The application of smart beta investment strategies to real estate

July 25th, 2014 by Andrew Ballantyne

The concept of smart beta is gaining traction amongst investors as a viable investment strategy. At the moment, it is more prevalent in equity markets, but is increasingly pushing into fixed income and alternative assets. The Economist magazine ran an article on the topic in July 2013 titled: The Rise of Smart Beta – Terrible Name, Interesting Trend. The Economist’s assessment of the name is rather harsh, but they are correct – the concept is interesting.

As an investment strategy, smart beta sits between market capitalisation and an active strategy (alpha). The growing interest in smart beta is partly to offset the undesirable characteristics of the market capitalisation investment strategy. For example, when an equity market investor maintains a market capitalisation weighted portfolio, they have to invest into strong performing stocks and reduce their position in under-performing stocks. Potentially, this strategy leads to higher allocations to over-valued stocks and an under-weight position on stocks which may have attractive valuations. While the process of mean reversion is neither deterministic nor smooth, there is sufficient empirical evidence to suggest stocks mean revert over the long-term.

A further limitation of the market capitalisation strategy is that sectoral weights are determined by the composition of an individual equity market. As an illustration of this limitation, Financials (excluding property), Materials and Property Trusts account for almost two-thirds of the market capitalisation of the S&P/ASX 200 index. A market capitalisation strategy is, therefore, heavily weighted to these sectors with very low allocations to Education and Health Care, which are among the growth sectors of the Australian economy.

Smart beta is an evolution of the traditional market capitalisation strategy. Three of the widely promoted smart beta investment strategies are:

  • Equal weighted portfolio.
  • Economically weighted portfolio.
  • Minimum volatility portfolio.
  • What are the implications of smart beta investment strategies for real estate? The first part of any analysis is to estimate the market value of the six CBD office markets (Sydney, Melbourne, Brisbane, Perth, Adelaide and Canberra). This provides a numerator and a denominator for the calculation of the market capitalisation asset allocation strategy. Our modeling estimates a market value figure of AUD 120 billion for the Australian CBD office markets. A market capitalisation asset allocation strategy would imply that Sydney CBD, with a 43% allocation, is the cornerstone of a diversified office portfolio.

    A CBD office portfolio constructed using the market weights of 2013 would have generated a return of 10.54% per annum over the past 10 years. An equal-weighted portfolio, however, would have generated a return almost 100 basis points higher at 11.40%.

    At first glance, there appears to be some merit in further exploring the application of smart beta investment strategies to commercial real estate. However, we remain cognisant that smart beta strategies can reduce liquidity and with real assets – the idiosyncratic risk factors need to be carefully reviewed and managed.

    About the author

    Andrew Ballantyne is Head of Capital Markets Research for JLL in Australia, based in Sydney.

    Shopping Mall Conversions to Office Space in Beijing

    July 24th, 2014 by Tin Sun

    During a recent shopping trip to a large mall near my home, construction activity on the upper floors attracted my attention. All of the retail shops on the upper floors, which I never visited due to lack of interesting tenants, were closed and the space was being converted to office space for strata-title sale. Meanwhile, the Carrefour in the basement and restaurants on the ground floor continue to operate and satisfy the main goal of most visitors to the mall – to eat and to buy groceries.

    This was not the only case. Several Beijing shopping malls underwent similar conversions in the first half of the year. One centre in Wangjing closed down its anchor department store and converted the space into offices for strata-title sale. Two other examples near the train station closed several floors for conversion to office use which will be put on the leasing market. The phenomenon has raised concerns from many industry players.

    Why are these properties converting to office? First, all of the projects are located in key office submarkets (for example, Zhongguancun, Third Embassy, Wangjing, and East Second Ring Road), and demand for office space in these locations is strong while vacancy remains limited. Also, office rents are very high in Beijing. On the other hand, they are not key retail clusters and upper floors of retail space, if converted to office, may achieve rents 10%-20% higher. Although ground floor retail rents are high in Beijing, the same is not true for less accessible and less visible parts of a shopping mall. But for office space, visibility does not matter and achievable rents are high.

