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JLL Research Report How will interest rate movements affect prime office yields in Asia Pacific?
2 JLL Executive Summary JLL expects office yields in most Asia Pacific cities to stay stable over the next three years so long as financing costs increase by 50-150bps from here, in line with current expectations. Prime office yields in most global cities in Asia Pacific have compressed over the last ten years, due both to an abundance of capital chasing assets as well as lower financing costs. Yet, we find that the yield compression in Asia Pacific has not fully reflected the decline in financing costs and yield spreads have widened across the region since 2013. Investors are likely to have been sceptical of the sustainability of low interest rates and already accounted for a 50-150bps increase in interest rates in their asset pricing. Lending margins have also narrowed by 50-100bps over the last five years due to new sources of funding and competition.
How will interest rate movements affect prime office yields in Asia Pacific? 3
Interest rates likely to rise from here as economic growth improves
Over the last six months, expectations of growth over Interest rate is one of the components that makes up This paper aims to answer the following questions:
the next three years have improved significantly. The IMF total cost of capital, hence is a major consideration for
1. How far have prime yields compressed in major AP office
now expects 2018 global economic growth to hit 3.9%. property investors. Most investors use leverage by taking
markets in the last decade and did they fully reflect the
As economic growth improves globally, interest rates are loans or issuing bonds as part of financing requirements
decline in financing costs?
likely to rise. The U.S. Federal Reserve is expected to raise when purchasing a real asset, be it for owner occupation
interest rates three or four times in 2018. South Korea raised or investment. Even if investors were to use only their 2. How have property investors’ financing costs changed in
their benchmarking rate for the first time in six years. The own capital, the required return would still be influenced the last decade amid quantitative easing and low bond
European Central Bank cut bond-buying from January 2018 by interest rate benchmark movements, thus potentially yields?
and agreed to revisit monetary policy in early 2018 as the moving real estate market yields.
3. Based on economists’ consensus estimates of
bloc’s economy continues to grow.
government interest rates over the next three years, how
will financing costs and prime office yields react?
4 JLL
Has yield compression fully reflected the decline in financing costs?
Since 2010, total Asia Pacific real estate transaction volumes Fig 2: Prime office yields in Asia Pacific cities (%)
almost doubled to USD150bn in 2017 due to increasing 8.5
allocation of capital to real estate and the decline in
financing costs globally. With the weight of capital chasing 7.5
assets, real estate yields have fallen over the last decade.
6.5
5.5
Fig 1: Asia Pacific transaction volumes
4.5
160,000 3.5
140,000 2.5
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
120,000
Sydney Singapore Seoul Shanghai Tokyo Hong Kong
100,000 Source: JLL estimates. NOI yields except Shanghai yields which are gross yields.
80,000
60,000 Fig 3: Financing cost for landlords/investors in Asia Pacific cities (%)
40,000 10
20,000
8
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 6
Japan China Australia South Korea
Hong Kong Singapore AsiaPac All Others 4
Source: JLL estimates
2
In key office markets across Asia Pacific, prime office yields 0
compressed significantly over the last decade, with the 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
steepest compression of over 200bps in Sydney, Shanghai Sydney Singapore Seoul Shanghai Tokyo Hong Kong
and Hong Kong, and the smallest decrease of up to 100bps
in Singapore and Tokyo. Source: JLL estimates
How will interest rate movements affect prime office yields in Asia Pacific? 5
One would argue that prime office yields could start to rise Fig 4: Office yield spread over financing cost in Asia Pacific cities (%)
should interest rates increase. We believe this broad-brush
assumption may not fully hold for all markets and the 140
+ 65 bps
outcome could be more nuanced. While financing costs fell 2.5
significantly from 2013, prime office yields did not fall by 105
as much. + 44 bps + 66 bps
1.5 70
Across Asia Pacific, when cost of financing decreased
sharply from 2013, yield spreads over the cost of debt took + 138 bps + 103 bps 35
0.5
a step up. Yield spreads in 2013-2017 range from 30-240bps,
which are 50-140bps higher than the period in 2009-2012. -
This could potentially be due to investors’ scepticism about -0.5
the sustainability of low interest rates. Investors may have -35
started to account for higher longer term financing costs in
their asset pricing from 2013. As a result, prime office yields -1.5 Sydney Singapore Seoul Shanghai Tokyo Hong Kong -70
did not fully reflect the compression in financing costs. One
could argue that this buffer allows some flexibility for cap 2009-2012 2013-2017
rates to stay flat even if financing costs were to rise 50-140
bps over the next three years. Source: JLL estimates. Note: For Shanghai and Hong Kong, cost of debt only fell from 2015 so we use 2008-2014 and 2015-2017 respectively
The exception is Japan, potentially because investors do
not expect interest rates to rise in the foreseeable future.
