high investment. However, in the near term, given strong national finances and a banking system which is still reasonably healthy overall, we see the probability of a financial crisis as small. The chance of a significant correction in residential property prices appears higher, although recent signs of cooling in the market are encouraging. Figure 4: USD dollar vs JPY (last ten years) Hong Kong has also recorded positive economic surprises recently. Real GDP growth has picked up, goods exports have increased, and business sentiment has improved. Historical evidence suggests that business confidence in Hong Kong has been closely correlated with the performance of office rents in the territory. The recent improvement in confidence should drive further rent increases in Hong Kong Island, although the Kowloon market is much weaker. Source: Bloomberg Singapore’s recent economic performance has been disappointing. GDP growth slowed sharply in Q2 2016, and may have been negative, while manufacturing activity contracted. However, the recent weakness is insufficient to dent Singapore's long-established reputation as both a highly resilient economy and a world-class metropolis which is attractive for business. In Australia, the economy continues to roll, and the country has recently recorded its 100th consecutive quarter of GDP growth. Since the end of the mining boom, the Australian economy has been driven increasingly by expansion in professional and services employment in the traditionally dominant south-eastern states of New South Wales and Victoria. This expansion has driven strong rent growth in Sydney and Melbourne, and looks set to go on for the next couple of years. 6 130 120 110 100 90 80 70 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 60 In short, with a few exceptions, economic performance has been improving across the Asia Pacific region recently. The UK's vote for Brexit, i.e. departure from the European Union, on 23 June 2016 caused a certain shock to confidence, but this was short-lived. We would have been in a position to express high optimism about continuing growth prospects in the region had it not been for the second, perhaps even greater shock to transpire in the western world so far this year; the election on 8 November of Donald Trump as the 45th President of the United States of America. Trump's presidency threatens to hold down growth in Asia Mr Trump's election victory raises challenges for Asia, including a possible hit to US and global confidence and growth and radical trade policies targeting China and other countries. Uncertainty has increased for China in particular. This must temper our optimism about improving economic prospects for China, since it is quite possible that the carry-over effect into 2017 of stronger economic growth this year will be offset by the negative impact of a combination of new tariffs on imports, weaker US demand for Chinese goods, and a stronger US dollar which renders Chinese exports less competitive. Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International In office, it is conceivable that Mr Trump will prove rather less radical than his policy proposals suggest. Nor is it yet clear whether his policies will serve to boost or depress US economic growth in the near term; there are arguments both ways which we shall discuss further in the final section of this report. However, if US growth does suffer under Mr Trump, then the Federal Reserve may only raise US interest rates very gradually over the next few years. This would be positive for Hong Kong property assets, since Hong Kong interest rates are effectively tied to US rates as a result of the territory's currency peg. If US interest rates only rise gradually, then the US dollar may also start to weaken after many years of strength. This would be negative for Asia exporting nations in general because it would reduce their trading competiveness; this would apply not only to China but also to Japan, South Korea and Taiwan. As it happens, Japan has already experienced declines in property investment volumes so far in 2016 as the combined result of a dull economy and the strength of the Japanese yen. Direct medium-term implications of Mr Trump's victory for the property markets within developing Asian economies are more limited. As noted, China and India are experiencing strong secular growth which is unlikely to slow sharply for some time, despite the risks posed by Mr Trump's presidency to Chinese trade. Investors and large multinational occupiers should continue to be attracted to important commercial property markets like Shanghai regardless of who is US president. Meanwhile, demand and supply in the Chinese and Indian residential markets are driven largely by domestic factors such as urbanisation, wealth levels, interest rates, lending policies and real estate regulation which have little to do with the US. 7 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International China Real GDP growth remains high and steady We believe that China's real GDP will continue to expand, albeit at a moderating pace. Real GDP looks set to grow by at least 6.6% y-o-y over 2016, and according to the International Monetary Fund growth should decelerate to the 6.0-6.2% range for 2017. There was a positive surprise in Q3 2016, in which real GDP rose by 6.7% y-o-y; this was above many economists' forecasts. Certain economic analysts believe that Chinese economic growth is modestly lower than the official figures suggest. Nevertheless, it is important to understand that GDP growth in the region of 6-7% means that China is adding more or less the equivalent of Switzerland to the global economy each year. Moreover, this robust growth is increasingly being driven by services and light industry, which now account for 57% of total GDP. Overall fixed asset investment has been rising in China recently, growing by 9.0% y-o-y in September 2016 after a pick-up to 8.2% in August according to figures from the State Council Information Office. This improvement partly reflects stronger property investment amid surging housing sales. However, fixed asset investment in manufacturing also increased in September, in part because industrial profits are rising again. Profits in manufacturing rose by 16% y-o-y in Q3 2016, i.e. at the fastest growth rate in two years. This growth in profits reflected not only increasing sales, but also margin expansion driven by rising output prices. This recovery was vividly reflected in the first y-o-y increase in the producer price index (PPI) in 54 months in September 2016. October showed a further 1.2% y-o-y increase in the PPI. The pick-up in producer prices is good news for heavy industry in particular. Other news for industry has not been so good. Exports from China actually weakened in September 2016. This was because mainly global demand remained patchy, outweighing the boost to export performance from a weaker currency; the Chinese renminbi continues to hover at around a six-year low versus the US dollar. Industrial production growth therefore softened somewhat in September. Then again, household consumption remained robust in Q3 2016, rising by 6.6% y-o-y in real terms; sales of passenger cars were especially firm. The increase in consumption reflects both strong real wage growth (up by 6.7% y-on-y over the first three quarters of 2016) and high government spending in the economy. Rising consumption is, of course, one of the key explanations for the continuing growth in the services sector, which has outpaced growth in industry since 2012. In the light of the recent positive developments, Oxford Economics recently nudged up GDP growth forecast for China to 6.7% for 2016. However, the firm believes that the positive carry-over effect of this higher number into next year may now be offset by the impact of the more challenging global growth environment following the US election, and so has kept its growth forecast for 2017 unchanged at 6.3%. Moreover, Oxford Economics foresees a significant slowdown over the next ten years towards real GDP growth of 5.5% as China gradually weans itself off a model of credit-fuelled expansion. Figure 5 below summarises key economic forecasts for China for the next three years. Debt is high, but a financial crisis is unlikely While persistent high economic growth has been a positive surprise in China, this growth is being achieved at a cost. The cost is rapidly increasing indebtedness. The most commonly used measure of total outstanding credit in the Chinese economy is so-called Total Social Financing (TSF), which is a much broader measure than simple bank lending. Over 2009-2010, in the aftermath of Figure 5: China: Recent economic performance and key forecasts GROWTH RATE (%) 2014 2015 2016 2017 2018 2019 Real GDP 7.3 8.9 6.7 6.3 5.9 5.7 Private consumption 8.2 7.6 7.5 6.9 6.8 6.7 Fixed investment 6.9 7.5 5.6 4.4 4.2 4.0 CPI 2.0 1.4 1.9 2.1 2.5 2.8 6.16 6.28 6.62 6.91 6.75 6.54 USD1.0 = RMB Source: Oxford Economics 8 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International the Global Financial Crisis (GFC), the authorities allowed TSF to expand at y-o-y rates of up to 35% in order to stimulate the Chinese economy. Growth in TSF decelerated over 2011 before accelerating again in the wake of global economic stagnation in 2012 and then slowing again in 2014-2015. However, since the start of 2016 TSF has again been expanding quite rapidly: according to official government statistics, TSF grew by 12.5% y-o-y in September¹. Certain economic forecasting groups make adjustments to the data and so estimate slightly different figures. Oxford Economics calculates figures for TSF excluding equity, adjusted for local government loans. On this definition, y-o-y growth in September was about 16%. By the standards of emerging markets, China's debt/ GDP ratio is high. For comparison, most observers quote a debt/GDP ratio of 66-67% for the other large, highgrowth Asian economy, namely India. In contrast, many developed countries have higher total debt/GDP ratios. Although again calculations vary, Japan is usually considered to top the list with a ratio approaching 400%, with various smaller European countries such as Portugal and Greece not far behind. Despite high and rising indebtedness, we believe that a financial crisis is unlikely in China, at least for the next few years. There are various reasons for our view. > ¹ Please see http://www.gov.cn/xinwen/201610/18/content_5120978.htm. China runs a large current account surplus, meaning that it is not reliant on foreign capital to finance its growth. Figure 6: China - bank lending and total social financing: y-o-y change (to September 2016) Bank lending and total social % yoy Bank lending 40 TSF ex equity, adjusted for local government loans 35 China runs a large current account surplus > China has a high savings rate In 2015, China’s economy-wide (“gross national”) savings ratio was 48.7% of GDP in 2015, compared to an investment ratio (“gross capital formation”) of 45.7%. Countries with high savings rates can support rising levels of debt. 30 > 25 China's banking system looks reasonably healthy overall 20 15 10 5 2006 2008 2010 2012 2014 2016 Source: Oxford Economics, CEIC Data Source: Oxford Economics, CEIC The People's Bank of China published data for TSF for October 2016 on 11 November, just before this report was published. On the Bank's definition, these figures show that the y-o-y change in TSF for that month was steady at 12.7%. As a consequence of the continuing expansion in credit in the economy, China's total indebtedness has reached levels which certain observers consider excessive. One of the commonly used yardsticks of a country's ability to support outstanding credit in its economy is the debt/GDP ratio. This ratio is estimated in various different ways, with the result that there is a range of figures for China. According to Oxford Economics, the debt/GDP ratio in China was 250% at the end of 2016. 