Another residential conversion for St Kilda Road – is this deja vu of the 1990’s?

August 20th, 2014 by Kimberley Paterson

The number one question I have been asked over the past six months is: What about the residential conversion story? While this theme is evolving in Melbourne’s CBD, the trend is more pronounced in the St Kilda Road office precinct. With 95,400 sqm of stock in St Kilda Road recently acquired by residential developers, is this deja vu of the 1990’s?

The St Kilda Road office precinct is made up of 750,000 sqm of stock. Although this stock figure has remained relatively static since 2000, conversions to residential towers during the mid-1990’s to late 1990’s resulted in a 15% (131,340 sqm) decrease in stock in the precinct, down from 876,000 sqm in 1991 to 752,000 sqm in 2000.

Over the past 24 months, subdued demand for office space, low interest rates and a surge of Asian and local investment in apartments is driving a significant uplift in demand for residential units – notably of older office buildings. The St Kilda Road office precinct largely comprises of secondary grade space, accounting for 75% of total stock – the highest across all Melbourne office markets. There are only 10 A-Grade assets in the precinct, with no significant completions since 2004. The demand for sites is exerting upward pressure on land values, which have doubled over the past decade, making residential conversion the highest and best use for many secondary grade assets on under-utilised sites.

Since the start of 2012, 30 assets have traded in the St Kilda Road precinct. Of this, nine assets totaling 95,400 sqm have been acquired for residential conversion. This theme has been more prevalent in 2014. Over 50% of assets (45,400 sqm) transacted over the past six months have been purchased by developers who are likely to pursue a conversion to residential. Chinese developer Golden Age last month acquired a five-storey tower at 450 St Kilda Road for AUD 20 million with plans to demolish it for an apartment project. Also, 20-22 Queens Road changed hands for AUD 35 million to a company controlled by Chinese national Kathryn Yang. Multiple other sales have transacted (or are currently being offered to the market) with a similar residential conversion motive, suggesting overseas capital strongly believes there is money to be made in the space.

While 95,400 sqm of stock has recently been acquired for potential residential conversion, it is unlikely conversion activity will match the same quantity experienced in the 1990’s. Although we will see a gradual decline in stock over the medium term, growing residential activity is likely to have a positive impact on the St Kilda Road office market going forward. Not only will it provide improved amenity, conversions that do occur tend to be limited to low quality, inflexible secondary grade assets. Removing poorer secondary stock will have a positive impact on average net rents in the St Kilda Road market and encourage headline vacancy to decrease with displaced tenants most likely to seek out alternative premises within the precinct.

About the author
Kimberley Paterson is the Senior Analyst of Research for JLL, based in Melbourne, Australia.

Hi-tech Xi’an? Yes! Business park space supports industry growth

August 19th, 2014 by Frank Ma

Xi’an has several of the best universities in China and they consistently turn out an abundance of skilled labour. These graduates include many engineers which has, in turn, attracted many IT/high-tech giants, including IBM, ChinaSoft, Oracle, Emerson and Rockwell. Aided by government incentives for the high-tech industry, these companies have tended to locate in Xi’an’s business parks, the Xi’an High-Tech Zone in particular. But with that Zone now almost full, what is the likelihood of success for business park developments in emerging submarkets?

There is 1.5 million sqm of completed stock in Xi’an’s business park sector. Around 60% of total business park space is located in Xi’an High-Tech Zone, which was the first cluster in the city. In the past, the supply of business park space was mainly controlled by the government, because the provision of high quality but low rent space was regarded as a competitive advantage for attracting high-tech firms. After a decade of operation, almost all of the buildings in Xi’an High-Tech Zone are full. Those high-tech companies looking to expand often must temporarily turn to office buildings within High-Tech Zone in order to find space. Rents in the office buildings can be 50% higher than in the business park buildings and are typically missing some of the important technical specifications required by IT companies, such as increased electrical power and 24 hour chilled water for server rooms.