Prime office yields in Japan were at a 217bps spread above
financing costs in 2009-2012 and this remained unchanged
in 2013-2017.
Yield spreads widened from 2013 due to investors’
scepticism about sustainability of low interest rates
6 JLL
How about financing spreads?
Furthermore, while base interest rates or government bond Fig 5: Financing cost spread over government bond yields in Asia Pacific cities (%)
yields may rise over the next few years, financing costs may
not fully reflect that increase. In 2013-2017, asset owners - 90 bps - 73 bps
across the region have been able to secure financing at 3.0
a lower spread over base bond yields than in 2009-2012,
as banks reduced their lending margins amid strong 2.5
competition. For this paper, we have used the average
financing cost secured by large landlords or listed REITs
where available. 2.0
Listed REITs in the region were also able to diversify their 1.5 - 83 bps
sources of funding to include multi-term notes, retail - 73 bps
bonds in addition to traditional bank loans. On average,
1.0 + 13 bps
financing spreads are now 20-200bps above bond yields, - 34 bps
which is about 40-90bps lower than the 60-300bps
spread in 2009-2012. The only exception is Japan, where 0.5
financing spreads have stayed relatively unchanged. While
bond yields may rise over the next few years as central 0
banks raise policy rates, we think it is unlikely for lending
Sydney Singapore Seoul Shanghai Tokyo Hong Kong
margins in these developed markets to widen too far out
again. Margins are only expected to increase if the risks
associated with real estate, corporate defaults or bond 2009-2012 2013-2017
market dislocations increase.
Source: JLL estimates. Note: For Shanghai, cost of debt only fell from 2015 so we use 2008-2014 and 2015-2017 respectively
Asset owners have secured financing at a lower spread
over bond yields in the last 5 years
How will interest rate movements affect prime office yields in Asia Pacific? 7 What could happen to prime office yields as interest rates start to rise in the next three years? Based on economists’ views on government interest Fig 6: Financing cost in Asia Pacific cities (%) rates across Asia Pacific in the next three years, we expect financing cost to rise by 30-130bps, potentially reverting to 10 2012-2014 levels. The exception is Japan, where economists continue to expect the current low interest rate regime to persist for the next three years. 8 We have assumed the highest increase in financing cost for Australian landlords of about 130bps to 5.5% in 2020, 6 close to 2014-levels, based on the 10-year Commonwealth Government bond rate rising to 3.5% by 2020 and the spread between financing cost and bond yields staying 4 at 200bps. In Shanghai and Hong Kong, we assume financing cost 2 could rise about 100bps to 2013 levels. For Singapore, we expect financing cost for landlords to rise to 2.95%, close to 2011-levels but just 40bps higher than 2017 levels. 0 While economists expect US Treasury bond yields to rise to 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E c.3.5% by 2020, the Singapore 10Y government bond yield is not expected to exceed 3.0% by 2020 after accounting Sydney Singapore Seoul Shanghai Tokyo Hong Kong for historical spreads and some appreciation of the Singapore dollar. Source: JLL estimates
8 JLL
Office yields in 2018-2020 Fig 7: Prime office yields in Asia Pacific cities (%)
In our view, investors may have fully accounted for this 7.5
magnitude of increase in financing costs. As a result, in
Singapore, Seoul and Tokyo, we forecast prime office yields 7.0
to stay flat or rise only mildly in 2018-2020, after accounting
6.5
for financing costs increasing in line with these expectations
(see Fig 7-12). 6.0
5.5
For Sydney, we expect prime office yields to increase by c.
