In 2015, we published “The APAC Core Real Estate Realization” paper, which highlighted the structural characteristics of Asia Pacific (“APAC”) core real estate and its benefits to a real estate portfolio. We outlined that an allocation to APAC core real estate helps to remedy the domestic bias in investors’ real estate portfolios, significantly improves portfolio diversification and has the potential to enhance risk-adjusted returns. Since then, the APAC market has further matured and grown at a pace faster than envisioned at the time, reinforcing our view on the qualities of - and confidence in the prospects of - APAC core real estate. This paper details why today is the right time to increase your allocation to APAC core real estate (Part One) as well as the long-term case for APAC core real estate (Part Two).

Why APAC core real estate today?

Conducive market environment
  • Strong and resilient economic growth
  • Increased stability in GDP growth and prime office occupancy
Favorable macro-economic conditions
  • Economy is in mid-cycle, with strengthening business momentum
  • Moderate interest rate normalization
  • Ample market liquidity
  • Strong employment growth
Potential to generate attractive long-term risk-adjusted returns
  • Reasonable yield spreads to government bonds, which are expected to decrease further as Asia core real estate markets mature and hence command a lower risk premium
  • Healthy growth in occupier demand could help to outweigh potential negative impacts from rising interest rates
Optimal long-term strategic allocation
  • Scale of APAC economy and real estate universe warrants a 30% allocation to APAC core real estate in a global real estate portfolio
  • Under-allocation to APAC core real estate may risk the loss of diversification benefits and enhanced risk-adjusted returns

Long-Term case for APAC core real estate

Positive demographic trends
  • Growing urban population and household numbers, underpinned by the youngest regional population
Favorable economic characteristics
  • High savings and labor participation rates
  • Lower economic, political and sovereign risks
  • Increased economic self-sustainability
Growing significance of APAC as a real estate investment destination
  • Increasing global influence due to large number of megacities
  • Higher level of real estate market maturity and transparency
  • Growing investor interest and capital flows
Diversification and return enhancement benefits in a global portfolio
  • Benefits of multiple levels of diversification and enhanced risk- adjusted returns
  • APAC real estate outperformance versus other regions

Part one: Why APAC core real estate today?

A more conductive market environment

The APAC market environment has become more conducive for core real estate investment. The region benefits from strong and durable economic growth versus the Americas and Europe (Exhibit 1), driving stronger growth in real estate market size and demand in the region. In addition, the volatility of APAC economic growth has also declined in the last five years, bringing about stability in occupier demand (Exhibit 2).

EXHIBIT 1: STRONG APAC ECONOMIC GROWTH
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Source: Oxford Economics, as of July 3, 2018. Regions include both developed and emerging countries.

EXHIBIT 2: INCREASING STABILITY IN APAC GDP GROWTH AND PRIME OFFICE VACANCY RATES, FAVORABLE FOR CORE REAL ESTATE INVESTMENT
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Source: CEIC, JLL – REIS, J.P. Morgan Asset Management (“JPMAM”) – Real Estate APAC, as of May 2018. Volatility in each period is the standard deviation of year- on-year APAC GDP growth/ vacancy rate over the last twelve quarters. Estimation of APAC GDP growth volatility is based on the average year-on-year growth on  a rolling quarterly basis for Japan, Australia, South Korea, New Zealand, Hong Kong, Singapore, Taiwan and China. Estimation of APAC vacancy rate volatility is based on average vacancy of prime/ Grade A offices in Beijing central business district (“CBD”), Shanghai CBD, Tokyo 5-ku, Singapore, Hong Kong, Seoul, Taipei Xinyi, Sydney CBD, Melbourne CBD and Auckland CBD.

Favorable macro-economic conditions for growth in APAC core real estate

We believe now is a good time to increase exposure to APAC core real estate. Many developed APAC markets are moving towards or undergoing an upswing in their business cycle (Exhibit 3). Using the gap between rolling year-on-year and long-term economic growth as a proxy for the business cycle, Japan and South Korea are picking up momentum, and Australia is experiencing above-trend growth. Singapore and Hong Kong exhibited significant improvement, emerging from a period of below-trend growth. This consolidation in business momentum may not only induce more real estate demand but also contribute to positive market sentiment.