9 While individual banks may have problems, in our view the Chinese banking sector as a whole is reasonably sound. According to Oxford Economics, the loan/deposit ratio for the Chinese banking sector at the end of Q3 2016 was 72%, compared to the level of 80-90% traditionally considered to be prudent by UK and US banks. Moreover, deposit intake remains strong, meaning that the loan/deposit ratio should not deteriorate greatly if lending continues to rise. Since y-on-y credit growth of 16% (to use Oxford Economics' adjusted TSF figure) is double nominal GDP growth of 7.8% for Q3 2016, non-performing loans (NPLs) must surely be rising, and there is widespread scepticism about the NPL ratios of around 1.5% typically reported by Chinese banks. However, many economists believe that the NPL problem in the Chinese banking sector is less severe than that in India, where many banks have been extending very low-quality loans in recent years. Our view that a financial crisis is unlikely in China in the near term does not mean that the country can be complacent. As already suggested, in coming years China needs to reduce its dependence on a creditfuelled growth characterised by high levels of investment. Making the long-awaited shift away from an investment-led economic model will push down China's growth rates, but is necessary to prevent severe Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International long-run imbalances and perhaps outright crisis in the financial system. Fortunately, there is scope for optimism that China can make the shift, for a number of reasons. Firstly, the government is now aiming to increase the domestic consumption rate: recent policies include boosting rural incomes and higher spending on health, including projects to provide basic medical insurance for at least 90% of the population. Secondly, reform to the "hukou" (housing registration) system is being pushed forward in order to allow migrant workers to access social services in the cities where they work. Thirdly, reforms in the financial sector are spurring more efficient use of capital, and providing a greater range of savings instruments for to both households and companies. Prospects for commercial property favourable The improving economic picture provides a favourable background for continued expansion in commercial property markets in China. Below we summarise recent developments in the office property segment in China's two most important property investment markets, Shanghai and Beijing. For Shanghai, we predict average annual growth in Grade A office rents of 1.6% for the period 2016-2019, despite a significant increase in new supply and consequent upward move in the vacancy rate. For Beijing, we expect Grade A rents to decline by a very modest 0.2% per year over the period 2016-2019. Shanghai (Q3 2016) Demand Shanghai’s economics remained positive, with tertiary industry growing by 11.6% y-o-y in H1 2016, according to the city’s statistics bureau. This solid background continued to drive demand for Shanghai’s Grade A office space, with net absorption rebounding to 33,700 sq metres (362,750 sq ft). The primary contributors to demand were the finance and professional services sectors, and retreats by peer-to-peer lending companies moderated in the period. Given the background of continuing strong economic growth and Shanghai's status as China's commercial hub and gateway to the whole Yangtze River Delta region, we expect Shanghai to remain a very popular location for multinational companies. 10 Rent Rent increased by 2.5% q-on-q or 6.2% y-o-y to RMB10.5 per sq metre (USD0.14 per sq ft) per day in Q3. This rent includes a VAT tax, which is deductible in most cases. Consequently, most tenants actually saw real estate costs fall in the period. Looking forward, we predict average annual rent growth of 1.6% for the period 2016-2019. Supply A total of nearly 640,000 sq metres (6.89 million sq ft) of new supply is scheduled for 2016. More than one-half of this new supply will be completed in the Pudong district. We predict a further significant increase in new supply in 2018 to just over 900,000 sq metres (9.69 million sq ft) before new supply falls back in 2018. Consequently, we predict average annual new supply of 670,000 sq metres (7.21 million sq ft) over the period 20162018. This will be almost exactly double average new supply over the period 2010-2015 of 340,000 sq metres (3.66 million sq ft). Vacancy rate The vacancy rate spiked to 9.8% in Q3 as a result of the new supply and retreats by tenants in the peer-to-peer lending sector. With new supply likely to rise further in 2017 but to fall back thereafter, we predict a vacancy rate of 10.3% for end-2019. Beijing (Q3 2016) Demand Beijing's economy is growing less rapidly than Shanghai's, but nonetheless remains high. According to the city's statistics bureau, real GDP growth in Q3 2016 was unchanged from Q2 at 6.7% y-on-y. Tertiary industry growth was 7.3% in the period, versus 10.3% in Shanghai. Multinational companies reduced space requirements over Q3 due to tighter leasing budgets, while new business start-ups slowed. In contrast, demand from domestic companies and from the IT and media sectors remained Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International high. New leases by IT companies alone included Sina's lease of 9,000 sq m at Genesis Beijing in the Lufthansa submarket; Nvidia’s new lease of 1,800 sq m at Fortune Financial Centre in the CBD submarket; and Symantec’s new lease of 1,300 sq m at Oriental Plaza in the East Chang An Avenue submarket. China as a whole was the most active investment market in Q3 in the Asia Pacific region ahead of Japan and Australia. For the first nine months of 2016, China overtook Australia to become the second most active Asia Pacific market behind Japan, and accounted for 24% of aggregate transactions across the region. Rent Position Market Value (USD m) Y-o-y chg. (%) 1 China 9,983.5 28% 2 Japan 6,831.5 -27% 3 Australia 5,135.8 -13% 4 Hong Kong 2,795.0 -6% 5 South Korea 2,787.0 103% 6 Singapore 1,241.9 54% 7 New Zealand 747.7 40% 8 Taiwan 350.2 -3% 9 India 191.5 -82% 10 Malaysia 103.0 -69% - APAC Other 280.8 -19% - APAC Total 30,448.0 1% Average rent remained stable, falling by 0.1% q-on-q to RMB330.8 per sq metre per month (USD4.55 per sq ft per month) due to new supply. We expect rental growth to be constrained for 2016 due to new supply, and to decline by a modest 0.2% per year over the period 2016-2019. Supply Total grade A office stock in Beijing grew by 2.2% q-on-q in Q3 2016 to 5.9 million sq metres (63.5 million sq ft). We know that 164,000 sq metres (1.77 million sq ft) of new supply is scheduled for Q4 alone, and that several projects have been postponed to 2017. Looking ahead, we predict average annual new supply of 465,000 sq metres (5.0 million sq ft) over the period 2016-2019. This will be slightly more than double the average annual new supply over the 2010-2015 period of 250,000 sq metres (2.7 million sq ft). Figure 7: APAC property deals, Q3 2016 Source: RCA Figure 8: APAC property deals, Q3 2016: market as % of total transaction value 4% China 5% Japan 9% 33% 9% Hong Kong Vacancy rate The vacancy rate in Beijing increased by 1.6 percentage points q-on-q to 7.6%. The large volume of future supply over the next couple of years will almost certainly push up the vacancy rate further. We predict a vacancy rate of at least 11.0% for end-2019. South Korea 17% Singapore 22% Source: RCA China now the second-ranked country investment market in APAC The combination of economic improvements and stable conditions in the office property market has made China an increasingly popular destination for real estate investment. According to Real Capital Analytics (RCA), China recorded USD10.0bn in direct real estate transactions in Q3 2016, up by 28% y-o-y. On this basis 11 Australia Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International Other Figure 9: APAC property deals, Jan-Sep 2016 Position Market Value (USD m) Y-o-y chg. (%) 1 Japan 21,502.3 -34% 2 China 20,308.5 -7% 3 Australia 14,703.1 -38% 4 Hong Kong 10,196.7 16% 5 Singapore 5,460.2 54% 6 South Korea 5,302.9 46% 7 APAC Other 1,843.8 133% 8 New Zealand 1,623.2 -35% 9 Taiwan 1,456.8 0% 10 India 1,401.6 -42% - Malaysia 522.2 -60% - APAC Total 84,321.3 -18% Source: RCA Figure 10: APAC property deals, Jan-Sep 2016: market as % of total transaction value Japan 8% 6% 26% 6% China Australia Hong Kong 12% Singapore 17% 24% South Korea Other Source: RCA, Colliers International Residential market remains at risk, but recent cooling is encouraging On balance we are optimistic about China. However, China faces two long-run risks. The first risk, which we have already largely addressed, is that the authorities may fail to make adequate attempts to rein in credit growth, sowing the seeds of major financial imbalances and perhaps even a full financial crisis in the future. The second, related risk is the fact that excessive credit expansion has helped to feed overheating in China's residential property market. According to China’s National Statistics Bureau, average prices of new homes in 70 Chinese cities increased by 11.2% y-o-y in September 2016 after a 9.2% increase in August. This was the twelfth straight month of gain and the fastest rise since the series was started in 2011. Looking at Tier I cities, residential prices in Beijing and Shanghai rose respectively by 28% and 33% y-o-y, quickening from 24% and 31% in August. Price growth in the southern city of Shenzhen, which has led price increases for much of the past year, dropped modestly from 37% in August to 34% in September. In response to the market's overheating, according