50-100bps over 2018-2020 in tandem with rising financing 5.0
costs. For Hong Kong and Shanghai, our analysts expect
strong liquidity to result in mild compression of office cap 4.5
rates in the next few years. 4.0
3.5
3.0
2.5
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
Sydney Singapore Seoul Shanghai Tokyo Hong Kong
Source: JLL estimates. NOI yields except Shanghai yields which are gross yields.How will interest rate movements affect prime office yields in Asia Pacific? 9
Fig 8: Forecast prime office yield in Singapore (%) Fig 9: Forecast prime office yield in Seoul (%) Fig 10: Forecast prime office yield in Sydney (%)
6.00 8 10
5.50 7
8
5.00 6
4.50 5 6
4.00 4
3.50 3 4
3.00 2
2
2.50 1
2.00 0 0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 -1 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E2019E2020E
-2
Office REITs Cost of Debt Spread JLL Market Yield AAA Bank Bond Yield Yield Spread JLL Market Yield
-4 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 20172018F2019F 2020F
Mid-point (A vs BBB) Spread CBD Prime
Fig 11: Forecast prime office yield in Tokyo (%) Fig 12: Forecast prime office yield in Hong Kong (%) Fig 13: Forecast prime office yield in Shanghai (%)
4 8% 10%
8%
3 6%
6%
2 4%
4%
1 2%
2%
0 0% 0%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
Office REITs cost of debt Spread JLL Market Yield -2% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E -2%
Cost of Debt Spread Grade A Office Yields - Central -4% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E2019E2020E
Cost of Debt Spread Gross Office Prime Yield
Source: JLL estimates10 JLL
Singapore economy and bond yields
The Singapore economy expanded by 3.6% in 2017, the bond yields. Consensus amongst economists indicate Fig 14: 10Y government bond yields in Singapore and US (%)
highest growth since 2013. Unemployment eased in approximately 8-10% appreciation of the Singapore dollar
7
4Q2017 and median gross monthly income rose 3% in 2017. over the next four years and the SGD 10Y bond yield to rise
Consensus Economics forecasts 2018-2019 GDP growth less than US treasury bond yields over the next three years. 6
of 2.7-3.0% as momentum in both manufacturing and 5
exportable services continue. Singapore government bonds had traded at a tighter
4
yields than US Treasury bond yields prior to 2012 due to
3
With the Singapore economy and inflation picking up in expectations of appreciation of the Singapore dollar. After
2018-2020, we expect the Central Bank to revert to a policy 2012, the weaker Singapore economy and moderation of 2
of slight appreciation for the Singapore dollar. This is likely the SGD by Singapore’s Central Bank have caused the gap 1
to cushion Singapore bond yields from rising US Treasury to close.
0
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UST SGD 10Y bond yield
Source: Monetary Authority of Singapore, Thomson Reuters
Fig 15: SREITs cost of debt vs 10Y government bond yield (%)
4.0
3.5
3.0
2.5
2.0
1.5
1
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
SGD10Y SREIT cost of debt
Source: Monetary Authority of Singapore, Thomson ReutersHow will interest rate movements affect prime office yields in Asia Pacific? 11
Financing costs for investors Fig 16: Singapore prime office yields vs investors’ financing cost (%)
In 2008-2012, 3-4 year financing costs for Singapore office 6.50
REITs (i.e. CapitaLand Commercial Trust, Keppel REIT and
Suntec REIT) were 100bps above the 10Y SGD government 6.00
bond yield. But this narrowed to 30bps in 2013-2017, and 5.50
40bps currently, as they diversified their sources of funding
to include multi-term notes and retail bonds in addition to 5.00
traditional bank loans. We do not expect financing margins 1.85 2.55
4.50
to expand dramatically over the next few years. We think
office REITs’ financing costs could rise 30-50bps over the 4.00 0.61
next three years. 0.68
3.50 1.05 0.84
1.81 1.25 0.89
What could happen to prime office yields? 3.00 0.91 1.81 1.06 0.99 0.95
As interest rates fell significantly from 2013, Singapore
2.50
prime office yields did not fully reflect the compression.