Recently, the government realised that the shortage of business park space would hinder the development of high-tech industries, so more land for business park use has been put on the market. The overall market will see supply of around 400,000 sqm of new business park space each year from 2014 to 2016.

Similar to other property sectors in the city, most of the new supply will come from emerging areas where the infrastructure and business support facilities are still under development. And this is where the challenge lies. In Xi’an High-Tech Zone, almost all of the business parks have achieved full occupancy levels, whereas the emerging sub-markets, such as Fengdong New Town and Fengxi New Town, have high vacancy rates across most of the business parks.

We see demand for business parks in emerging areas coming from a variety of sources: expansion requirements from companies in the established High-Tech Zone and from foreign newcomers attracted by government initiatives, as well as by the huge business potential in West China. With the extended capacity, Xi’an’s High Tech Zone and its business park sector will continue to flourish and further enhance Xi’an as the leading sophisticated manufacturing base in the region.

About the author
Frank Ma is the Head of Research for JLL in Chengdu.

REITs in Thailand – Towards a more competitive, transparent market?

August 14th, 2014 by Chawan Ratapana

A Brief History

In 2003, the Stock Exchange of Thailand (SET) introduced property funds (PFPO) as a new investment vehicle in an attempt to ease the lack of liquidity in the capital markets following the 1997 financial crisis. Since their introduction, total market capitalisation of property funds has increased by an average of 60.1% per annum, and currently stands at THB 277,801 million (USD 8.6 billion).

With widespread sentiment that the property fund scheme had run its course, the SET began planning for the introduction of Real Estate Investment Trusts (REITs) as early as 2007.

As the registration window for new PFPOs came to a close at the end of 2013, many firms had already started to plan the listing of new assets via REITs. With the REIT vehicle being the only way to list a property in the capital markets moving forward, the backlog at some law firms handling the deals is reportedly at least one year long.
So far, publicly announced REITs have been well received by the investment community.

Among known listings are four planned IPOs with an estimated capitalisation of USD 1.2 billion at launch. The first Thai REIT (comprising four assets, including an arena, convention centres and multiple exhibition halls with a combined GFA of 480,000 sqm) is expected to launch in 3Q14 with a value of USD 300 million at IPO.

What’s New – Increasing Competition

Unlike PFPOs, REITs can wholly own a property holding business, invest in both ongoing and greenfield (with limitations) projects, and invest in both domestic and foreign income generating properties. Furthermore, there are fewer limitations on REITs in terms of the types of assets that can be included.

REITs can gear up to 35% (or 60% with an Investment Grade credit rating) of their net asset value, potentially allowing for higher returns, whereas PFPOs were limited to 10%. REITs are also allowed to issue debentures.

REIT management is open to asset management companies as well as experienced real estate firms and entities than meet eligibility criteria whereas PFPOs were restricted to asset management firms.

What’s New – Improving Transparency

Whereas PFPOs were not required to hold annual shareholder meetings, REITs must hold meetings annually within four months of the end of a fiscal year, the same as other listed SET companies. Moreover, REIT regulations dictate that a shareholder resolution is required for all transactions of significant size, unlike PFPOs, which had no such requirements.

Under the REIT structure, underlying assets are subject to valuations every two years or after significant changes in the asset(s) to ensure transparency whereas valuation regulations under the PFPO structure were more lax.

The Bottom Line

As the REIT vehicle matures, we expect that increased information disclosure requirements should boost market transparency as a whole. Foreign investors who continue to look for attractive yields and liquidity should find T-REITs an improvement over their PFPO predecessors. Higher gearing ability and increased transparency are expected to translate into higher liquidity and return figures.

On the whole, we believe that the transition to REITs is a significant positive step forward and should encourage future growth across the different property market sectors.

About the author
Chawan Ratapana is an Analyst in JLL Thailand’s Research and Consultancy group, focusing on Capital Markets and Investment research.