to Bloomberg data, 21 Chinese cities announced measures to cool the residential market in late September or early October. These measures ranged from relatively modest steps such as bans on new home purchases over the Golden Week holiday to firmer and more permanent steps such as tightening of downpayment requirements. Strictest of all is Shenzhen, which now requires a 50% initial deposit on first home purchases and a 70% initial deposit on second home purchases. These tightening measures appear to have had a tangible impact on the market. On 21 October 2016, the National Statistics Bureau took the unusual step of publishing house price data for certain cities for the first half of the month. The figures showed that prices fell over the first half of October compared to the September level in 15 Tier 1 and Tier 2 cities. While the declines were modest (in the low single-digit per cent range), the direction of movement is reassuring. If the impact of the cooling measures persists, then China may be able to avoid a sharp residential market downturn. Figure 11: Change in new build price index for 15 leading cities, first half of October 2016 City Oct H1 index Sept index Chg in index Beijing 101.2 104.9 -3.7 Tianjin 101.9 104.2 -2.3 Shanghai 100.7 103.2 -2.5 Nanjing 102 103.7 -1.7 Wuxi 104.4 108.2 -3.8 Hangzhou 103 105.5 -2.5 Hefei 101 104.6 -3.6 Fuzhou 102.5 105.1 -2.6 Xiamen 101 102.9 -1.9 Jinan 103.2 105.2 -2 Zhengzhou 104.3 107.6 -3.3 Wuhan 102.9 103.9 -1 Guangzhou 101.3 103.1 -1.8 Shenzhen 99.7 101.9 -2.2 Chengdu 99.9 102.5 -2.6 Source: National Statistics Bureau of China 12 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International Another reason why it would be wrong to suggest that a residential property crash in China is either certain or imminent is that the recent strong recovery in the housing market has been unevenly spread. Indeed, many Tier 3 or Tier 4 cities are still struggling to digest large inventories of unsold housing. Housing unit sales are now recovering in smaller as well as large cities, and this recovery is helping to reduce housing stock, even if it remains high by historical levels. While developments in Tier 1 cities receive the greatest attention, the situation in smaller cities is more representative of the residential property sector overall and, therefore, more important for national policy-making. Nevertheless, the Chinese authorities need to continue to pay close attention to residential prices in Tier 1 and Tier 2 cities. It is interesting to note that the national government appears to have market cooling measures largely to the discretion of individual city authorities. This approach is understandable, because individual Chinese cities vary widely by population and wealth levels. However, it may be that a more nationally coordinated approach to cooling the residential market is required to preclude (or, at least, greatly reduce) the risk of a housing price crash. 13 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International August followed by 4.1% in September. The strength of imports points to a recovery in domestic demand. Hong Kong Prospects turning brighter Hong Kong’s economy is steadily improving. Whereas real GDP growth for Q1 2016 was 0.8% y-o-y, GDP growth for Q2 reached 1.7%. Other recent data have also generally been positive. Notably, goods exports grew for the first time in 16 months in August, rising by 0.8% y-o-y; this growth accelerated to 3.6% y-o-y in September. The recovery in exports has been driven by increasing shipments to mainland China, Hong Kong's biggest export destination; exports to China grew by 5.1% y-o-y in September. Moreover, goods imports have been outpacing exports, with growth of 2.8% y-o-y in The Hong Kong government released GDP data for Q3 on 11 November, just before publication of this report: yo-y growth in the period increased further to 1.9%. This further improvement in growth was driven by continued strength in domestic demand, with consumer spending, investment and imports all picking up. Exports also increased, although imports grew faster. Oxford Economics has commented that the reassuring Q3 data may lead the firm to revise up its current 2016 forecast of real GDP growth of 1.4%. The encouraging growth figures have contributed to an improvement in business sentiment, as measured by the PMI survey. The PMI survey for September 2016 came Figure 12: Business sentiment in Hong Kong continues to improve Source: Hong Kong Census and Statistics Department Figure 13: Recent economic performance and key forecasts for Hong Kong GROWTH RATE (%) 2014 2015 2016 2017 2018 2019 Real GDP 2.7 2.4 1.4 2.0 2.5 2.5 Private consumption 3.3 4.7 1.0 2.0 2.5 2.5 Fixed investment -0.1 -2.0 -2.7 2.5 4.1 4.0 CPI 4.5 3.0 2.5 2.4 2.3 2.1 USD1.0 = HKD 7.75 7.75 7.76 7.76 7.76 7.76 Source: Oxford Economics 14 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International in at 49.3, the highest level since March 2015 and edging closer to the 50 mark that indicates expansion rather than contraction. In addition to the PMI survey, we find the Quarterly Business Tendency Survey Report produced by the Hong Kong government's Census and Statistics Department to be very useful. This survey collects the views of business owners and senior managers about their prospects for coming quarters, and so becomes a de facto business sentiment index. The Business Tendency Survey for Q4 2016 showed that the proportion of respondents expecting business conditions to deteriorate on a q-on-q basis had decreased to 10%, from 17% in Q3 2016. cumulative annual growth rate (CAGR) of total added value from these sectors was 5.4%, while the CAGR of benchmark rent was 5.0%. We believe that the growth of the high value service sectors, rather than the overall economy, has a more significant impact on office rental growth. This relationship is illustrated in Figure 15 below. Figure 15: Benchmark Rent and Value Added of High Value Service Historical evidence suggests that the results from certain subsectors of the Business Tendency Survey, namely financing and insurance, real estate, professional and business services, and information and communications, are closely correlated with the performance of office rents in Hong Kong. This close historical correlation is illustrated in Figure 14 below, which also shows our assumptions about how the relationship will develop over the period 2017-2020. Source: Colliers There has also been a close relationship between growth in high value added service sectors and growth in Grade A office rents. Between 2000 and 2015, the As Figure 15 illustrates, between 2015 and the summer of 2016, business sentiment and rental growth in Hong Kong were moving in opposite directions, with business Figure 14: Business Sentiment and Office Rental Changes Source: Colliers 15 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International sentiment deteriorating but benchmark rent rising. In other words, a decoupling took place. We believe that this decoupling chiefly reflected an extremely low vacancy rate and strong demand from the Chinese companies in the core CBD area. We believe the decoupling will not develop into a long-term phenomenon and assume that the vacancy rate will eventually move back towards the historical average. Island office rents and investment market strong, Kowloon weaker Past records have revealed that business sentiment tends to move in three to four year cycles and it is very rare for the survey result to stay in negative territory for a long period. As noted, business sentiment in Hong Kong was moving downwards until Q2 2016, which looks as though it was probably the bottom of the most recent cycle. Looking forward, we expect the present rebound in business sentiment to continue over the rest of this year and into 2017, driven by stabilisation in the Chinese economy and modest US economic expansion. This in turn should support positive rent growth. This is the crux of our prediction that the benchmark rent in Hong Kong will rise by 12% between end-2015 and end-2020. While overall office rent market has been edging up, the core and non-core districts have been developing into a two-tier market due to uneven demand and supply. In core CBD locations, rent has been supported by keen interest from mainland Chinese companies and very limited supply. In decentralised locations, new supply has added pressure to an office leasing market which is already softening as tenants in the trade and sourcing industry tenants undergo restructuring and downsizing. Looking forward, the rent gap between core and noncore districts should continue to expand. Hence our estimate that average rent between now and end-2020 will rise by 22% to HKD137 per square foot in Central and Admiralty, but will drop by 8% to HKD33 per square foot in Kowloon East. Hong Kong now the second-ranked city investment market in APAC Another indication of improving sentiment in Hong Kong's office property market has been continuing strength in market transactions. Based on Colliers data, he number of property investment transactions above HKD100 million (USD12.8 million) increased substantially in Q3 2016 with the largest increases in residential, strata-title office and en-bloc office transactions. Chinese investors have remained very active in Hong Kong, since investment in the territory provides a simple way to hedge against the possibility of continuing RMB depreciation over the medium term. Figure 16: Hong Kong district Level Rent Projection 2016-2020 Source: Colliers 16 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International 3 Sydney 6,262 -19% 4 Shanghai 6,230 -38% 5 Singapore 5,460 54% 6 Seoul 4,950 96% 7 Melbourne 3,299 -53% 8 Beijing 3,286 -12% 9 Kyoto 2,747 -35% 10 Brisbane 1,534 -55% Source: RCA Risks: retail sector and long-run outlook for residential property We have seen that the economic environment in Hong Kong is improving and that the office property market benefiting. However, there are two clouds on the horizon. The first is the continuing pressure on the retail sector. This pressure reflects weak tourist arrivals (inbound tourist numbers fell by 6.1% y-o-y over the first nine months of 2016, according to the Hong Kong Tourist Board) and changes in mainland tourists’ spending patterns. The weakness of tourist arrivals in turn reflects various factors in mainland China including general economic uncertainty and the anti-corruption drive, but most importantly - in our view - the steady depreciation of the RMB, which has dropped by about 11% against the US dollar (to which the Hong Kong dollar is pegged) since January 2014. We do not expect the RMB to decline much further, so to that extent the Hong Kong retail market is probably near the bottom. However, recovery in the sector is likely to be gradual. 