Prime office yields traded on average 80bps above 2.00
financing costs in 2009-2012, but this widened to 120bps 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
in 2013-2017. Potentially, investors were sceptical about
the sustainability of low interest rates and accounted Office REITs cost of debt Spread JLL market yield
for slightly higher longer term financing costs in their
acquisitions. As financing costs rise over the next three Source: Singapore office REITs, Monetary Authority of Singapore
years, potentially, the yield spread could normalise to 80-
90bps, moderating the rise in prime office yields.12 JLL
Korean economy and bond yields
Korea’s GDP grew 3.1% in 2017, the largest gain since 2014. one or two interest hikes. However, many economists Fig 17: Five-year government bond yields in Korea and US (%)
Solid export growth and facility investment led to the forecast only three hikes ahead, unlike the Federal
10
firm growth. The Bank of Korea (BOK) economic outlook Reserve – this denotes the bank will end its tightening at a
9
indicated the country’s economy would continue to benchmark rate of 2.25%. Massive household debt, weak
8
expand at a decent pace in upcoming years – growing 3% inflationary pressure, the appreciating Korean won and the 7
and 2.9% for 2018 and 2019, respectively, as robust export accommodative fiscal policy will play a role in forcing the
6
growth continues and consumer spending improves. bank to limit its monetary tightening. 5
4
The BOK raised its benchmark rate by 25 bps to 1.5% in Given the more aggressive interest rate hikes scheduled
3
November 2017, a sudden move that signalled an official in the US – the Federal Reserve aims to end its tightening
2
end of the dovish monetary policy era. Since the increase, cycle at 2.75% of the Federal Fund Rate – overall Korea
1
the interest rates of government bonds across maturities yields are predicted to trade lower than the US yields
0
continue to ascend, already pricing in an additional over the next few years. By adding 2.25%, the maximum
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benchmark rate at the end of the current interest hike cycle
to 40 bps, a historical spread between the BOK benchmark 5Y korean gov’t bond yield UST 5 years
rate and five-year government bond yield in the previous
Source: Dongbu Securities, Oxford Economics
interest rate hike cycle, we think that, at the end of the
current cycle, the Korea five-year government bond yield
could increase to the 2.65% mark, 65 bps up from the Fig 18: Five-year AAA bank bond vs. five-year government
average 2017 yield. bond yield (%)
6
5
4
3
2
1
0
2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
5Y AAA bank bond 5YR Korean gov’t bond yield
Source: Dongbu Securities, Oxford EconomicsHow will interest rate movements affect prime office yields in Asia Pacific? 13
Financing costs for investors Fig 19: Korea prime office yields vs. AAA bank bond yield (%)
Since the cost of debt is not publicly available in Korea due to 8
its relatively small REIT market, we have chosen the five-year
AAA bank bond rate as a proxy for the cost of debt. Financial 7
institutions refer to the bank bond rate as their cost of funding 1.37
and employ the bond rate as a benchmark in setting their 6 0.61 1.50
lending rate. Since 2010, the spread of the bank bond yields 1.81
5
over government bond yields has narrowed and stabilised at 2.23
around 20 bps. We believe the low interest rate environment 2.06
4 1.99
coupled with the sanguine economic outlook ahead would 2.60 2.29
2.89
encourage yield-hungry bond investors to continue to 3
purchase bonds, preventing the spread from widening.
Thus, we expect bank bond yields to increase in tandem with 2
government bond yields in 2018-2020, i.e. by around 65bps.
1
What could happen to prime office yields?
