GLOBAL CAPITAL MARKETS

RESEARCH

GLOBAL CAPITAL MARKETS Q1 2015

JAPANESE PENSION FUNDS

OPPORTUNITIES & RISKS

OUTLOOK

composite index)


RESEARCH

SHARES

(FTSE 100 index)

5

19 5 19 0 6 19 0 7 19 0 8 19 0 9 20 0 0 20 0 1 20 0 2 20 0 3 20 0 4 20 0 5 20 0 6 20 0 7 20 0 8 20 0 9 21 0 00

0

Source: Pensions & Investments/Towers Watson 300 Ranking, 2013

2

Significantly Moderately Slightly (by >20%)

(by 11-20%) (by 1-10%)

St

ab

le

Si g (b nific y a >2 nt 0% ly ) M (b od y e 11 ra -2 te 0% ly ) (b S y lig 1- h 10 tly % ) No ta ta ll 40 50

40

% 30

% 30 40

% 20 30

20

31%

10

20 10 10 0

6%

0

6%

St

ab l

e

0

FIGURE 7 Preferred

target regions for Japanese pension funds investing in international real 60 Significantly Moderately Slightly Not at all estate (ranked popularity) (by >20%) (by by 11-20%) (by 1-10%)

80 70 60

50 40

50

12.4%

EUROPE

% 30

40

18.8%

20

30

ASIA

20

0

10

n ca

he

tio

dg

ns

e

10

0

ifi

n Di

ve

rs

tio

2,056,810

50

56%

ur

Total assets (US$ mn)

Source: United Nations

Just a 5% allocation to international property by the fifteen largest Japanese pension funds would amount to US$100 billion. This is unlikely to occur overnight, but could well have a major impact over the next 3-5 years.

10 At a country level, the US is expected • to be the clear number one choice 0 for Japanese pension funds investing in international real estate, followed by the UK. Germany and France also featured, as did Australia, India, Indonesia, Malaysia and Singapore among Asian markets.

60

50 60

fla

10

JAPAN USA CANADA AUSTRALIA UK

• Nearly 70% of brokers believe that 40 North America will be the most popular % 30 region for Japanese pension funds investing abroad, with other Asian 20 markets and Europe trailing behind.

attraction of real estate for Japanese pension 60 funds (ranked by popularity)

re t

15

• Most say that the key attraction of property for Japanese pension funds 60 is income stability, followed by the opportunity to diversify. 50

FIGURE 6 Main

In

% 20

10

• Offices will be the most popular sector, 0 followed by residential – the sectors with which they are most familiar. Hotels and specialist property will be the least preferred sectors.

0

0

e

25

1,292,003 201,443 119,199 93,149 67,976 54,788 40,611 28,843 25,282 24,388 21,269 17,462 17,153 16,365 12,585 12,334 11,960

40

• Most brokers believe that pension 33% % 30 funds’ preferred routes will be via 20 funds and REITs rather than direct 13% property acquisitions.

10

er

30

Government Pension Investment Fund Local Government Officials Pension Fund Association National Public Service Public School Employees Organization for Workers Private Schools Employees National Pension Association Mitsubishi UFJ Financial Nippon Telegraph & Telephone Panasonic Mizuho Financial Group Zenkoku Shinyo Kinko Hitachi Toyota Motor Fujitsu Sumitomo Mitsui Financial Group

To-date, the shift into riskier assets has been relatively modest but the trend is clearly underway and real estate will feature increasingly on pension funds’ radar. With the top 15 Japanese pension funds managing over US$2 trillion between them – including US$1.3 trillion by GPIF alone – even a small allocation to property is likely to have a significant impact on global real estate markets.

• A clear majority also believe that funds which increase their exposure 60 to property will focus initially on the 53% 50 domestic property market rather than international markets.

