Investment in a Minute - Japan Real Estate Looks Compelling as Yen Declines

A Shift in Investment Capital Flows

Over the past few years, despite real estate capital rates compressing to record low levels, the availability of cheap financing meant that investors could still achieve positive leverage by taking on debt to improve their equity returns; this, however, is no longer the case in many markets. In some of the favoured Asia Pacific real estate markets like South Korea and Australia where financing costs have risen significantly over the past 6 months, investors are now facing a situation that has not been observed in a long time – negative leverage.

With Japan being one of the only countries swimming against the tide of tightening monetary policy and maintaining its ultra-low interest rates, it has been the biggest beneficiary of capital inflows. Furthermore, with the Japanese Yen currently at a 32-year low against the US Dollar, Japanese real estate prices look attractive from a dollar perspective, and many global investors are looking at this as a compelling time to increase their exposure into the market.

Attractive Sectors

We maintain a long-term positive view on the “beds and sheds” thematic across the region:

• The living/multi-family sector benefits from structural tailwinds of positive demographic and urbanization trends in the region (with Asia being home to some of the fastest growing cities). It is also seen as a defensive sector, having proven to be resilient through past downturns. While already a very established asset class in Japan, it is still nascent in other regional markets such as Australia where there is an acute housing shortage and a dearth of institutionally managed product.
• High quality modern logistics properties continue to be an attractive investment, in our view. While there may be some near/medium-term repricing within the sector particularly in markets that were running too hot, the fundamental multi-year drivers of rising e-commerce adoption and broader economic digitalization remain. In addition, we expect a faster, stronger economic growth/recovery in the Asia Pacific region, which would support this sector further.

Be mindful

Given the uncertain macro environment as well as the typical lag in asset revaluations, it would not be surprising to see a further softening of asset values in the coming months. However, the repricing will be discriminate, with higher quality assets likely to have their values hold firm while inferior assets may see their values impacted to a larger extent.

Additionally, the focus on ESG within the real estate investment market will only continue to increase; similar to what we’re seeing in the United States and UK/Europe, green premiums / brown discounts will almost certainly become more prevalent in the Asia Pacific markets going forward.

Should one still look at real estate investments?

Real estate is widely known to provide a good inflationary hedge, and rental and capital value growth have historically kept up well with inflation. Many contracted leases have built-in annual escalations, and at times the escalations are pegged to inflation.

In many Asia Pacific markets, leases are relatively shorter (typically ranging 3-5 years) which allows for rents to adjust more quickly to the market in times of sustained inflation.

While more illiquid, private real estate does come with less volatility compared to public assets. Investing in private real estate provides the ability to enhance the value of assets (for instance through tenant repositioning or asset enhancement initiatives) to increase income and yield, further hedging against cyclical inflation over time.