Furthermore, the economic cycle in developed APAC is currently behind that of the United States. The pace of interest rate normalization is currently relatively moderate (Exhibit 4A) and ample liquidity is expected to remain in the market (Exhibit 4B). The region also saw stronger employment growth (Exhibit 4C) than in the United States, but rental recovery was slower in some markets (Exhibit 4D). As such, we believe that APAC real estate market has further “room to run.”

EXHIBIT 3: MAJOR APAC ECONOMIES SEE UPTICK IN THEIR BUSINESS CYCLES
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Source: CEIC, JPMAM Real Estate – APAC, as of 1Q 2018. Long term growth rate refers to average GDP growth rate over the last 10 years.

EXHIBIT 4A: LAGGED INTEREST RATE NORMALIZATION IN APAC
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Source: Bloomberg, as of April 2018.

EXHIBIT 4B: Y/Y M2 MONEY SUPPLY GROWTH REMAINS HEALTHY IN APAC, AMPLE LIQUIDITY AVAILABLE
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Source: CEIC, as of 1Q 2018.

EXHIBIT 4C: STRONG EMPLOYMENT GROWTH IN DEVELOPED APAC
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Source: CEIC, as of 1Q 2018.

EXHIBIT 4D: SLOWER RENTAL RECOVERY IN SOME APAC OFFICE MARKETS
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Source: Jones Lang LaSalle for APAC countries, as of 1Q 2018. Savills Studley for New York, as of 4Q 2017.

Sidebar 1: Defining “APAC Core”

Not all real estate markets in APAC display the necessary characteristics to be considered “core.” With this in mind, we have developed a proprietary, multi-factor and risk-adjusted framework – the J.P. Morgan Target Market Analysis (“TMA”) (Exhibit S1) – in order to systematically define core markets in the APAC region and rank along multiple dimensions.

EXHIBIT S1: TARGET MARKET ANALYSIS FRAMEWORK
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* The number of factors adopted for the above target market analysis may vary for different sectors.

The TMA framework takes a quantitative approach to analyze each APAC market’s long-term structural characteristics, long-term real estate fundamentals, and medium-to-long-term capital market fundamentals, i.e., the key variables in understanding a market’s depth, breadth, liquidity, return potential and overall core attributes. The framework incorporates over 20 discrete, market-specific factors.

EXHIBIT S2: RISK OVERLAY - TARGET MARKET ANALYSIS
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The TMA model utilizes a risk overlay that takes into consideration both long-term structural and real estate market risks (relatively cyclical in nature). The overlay incorporates quantitative inputs derived from independent, third-party research in order to objectively measure such macro variables as social and political stability, efficiency of regulatory/legal frameworks, real estate market transparency and financial market development, as well as real estate-specific factors such as total return volatility, supply imbalances and downside market liquidity.

The current result of the TMA framework is a list of eight economies and 15 cities that have systematically cleared the threshold for the potential to deliver core risk-adjusted returns and achieved core market status:

Australia (Sydney, Melbourne, Brisbane, Perth)

AJapan (Tokyo, Osaka, Nagoya, Fukuoka)

Hong Kong

Singapore

New Zealand (Auckland)

South Korea (Seoul)

Taiwan (Taipei)

China Tier 1 (Beijing, Shanghai)

It is important to note that this list can and will expand over time, as other APAC markets mature and become more suitable for institutional investment.

APAC core real estate has the potential to generate attractice long-term risk-adjusted returns

Another appealing reason to increase investment in APAC core real estate is its potential to generate attractive risk-adjusted returns.

According to ANREV1 (Exhibit 5), APAC core real estate has meaningfully outperformed higher-risk, non-core strategies across the three-, five- and seven-year time periods. Considering the underlying risk associated with non-core strategies, APAC core real estate offers better risk-adjusted returns.

The pricing of APAC core real estate also remains supportable. Using the office sector as an illustration, estimated average regional yields still offer attractive spreads over risk-free rates (Exhibit 6). Yield spreads of core office markets in Sydney, Melbourne, Auckland, Taipei, Tokyo and Seoul are within a reasonable range of long-term average levels (Exhibit 7), while those in Singapore, Hong Kong, Beijing and Shanghai are currently below their long-term averages. As such, by this measure, property prices in major Australasia and North Asia cities are considered to be close to “fair value”.