20

10

m

35

Total assets (US$ mn)

• A significant majority expect Japanese pension funds to slightly or moderately increase their exposure to real estate. Just over half expect a slight increase and around a third expect a moderate increase in pension fund allocations to property.

gh

40

Pension fund name

% 30

13%

co

% of over 65s in the population

leading pension funds

As with other investors with limited experience in global property markets, the first wave of international investment is likely to focus on the larger gateway cities such as London, New York, Paris and Frankfurt. These cities have the most mature property markets, along with transparency, liquidity and a range of trophy buildings typically acquired by large global investors.

% 30 20

Key findings

50 40

33%

Hi

FIGURE 3 Japan’s

It is difficult to gauge how quickly the diversification will occur but, initially, GPIF is expected to invest more heavily in Japanese equities, followed by overseas shares. Allocations to real estate should also increase in the next 1-2 years, initially in the domestic market.

40

le Sign in (b ifi coy ca m>2 nt e 0% ly Di ) ve rs (b Mo ifi y de ca 1 ra tio1-2 te n 0% ly In fla ) tio n (b S hey lig dg1-1 ht e 0% ly Hi ) gh er N re ot tu a rn t a ll s

FIGURE 2

from bonds, but the expected rise in inflation is likely fuel investor demand for higher-yielding assets.

68.8%

ab

In 2013, Japan’s population declined for the third successive year, reaching 127.3

Source: GPIF

50

in

Source: Macrobond

The new strategy is expected to involve a reduction in its holdings of low-yielding Japanese government bonds, with the scale of the anticipated changes likely to result in downward pressure on the Yen over the medium term. The deflationary environment has enhanced the real return

DOMESTIC BONDS SHORT-TERM ASSETS

60

NORTH AMERICA

53%

St

De c0 De 5 c0 De 6 c0 De 7 c0 De 8 c0 De 9 c1 De 0 c1 De 1 c1 De 2 c1 De 3 c14

0.0

The government has therefore been pushing for an overhaul of the structure and governance of the country’s largest pension fund, GPIF, which manages Yen 127 trillion (US$1.3 trillion) of public pension money. As part of this process, GPIF is set to increase its allocation of capital to riskier assets, including domestic and overseas equities, as well as greater exposure to alternative investments such as real estate.

INTERNATIONAL STOCKS INTERNATIONAL BONDS DOMESTIC STOCKS

60

le

0.5

Japan is the most rapidly ageing country in the developed world. Many post-war “baby boomers” are now reaching retirement, increasing the need for pension provision and putting existing funds under pressure, with a growing problem of payouts exceeding contributions.

million, while the proportion of over 65s now exceeds 25% and the birthrate 15.6one of the lowest in the world. remains 11.1 With further 16.5 population decline expected, the country’s ability to support its elderly through health and social services will become even more challenging.

Will Japanese pension funds increase their allocations to real estate in the next 1-2 years?

ab

While a major change in strategy is unlikely in the short term, some of the bigger funds are expected to significantly increase their exposure to global real estate over the coming years. In fact, the sheer size and scale of a number of these funds will likely mean that they become some of the world’s largest property investors, potentially dwarfing some of the current leading players.

EUROPE

FIGURE 5

St

% 1.0

16.5%

Knight Frank/SMTB undertook a survey of leading SMTB brokers to establish their views on how the large Japanese pension funds might approach the real estate market over the next 1-2 years. The questionnaire focused on issues such as their allocations to real estate, their anticipated geographic and sector focus and their key reasons for investing in property.

ll

1.5

55.4%

US$1.3 TRILLION

INTERNATIONAL STOCKS

Economics aside, the impetus for the move into global real estate comes from a number of factors, not least because of the problem of underfunded pensions, which is partly the result of an ageing population and a lack of diversification.

2.0

11.1%

1.5%

ta

Japanese 10-year bonds

Against a backdrop of a weak economy and persistent low inflation, Japanese pension funds are gradually shifting away from low-yielding fixed income assets such as government bonds, which have historically been the mainstay of their portfolios.

