Investment in a Minute - Weathering the storm: How does the recent banking turmoil impact Asia Pacific real estate?

In the past two months, global financial markets have experienced substantial volatility, brought about by the emergence of turmoil within the banking system.

Notably, we saw the collapse of Silicon Valley Bank (SVB), the seizure of Signature Bank in the US and a regulator-driven takeover of Credit Suisse in Europe. With regulators stepping in promptly and decisively to provide liquidity, stability and confidence, volatility has eased somewhat. 

Rates markets have recalibrated to factor in tighter credit conditions, while broad equity market indexes have largely taken the turmoil in their stride. 

Emerging fragilities but hard to predict where the next domino will fall

While the recent turmoil has centred on the banking sector, we are cautious that other economic sectors may be more exposed to the sharp change in interest rates.

For instance, financial institutions with a sizeable liquidity mismatch between the assets they hold and the speed with which liabilities can be called could be a source of instability, if they are forced to sell their most liquid assets first. 

Commercial real estate is also vulnerable, particularly office markets impacted by hybrid working, and where banks are more exposed to the sector, such as the US regional banks. Housing markets that went through an extended boom in prices with increased borrowings and have floating rates may also start to crack, for instance Canada, Sweden, Australia or South Korea. 

Asia Pacific banks unlikely to suffer any contagion

Generally, Asia Pacific banks are in a stronger, better capitalised position with robust balance sheets, sound funding and liquidity profiles. Unlike SVB and Signature Bank, customer bases of most APAC banks tend to have a significantly larger retail flavour with most deposits from domestic households constitute a significant proportion of total domestic deposits (Chart 1). Furthermore, liquidity ratios remain healthy across most Asia Pacific banks (chart 2). 

APAC real estate values largely expected to weather rate hikes well

The magnitude of policy rate hikes in Asia Pacific is less pronounced compared to the US. But some markets, such as Australia and South Korea, have been more aggressive and raised policy rates by 300 and 175 basis points respectively in 2022. Real estate values have weathered this well. Logistics and office cap rates expanded by around 70 bps and 30 bps respectively in these two markets in 2022 (chart 3) and we expect similar yield expansion for 2023.

However, we do not expect Australian logistics or Seoul office asset values to fall due to the strong rental increases in these two sectors. For Australian logistics, vacancy rates are low (<1.5% at end 2022) and demand is resilient. The upcoming supply in 2023-24 is already 58% pre-committed, according to CBRE.

South Korea’s logistics could offer a pricing opportunity 

One area of price dislocation could be South Korea’s logistics sector, where development activity ballooned in the last two years with elevated leverage. The volume of modern logistics facilities earmarked for completion in 2023-2024 is close to double the existing stock and there is a glut of cold chain logistics development. Meanwhile, credit conditions in South Korea have tightened, evident by the Legoland default and difficulties among state-backed developers in obtaining financing.

We think some developers may face refinancing issues if they are unable to secure pre-commitments for these development projects. Asset valuations are now sharply lower than their underwriting as borrowing costs are now significantly higher. Assets in sub-markets with severe oversupply or poorer quality assets with a higher proportion of cold space and situated in non-core locations are likely to trade at higher yields. With the recent global volatilities and a slew of developers seeking capital restructuring, we believe that investors will be able to demand increased risk premia and enter the market at an attractive price point.