However, assessing fair value by examining the yield spread relative to its long-term average has its shortcomings, especially when the market is going through structural re-pricing. The yield spread framework might be helpful in evaluating price levels in developed markets with a more muted growth outlook. However, many APAC core markets are still going through structural changes as their economies further mature, and we believe these shifts may serve to reduce the APAC core real estate risk premium and yield spread in the long run. Therefore, a simplistic comparison between the prevailing yield spread and long-term average may overstate how “expensive” a particular market may be. Currently, yield spreads and long-term averages for most of the key APAC office markets are higher than that of New York and London (Exhibit 7). In certain APAC cities, the yield spread is comparatively tighter, and is partly due to stronger expected rent growth; Singapore is currently going through a meaningful rental recovery, and the Tier-1 cities of Beijing and Shanghai are expected to undergo structural growth as the markets continue to mature.

EXHIBIT 5: ANREV REAL ESTATE FUND INDEX ANNUALIZED LOCAL RETURNS OVER 3, 5 AND 7 YEARS TO 4Q 2017
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Source: ANREV, JPMAM, as of 4Q 2017. For a more representative comparison, APAC Core Funds Index is constructed from ANREV Australia and APAC
Core Funds Indices with circa 20% exposure to Australia and 80% to other developed APAC countries.

EXHIBIT 6: WEIGHTED YIELD SPREAD OVER GOVERNMENT BOND YIELD FOR DEVELOPED APAC MARKETS REMAINS ATTRACTIVE
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Source: Jones Lang LaSalle, Bloomberg, JPMAM Real Estate – APAC, as of 1Q 2018. APAC office and government bond yield are constructed based on weights of 28% in Japan, 23% in Australia, 10% each in China, Hong Kong, South Korea, Singapore, 5% each in New Zealand and Taiwan.

EXHIBIT 7: APAC PRIME/GRADE A OFFICE MARKET YIELD SPREADS OVER BONDS ARE MOSTLY WITHIN REASONABLE RANGE

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Source: Regional cities’ office yields are sourced from JLL REIS, CBRE and NCREIF Open End Diversified    Core Equity Index, as of 1Q 2018. Risk-free rates are based on 10-year government bond yield sourced from Bloomberg. For the best available comparison, Grade A/ prime office yields in Auckland CBD, Melbourne CBD, Sydney CBD, Tokyo 5 wards, Taipei Xinyi, Seoul, Hong Kong and Singapore overall markets, London West End, and New York City are reflected.

Impact of interest rate increases on APAC real estate

The normalization of interest rates in the U.S. and quantitative tightening in other jurisdictions have raised questions from investors regarding the potential impact on commercial property values should APAC interest rates commensurately increase. However, from an historical perspective, rising rates have not necessarily led to a decline in property values. The performance of property markets has more to do with overall economic and physical market conditions than a singular movement in interest rates. Thus, it is important to understand the overall market environment and the economic fundamentals behind any rate increases to ultimately determine the impact on real estate pricing levels.

The relationship between interest rates and capitalization rates is not a direct one. Using the Sydney office market as an illustration, market yields have not moved in tandem with bond yields (Exhibit 8A) and there is technically no correlation between market and bond yields over the long run (Exhibit 8B). This lack of correlation is also evident in the U.S., where there is little evidence to support an increase in real estate yields from a rise in interest rates.

The reason for this weak relationship is because real estate performance is determined by a confluence of factors, and interest rates are just one of them. We believe that underlying economic growth and real estate supply are more important drivers of real estate performance. The benefits of healthy real estate demand growth in a relatively balanced market could outweigh the negative impact from a rising interest rate environment, as observed in many markets in the past, including the U.S. As an example, during 2005 to 2007, the Reserve Bank of Australia raised the target rate by 1.5%. The economy continued its expansion with the unemployment rate dropping to 4%. The Sydney CBD office market saw steady demand for space with relatively low supply, and occupancy increased from 87% to 97%, which subsequently helped drive rental growth. The average yield actually declined by 1.4% despite the increase in interest rates during the period.

Additionally, by historical standards, most APAC markets currently have high prime yield spreads over risk-free bond yields, which should provide some “cushion” for the impact of future interest rate increases. Under healthy real estate market conditions where global investors continue to allocate to APAC and liquidity remains ample, yields can be expected to remain at relatively stable levels.