0
The Korea prime office yield hovered on average 170 bps 0.41
above the bank bond in 2009-2012. Over the subsequent five -1
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
years, the spread extended to 237 bps on average. Looking
closely at the historical spreads, they are well tied with AAA Bank Bond Yield Yield Spread JLL Market Yield
two dominating forces: overall economic conditions and
liquidity. Excluding the period between 2007 and 2009 when Source: Korea Financial Investment Association, JLL Korea
spreads became abnormal due to a sudden spike in bond
yield caused by the financial crisis, 2011, 2014 and 2017
stand out as years with low spread – they all feature resilient
economic growth and ample investment volumes.
We expect spread of office yields over financing cost to narrow
in 2018-2020, due to the solid economic outlook, strong
liquidity and the heightened interest from international and
domestic investors. We think the market is poised to test the
previous historical lows in the post-crisis period going forward
– this indicates the yield spread would shrink to around
180-200 bps. Therefore, prime office yields are expected to
increase marginally by around 5-10 bps per annum.14 JLL
Japan economy and bond yields
The Japan economy is expected to have expanded by 1.6%
in 2017, marking the sixth year of positive growth after the The unemployment rate for December 2017 was 2.8%. Fig 20: 10Y government bond yields in Japan and US (%)
Great East Japan Earthquake. While growth was moderate, While it crept up for the first time in seven months, the job
the trend of increased corporate investment continued, 7
offer ratio has increased for the third consecutive months
and private consumption also picked up. The Tankan by 0.03 to 1.59. This reflects a serious labour shortage, 6
Diffusion Index which measures companies’ sentiment and amid a gap between the personnel required by corporates 5
confidence in the economy rose to 25 point in 4Q17. This and job seekers’ abilities. The Japanese government bond
marks the fifth consecutive quarter of improvement, and yield has stayed at zero for a year, due to monetary easing 4
shows market confidence has recovered to a level similar by the government. 3
to 11 years ago. The strong performance of corporate
2
performance against the backdrop of a solid global
economy boosted the business climate. 1
0
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UST JP 10Y bond yield
Source: Oxford Economics, Thomson Reuters
Fig 21: JREIT cost of debt vs 10Y government bond yield (%)
2.00
1.50
1.00
0.50
0
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JGB 10Y JREIT cost of debt
Source: Oxford Economics, Thomson ReutersHow will interest rate movements affect prime office yields in Asia Pacific? 15
Financing costs for investors Fig 22: Japan prime office yields vs investors’ financing cost (%)
In 2009-2012, the average cost of debt for Japan office 4.50
REITs (i.e. Nippon Building Fund, Japan Real Estate
Investment, and Mori Hills) was 57bps above the 10Y 4.00
Japan government bond yield. But this widen to 70bps 3.50
in 2013-2017. We do not expect financing margins to
expand dramatically over the next few years, unless there 3.00
2.25 2.09 2.16
are changes in the current monetary policy. 2.31
2.50 2.06 2.40
1.71
2.19
What could happen to prime office yields? 2.00 2.06 2.15 2.14
As interest rates fell significantly from 2013, Japan prime 1.50
office yields mirrored the compression. Prime office
yields traded on average 220bps above financing costs in 1.00
2009-2012 and this stayed at 219bps in 2013-2017. Unlike
0.50
other Asia Pacific office markets, office yield spreads
over financing costs did not widen, potentially because 0
investors did not expect interest rates to increase in the 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
foreseeable future.
Office REITs cost of debt Spread JLL Market Yield
Based on forecasts by Oxford Economics, the 10Y JGB
yield is expected to stay close to zero, keeping financing Source: JLL, Each J-REIT’s Public Information
costs relatively stable over the next three years. We
expect prime office yields in Japan to stay at around 2.9%
over the next three years amid flattish financing costs.