15.6%

ta

FIGURE 1


12.4%

A survey of leading Japanese investment brokers from Sumitomo Mitsui Trust Bank

No

Inability of ageing workforce to support pensioners


BROKER SURVEY

y Slig 1- h 10 tly % )

Low bond yields which are likely to rise

4%

GPIF asset allocation at the end of 2013 financial year

(b

Diversification by geography and sector

4%


FIGURE 4

Si g (b nific y a >2 nt 0% ly ) M (b od y e 11 ra -2 te 0% ly ) (b S y lig 1- h 10 tly % ) No ta ta ll

Government pressure to invest to help economic growth

JAPANESE PENSION FUNDS POISED FOR DRIVE INTO GLOBAL REAL ESTATE

Si gn (b ific y a >2 nt 0% ly ) M (b od y e 11 ra -2 te 0% ly )

KEY FACTORS PUSHING JAPANESE PENSION FUNDS IN TO RISKIER ASSETS

NORTH AMERICA

68.8%

Source: SMTB / Knight Frank Research

Not at all

3


RESEARCH

GLOBAL REAL ESTATE OPPORTUNITIES & RISKS IN 2015 Knight Frank’s commercial research team continuously monitors trends in global real estate markets and has analysed the major opportunities and risks for investors in 2015. For each factor, we have provided a short summary and an assessment as to the likelihood of it happening and its potential impact on the property market. or low

for both probability and impact.

PROBABILITY:

OCCUPATIONAL MARKET RECOVERY

Some of the best investment opportunities lie in the continuing economic recovery and, with it, a rebound in occupier activity. The US has seen the strongest occupational recovery, with Europe lagging because of economic weakness and high supply holding back rents in Asia Pacific. However, growing demand and falling availability will lead to supply constraints in the next 6-12 months – pushing up rents in many major cities. PROBABILITY:

SPECIALIST INVESTMENTS

IMPACT:

IMPACT:

EUROPEAN RECOVERY

New York

Moscow

POLITICAL & SOCIAL INSTABILITY

A major issue for investors has been social and political instability, which may persist in 2015 if the economic recovery falters. Europe has high unemployment rates, while a number of developing countries have seen serious protests against corruption and lack of democratic accountability. A prolonged period of low oil prices may lead to further instability in some countries in 2015. PROBABILITY:

Dubai

Tokyo

New Delhi

CENTRAL BANK POLICY TIGHTENING

Hong Kong

The direction of central bank policy remains critical to the still fragile global economy and many investors were concerned that monetary policy would begin to tighten in 2015. However, throughout 2014, it became clear that monetary policy around the world is likely to remain relaxed for the foreseeable future, notably in Europe where key interest rates are close to zero or even negative. PROBABILITY:

Singapore

IMPACT:

IMPACT:

Sydney

CHINA SLOWDOWN

A possible hard landing for the Chinese economy – a major driver of global growth – would impact significantly on many parts of the world. However, arguably, the pace of Chinese growth has been falling for several years and, in any case, China is rebalancing to become more focused on consumption – a trend which will benefit other exporting nations. PROBABILITY:

Europe’s economy remains fragile, but the commercial property market is recovering and is set to see further gains in 2015. Perhaps the most encouraging trend is the rebound in Ireland and parts of Southern Europe. A buoyant investment market has led to yield compression in many areas and, with rents generally below their pre-recession peaks, activity should receive a further boost in 2015.