Looking ahead, the outlook for APAC’s economic growth is positive, with strengthening global trade and favorable corporate earnings prospects. Notwithstanding, inflation is likely to remain below central banks’ target rates in APAC and the timing and pace of interest rate increases are likely to lag behind that of the U.S. All these are positive for real estate demand and supportive of stable real estate market yields.

EXHIBIT 8A: INCREASES IN BOND YIELDS HAVE NOT ALWAYS COINCIDED WITH INCREASES IN THE SYDNEY OFFICE MARKET YIELDS

 

EXHIBIT 8B: NO CLEAR RELATIONSHIP BETWEEN MOVEMENT IN BOND YIELDS AND SYDNEY OFFICE YIELDS
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Source: Jones Lang LaSalle REIS, Oxford Economics, Bloomberg. Based on year- on-year data on a quarterly rolling basis from March 1998 to December 2017.

Optimal allocation to APAC core real estate

As we discuss the benefits of adding to a strategic APAC core real estate allocation today, it is helpful to determine an appropriate allocation for a global real estate portfolio.

Based on proprietary quantitative and qualitative frameworks, which incorporate significant historical data, the optimal long- term strategic allocation to core real estate is in the range of 60% to 80% in a global real estate portfolio, of which it may be appropriate to allocate up to 30% to APAC.2

Another approach is to consider the scale of the APAC economy and real estate investment universe. The APAC economy currently makes up half the world’s economy in purchasing power parity (“PPP”) terms (Exhibit 9A) and this will expand further given its faster pace of projected economic growth compared to other regions. In terms of real estate market size, APAC is estimated to be the largest region, forming almost 40% of the global investment universe (Exhibit 9B). The economic activity in the region, and the fact that ~50% of 2017’s global IPOs took place in APAC,3 and 40% of the Fortune Global 500 companies4 are headquartered in the region should continue to help drive significant real estate demand. Based on these measures, it would suggest that a market-neutral APAC allocation could comprise 40% of a global core real estate portfolio.

 

EXHIBIT 9A: APAC IS THE LARGEST ECONOMIC REGION IN PPP TERMS (2017)1

 

EXHIBIT 9B: APAC HAS THE LARGEST REAL ESTATE MARKET BY REGION (2016)2,3

 

EXHIBIT 9C: 8 APAC MARKETS MAKE UP ~90% OF THE REGIONAL REAL ESTATE UNIVERSE2,3
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Source: (1) World Bank, International Currency, latest available as of January 2018. (2) Based on DTZ’s latest available investable stock research - “Money into Property 2015” and subsequent JPMAM Real Estate – APAC’s estimate, as of December 2016. (3) JPMAM Real Estate – APAC based on GDP proxy as of December 2016.

2 Please refer to “Global Core: Building the global real estate foundation” (2Q 2017, JPMAM).
3 Source: World Federation of Exchanges.
4 Source: The Fortune Global 500.

However, the 40% APAC allocation may be overstated when we consider the suitability of China as a core real estate market. China comprises 32% of the APAC real estate universe (Exhibit 9C). While there is significant diversity across Chinese cities in terms of economic and real estate market development, we believe only select assets in top Tier-1 cities qualify as core real estate, and thus recommend an underweight to China. This would reduce the APAC allocation from a market-neutral weight of 40% to a strategic weight of 30% in a global core real estate portfolio.

Increase Exposure to APAC Core Real Estate or Risk Falling Behind?

In conclusion, the sheer scale of the APAC economies and real estate markets, the long-term growth potential, and favorable characteristics of APAC core real estate, would warrant a meaningful allocation in a global real estate portfolio.

We believe this is the right time for global institutional investors, particularly those who are underweight the region, to begin to build up exposure to APAC core real estate. Significant delay in this process may risk a perpetual under-allocation and subsequent loss of diversification benefit and enhanced risk-adjusted returns.

Part two: The long-term case for APAC core real estate

Positive demographic trends – the differentiating factor

An aging population, low birth rates and a declining population are major challenges faced by many countries in the world. While these macro trends can have an influence on real estate performance, it is more important to focus on shifts in demography at a micro level.