Amongst Asia Pacific cities, Tokyo office yields’ spread
over financing cost is the widest, potentially due to low
expectations for growth. If these expectations change,
there is some potential for a structural change in office
yield spreads in Japan.16 JLL
Australian economy and bond yields
The Australian economy expanded by 0.6% in 3Q17, The RBA is acutely aware of the economy’s transition after Fig 23: 10-year Australian Treasury Bond yield vs US Treasury (%)
following an upwardly revised 0.9% in 2Q17. While growth the mining boom to more broad based drivers, and has
7
was marginally below market expectations (0.7%), y-y maintained a stimulatory monetary policy stance so as
growth rebounded to 2.8% and continues Australia’s 26-year to support this transition. Low wage growth and benign 6
run of uninterrupted economic expansion. inflationary pressures have also supported this policy. 5
However, with the transition almost complete, and with
4
The national jobs boom has maintained momentum economic growth, most economists expect that the cash
through 2017. Total employment increased by 3.3% in 2017 rate will be lifted during 2018. 3
and full-time employment growth accounted for 75% of 2
total job creation in 2017. The labour force participation rate The futures market expects a 25 bps rise in late 2018 and a 1
pushed to a seven year high of 65.7%, as better employment further 25 bps by June 2019. If this eventuates, this will move
0
prospects encouraged more people to try to enter the the cash rate to 2.0%, which will be the highest rate in more
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workforce. Nevertheless, wage growth remains subdued, than three years. Bonds yields trended down in the December
suggesting there is still excess capacity in labour market. quarter. The 10-year inflation-indexed Commonwealth 10-year US treasury bond yield
Government bond rate fell to 0.93% in December (from 1.15% 10-year Australian Commonwealth Treasury Bond yield
The RBA has suggested full employment is consistent with in September), but has moved back up to around 1% in
Source: RBA, JLL estimates
an unemployment rate of around 5% and that a further January 2018. This highlights the pressure on bond yields as
decline of 0.5% from the current 5.5% should see wages some central bank, particularly the US Fed, start to unwind their
grow more substantially. very large balance sheet expansion since the GFC. However, to Fig 24: Estimated Australian REIT cost of debt vs bond yield (%)
date, the process has been very gradual and orderly.
5
With the headline inflation rate persistently below the
Reserve Bank’s target band of 2% to 3%, the monetary 4
authorities left the overnight cash rate at 1.5% at their
February 2018 meeting, unchanged since August 2016. 3
2
1
0
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Estimated REIT/Landlord Cost of Debt
Hong Kong Exchange Fund Note (10 Year)
Source: RBA, JLL estimatesHow will interest rate movements affect prime office yields in Asia Pacific? 17
Financing costs for investors What could happen to office yields? benchmarks. The spread between Sydney CBD prime
yields and the real risk-free rate is currently 398bps, or
Given that a number of Australian REITs (A-REITS) have S&P Sydney CBD prime office yields are currently in unchartered
33bps wider than the historical average benchmark of 365
credit ratings ranging from BBB+ to A-, we have adopted a territory with the prime yield high-low range compressed
bps. JLL believes that the Sydney CBD yield compression
midpoint between A-rated and BBB-rated 10-year Australian to just 37bps, at 4.63% - 5.00%. The strong rental growth
cycle is approaching its end. However, current momentum
corporate bond yields as a proxy for the cost of debt. The assumptions being priced in by investors coupled with
from global capital markets and strong local market
average spread between the estimated cost of debt for record low Commonwealth Treasury bond yields have
fundamentals are expected to persist in the near term,
AREITS and the 10-year Australian Commonwealth Treasury resulted in compression of both the upper and lower bound
creating modest scope for further prime yield compression.
bond yield has been 258 bps over the last 10-years which of the prime CBD office yield.
The tighter end of the prime yield range is expected to reach
of course includes the volatile 2008-2010 period. This
4.50% by the end of 2018, with a gradual decompression
spread has however reduced to 204bps bps over the last Although yields are at unprecedented levels, the spread
cycle to commence in 2019.