Finance innovation: the untapped market in Shenzhen

August 12th, 2014 by Silvia Zeng

In my previous blogs, we discussed the big picture of Shenzhen’s ‘story’ and Qianhai’s ‘story’ in the area of policy incentives, supply vs demand balance, and analysis of industries such as technology. With regard to the question of ‘why Qianhai’, in my recent discussions with clients, including investors, developers and tenants, I have found some of them taking the view that potential demand growth in Shenzhen and Qianhai will primarily be policy and cost driven, i.e. preferential corporate income tax for qualified industries, and the advantage of lower rents in Qianhai compared to Hong Kong. However, I think this underestimates the role organic growth and innovation in key industries will play.

Qianhai is promoting five key industries, namely:

  1. Finance
  2. Logistics
  3. Information services
  4. Technology, and
  5. Other modern services industries

These are growth industries which are the focus of government reforms and where potential synergies exist by grouping them together.

Two examples of such cross-industry innovation in Shenzhen are:

  • Supply chain finance (SCF). SCF is a developing segment at the intersection of Logistics and Finance, providing credit and liquidity along the supply chain of traditional manufacturing industries such as automotive and Chinese medicine. SCF companies registered in Qianhai are pursuing business not only in Shenzhen, but also China and Asia-wide. For example, the Shenzhen-based Eternal Asia is the first listed supply chain service enterprise in China, with business across 380 cities in China and Southeast Asia.
  • Internet finance. At the intersection of Technology and Finance is the rapidly emerging area of internet finance. Leveraging the internet, smart phones, cloud computing, social networking and eCommerce, China’s internet giants and startups alike are launching securities and wealth management services, peer-to-peer lending, online high interest savings, and third party payment processing services. Shenzhen-based Tencent partnered with five securities companies to establish “Webank” in Qianhai, which is the first private bank approved by the China Banking Regulatory Commission and focuses on e-finance for individuals and SMEs. Local governments have been very supportive of the development of this sector because the financial services offered are well-aligned with key areas of financial market reforms. This will be a significant growth area of financial services in the coming years.
  • Riding high on the well-developed finance, high-tech, and logistics industries already established in Shenzhen, the economic development model in Qianhai is well positioned to foster the innovative companies and industries that emerge in China. Of course the preferential policies in Qianhai will play an important role in nurturing these new businesses, but their success will depend upon identifying market opportunities and exploiting them. As of end-May, the number of registered companies in Qianhai already reached 6,500, including 46 Fortune 500 companies, with 30 new companies registering each day.

    About the author
    Silvia Zeng is the Associate Director of Research for JLL in Guangzhou, China.

    Asset price inflation in real estate – a rational collective action problem?

    August 11th, 2014 by Megan Walters

    History tends to view a run up in asset prices as irrational bubbles, produced by illogical investors acting on psychological motivations, named animal spirits by Keynes. In real estate a rapid rise in asset prices can be viewed as a rational collective action problem, much like the tragedy of the commons or the paradox of thrift[1], and not the result of irrational investments.

    The question of asset pricing and whether bubbles – which can be defined as irrational price changes – can and do exist is at the forefront of public debate following the unusual monetary conditions that have occurred since the global financial crisis. For real estate an irrational price change would be a capital value rise in excess of the commensurate income stream rise- in short excessive yield compression.  Shifts in real estate asset prices are the result of cumulative actions of rational investor actions, even if the final result may look irrational.

    Tuplipmania is usually cited as the classic bubble based on irrational behaviour. The Economist ran an excellent article in October ‘13 on the Dutch tulip bulb bubble of 1637. (see the article here) This article which is based on a series of academic papers suggests that investors in the tulip bubble were acting rationally and that there was no ‘mania’ causing investors to act irrationally[2].

    This response can also be observed in the real estate market where shifts in rules or shifts in demand result in a sharp change in pricing. Real estate as an asset class comes in large lot sizes and is in general less liquid than, for example equity, bond or foreign exchange markets. This means that shifts in asset prices are more likely to be based on rational criteria compared frequently traded assets such as shares in a particular company.