Developed countries in APAC are not immune to longer-term, global demographic challenges, such as population decline. However, relative to other regions, there is a more positive picture. Urban population growth is much stronger in APAC (Exhibit 10A) and the region also has the highest proportion of population below 65 years old (Exhibit 10B), implying higher labor participation rates and productivity. Core real estate in urban APAC would benefit from these demographic tailwinds. In addition, the growth of household numbers in APAC is also higher than household growth in other regions. This is not only driven by a growing population but also by smaller household sizes (Exhibit 10C). The faster pace of household formation positively impacts demand for multi-family and non-discretionary retail assets. Therefore, by filtering through the negative headlines on population and understanding the differentiating factors at a deeper level, we gain additional confidence in APAC core real estate investments.

EXHIBIT 10A: APAC IS EXPECTED TO SEE THE STRONGEST URBAN POPULATION GROWTH

 

EXHIBIT 10B: APAC HAS THE YOUNGEST POPULATION

 

EXHIBIT 10C: …AS WELL AS THE FASTEST GROWTH IN NUMBER OF HOUSEHOLDS, AT TWICE THE RATE OF POPULATION GROWTH
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Source: Oxford Economics, as of July 2018.

Favorable economic characteristics

Lower Economic, Political and Sovereign Risks

Asia has come a long way in economic development over the last five to six decades. Post-war economic recovery in the West, trade globalization and rapid industrialization helped create the “Asian miracle” where there was a prolonged period of economic expansion. However, this came at a price of high volatility in the real estate markets due to mismatches in demand and supply cycles. Real estate investments were generally perceived to be riskier due to wider swings in market cycles, especially during periods of demand shocks.

Since then, overall regional economic volatility has been trending down (Exhibit 11) and the growth of underlying demand for real estate is consequently more stable compared to the past. Core real estate investors in the region have welcomed such a structural shift. In addition, the political environment in key developed countries is more stable than that of major Western countries (Exhibit 12A). Forward-looking economic risk indicators also suggest low risk for these economies (Exhibit 12B). Furthermore, the debt-to-GDP ratio is low in many of these countries, providing a robust and sustainable environment for core real estate investments (Exhibit 12C). Although the ratio for Japan looks high, the national savings rate is also high and the fact that the majority of debt is held domestically mitigates the risk substantially. In fact, the sovereign credit rating is favorable for Japan, alongside other major economies in APAC (Exhibit 12D).

EXHIBIT 11: REGIONAL GDP GROWTH SEES REDUCED VOLATILITY, FAVORABLE FOR CORE REAL ESTATE INVESTMENT
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Source: CEIC, JPMAM Real Estate – APAC, December 2017. APAC GDP growth is based on the average Y/Y growth on a quarterly basis for Japan, South Korea, Australia, New Zealand, Hong Kong, Singapore, Taiwan and China. Volatility refers to the standard deviation of APAC Y/Y GDP growth over the last three years.

EXHIBIT 12A: KEY APAC CORE MARKETS HAVE HIGH POLITICAL STABILITY SCORES (2016)
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Source: World Bank Governance Indicator, as of December 2016.
EXHIBIT 12B: EXCEPT CHINA/HK, MOST APAC ECONOMIES HAVE COMPARABLE ECONOMIC RISKS TO DEVELOPED MARKETS IN THE WEST
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Source: Oxford Economics, as of December 2017.

EXHIBIT 12C: LOW GOVERNMENT DEBT-TO-GDP RATIO
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Source: IMF, World Economic Outlook Database, as of October 31, 2017.

EXHIBIT 12D: FAVORABLE SOVEREIGN CREDIT RATING FOR MAJOR APAC ECONOMIES
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Source: S&P Ratings, as of December 31, 2017.

Higher Saving and Labor Participation Rates

In addition, the high savings-to-GDP rate in APAC economies serves as a strong buffer in times of economic and financial disruption (Exhibit 13A). The high savings rate was a key attribute that helped support the regional economy during the Global Financial Crisis and contributed to its quick recovery. The high level of savings is complemented by high labor participation (Exhibit 13B), which underpins long-term productivity gains for the region. In fact, long-term labor participation in the region is expected to increase further (Exhibit 13C), which will benefit productivity and lead to stronger real estate demand.

EXHIBIT 13A: HIGH NATIONAL SAVINGS RATES IN THE REGION COMPARED TO U.S. AND EUROPE…

 

EXHIBIT 13B: …ALONG WITH HIGH LABOR PARTICIPATION RATES…

 

EXHIBIT 13C: …WHICH ARE EXPECTED TO INCREASE FURTHER, AND REMAIN SIGNIFICANTLY ABOVE THE AMERICAS
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Source: International Monetary Fund, World Economic Outlook Database, as of October 2017.