5-years. The decline in the spread is largely due to increased between Sydney CBD office yields and the real risk-free
demand for higher yielding corporate debt issuances, Government 10-year bond rate remains wider than historical
and the current lower-for-longer global financial returns
environment. Fig 25: Sydney CBD prime office yields and 10-year Australian corporate bond yield (%)
The recent reduced spread is expected to remain in the near 12
term as regulatory bodies slowly unwind fiscal stimulus
10
policy as the domestic and global economy improves. As
domestic interest rates move out, the estimated AREIT cost
8
of debt is expected to move out accordingly. Many rated
A-REITs have accessed debt funding from the liquid US 6
markets. Hence, investment hurdle rates in the local market
are not determined entirely by domestic factors. These 4
lower US rates and hedging costs are not taken into account
in the above AREIT cost of debt estimation. 2
0
-2
-4 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
AREIT Cost of Debt Spread JLL Prime Yield
Source: JLL Research, RBA18 JLL
Hong Kong economy and bond yields
Supported by strong global trade and higher-than-expected strengthening Renminbi, inflation is set to quicken from Fig 26: 10-year Exchange Fund Note vs US Treasury (%)
economic output from mainland China, Hong Kong’s 1.5% in 2017 to return above 2.0%, albeit still well below the
economy grew by 3.8% in 2017, a significant improvement on annual average of 3.3% recorded over the previous 10 years. 8
the 2.0% recorded in 2016 and the strongest year of expansion 7
since 2011. Yet growth is likely to ease as we head into Ample liquidity in the local money market and strong 6
2018. With domestic demand forecasted to weaken against demand for fixed-income securities has contributed to 10- 5
moderating growth on the mainland, rising interest rates Year Exchange Fund Notes issued by the HKMA trading at 4
and an elevated property market, the consensus view is for yields below US 10-Year Treasuries since 2004. More recently, 3
economic output to slow to 2.8% in 2018 and 2.6% in 2019. the tighter yields also reflect the lower default risk perceived
2
by investors. US government debt to GDP has ballooned by
1
The labor market continues to be near a state of full more than 55% over the last 10 years and stood at about
0
employment with the seasonally adjusted unemployment 105% in 2017. In contrast, JLL estimates that Hong Kong
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rate tightening to 2.9% between October and December, government debt (including HKMA’s Exchange Fund Notes)
a 20-year low. Despite the expectations of slower growth amounted to only 40% of GDP in 2017. Bond yields have US 10 Year Treasury
ahead, results from an array of business sentiment surveys been steadily rising in tandem with the tightening in US HK Exchange Fund Note (10 Year)
suggests that the private sector remains upbeat about monetary policy since 2016.
Source: Oxford Economics, JLL estimates
the city’s business prospects in 2018. Coupled with a
Fig 27: Estimated Hong Kong REIT/Landlords Cost of Debt
vs US Treasury (%)
5
4
3
2
1
0
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Estimated REIT/Landlord Cost of Debt
Hong Kong Exchange Fund Note (10 Year)
Source: Oxford Economics, JLL estimatesHow will interest rate movements affect prime office yields in Asia Pacific? 19
Financing costs for investors 2016. Investor expectations for further rental growth—the
vacancy rate in the Central Grade A office market stood
Owing to Hong Kong’s relatively small market for
at just 1.7%—and still low borrowing costs should also
government bonds and the currency peg between the
continue to weigh on yields.
Hong Kong dollar and US Greenback, corporate bond
yields generally benchmark against a spread over HIBOR.
Still, JLL believes that the current yield compression cycle
However, there is no complete historic data on spreads
is nearing its end. After reaching a low in 2018, Grade A
and anecdotal evidence has shown that it is not stable.
office yields expected to flatten out before steadily rising
As such, JLL has taken the average corporate bond yield
from 2020 onwards. In Central, yields are likely to remain
of Hong Kong’s major REITs and landlords to estimate the
at a lower level for a slightly longer period owing to strong
cost of debt.
demand from mainland Chinese investors targeting trophy
assets in the city’s CBD.