    The resolution of such a collective action problem is first to gain agreement from the parties that their individual maximisation of value does not produce the optimal outcome for society, and second agree what measures need to be put in place to ensure cooperation.  In the tragedy of the commons, formal rules are put in place to conserve stocks or to implement private property rights.

    Solving other collective action problems is not as easy. Following the GFC, to prevent a collapse of aggregate demand the G 20 governments agreed to implement stimulus packages and ultra-low interest rates to keep demand above a point where economies could spiral downward into deflation. The steps taken were the solution to a paradox of thrift problem and in turn have created another collective action problem.

    Monetary conditions aimed at easing the paradox of thrift, have created conditions where real estate asset prices have held up; the result of a series of rational decisions- not irrational investment sentiment.

    About the author
    Dr Megan Walters is the Head of Research, JLL Asia Pacific Capital Markets.


    [1] The tragedy of the commons is where individuals act rationally in their own self-interest, however the outcome is contrary to the whole group’s long-term best interests by depleting some common resource. Paradox of thrift is where faced with an economic downturn people act rationally to save more money however then aggregate demand falls leading to a decrease in consumption and a worse economic position.  What is rational for the individual may appear irrational for the whole.

    [2] The academic papers argue that there had been a shift in regulations by the Dutch government in 1637 and that investors had each acted rationally in the light of the incentives and information at hand. The market for tulips was an efficient response to the changing financial regulations which meant that ….investors who had bought the right to buy tulips in the future, were no longer obliged to buy them. …The inevitable result was a huge increase in tulip option prices.

    Singapore Strata Office Space: More Room for Capital Appreciation?

    August 8th, 2014 by Cedric Chng

    The strata office scene in Singapore has been witnessing a surge in investment interest in recent years. In less than five years, since January 2010, developers have sold 1,208 units of new strata office space, almost twice the 693 units sold in the 15 years preceding 2010. Although strata office space is not new in the market, it accounts for a tiny proportion of the overall stock of office space, which is dominated by larger en bloc developments. The limited availability of strata office space hence attracts the likes of investors searching for alternative asset classes and business owners looking for a suitable space to house their operations over the long term. The healthy demand has likewise supported the appreciation of prices for strata office space, creating a cycle that has drawn more capital into the market.

    Already, some strata office space sold by developers in recent years has been divested for profit way ahead of its completion. A transaction is classified as a sub-sale if resold prior to completion of the development. Based on the latest sub-sales data released by the authorities, strata office space developments currently under construction resold for an average 13.6% gain. Projects in the suburbs posted an average gain of 14.2%, ahead of the 9% gain recorded by similar projects in the CBD. Nevertheless, based on sub-sales records since 1995, completed strata office projects have historically posted average gains of 22.1% during their sub-sales period.

    As such, prices for strata office space currently under construction could have more room for growth, playing catch-up to past averages. The potential growth may also be boosted by the limited availability of new strata office space expected in the near term.

    About the author
    Cedric Chng is Senior Research Analyst for JLL, based in Singapore.

    Reviving the Indian Housing Sector

    August 7th, 2014 by Trivita Roy

    The new government coming into power with a clear majority has created a new wave of optimism in the Indian business environment. The determination and political will of this new government to make changes is likely to rejuvenate the nation’s economy. Recently there was some good news for the housing sector with the easing of the FDI regulations regarding project size and the allocation of INR 40 billion for affordable housing through the National Housing Bank (NHB). These measures were announced in the budget and came as much needed revival mechanisms for the housing sector. In addition to this, the Reserve Bank of India (RBI) eased restraints on residential lending.