IMPACT:

Beijing

Paris

IMPACT:

PROBABILITY:

4

London

“Specialist” property continues to attract investor interest and offers significant opportunities. All mainstream sectors start life as “specialist” before becoming a viable asset class, a trend which can take years but one which has helped the property universe to expand. Out-oftown retail now features strongly in investor portfolios and student accommodation, healthcare and car parks are becoming increasingly popular. PROBABILITY:

IMPACT:

IMPACT:

Development activity is accelerating across all property sectors and will feature increasingly on investors’ radars in 2015. In part this reflects the weight of capital chasing stock, with many investors finding it difficult to access “value” opportunities. The recent lack of development is leading to a falling supply of good quality office space, particularly in CBDs in the gateway cities PROBABILITY:

PROBABILITY:

S SK RI

DEVELOPMENT

“Events”, which range from military conflicts such as Ukraine and the Middle East, to volcanic eruptions and the recent Ebola outbreak, can have a significant impact on investor sentiment. Some events have a direct economic impact on trade and travel, while others just add to the existing uncertainty.

EVENTS

Governments around the world are investing billions in urban infrastructure as they recognise its importance for our economic and social fabric, particularly the buildings where we live, work and play. High quality infrastructure, economic growth and the creation of real estate opportunities go hand in hand. Noteworthy forthcoming projects include the Grand Paris Express and the Beijing Capital Second International Airport.

INFRASTRUCTURE

T U R NIT O P I P ES O

We have used a simple grading of high

DEFLATION

IMPACT:

The threat of deflation applies mainly to Europe, with some countries now seeing steady month-on-month price falls. However, Europe will likely see a further period of low inflation rather than outright deflation. While demand has been weak, lower prices have in fact been caused mainly by falling food and energy costs, rather than consumers delaying purchases because they believe prices may fall. PROBABILITY:

IMPACT:

5


OUTLOOK

KEY FINDINGS Declining availability to drive rental growth

• The main engine of growth will be the US, while China’s expansion is forecast to moderate. Weakness will persist in the Euro area, Japan and some emerging markets.

Increasing investor interest in smaller cities New wave of Chinese capital emerging Investors looking at development to drive returns 2.26% Prime office capital values vary 1.83% significantly around the world 1.07% 1.34%

SINGAPORE

10-YEAR GOVERNMENT BOND

• With perhaps the exception of the US, the likelihood of interest rate rises in 2015 has therefore receded. Interest rates will remain lower for longer and increases are likely to be gradual.

• Global interest rates will rise at some point, but the recent soft economic data – particularly in Europe – will delay the process. In fact, rates in the Euro area have recently been cut to aid the fragile recovery and to 0.41% boost lending. 2.26% 2.98% 1.83% 1.07%

1.07%

1.34%

1.07%

1.34%

1.07%

1.34%

HONG KONG

SINGAPORE

HONG KONG

SINGAPORE

HONG KONG

SINGAPORE

1.02%

TOKYO FIGURE 2

PARIS

PRIME OFFICEcommercial YIELD Global

volumes (US$ bn)

FULL YEAR FORECASTS FOR 2014 & 2015

US$ bn

800

400

1.02%

1.34% 1.83%

2.26%

HONG KONG

SINGAPORE

3.39%

TOKYO

200

0

2.98%

PARIS 2007

2008

2009

2010

2011

2012

2013

2014

2015

Source: Real Capital Analytics, Knight Frank Research Data relates to commercial property only and excludes apartments and development sites. Data correct as at Q3 2014

FIGURE 1

GDP Growth Forecasts for 2015 FIGURE 3

Prime office yields and government bonds

7.1%

7.1%

7

8%

6

7%

5

6%

%4

3.1%

3

5%

3.1%

2.7%

2.7%

4%

Source: IMF (October 2014)

U

Source: Knight Frank Research / Trading Economics Data correct as at December 2014

DUBAI

SYDNEY

SHNAGHAI

0%

FRANKFURT

Ja pa n

ar ea Eu

ro

an y er m

om ng d Ki

G

es St at

1%

te d U ni

U

ni

te d

C hi

na

0

0.8%

Ja pa n

2%

na ni TOKYO te d St U at ni es te d Ki ng PARIS do m G er m YORK NEW an y Eu ro ar ea LONDON

0.8%

C hi

1

1.5% 1.3%

3%

SINGAPORE

1.5% 1.3%

2

6

10-YEAR GOVERNMENT BOND PRIME OFFICE YIELD

HONG KONG

8

• Investors’ focus has been on transparency and liquidity, which has played to the gateway cities. However, demand is increasing for second and third tier cities where competition for stock is less intense and potential returns are higher. • Cross-border investment will continue to grow, as investors seek better returns and diversification outside home markets. Partnerships between overseas and domestic players - which provide a powerful combination of capital and local market knowledge - will be increasingly common.