 

Source: Oxford Economics, as of December 2017.

 

Source: Oxford Economics, as of August 2017.

Increased Economic “Self-Sustainability” Due to High Intraregional Trade

Over the past few decades, APAC economies have diversified either via market forces or led by proactive government strategic planning and investment (e.g., Singapore and China). The “Asian miracle” that was characterized by exceptional growth in exports and catalyzed by low labor costs (e.g., China and various Southeast Asian economies) and rapid technological advancement (e.g., Japan and South Korea) has led APAC’s development into the world’s-largest economic ecosystem. In the past, the region relied heavily on exports to the West for growth. Today, it still does, but its reliance is less. This can be seen from the lower correlation in economic growth with the western world. The largest share of exports from APAC is bound for countries within the region (Exhibit 14).5 This intra-regional trade helps to enhance the region’s resilience to uncertainties in global economic and trade policies.

Exports have evolved to be a more sustainable growth engine and will remain an important economic driver for APAC. Today, the region maintains both competitive and comparative advantages in exports, and the U.S. and Europe area able to avail themselves of high-quality technological products from the region as compared to simply lower-cost products characteristic of the past. An example is Samsung’s smartphone, which is exported by South Korea and has a higher global market share than Apple’s iPhone. This increasing market strength reflects the growing importance of Asian exports to other regions.

EXHIBIT 14: SIGNIFICANT SHARE OF APAC TRADE IS INTRA-REGIONAL (2016)1
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Note: All figures are as of end 2016 and denoted in USD. Source: Direction of Trade Statistics (DOTS), International Monetary Fund (IMF), JPMAM Real Estate – APAC. APAC includes China, Australia, Hong Kong, Japan, New Zealand, Singapore and South Korea. Excluding re-exports from Singapore and Hong Kong.

Growing significance of APAC as a real estate investment destination

APAC as a Region of Megacities and Global Influence

Strong economic growth and rapid urbanization in the region have led to the emergence of numerous megacities6.With populations of greater than 10 million, these megacities are economic powerhouses and magnets for foreign capital and talent. Growth of real estate demand is strong in these megacities and, together, they represent the lion’s share of commercial real estate demand in the region. Investing in these cities, particularly in the prime or CBD areas, provide significant exposure to the region with positive growth prospects.

More than 30 years ago, New York and Tokyo were the only two megacities in the world. By the end of 2016, however, there were 31 megacities globally. Seventeen of these megacities are in APAC (Exhibit 15A), with cities such as Tokyo, Osaka, Seoul, Hong Kong, Singapore, Beijing, Shanghai and the eastern seaboard cities of Australia exerting substantial global influence. According to A.T Kearney, eight out of the top 25 most influential global cities7 are in the APAC region (Exhibit 15B). In relation to this, APAC has not only attracted many multi-national companies from other 70 regions but also nurtured the emergence of domestic companies of significant scale.

The region has the largest share (40%) of Fortune Global 500 companies, a significant increase from more than a decade ago. These large companies generate jobs, enhance productivity and innovation, and create a service value chain that will underpin the growth of demand in various real estate segments. Furthermore, APAC has a rapidly expanding financial market and the region has also been the most active in financing activities with the growth in economies and expansion of business sector. As a whole, APAC made up 36% of global market capitalization in U.S. dollar terms in 2017. The growth of listed companies has been strong in APAC as the region leads the global IPO market, both by market capitalization and number.

EXHIBIT 15A: 17 OF THE WORLD’S MEGACITIES ARE IN APAC
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Source: United Nations, The World’s Cities, as of December 2016.

EXHIBIT 15B: 8 OUT OF TOP 20 CITIES WITH STRONGEST GLOBAL INFLUENCING POWER ARE IN APAC
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Source: A.T. Kearney Global Cities Report, as of December 2017.