    The July budget opened the door to FDI in projects of a size of only 20,000 sqm instead of the 50,000 sqm previously and the minimum investment for FDI was set at USD 5 million (previously USD 10 million). This will allow capital to flow to smaller sized projects, which are usually in the centre of cities due to the limited availability of land, and boost the development of the residential sector, which is currently the most preferred target for foreign investors. This is likely to improve the residential supply within city limits.

    In addition to the above, the affordability of housing should improve significantly with the allocation of funds for the mass market housing sector through the easing of lending regulations by the NHB and RBI and making loans eligible on a priority basis. The RBI has stipulated that housing units priced at a maximum of INR 6.5 million in six metropolitan cities (Mumbai, New Delhi, Chennai, Kolkata, Bengaluru and Hyderabad) may be considered as affordable housing. This move is likely to uplift buying sentiment in these cities and revive the residential sector which has been struggling with soaring unsold stock.

    With all of these new measures, the overall sentiment in India towards house-purchase is likely to improve.

    About the author
    Trivita Roy is the Senior Manager of Research and Real Estate Intelligence Service, for JLL in India, based in Hyderabad.

    The “global hunt for yield” – a 30-year story

    August 5th, 2014 by David Rees

    The Global Financial Crisis (GFC) has ushered in a period of historically low interest rates. This is good news for borrowers and users of capital. It’s not such good news for investors and savers. The result has been a “global hunt for yield”, which sees investors scanning financial and asset markets for income-generating opportunities.

    It’s a nice parable. But like many parables, reality is a bit more complex.

    Consider the chart.

    Figure: Yields on bonds and office markets

    Source: IMF, JLL Research

    Based on International Monetary Fund (IMF) calculations real (inflation) adjusted sovereign bond rates have been falling for more than thirty years. Admittedly the GFC shows up as a sharp dip in real bond yields in 2008. But it’s just a part of a much longer story that tells of a generation-long decline in real long term bond rates. In contrast, prime yields averaged across a sample of major office markets have remained remarkably stable, at between 4.50% and 7.50%.

    So the global hunt for yield is not simply a post-GFC event. Certainly the low interest rate world that has been ushered in, has added an extra twist to the “global hunt for yield”. But it’s a chapter in a much longer story. And for income-seeking investors, the relative attractiveness of commercial real estate has been rising steadily, not just since the GFC, but for a generation.

    But there is another twist to this story. Falling bond yields mean that bond values have been rising. So the past thirty years has been a bull market for bonds, as a broad global statement. Issuers of long term bonds have had a thirty-year tail wind; and falling bond yields mean that investors in these bonds have had a thirty year ride on rising capital values.

    It’s salutary to reflect that most people reading this blog will have spent their business careers in a world where real interest rates (and so, the hurdle rate for investment) have been falling steadily. But policy interest rates in the major economies – the UK, US, Japan and the Eurozone are now at or close to what central bankers call the ZLB – the zero lower bound. And real long term bond rates, which are the effective hurdle rate for commercial real estate investment, are close to zero too.

    Is the bond market party over?

    A trend is a trend is a trend
    But the question is, will it bend?
    Will it alter its course through some unforseen force,
    And come to a premature end?

    Sir Alec Cairncross

    Unlike short term central bank nominal policy rates, long term real bond rates can go negative as was the case in the 1970s. And in the US, the UK and Japan this has been the post-GFC experience.

    The GFC has certainly given added impetus to the “global hunt for yield”. But it’s not the full story. And if the thirty-year bull market in bonds is now over, it’s possible that investors will be looking for alternative yield investments with low volatility income streams, like commercial real estate, for a long time to come.

    About the author
    David Rees is the Head of Research for JLL in Australasia, based in Australia.

    Can Hong Kong become a tech hub?

    August 4th, 2014 by Denis Ma

    The Information and Communications Technology (ICT) sector has been one of the fastest growing occupier groups in US and European office markets over the past 6-months with technology companies now starting to move into some of the most highly sought after addresses in cities such as New York and London. In many instances, they are competing with banking and finance companies, an industry that is still in the midst of ‘rightsizing’.