17 2016 - Jun 16% 2015 - Dec 10,197 2015 - Jun Hong Kong 2014 - Dec 2 2014 - Jun -34% 5.60 2013 - Dec 12,740 5.80 2013 - Jun Tokyo 6.00 2012 - Dec 1 6.20 2012 - Jun Y-o-y chg. (%) 6.40 2011 - Dec YTD sales volume (USD m)) 6.60 2011 - Jun Market 6.80 2010 - Dec Position 7.00 2010 - Jun Figure 17: Most active urban investment markets in APAC over first nine months of 2016 Figure 18: USD dollar vs RMB (last seven years) 2009 - Dec According to Real Capital Analytics (RCA), total property transaction volume in Hong Kong reached USD2.8 billion in Q3 2016. While this figure represents a 6% y-o-y fall, for the first nine months of 2016 total property transaction volume was USD10.2 billion, a 16% y-o-y rise. On this basis, Hong Kong ranks as the second most active city (as opposed to country) property investment market in the Asia Pacific region so far in 2016. Source: Bloomberg The other cloud is medium-term prospects for the residential property sector. Until very recently, we would have said that prospects for the residential sector in the near term were brightening. Improving economic news, the 12% increase in the Hong Kong stock market over Q3, the persistence of negative real interest rates and a pool of pent up end-user demand had all driven a recovery in sentiment in the Hong Kong residential market. As a result, the overall rate of decline in prices in both the mass and luxury segments had tapered off to about 6% from their peak in September 2015. This drop compares with a decline of 11% between September 2015 and March 2016. However, we have revised our view following the recent announcement by the Hong Kong government that it will increase the ad valorem stamp duty to 15%, effective from 5 November 2016. We expect that the new rate will put pressure on both private residential growth and investment demand. Overall, the flat rate ought to have a bigger impact on the secondary market in terms of investment volume as the primary market is dominated by developers offering more selling incentives. We expect home prices to stay flat in the short term as the majority of owners are not desperate to sell, but to trend down over the coming years as investors stay away. Based on the latest development, we now predict that mass market and luxury market home prices in Hong Kong will fall between 5-8% in the next twelve months. Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International interest rates? The near-200% surge in Hong Kong residential prices between end-2008 and their peak in 2015 almost exactly coincides with the period over which Hong Kong has enjoyed negative real interest rates. We would argue that Hong Kong has benefited from the loosest monetary conditions in Asia for most of that time. Figure 19: Hong Kong - mass vs luxury residential price trend Using three month HIBOR and underlying CPI inflation of 2.1%, we estimate that the real interest rate in Hong Kong currently stands at -1.5%, compared to this year's high point of -2.3% in February and March. On the assumption that US interest rates only increase gradually and that inflation in Hong Kong stays constant, we do not expect Hong Kong to return to positive real interest rates before early 2018, and more probably H2 2018. However, residential property prices should start to reflect this return six to nine months before it happens. The strength of the increase in prices driven by negative real interest rates suggests that there is ample scope for prices to fall as the process is reversed. Source: Colliers, Rating and Valuation Department The chance of a substantial downward correction in Hong Kong residential property prices over the medium term remains significant. Apart from very stretched affordability, the potential for interest rate increases following the lead of the US - most probably from December onwards - and an ample pipeline of new apartment supply represent important threats to the recovery in market sentiment that had become apparent before the changes in stamp duty. For us, perhaps the fundamental question is: when will Hong Kong return to an environment of positive real Figure 20: Real interest rates in major APAC markets and the US (2009-2016) 8.0% 6.0% 2.0% -4.0% -6.0% -8.0% US China Hong Kong Japan Singapore Australia Source: CEIC, US BEA, US Federal Reserve 18 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International Jul-16 Oct-16 Apr-16 Jan-16 Jul-15 Oct-15 Apr-15 Oct-14 Jan-15 Jul-14 Apr-14 Jan-14 Jul-13 Oct-13 Apr-13 Jan-13 Jul-12 Oct-12 Apr-12 Jan-12 Jul-11 Oct-11 Apr-11 Jan-11 Jul-10 Oct-10 Apr-10 Jan-10 Jul-09 Oct-09 Apr-09 Oct-08 Jan-09 Jul-08 -2.0% Apr-08 0.0% Jan-08 Real Interest Rates 4.0% Singapore economy's well-known gearing to international trade flows. However, the pace of the pick-up trade depends in part on the outcome of the US presidential election (see later in this report). Singapore Economic growth has been slowing Singapore’s recent economic performance has been disappointing. According to Oxford Economics, real GDP in Singapore has increased at a compound average rate of 6.7% since 1980; and the most recent boom year was 2010, during which, with growth of 15.2%, Singapore was the world's second fastest-growing country after Qatar. However, since then Singapore has slowed down steadily. Real GDP growth fell from 3.3% y-o-y in 2014 to 2.0% in 2015, and looks set to fall further in 2016. The slowdown seems to have intensified in recent months. Based on the advance estimate for Q3 2016, real GDP grew by only 0.6% y-on-y and contracted by 4.1% q-o-q on seasonally adjusted annualised basis. Manufacturing activity shrank by 17.4% versus Q2 as an earlier boost from the biomedical sector dissipated and as Singapore's important transport engineering sector shrank further. In addition, the services sector - which accounts for two-thirds of the economy - declined for the third quarter in a row. Advance estimates of GDP are well-known to be unreliable, and it is quite possible that the final number for Q3 will be rather different from the weak initial estimate. Nevertheless, the scale of the decline in the manufacturing sector suggests that weakness will continue into Q4. Real GDP growth for 2016 now looks likely to be little higher than about 1.4%. Moreover, if the economy shrinks in Q4 from the Q3 level, then a technical recession (defined as two consecutive quarters of negative growth) is possible. A particular long-run challenge for Singapore is the country's slowing population growth. Despite government policies intended to boost Singapore's low birth rate, after annual average growth of 2.7% over the past ten years Oxford Economics predicts average annual growth of just 1.3% over the next two decades. Restrictions on foreign workers may eventually need to be eased if labour supply growth is to recover. Figure 21 below summarises key economic forecasts for Singapore for the next three years. Office property market under pressure in the near term Recent developments in the Singapore office property market are not encouraging. In Q3 2016, overall office rentals across Singapore slid for the fifth consecutive quarter under the pressure of oversupply and lacklustre demand. We now predict that Premium¹ and Grade A² office rents in Singapore's CBD will fall by 7-12% over 2016 as a whole. With upcoming new supply set to remain high, we expect the pressure to continue well into 2017. We summarise recent developments in the office property market below. ¹ The Premium Grade office buildings are new buildings with the highest quality specifications in the Raffles Place/ New Downtown area. ² The Grade A office buildings are good quality buildings with well-sought after specifications in strategic locations that are well served by amenities and transport nodes. At this stage it seems reasonable to expect the Singapore economy to stay subdued into early 2017. Looking further ahead, GDP growth should recover gradually as global trade gradually accelerates, given the Figure 21: Recent economic performance and key forecasts for Singapore GROWTH RATE (%) 2014 2015 2016 2017 2018 2019 Real GDP 3.3 2.0 1.4 2.0 3.4 3.2 Private consumption 2.2 4.5 3.2 3.4 3.9 3.9 Fixed investment -2.6 -1.0 -0.2 3.5 4.6 4.1 CPI 1.0 -0.5 -0.6 0.9 2.3 2.1 USD1.0 = SGD 1.27 1.37 1.37 1.41 1.38 1.35 Source: Oxford Economics 19 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International Demand In terms of new demand, Q3 2016 was another weak quarter. Demand continues to lag behind supply comprising more office relocations than expansions. Supply Upcoming island-wide supply remains high. Based on Colliers' office supply data, we predict that premium and Grade A supply in Singapore's CBD will grow 5.6%* in 2016 and another 12.1%* in 2017 due to bumper completions of new office buildings. Rent We predict that premium and Grade A office rents in the CBD will decline by up to 3.0% in Q4 2016, bringing the fullyear decline between 7.0% and 12% Vacancy rate Vacancy rates are likely to surge as the new office buildings are completed. We predict an end-2019 vacancy rate of 8.4%, versus 3.7% at end-3Q 2016. This would be high by Singapore's historical standards. * Based on Colliers Premium and Grade A office supply through tough times like the Asian Crisis of1997 and the SARS epidemic of 2003. This resilience reflects the country’s status as a world-class metropolis with a welldeveloped and sophisticated market economy and high legal and regulatory transparency. These advantages are likely to stay unchanged for the foreseeable future. With the caveat that the country needs to address the issue of slowing population growth, we believe that Singapore's long-run advantages provide a firm foundation for an eventual pick-up in economic growth in the territory. This is especially true in the services sector, which is likely to outperform the manufacturing sector for most of the next decade. That said, manufacturing should also benefit as global trade flows gradually recover. With long-run prospects relatively sound and to the extent that we regard the country's present economic downturn as cyclical and not structural, we consider that the recent price declines in the Singapore property market present new opportunities for investors and endusers. The fact that total investment volumes in Singapore increased by 54% over the first nine months of 2016 to USD5.5 billion (based on RCA data) suggests that many investors agree with us, even if the landmark sale in Q2 of Asia Square Tower 1 to the Qatar Investment Authority for SGD3.38 billion (USD2.43 billion) accounts for 44% of this total. As noted earlier in this report, so far in 2016, Singapore has been the fifth most active urban investment market in the Asia Pacific region. Figure 22: Most active urban investment markets in APAC over first nine months of 2016 Position Market YTD sales volume (USD