Strong capital inflows, along with the commencement of
the Mainland-Hong Kong Bond Market Connect, which
allows for cross-border bond trading between the markets,
has kept the local money market awash with liquidity. Fig 28: Hong Kong Grade A Office Yields vs Financing Costs (%)
Consequentially, the cost of debt has plummeted to below 7.0
2.0%. Notwithstanding, JLL expects financing costs to
steadily rise in line with US interest rates. However, owing 6.0
to strong capital inflows any increase in financing costs will 2.08
likely be moderate; up by about 80bps over the next three 5.0
0.39
years. 1.27
4.0
0.01 0.32
What could happen to office yields? 3.0 1.01
1.14 1.28 1.68 0.97
Despite reaching unprecedented lows, JLL believes that 2.0
Grade A office yields still have room to compress further
even as interest rates start to rise. Investment into the 1.0
Grade A office market reached a record USD 16.5 billion 0
in 2017, up about 50% from a year earlier. Mainland
Chinese buyers returned to the market in the second half -1.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
of 2017 and were again prominent in the city’s biggest
transactions. The uptick in activity is a reversal of the drop Cost of Debt Spread Grade A Office Yields - Central
we observed following China’s implementation of capital
Source: Bloomberg, JLL estimates
controls on outbound real estate investments in late20 JLL
China economy and bond yields
China’s GDP rose to RMB82.7 trillion in 2017 as growth The People’s Bank of China (PBoC) made no changes to Financing costs for investors
accelerated to 6.9% y-o-y compared to 6.7% in 2016, beating benchmark interest rates in 2017, leaving the one-year
Since the cost of debt is not publicly available in China, we
expectations. Most of the economy’s resilience can be benchmark lending rate flat at 4.35% since Nov. 2015. Most
have chosen the weighted average of interest rates of bank
attributed to the services sector, whose growth accelerated economists agree that China’s government will eventually
loans to non-financial institutions and other sectors as a
to 8.0% y-o-y, up from 7.7% in 2016. need to raise rates to deal with risks that rising leverage may
proxy for the cost of debt. The rates decreased significantly
pose to the country’s banking system.
by 190 bps between 2014 and 2016 and picked up in 2017 by
49 bps to 5.76%.
However, there remains a possibility that the timing for
rate increases could be delayed, as the leadership recently
It is worth mentioning that real estate financing in China
showed signs of wariness that applying tightening measures
currently stands at a crossroads, especially for Chinese
too rapidly could produce a sharper economic slowdown
domestic investors, who are playing an increasingly
than the government is willing to tolerate.
important role in the investment market. They have started
to combine traditional approaches of securing financing
(such as bank loans) with newer methods. For instance,
as China relaxed rules for the sale of mortgage and asset-
backed securities, securitization, which is still in its nascent
stage in China, hold considerable potential for developers
and investors. Such new methods will help investors to
diversify their sources of funding.How will interest rate movements affect prime office yields in Asia Pacific? 21
What could happen to prime office yields? Fig 29: Shanghai Gross Office Yields vs Financing Costs (%)
Due to the robust net take-up in the office leasing market 10
and strong investment interests from a wide range of
investors, gross market yield compressed 31 bps over the
past three years in Shanghai. Going forward, we expect 8
prime office yield to compress mildly by 8 basis points in
2018-2020. This is based on the following factors: 1) leasing 6
demand will remain strong as the city is in the process of
building into a global city; 2) rental outlook for the mid- to
long-term is very positive; and 3) investors will become more 4
diverse including Chinese insurance companies, the rapidly
growing ABS/CMBS market and foreign core investors. 2
0
-2
-4 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
Cost of Debt Spread Gross Office Prime Yield
Source: Bloomberg, JLL estimates22 JLL
How will interest rate movements affect prime office yields in Asia Pacific? 23 Authors Regina Lim Denis Ma Head of Capital Markets Research, Southeast Asia Head of Research, Hong Kong Regina.Lim@ap.jll.com Denis.Ma@ap.jll.com Takeshi Akagi Sungmin Park Head of Research, Japan Head of Research, Korea Takeshi.Akagi@ap.jll.com Sungmin.Park@ap.jll.com Andrew Ballantyne Joe Zhou Head of Research, Australia Head of Research, China Andrew.Ballantyne@ap.jll.com Joe.Zhou@ap.jll.com
24 JLL jll.com JLL © Copyright 2018 JLL. All rights reserved. All information contained herein is from sources deemed reliable; however, no representation or warranty is made to the accuracy thereof.
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