600

0.41%

• The finalised data are expected to show that global investment volumes for commercial property exceeded US$600bn in 2014, circa 15% up on 2013. Our forecast for 2015 is for at least another 10% rise to over US$700bn, given the significant weight of capital targeting real estate.

• Occupier markets will tend to mirror economic trends in 2015. However, tenant demand for prime commercial space is generally improving, led by offices and logistics. Falling availability will lead to supply constraints in major global cities, 2.26% 2.26% 1.83% to drive helping rental growth.1.83%

1,000

1.07%

• Real estate capital markets have been increasingly buoyant and disconnected from occupational Brussels, trends. Globally, transaction volumes Copenhagen, for the first nine months of 2014 Budapest, were US$427bn – comfortably ahead Lisbon, of 2013 – with Europe and the US in Bucharest. particular seeing strong growth.

Economic forecasts for 2015 are slightly less positive than six months ago, as the global recovery remains uncertain and uneven.

Global transaction volumes to reach US$700bn in 2015

HONG KONG

RESEARCH

• A new wave of outbound Chinese capital is also emerging, comprising mainly ultra-high net worth Individuals (UHNWIs), small- to midcap state owned enterprises (SOEs) and private developers. • With domestic investors increasingly active again, competition for stock will intensify in 2015. As a result, a corporate acquisition may provide a quicker and easier solution for some buyers. Development is also accelerating which reflects greater risk tolerance, as well the need for new stock. • Areas of real estate currently perceived as “specialist” such as healthcare and student housing will feature increasingly in 2015, as the search for higher returns continues and new sectors become more familiar.

FIGURE 4

How much prime office space does US$100m buy? sq m HONG KONG

1,427

SINGAPORE

3,529

TOKYO

3,643

PARIS

3,995

LONDON (CITY)

4,439

ZURICH

4,863

NEW YORK

6,131

STOCKHOLM

7,059

FRANKFURT

8,286

DUBLIN

8,305

TAIPEI

8,399

MUNICH

8,544

SYDNEY

8,661

MILAN

8,886

BEIJING

8,914

MOSCOW

9,754

DUBAI

10,161

SHANGHAI

11,623

HAMBURG

12,059

EDINBURGH

12,101

VIENNA

12,729

MADRID

13,160

BERLIN

13,836

AMSTERDAM

13,951

SEOUL

16,173

WARSAW

16,407

JAKARTA

17,572

MUMBAI

19,595

PRAGUE

22,038

BARCELONA

22,660

BANGKOK

25,207

KUALA LUMPUR

34,200

Source: Knight Frank Research The diagram above shows the ‘theoretical’ amount of prime office space that can be purchased for US$100m in each of the cities listed. The analysis is based on implied hypothetical capital values calculated from the prime rent and yield in each market. Please note that the figures are indicative only and are not related to any specific building or transaction.

7

COMMERCIAL BRIEFING For the latest news, views and analysis of the commercial property market, visit knightfrankblog.com/commercial-briefing/

GLOBAL RESEARCH CONTACTS EUROPE Darren Yates Partner, Head of Global Capital Markets Research +44 20 7629 8171 [email protected] MIDDLE EAST Khawar Khan Research Manager +97144267624 [email protected] ASIA PACIFIC Nicholas Holt Asia Pacific Head of Research +65 6429 3595 [email protected] NORTH AMERICA Jonathan Mazur Tri-State Managing Director of Research +1 212 372 2154 [email protected]

© Knight Frank LLP 2015

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