m)) Y-o-y chg. (%) 1 Tokyo 12,740 -34% 2 Hong Kong 10,197 16% 3 Sydney 6,262 -19% 4 Shanghai 6,230 -38% 5 Singapore 5,460 54% 6 Seoul 4,950 96% 7 Melbourne 3,299 -53% 8 Beijing 3,286 -12% 9 Kyoto 2,747 -35% 10 Brisbane 1,534 -55% Long-run prospects brighter In recent years, Singapore has not been a great place to invest in property. In the office sector, prime office capital values have been subdued due to weak rental income. At the same time, in contrast to most other major urban centres globally, residential property prices have been falling. According to the official Urban Redevelopment Authority (URA)'s property price index, private home prices have come down by 10.8% over the past 12 quarters, the longest losing streak in history, since the state implemented the Total Debt Servicing Ratio (TDSR) cooling measures. Prices in the luxury residential sector have dropped by a steeper 20-25%. However, we must ask: do the subdued near-term prospects for the economy and for the office property market really matter? Singapore has been famously resilient over the years, reflecting ample foreign reserves and strong state directives to navigate the territory 20 Note. Intentionally repeated from Table 17 above. Source: RCA We believe that 2016 should see real estate investment sales (defined by transactions over SGD5 million) surpass the level of 2015, anchored by several crossborder transactions in the Office and Residential Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International segments, where sovereign wealth funds, institutional investors and high net worth individuals continue to acquire trophy assets on a long-term view. Looking forward, any easing of the cooling measures could provide some impetus for participation in the luxury residential sector. Foreigners may find it attractive to reenter the market when the additional buyer's stamp duty of 15% imposed on foreigners is eventually relaxed or removed. Time to look at Singapore again We believe that Singapore's prime real estate in general should continue to be sought after by global institutional investors looking for stable long-term returns in a diversified portfolio. The near-term outlook for growth in office rents is clouded by our assumption of a significant increase in supply: hence our estimate of negative average annual prime grade office rent growth (-2.1%) between 2016 and 2019. However, the prime grade office net operating yield for the Singapore CBD of 3.5% is reasonably attractive - and more so than the corresponding figure of 2.5% for prime grade office property on Hong Kong Island. The long-run attractions of Singapore explain, in our view, why the investment market has been so firm in Singapore recently: investors are looking beyond a modest near-term decline in office rents to the prospect of rental growth and capital appreciation further into the future. As suggested, the office segment is not the only part of the property market that is attractive for long-run investment: the residential segment, including luxury property, is well worth considering too. 21 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International Australia Good times keep rolling for the Lucky Country Australia’s real GDP increased by 0.5% q-o-q and 3.3% y-o-y in Q2 2016, matching economists' consensus estimates and representing the fastest rate of annual growth in four years. Remarkably, Q2 2016 marked the 100th consecutive quarter of growth. This means that Australia has enjoyed continuous economic expansion for 25 years, in the process weathering the Asian Crisis of 1997, the bursting of the technology bubble in 20012002 and the Global Financial Crisis of 2008-2209. Figure 23: Australia: 100 consecutive quarters of growth Source: Deloitte Access Economics The recent strong economic growth in Australia has been driven in part by significant fiscal stimulus particularly at the state and local government levels. The GDP outcome suggests that the Reserve Bank of Australia's efforts to steer the economy in the direction of non-mining resources growth are slowly gaining traction after several years of monetary policy easing. Aside from the strength in government spending and national exports, recent growth has been bolstered by household spending and home building. These factors have helped offset the decline in mining investment which has been acting as a drag for more than three years. All the same, the original investment billions of dollars in the Australian mining sector is paying dividends in the form of strong exports of resources. The 2.0% month-on-month jump in Australian exports in September reflected strength in non-rural goods exports - especially coal due to rising prices and a recovery in demand from China. The recent strength of GDP growth also reflects high consumer confidence in Australia. Consumer confidence as measured by the Westpac Melbourne Institute increased 101.0 in August to 101.4 in September. The accompanying release noted that Australia’s consumer sentiment has been remarkably stable for the last six months, averaging 100.3, with the latest reading sitting just above this level. Among other factors, high consumer confidence springs from declining unemployment. Australia's overall unemployment rate dropped to 5.6% in August, reaching the lowest level since late 2013, even if this decline was assisted by a softening labour market participation rate. The rotation of the Australian economy back towards the traditionally dominant south-eastern states has been evident in the employment statistics, with the labour markets in those states improving noticeably. New South Wales has been the top performer with unemployment now down to 5.0% and matching the low point of early 2013. Victoria has also seen unemployment fall to 5.5%. In contrast, the resources-orientated states of Queensland and Western Australia have unemployment rates of 6.2% and 6.3% respectively, while South Australia has spiked upwards to 6.8%. Figure 24: Recent economic performance and key forecasts for Australia GROWTH RATE (%) 2014 2015 2016 2017 2018 2019 Real GDP 2.7 2.4 2.9 2.7 2.9 2.8 Private consumption 2.8 2.8 2.6 2.7 3.1 3.0 Fixed investment -1.9 -3.9 -2.8 2.1 3.2 2.9 CPI 2.5 1.5 1.2 1.7 2.2 2.5 USD1.0 = AUD 1.11 1.33 1.34 1.33 1.33 1.30 Source: Oxford Economics 22 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International Figure 25: Australia - the growth pendulum swings back south-east Source: Colliers Edge Australia is the developed Asia Pacific market where nominal monetary conditions have eased most noticeably in recent years. The Reserve Bank of Australia (RBA) has progressively cut its target cash rate from just below 5% in early 2012 to 1.5% now; and this easing has been another factor helping to drive both the economy in general and property markets in particular. Interest rate cuts have been permitted by a significant decline in CPI inflation, which stood at 3.1% in June 2014 but has now dropped to 1.3%. Despite a modest upside surprise in the Q3 CPI data, annualised inflation measures remain well below the RBA’s target range of 2-3%. In its most recent policy statement, the RBA indicated that it does not expect to cut interest rates further. Nevertheless, with inflationary pressures so subdued, Oxford Economics predicts that interest rates will stay on hold till 2018. 23 Figure 26: RBA - progressive interest rate cuts Source: RBA/Colliers Edge Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International still be overweight, with Adelaide balanced. Office markets still very strong in Sydney and Melbourne Figure 28: Australian cities - demand for CBD office space over next three years (sq metres) The Sydney and Melbourne office property markets continue to benefit from the buoyant economic conditions. Demand is strong due to expansion in professional and services employment, while supply is limited or diminishing. Nor has falling inflation impacted rental growth, because strong employment numbers are driving down vacancy and giving Australian landlords more room to lower their traditionally high incentive payments. As shown in Figure 27 below, over mid-2016, Sydney and Melbourne were experiencing effective rental growth of 10-20% y-o-y. 198,925 Melbourne 36,358 Sydney 129,875 Brisbane 31,921 Adelaide 86,171 Perth Incentives still have some way to fall. Currently, incentives are equivalent to 25% of rental income for Grade A office buildings in Sydney. However, high levels of withdrawal and rising tenant demand should put strong downward pressure on incentives in the medium term. Melbourne incentives are also falling, but at a slower rate than in Sydney, which benefits from a higher level of demand from financial services and larger technology companies. Melbourne demand is more diversified, with education, professional services firms and government being the primary movers. 0 50,000 100,000 Forecast Net Supply 150,000 200,000 250,000 Source: Colliers Over the medium term, undersupplied markets imply lower vacancy rates and room for further rental growth, and a further reduction in incentive payments. Against this favourable background, we predict average annual growth in prime grade office rents of 7% in Sydney and 4% in Melbourne over the period 2016-2019, and a decline in vacancy rates to 3.9% and 5.1% respectively by the end of 2019. As shown in Figure 28 below, our forecasts for whitecollar employment growth and net new supply over the next three years point to Sydney and Melbourne being underweight for office property stock. In contrast, Brisbane and Perth (the chief cities of states which are more dependent on resources employment) will probably Figure 27: Sydney and Melbourne: effective rental growth (LHS) versus CPI (RHS) 40.0% 30.0% 20.0% 10.0% 0.0% -10.0% -20.0% Sydney Prime Net Effective Rental Growth Jun-16 Dec-15 Jun-15 Mel Prime Net Effective Rental Growth Source: Colliers 24 Dec-14 Jun-14 Jun-13 Dec-13 Dec-12 Jun-12 Jun-11 Dec-11 Dec-10 Jun-10 Jun-09 Dec-09 Dec-08 Jun-08 Jun-07 Dec-07 Dec-06 Jun-06 Dec-05 Jun-05 Dec-04 Jun-04 Dec-03 Jun-03 Dec-02 Jun-02 -30.0% Headline CPI 300,000 Space required Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International 1.5 percentage points lower than the headline figures, but this is a blunt and questionable calculation and in any case incentive payments are falling. Investment in Australia driven by Asia, especially China As shown in Figure 29 below, in recent years investment in Australian office markets has been heavily driven by Asian investors, and especially by Chinese investors. China has been the fastest-growing investor in Australian commercial real estate since 2009. From 2001-2008 only AUD50 million (USD38 million) of Chinese investment was recorded; however from 2009 to the present there been over AUD17.0 billion (USD12.8 billion) of direct investment. Despite