APAC Real Estate Market Maturing, with Increased Transparency

In terms of commercial real estate, market transparency has improved in APAC, which helps to enhance clarity in market assessment, investment execution and mitigation of investment risks. Major real estate markets in the region share similar market transparency levels as that of their peers in the Americas and Europe (Exhibit 16A). The region has also shown the most consistent improvement in transparency in recent years (Exhibit 16B). This improvement has been in line with the growth in maturity and depth of the real estate market, helping to further attract global capital flows. In 2018, Singapore and Hong Kong both ranked at the top among transparent markets globally and just below the threshold of the highly transparent ranking. Similarly, China ranked top among semi-transparent markets, trailing slightly behind Luxembourg’s ranking as a transparent market in Europe.

EXHIBIT 16A: APAC REAL ESTATE MARKET’S TRANSPARENCY IS AT PAR WITH ITS PEERS IN AMERICAS AND EUROPE
EXHIBIT 16B: TRANSPARENCY IMPROVED FAST FOR MORE OPAQUE MARKETS IN APAC
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Source: Global Real Estate Transparency Index (GRETI), Jones Lang LaSalle. *China (Tier 1) refers to Beijing and Shanghai.

Increasing Investors’ Interest and Liquidity in APAC Real Estate

Commensurate with the increasing significance and maturity of the APAC market, interest in APAC real estate investments has also risen over the last decade. APAC is the only region globally where transaction volumes have exceeded pre-crisis levels (Exhibit 17A). In 2017, transaction volumes increased by 13.4% year-on-year and reached a record high of USD 149 billion (Exhibit 17B). Given the afore-mentioned significance of the APAC real estate market, investor demand is likely to continue growing. Core strategies remain the preferred approach, as suggested by the capital-raising survey by ANREV (Exhibit 17C).

EXHIBIT 17A: APAC WITNESSED THE STRONGEST REBOUND IN REAL ESTATE TRANSACTION VOLUMES8   SINCE PRE-GFC
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Source: Global Capital Flows 4Q 2017, Jones Lang LaSalle.

EXHIBIT 17B: REAL ESTATE TRANSACTIONS8 CONTINUED TO EDGE HIGHER IN APAC

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Source: Jones Lang LaSalle, as of 25 January 2018.

EXHIBIT 17C: A SIGNIFICANT PORTION OF CAPITAL RAISED FOR NON-LISTED FUNDS9 IN APAC IS FOR CORE STRATEGIES

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Source: ANREV Capital Raising Survey, 2015-2017 as of December 2017.

Diversification and return enhancement benefits of APAC real estate in a global portfolio

Given the unique structural characteristics of the regional economy and real estate market, APAC core real estate has multiple benefits in a global portfolio, including diversification, resilient performance and enhancement of risk-adjusted returns.

Triple Diversification

In addition to the low correlation in intra-regional economic growth in the region (Exhibit 18), APAC core real estate markets have also demonstrated low correlations versus: 1) financial assets, 2) other developed market real estate, and as importantly, 3) one another. This triple diversification benefit is unique in the global core real estate universe in which correlations tend to be higher within and between the major markets of the U.S. and Europe. APAC core real estate also proved far more defensive during the Global Financial Crisis, with the region’s diversity of economies and market cycles buoying real estate market performance. Furthermore, these major markets display different dynamics and are not in sync in both economic and real estate cycles. This provides for a further diversification opportunity within the region and brings more flexibility in portfolio construction (Exhibit 19).

EXHIBIT 18: RATHER LOW CORRELATION FOR APAC’S GDP GROWTH OVER THE LONG TERM
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Source: Oxford Economics, JPMAM Real Estate – APAC, as of December 1997-2016.

EXHIBIT 19: UNIQUE INTER- AND INTRA-REGIONAL DIVERSIFICATION AMONG APAC CORE REAL ESTATE MARKETS
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Sources: NCREIF, IPD, CBRE, JLL, and JPMAM – Global Real Assets Research. Annual data as of December 1998-2017. All data is denominated in local currency. Note: The real estate historical return series are unlevered. Past performance is not indicative of future results. Diversification     does not guarantee investment returns and does not eliminate the risk of loss. The above table is for illustrative and discussion purposes only.

Enhanced Risk-Adjusted Returns in Global Real Estate Portfolios

Furthermore, inclusion of APAC real estate is expected to enhance the risk-adjusted return of a global real estate portfolio over the long run. Utilizing 15 years of regional real estate total return data, we have analyzed the impact on risk-adjusted returns with allocations to APAC real estate. For both U.S.- and Euro-centric portfolios, the introduction of APAC real estate (from zero to 25% of total portfolio) would have reduced total return volatility and increased return per unit of risk by about 10% (Exhibit 20). This is indeed a meaningful improvement for risk-adjusted returns for a long-term core portfolio, achieved through diversification and the resilient nature of APAC real estate returns.