    In recent months, ICT companies such as Capco, Facebook, Qihoo 360 and an array of online gaming developers have either expanded or set up new offices in Hong Kong. However, the scale of their requirements remains small when compared with their counterparts overseas. New lettings from the sector accounted for less than 7% of all floor space leased in 1H14.

    One of the reasons why we are not seeing as much growth from the sector compared to other cities is because these companies continue to largely open offices in Hong Kong for sales and marketing purposes.

    However, the tide may be changing.

    Local press recently reported that Giant Interactive–one of China’s leading online game developers–plans to delist from the New York Stock Exchange and relist on the local bourse sometime next year. One of the reasons why Chinese technology companies are considering a move to list on the Hong Kong exchange is the stronger valuations that can be achieved since local investors typically have a better understanding of the regional markets in which these companies operate. Others, such as Qihoo 360, are in Hong Kong as active investors in the city’s financial market. The mainland company, which is known for its antivirus software, has been a cornerstone investor in three IPOs in Hong Kong in recent months.

    If these examples are the beginnings of a new trend, in the future we may potentially see more ICT companies setting up sizeable offices in Hong Kong that serve business functions beyond sales and marketing.

    About the author
    Denis Ma is the Head of Research for JLL in Hong Kong.

    The “small cap”, or should that be, the “small town” premium in the Australian property market

    July 31st, 2014 by Lincoln McEwen

    Does Adelaide offer property investors a free lunch?

    As the JLL Analyst for Adelaide, my colleagues never pass up the opportunity for a light hearted jab at our “small town” ways. Adelaide’s largest ever residential tower development was recently described by a Sydney colleague as a three storey walk up.

    But, jokes aside, this got me thinking. In equities markets, it can be a good thing to be small. So maybe the same argument can be applied to property?

    The “Small Cap Premium” theory describes the tendency for stocks with smaller market capitalisations to outperform the wider market. Without going into detail, here are some reasons for the phenomenon.

  • The low information nature of small cap stocks means that for fund managers, researching and pricing these stocks is not cost effective, and hence they are avoided.
  • Low information markets are less efficient, with a greater prevalence of mispricing, and for those with the necessary time and expertise, bargains can be found.
  • Smaller stocks tend to be more nimble, able to react to market shifts (or shocks) swiftly and take advantage of changes, or minimise losses.
  • So, can we apply the same reasoning to smaller commercial property markets? Well let’s run through those same explanations again.

  • The big AREITs are generally underweight (or absent) in the Adelaide market. Assets of sufficient value to warrant their attention are scarce, and many feel less comfortable in a market with which they are unfamiliar.
  • Adelaide could also be described as a low information market. Australia is third most transparent real estate market in the world, but with fewer firms committing resources to researching Adelaide, it could be argued that the pool of research knowledge is far shallower.
  • Adelaide has a greater proportion of private ownership, and a number of these local private investors have been very successful. Their ability to make quick decisions, without the constraints of a corporate decision making structure, is probably a big part of this success.
  • Returns in Adelaide are historically greater than those of the eastern states, as they well should be, to reflect the risk premium of our market. But even when comparing apples with apples, Adelaide has outperformed.

    An analysis of the JLL Total Returns Index demonstrates that despite greater returns, the volatility of Adelaide is only marginally higher than that of Sydney or Melbourne. Furthermore, Adelaide’s Sharpe Ratio (a measure of risk adjusted returns) over the last 10 years is significantly greater.
    So is this a free lunch? Let’s not get carried away. Firstly, this 10 year period of returns includes the Global Financial Crisis and the associated increase in volatility, and secondly, there is a great deal of risk not captured in the volatility of a decade’s returns. These results need to be considered in context, but they are interesting none the less.

    All I can tell you is, with the best food and wine in the country, free or not, lunch in Adelaide is a beautiful thing.

    About the author
    Lincoln McEwen is Strategic Analyst for JLL in Australia, based in Adelaide.