the surge in Chinese interest, however, Singapore is still the largest source of foreign investment in Australia. Colliers Australia anticipates further investment from Asian countries in 2017, particularly from Singapore and perhaps also Japan, which may look to re-enter the market. US investors may also look at Australia again. Core markets still attractive, even if investment story is well-known On a gross basis unadjusted for incentives, prime grade office property in Sydney and Melbourne yields 5.5%5.8%, or between 3.2% and 3.5% above Australian tenyear bonds. One could argue that the prevalence of incentive payments in the Australian commercial property means that true office property yields are 1.0- Given our expectation of a significant additional wave of investment in Australia from Asia in 2017, there is good reason to believe that demand for office property in Australia will remain very strong. This demand should push up capital values, and so suggests that further yield compression in Sydney and Melbourne at least is probable. Risks to this scenario include weakening wages growth, cuts in government spending and economic slowdown in China, but for the moment we see only limited scope for concern on any of these fronts. Like Singapore, Australia benefits from high legal and regulatory transparency and low sovereign risk. It is little surprise that the country remains a very popular investment destination. Nevertheless, the attractions of Australia are well-appreciated; there is an increasing shortage of office property stock; and and certain segments of the property market appear overheated especially residential. On a three to five year view, among the developed markets in the Asia Pacific region there may well be greater scope for upside positive surprises and hence for capital appreciation in Singapore than in Australia. Figure 29: Investment in Australia (AUD billion) - two big cyclical shifts $20 $15 2001-2008 2009-2016YTD $10 $5 $0 USA Canada UK Germany China Singapore Source: Colliers 25 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International Hong Kong Weakening outlook for Tokyo office property market Japan Demand Economy only ticking away The market is suffering from a gap between landlords' rent expectations for new supply and tenants' demands for attractive prices. Pre-commitment levels for 2017 are low. The weak economy is weighing on demand, although overall leasing activity has been steady. Japan's economy is ticking away at a moderate pace impacted by weaker household consumption following the consumption tax hike in 2014, a decline in crude oil prices, and an uncertain global economy. Real GDP in Q2 2016 grew by 0.2% q-o-q, or by 0.7% on an annualised basis. In a reaction to weak domestic demand, corporate investment dropped by 0.1% q-o-q (or by 0.6% on an annualised basis) for two consecutive quarters even though corporate profits increased in Q2. Companies remain largely pessimistic in their outlook. Industrial production and goods export volumes both showed solid increases in Q3, but this momentum is unlikely to be maintained given the strength of the yen. Rent Grade A office rent was broadly flat in Q3 2016, but with signs of weakness. Rents are softening for new leases. That said, rent increase requests on lease renewal or expiry are common. Some tenants enjoying low rent for the initial lease term face steep increases, particularly for fixed term leases (FTLs). The currency is indeed one of the biggest obstacles to an economic pick-up. As of 11 November, the Japanese yen has strengthened by about 13% against the US dollar since the start of 2016, adversely impacting manufacturing and export-driven sectors. Oxford Economics assumes the yen will stay strong against the US dollar till the end of 2016 before starting to weaken modestly. However, Oxford Economics only expects the yen to fall to 110 versus the dollar by mid-2018. Supply We forecast total new supply of 172,000 tsubo (569,000 sq m, or 6.1 million sq ft) for Tokyo in 2016, followed by a 24% drop to 130,000 tsubo (430,000 sq m, or 4.6 million sq ft) in 2017. However, over 2018 and 2019 we predict a surge in supply to 245,000 tsubo (810,000 sq m, or 8.7 million sq ft) and 234,000 tsubo (774,000 sq metres, or 8.3 million sq ft) respectively. These two years are likely to be the second and third largest years for new supply in Tokyo for a decade. Moreover, 70% of the new supply will be located in Tokyo's three central wards (Chiyoda-ku, Chuo-ku and Minato-ku). Looking further ahead, the Japanese economy continues to face significant challenges. The lingering problems of weak aggregate demand, high corporate debt and deflation are starting to fade into the background. However, perhaps the biggest challenge remains poor demographic profile: Oxford Economics projects an average annual decline in the working age population of 0.8% over the next decade. Other issues include low productivity growth in semi-protected sectors such as retailing, and loss of competiveness in formerly efficient manufacturing industries. Figure 30: Recent economic performance and key forecasts for Japan GROWTH RATE (%) 2014 2015 2016 2017 2018 2019 Real GDP -0.1 0.6 0.6 0.6 0.8 0.7 Private consumption -0.9 -1.2 0.5 1.1 1.1 0.9 Fixed investment 1.1 0.2 0.4 0.6 0.8 1.1 CPI 2.8 0.8 -0.2 0.2 0.5 1.2 USD1.0 = JPY 105.9 121.0 106.9 105.8 109.5 110.0 Source: Oxford Economics 26 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International Vacancy rate We expect the currently low vacancy rate (3.8%) for Tokyo's CBD areas to rise to 6.0% by end-2019 as vacancy levels rise in existing office stock Investment volumes declining The weakness of the economy and the strength of the Japanese yen have taken their toll on investment volumes in the Japanese property market. According to global data from Real Capital Analytics (see Figure 31 below), so far in 2016 total investment transactions for income-earning properties in Tokyo have fallen by 33% y-on-y to USD13.0 billion; this is the second largest decline among major world cities after London. The majority of Japanese real estate transactions are made by J-REITS, and the strength of the currency is not a problem for domestic investors. But it does deter investment by foreign institutions. We do not think all is gloomy in the Tokyo investment market. Indeed, our impression is that even most foreign investors maintain high interest in all parts of the market given low financing costs, attractive spreads (3.6% for Tokyo office property) over the national ten-year bond with its negative yield, and the mostly stable Japanese political situation. Major purchases by foreign investors so far in 2016 have included PGIM Real Estate's purchase of the 12-storey Abercrombie & Fitch Ginza Building for JPY25 billion (USD245 million) and IDERA Capital Management's purchase of a 67.1% ownership of the 44-storey Harumi Island Triton Office Square Y for JPY50 billion (USD482 million). While interest remains strong, a lack of quality assets drives prices higher and compresses cap rates for all property market segments throughout Japan. The gap between bid and offer is narrowing, but is generally closing in favour of sellers, and remains wide enough to limit transaction volume. Most investors seem to think it is hard to find attractive assets in the current market. Japanese property: dull near-term outlook, brighter in the long term From the perspective of investors in property, Japan's principal problems at present are the dull economy and the strength of the Japanese yen. Neither of these problems is likely to be resolved any time soon. Additional concerns for investors in office property include our projection of a 2.4% average annual decline in Tokyo office rents over the next three years, combined with an increase in the vacancy rate to 6.0%. These factors ought to reduce cash income to investors, and over after a time lag lower cash income may depress capital values. In the near term, therefore, it seems hard to recommend Tokyo property in preference to property in other major cities in the Asia Pacific region. Japan's principal investment attractions are low financing costs, reasonably stable politics and high yield spreads over bonds with a negative return. In the long run, we expect these positive factors to come to the fore again. Some of the best investment opportunities in Japan in general may well be found in emerging sectors of the property market like hotels. The Japanese government targets 40 million foreign investors by 2020, a doubling from the level of 2015; and Mizuho Research Institute has estimated that there will be a shortage of 44,000 hotel rooms in 2020 based on existing stock. It is no surprise that several big property developers are working on long-run hotel projects. One example involving foreign capital is the cooperation between the Tokyobased developer Pacifica Capital KK and Hong Kong’s Great Eagle Holdings Ltd. to develop the first hotel under the Langham brand in Tokyo’s Roppongi district, at a reported cost of about JPY50 billion (USD485 million). Figure 31: Major global centres - total investment transactions so far in 2016 2014 1 4 5 2 3 6 7 10 14 11 Ranking 2015 1 3 4 2 6 5 7 8 13 9 YTD 2016 1 2 3 4 5 6 7 8 9 10 Market NYC Metro LA Metro SF Metro London Metro Tokyo Paris DC Metro Chicago Miami/ So Flo Dallas Sales Volum e (USD m illions) YOY Change $44,721 $23,728 $19,572 $18,358 $13,030 $12,959 $12,354 $11,984 $11,714 $11,450 Source: Real Capital Analytics 27 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International -14% -2% -11% -56% -33% -32% -13% -7% 10% 0% India Economic outlook remains positive, supported by new policy initiatives India, Asia's second largest economy, is the region's fastest-growing of all, with y-o-y real GDP growth set to reach 7.5% in 2016 and set to remain at or close to 7.0% for the next three years. India benefits from one of the most favourable demographic profiles in Asia: more than 50% of total population is below the age of 25 years, and more than 65% below the age of 35 years. India's working age population should continue to grow strongly over the next couple of decades. The expansion of the middle class and some of the lowest unit labour costs among the BRICS economies are other factors likely to help drive growth over the medium term. In the near term, the persistence of GDP growth of over 7.0% is supporting business confidence. CPI inflation is under control due to a downturn in food price momentum which looks set to persist over coming months. This abatement of inflationary pressures permitted the Reserve Bank of India to lower interest rates at the end of October 2016, catching many market analysts by surprise. Higher public sector wages, moderate oil prices and potential further monetary easing should all help boost