EXHIBIT 20: ENHANCING GLOBAL REAL ESTATE PORTFOLIO RETURNS THROUGH APAC REAL ESTATE
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Sources: NCREIF (U.S. Real Estate), IPD, CBRE, JPMAM – Global Real Assets Research (EU Real Estate), JLL/IPD/JPMAM – Global Real Assets Research (APAC Real Estate), as of December 2003 to 2017. Notes: Past performance is not indicative of future results. The exhibit represents returns of “diversification portfolios of direct real estate properties. The analysis shows returns on an unleveraged and gross returns basis for comparison purposes.

APAC Real Estate Outperformance

APAC real estate investments offer inflation protection (Exhibit 21) and better risk-adjusted performance compared to investment- grade corporate bonds. The APAC real estate annual total return is significantly less volatile than that of corporate bonds.

Excluding the early and post Global Financial Crisis periods that distorted the annual return for BBB corporate bonds, the average annual APAC real estate return was about 300 bps higher. It can also offer stability of returns that prove defensive in a market downturn (Exhibit 22).

EXHIBIT 21: STABLE APAC ANNUAL REAL ESTATE RETURN BEATS INFLATION AND BBB CORPORATE BONDS
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Source: Bloomberg, MSCI-IPD, JPMAM Real Estate – APAC, as of December 2016. APAC total return index is constructed based on weights of 28% in Japan, 23% in Australia, 10% each in China, Hong Kong, South Korea, Singapore, 5% each in New Zealand and Taiwan.

EXHIBIT 22: STABLE AND DEFENSIVE REAL ESTATE RETURNS OF A WELL-CONSTRUCTED APAC CORE REAL ESTATE PORTFOLIO
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Source: MSCI-IPD, as of December 31, 2016, JPMAM Real Estate – APAC. APAC total return index is constructed based on weights of 28% in Japan, 22% in Australia, 10% each in China, Hong Kong, South Korea, Singapore, 5% each in New Zealand and Taiwan.

In closing

An allocation to APAC core real estate not only provides access to a region that is poised for long-term growth, but also offers diversification benefits and enhanced risk-adjusted returns in a global portfolio. Today’s more conducive market environment and favorable macro-environment conditions make it an opportune time to build a strategic allocation to APAC core real estate.

Sidebar 2: Currency Considerations

Before investing in international assets, investors typically consider how exchange rates and volatility in the currency markets may impact their portfolio returns. For international real estate investments in particular, investors should note that core, unlisted real estate investments are typically held for seven to 10 years, if not longer. In the long-term, developed market currencies tend to revert to the mean; that is, the impact of exchange rates on long-term returns is generally less significant (Exhibit S3).

Additionally, developed market currencies tend to be more stable. For example, the U.S. dollar exchange rate to the Canadian dollar, Australian dollar, Euro, Japanese yen, and Great Britain pound, has fluctuated within a narrow band along the 20-year rolling average for the past few decades (Exhibit S4). This stability supports the theory that exchange rates are mean-reverting in the long term, resulting in only a marginal compounded currency impact over time.

EXHIBIT S3: VOLATILITY OF CURRENCY EXPOSURE DECREASES WITH HOLDING PERIOD
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Source: Datastream, as of December 2017. Volatility estimates are based on historical United States dollar denominated currency exchange rates data between 1999 and 2017. Annualized return volatility calculated using annualized returns on quarterly exchange rates. APAC Core Real Estate Market Portfolio weights: 42% Japanese Yen, 32% Chinese Yuan, 10% Australian Dollar, 8% South Korean Won, 4% Singapore Dollar, 4%
Hong Kong Dollar, 1% New Zealand Dollar.

EXHIBIT S4: DEVELOPED MARKET CURRENCIES ARE RELATIVELY STABLE; FLUCTUATING WITHIN A NARROW BAND

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Source: Bloomberg, JPMAM; data as of March 31, 2018. Currency spot rate refers to USD per foreign currency (e.g. USD for 1 AUD). Data is measured from 1976 – 2018.

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