households’ consumption power in the near term. Besides these encouraging economic developments, India's business-friendly government has undertaken various reform initiatives whose cumulative impact on growth should be positive. The most notable measure is the recent demonetisation of 1000 and 500-rupee currency notes, which we see as a bold and welcome step. This measure is being touted as a surgical strike on black money which aims to remove the parallel economy running on unaccounted cash accumulated through tax evasion. In the long run, this measure, coupled with the Real Estate Regulation and Development Act 2016 (RERA), ought to align the Indian real estate sector to international standards of doing business. This should result in increased funds flow from institutional investors and banks, and in higher sales. Measures such as increased ease of doing business, the implementation of the GST (Goods and Services Tax), the "Make in India” initiative and a less strict regulatory regime for FDI in sectors such as e-commerce should all make India more favourable as an investment destination. The e-commerce sector is already booming: risk capital worth over USD9.0 billion was invested in Indian start-ups in 2015. In property, most developers are preparing for the new regulations imposed by the Real Estate Regulation and Development Act, 2016, which we expect to increase transparency, discipline and accountability across the property market. The property sector should also benefit from other policy changes such as land reforms, the amendment to the Real Estate Investment Trust (REIT) norms, and the introduction of a uniform taxation system across all India’s states through the Goods & Services Tax reform. Most of these reforms are good for the property sector over the long term although slow implementation may reduce their effectiveness. Despite the brighter longer-term outlook, the recent demonetisation of currency notes will probably significantly reduce liquidity in the market in the near term and should lead to an immediate period of deflation, as money becomes dearer. We expect transaction volumes to go down in real estate sector in the near term and foresee downward pressure on prices especially in land and secondary market transactions. Figure 32: Recent economic performance and key forecasts for India GROWTH RATE (%) 2014 2015 2016 2017 2018 2019 Real GDP 7.0 7.2 7.5 7.2 7.0 6.8 Private consumption 6.7 7.0 7.8 7.5 7.4 7.3 Fixed investment 2.8 5.8 -1.7 5.2 5.9 6.2 CPI 6.6 4.9 5.3 5.3 5.3 5.2 USD1.0 = INR 61.0 64.1 67.0 67.1 67.5 68.5 Source: Oxford Economics 28 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International Office leasing market firm: focus on Bangalore and Hyderabad Office absorption has witnessed sustained momentum with Grade A absorption for the nine major cities totalling 28.3 million sq ft (2.63 million sq metres) so far in 2016. Occupier demand remains focused on quality space in preferred micromarkets in most of these cities. Despite a dip in Q3, we expect office leasing deals to pick up in coming quarters as a few large deals come to fruition. Meanwhile, office rents increased by 2.5% y-o-y in Q3 2016, led by rising rents in technology-driven markets such as Bangalore, Pune, Gurgaon and Chennai. IT and technology-enabled services contribute about 70% of total demand for office space in India. With 1012% annual growth in the IT sector likely to persist till 2020, demand for office growth should remain strong for the next few years. Bangalore, the technology capital of India, makes the highest contribution to total demand, and is the city likely to see the firmest demand. Hyderabad is also emerging as a new technology hotspot in India, with Google planning its biggest campus in this city. Apple, Amazon, Google, and Uber have queued up to locate their second largest development centres, outside the US, in Hyderabad. As space efficiency is the top priority for commercial real estate heads we can expect more consolidation and relocation to cheaper locations and a decrease in overall leasing volumes. There is also high demand for ready fully leased commercial assets. However, due to limited availability of Grade A buildings suitable for consideration by REITs, growth in this segment is being hampered. That said, there a few funds and developers such as Blackstone, Embassy Group and DLF which are likely to list their REITs in 2017. Listings should certainly boost the institutional investment in this sector. Medium-term investment opportunities substantial Numerous sovereign and international private equity funds including ADIA, GIC, Temasek, QIA, CPPIB, Blackstone, Ivanhoe Cambridge, Macquarie, Brookfield, Morgan Stanley, JP Morgan, KKR and Warburg Pincus either already have invested or are widely believed to have firm near-term investment plans for the Indian real estate market. This high level of interest is not visible from public transactions data. According to Real Capital Analytics (RCA), total property transaction volume in India over the first nine months of 2016 fell by 42% y-o-y to USD1.40 billion. On this basis, if one groups smaller markets 29 together under the heading of "Other", India ranks in tenth position among Asia Pacific investment market so far this year - behind even New Zealand. For Q3 2016, the RCA figures suggest that total investment volume dropped by 82% to just USD192 million. However, in a business like property which is characterised by transaction volumes, quarterly figures are often very volatile, so we would caution against reading too much into figures for a single quarter. Figure 33: APAC property deals, Jan-Sep 2016 Position Market Value (USD million) Y-o-y chg. (%) 1 Japan 21,502.3 -34% 2 China 20,308.5 -7% 3 Australia 14,703.1 -38% 4 Hong Kong 10,196.7 16% 5 Singapore 5,460.2 54% 6 South Korea 5,302.9 46% 7 APAC Other 1,843.8 133% 8 New Zealand 1,623.2 -35% 9 Taiwan 1,456.8 0% 10 India 1,401.6 -42% - Malaysia 522.2 -60% - APAC Total 84,321.3 -18% Note. Intentionally repeated from Figure 9 above. Source: RCA However, we would argue that the Indian property sector offers appealing medium-term investment opportunities: > Real estate is India's second largest employer after agriculture. The housing sector alone contributes 5-6 per cent to the country's GDP. > India is one of Asia’s largest office property markets, with about 35 million sq ft (3.3 million metres) of annual absorption and total market size of about 450 million sq ft (41.8 million sq metres), > We expect Real Estate and Infrastructure Investment Trusts to be launched soon in India. Hines, GIC, CPPIB, Blackstone, Ascendas and Mapletree are institutions thought to be actively seeking completed grade A office buildings in preparation for REIT listings. > Huge opportunity for affordable housing: with a current housing shortage of over 20 million units, the government aims to provide "Housing for All by 2022". However, we should note that the residential market has been stagnant for the past two years due to a demand and supply mismatch which we do not expect to be rectified quickly. Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International > Manufacturing revolution through "Make In India": The “Make in India” initiative, 100% FDI in the ecommerce sector and the new Goods and Services Tax (GST) should fuel growth in the industrial and warehousing segments of the property market. > Industrial parks: Chinese developers such as Wanda, Fosun and Country Garden are believed to have major plans to invest in India. Wanda is thought to be at the due diligence stage to develop 3,000 acres of “industrial townships”, while the private equity firm Warburg Pincus and the property firm Embassy announced earlier this year that they would invest USD250m in industrial parks. > Smart city initiative creating demand for Tier II and III cities: the government has initiated the development of 100 “smart cities” and rejuvenated 500 more. Time for investors to put India on their radar screens India is a less developed country than China: GDP per capita on a purchasing power parity basis was only USD6,200 for India in 2015, compared to USD14,300 in China (source: CIA World Factbook). Moreover, despite its undoubted huge potential, India continues to suffer from challenges such as inadequate infrastructure which hold the country back. Such factors help explain why most institutional investors consider India to be a deeper emerging market than China, and why the Indian riskfree rate is much higher than the Chinese (Indian tenyear bonds yield 6.7% rather than 2.8% as in China). However in the recent years the government has proactively been investing in infrastructure projects and encouraging public private partnership in this sector. In the property sector, most investors still regard India as non-core, and this situation is unlikely to change for some time. It therefore makes little sense to suggest, for example, that Indian office property is more attractive than office property elsewhere in the Asia Pacific region simply because it offers the highest absolute yields 8.3% in the case of Mumbai's BKC district. On the other hand, an increasing number of institutional investors are already present in the Indian property market, and the amounts of money that they have committed or plan to commit are significant. Considering the ample medium-term investment opportunities that we perceive in India, we think it is time for investors to start paying greater attention to the country. In this respect, institutional investors will be following the example of large multinational occupiers, which have already made major commitments to markets such as Bangalore, Mumbai, the National Capital Region and Hyderabad. 30 Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International US election: impact on Asia Trump's victory surprises global markets, but less so than Brexit At first sight, the unexpected victory of Donald Trump, the Republican candidate, in this year's US presidential election raises many challenges for Asia, including a possible near-term hit to US and global confidence and growth and radical trade policies targeting China and other countries. We saw some of the possible implications on 9 November in the form of falling Asian stock markets and a sharp strengthening of traditional safe haven assets such as gold and the Japanese yen. It is possible that any turbulence in financial markets following Mr Trump's victory will prove very short-term. Indeed, the US equity market rallied strongly over the days after Mr Trump's election, and the Dow Jones Industrial Average closed at an all-time high on Friday 11 November (although the broader S&P 500 index remains just short of its all-time high). Certainly, Mr Trump's victory appears to be having a less adverse impact on financial markets than the shock of Brexit, i.e. the UK's vote to leave the European Union 23 June. Even if politically driven tumult in financial markets restarts, for the moment there are few grounds to believe that it will lead to any long-run declines or recession in the US. Expansionary and contractionary: different views about Trump's economic policies However, now that Mr Trump has won, we must start to examine his policies. Mr Trump has many radical policy proposals, but he did not articulate them very clearly during his presidential campaign; nor is it clear which of his policies he will actively promote first. Domestically, Mr Trump has suggested that he will press for up to USD1.0 trillion of tax reductions and a major clampdown on illegal immigrant workers, while regarding foreign policy he has suggested that he will press for tariffs of up to 45% to be imposed on imports from China and other countries. In office, Mr Trump may prove less radical than his policy proposals suggest. That said, elections for 34 of 100 seats in the Senate and all 435 seats in the House of Representatives were held on the same day as the presidential election. The outcome has been very good for the Republican Party, which has regained control of 31 the Senate and retained control of the House of Representatives. If Mr Trump does face opposition to his policies, it will have to come from within his own party. There seem to be two quite different schools of thought about the probable domestic impact of Mr Trump's economic vision. The first is that the large proposed tax cuts will have an expansionary effect on the US economy. This view appears to be coupled with the idea that Mr Trump's administration will actively promote large-scale infrastructure projects in order to stimulate the economy. In this scenario, it is reasonable to expect the US budget deficit to increase, and inflation to pick up. This school of thought appears to have majority acceptance so far, and explains why the US bond market has experienced a major sell-off since Mr Trump's election: the ten-year Treasury bond yield has surged in just three days from 1.86% to 2.15%. If inflation is set to pick up, then the Federal Reserve will probably push up interest rates relatively quickly. Such action ought to support the US dollar. This view may explain why the dollar has strengthened over the past few days, even against "safe haven" currencies such as the Japanese yen. If it could be maintained over the medium term, US dollar strength would be positive for Asian manufacturing nations, since it would boost the competitiveness of their exports. To a limited extent, therefore, US dollar strength might compensate for possible new tariffs on Asian imports. The second school of thought is that Mr Trump's proposed tax reductions will end up being financed largely by cuts to government spending. The combination of lower spending and the deportation of large numbers of illegal immigrants (assuming that Mr Trump carries out his campaign threats) will have a contractionary effect on the US economy - perhaps not straight away, but within a year or two. Oxford Economics is a respected forecasting house which, at least in the run-up to the election, subscribed to this second view. In its "moderate Trump" scenario, Oxford Economics posited tax cuts of USD1.0 trillion, spending cuts of USD750bn and tariffs against China of 15%. This outcome would have a limited negative impact on US growth and marginal effect globally. In its "adverse Trump" scenario, Oxford Economics posited tax cuts of USD1.0 trillion, front-loaded spending cuts of USD1.0 trillion and tariffs against China of 45%, with additional tariffs on South Korea and India This outcome would have a significant negative impact on US growth and materially reduce growth prospects in Asia. It is obviously too early to take a very firm view one way or the other. However, considering the positive economic news that we have seen for the Asia Pacific region, and Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International especially China and Hong Kong, so far in 2016, in order to avoid excessive optimism we prefer for the time being to take the second view. Uncertainty has increased for China in particular as a result of Mr Trump's election, and this must temper our enthusiasm about improving near-term prospects. However, we are keeping an open mind, and will be ready to revise our opinion if and when the evidence permits it. Slow US interest rate rises would support Hong Kong property What would be the implications for Asia of the contractionary growth scenario for the US under Mr Trump? We have been assuming that the US Federal Reserve will raise interest rates again this December (as it has already signalled it plans to do), and thereafter that it will push up US interest rates steadily over the next few years. However, if US growth does suffer under Mr Trump, then the Federal Reserve may only raise interest rates very gradually over the next few years, and possibly barely raise them at all. This prospect has positive implications for property assets in Hong Kong, because Hong Kong interest rates are effectively tied to US rates as a result of the territory's currency peg. Hong Kong has enjoyed negative real (i.e. inflation-adjusted) interest rates since late 2009, and as a result has enjoyed what we would argue are the loosest monetary conditions in Asia. This prolonged period of easy money has coincided with an increase in residential property prices of roughly 200%. On the assumption that US interest rates only increase gradually and that inflation in Hong Kong stays constant, we do not expect Hong Kong to return to positive real interest rates before early 2018, and possibly H2 2018.This outcome should support capital values across most segments of the Hong Kong property market, although residential prices will remain vulnerable to further tightening measures similar to the harsh stamp duty increases announced by the government last week. USD weakness would hurt Japan and other Asian exporting nations If US economic growth suffers and US interest rates increase more slowly than we have assumed up to now, the US dollar may also start to weaken after many years of strength. This scenario would be negative for Asian exporting countries, notably China which would be the chief target of threatened new tariff barriers but also Japan (where the domestic currency is already strong), South Korea and Taiwan. This is because a weaker dollar would reduce the competitiveness of their exports, compounding the impact of possible weaker US demand and new tariffs on imports. 32 We should add that the weakness of the domestic economy and the strength of the Japanese yen have already taken their toll on investment volumes in the Japanese property market. According to global data from Real Capital Analytics, so far in 2016 total investment transactions for income-earning properties in Tokyo have fallen by 34% y-on-y to USD13.0 billion; this is second largest decline among major world cities after London. If the yen continues to strengthen, foreign investors may increasingly find themselves priced out of Japanese property markets. Direct implications for Asian property markets are limited Direct medium-term implications of Mr Trump's victory for the property markets within developing Asian economies are more limited. China and India - perhaps especially India - are experiencing strong secular growth which is unlikely to slow sharply for the next few years. Investors and large multinational occupiers should continue to be attracted to important commercial property markets like Shanghai regardless of who is US president. Meanwhile, demand and supply in the Chinese and Indian residential markets are driven largely by domestic factors such as urbanisation, wealth levels, interest rates, lending policies and real estate regulation which have little to do with the US. Trump and Brexit surprises should lower concern about Asia over time Perhaps the most important implication of Mr Trump’s victory for Asia lies in the long term. In combination with this year’s unexpected vote in the UK for Brexit, i.e. departure from the European Union, the success of an anti-Establishment candidate in the US should remind global investors and property occupiers of the potential for shocks in developed as well as emerging countries. Since the Global Financial Crisis, US financial assets have been in high demand and the US dollar has been strong. This has been reflected in heavy capital outflows from Asian real estate and stagnating capital inflows over the past eight years or so. Despite possible nearterm volatility in emerging markets, we believe that the twin developed market shocks this year of 2016 will mitigate long-standing political and economic concerns about Asia, and lead to higher demand for Asian financial assets including property over time. Asia Pacific: the dragons rise anew | 14 November 2016 | Property Research | Colliers International 554 offices in 66 countries on 6 continents United States: 153 Canada: 34 Latin America: 24 Asia Pacific: 231 EMEA: 112 $2.5 billion in annual revenue 2 billion square feet under management 16,000 professionals and staff About Colliers International Group Inc. Colliers International Group Inc. (NASDAQ: CIGI; TSX: CIG) is an industry leading global real estate services company with more than 16,000 skilled professionals operating in 66 countries. With an enterprising culture and significant employee ownership, Colliers professionals provide a full range of services to real estate occupiers, owners and investors worldwide. 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Primary Authors: Andrew Haskins Executive Director | Research | Asia +852 2822 0511 [email protected] Contributors: Luke Dixon Director | Research | Sydney CBD +61 292 492 020 [email protected] Daniel Lees Director | Research | Sydney CBD +61 292 570 327 [email protected] Daniel Shih Director | Research | Hong Kong +852 2822 0654 [email protected] Tricia Song Director | Research | Singapore +65 6531 8536 [email protected] Carlby Xie Senior Director | Research | China +86 21 6141 3590 [email protected] Ines Li Associate Director | Research | Beijing +86 10 8518 1633 [email protected] Yumiko Yasuda Head of Research | Japan +81 3 5563 2174 [email protected] Surabhi Arora Senior Associate Director | Research | Gurgaon +91 124 456 7580 [email protected] colliers.com Copyright © 2016 Colliers International. The information contained herein has been obtained from sources deemed reliable. While every reasonable effort has been made to ensure its accuracy, we cannot guarantee it. No responsibility is assumed for any inaccuracies. Readers are encouraged to consult their professional advisors prior to acting on any of the material contained in this report.