    In addition, home purchase restrictions in the residential property market have led to increased demand for strata-titled commercial properties, and sales prices for office space are very high. It is much easier to sell strata-titled office space compared to retail space because vacancy risk is much lower. Furthermore, some landlords may wish to strata sell some space in order to raise capital.

    How will these conversions impact the office and retail markets? For the office market, once the construction is complete, the quality of new office space can only meet the requirements of small companies, a tenant group which does not overlap with Grade A offices. The space which was removed from the retail market was not occupied by big name retailers, and they were not busy stores, therefore they will hardly influence the market. However, it is possible that local neighbourhood centres in this area might enjoy less competition than they once did.

    About the author
    Tin Sun is Senior Manager in JLL’s research team in China, based in Beijing.

    The dawn of 100 smart cities: an Indian Experiment

    July 23rd, 2014 by Sujash Bera

    Four years ago, for the first time in the history of humanity, the majority of the world’s population became city dwellers. While only two in every 10 people lived in urban areas 100 years ago, by 2010 that figure reached 5 in every 10, or 50% [United Nations (UN), 2010]. As regards India, many people have long held the nostalgic idea that it is a country of villagers, but, in fact, more than 370 million people (31% of the population [Census of India, 2011]) now live in cities. This increasing urban population is creating challenges in providing a better quality of life, particularly in the mega-cities of Delhi, Mumbai, Chennai, Bangalore, Pune, and Kolkata that are at the receiving end of migration. Poor water and electricity supply, lack of social infrastructure, primitive sanitation, and proliferation of slums owing to a lack of affordable housing are, sadly, the most easily identifiable problems of many Indian cities. Despite this, we see a continuation of migration because of the economic opportunities the cities continue to offer.

    The newly elected Union Government of India has taken up this situation as a priority and is planning to build 100 smart cities across the country and INR 76 billion (about USD 1.3 billion) has been allocated in the 2014-2015 General Budget as seed money for the project. To begin with, these cities are likely to be developed as feeder towns to larger cities, with the objective of eventually generating enough economic activity to be self-sufficient. Consequently, to facilitate funding, the government has proposed a reduction in the size of projects eligible for Foreign Direct Investment (FDI) from 50,000 sqm to 20,000 sqm and a halving of the minimum investment limit for FDI to USD 5 million. In addition, the government has earmarked large funds for rural and urban housing in the affordable sector.

    Smart cities are identified as cities that promote efficient usage of their resources including physical, social, intellectual, and environmental infrastructure, in a manner that fosters sustainable economic development and high quality of life (Figure 1). These smart cities are also planned to be vibrant hubs for research and progress. Examples that already exist are Curitiba in Brazil, with its impressive transport system and meticulous city planning approach, and Osaka in Japan which has designated a special economic zone for development of environmental and energy industries. In India the master planning of three new smart cities, Ponneri, Krishnapatnam and Tumkur, is likely to be completed soon.

    Figure 1: Concept of Smart City

    Source: Centre of Regional Science, Vienna University of Technology, 2007

    With the intention of spotting the challenges early, the Indian Government’s initiative to develop smart cities is a welcome step and taking a cue from the world scene, pioneering techniques in e-governance, energy conservation, optimal housing density, etc., could be the next game changer. While this initiative will have clear and tangible benefits in terms of housing, infrastructure, living conditions and improved economic opportunities, it will also lead to nation-building and be another step along the road to India becoming a developed country.

    About the author
    Sujash Bera is the Assistant Manager, Research for JLL in India, based in Kolkata.

    Urbanisation in Asia Pacific: more city dwellers are creating huge consumer demand

    July 17th, 2014 by Lee Fong

    Extract from JLL’s Redefining Retail Places

    In Asia Pacific, urbanisation has been one of the most compelling stories of the past decade as an unprecedented number of people have moved to cities and helped drive wealth creation. The region now accounts for slightly more than one-third of the world economy, and that share is set to rise further by 2020 with forecast growth roughly twice as fast as the rest of the world from now to the end of the decade. Asia Pacific is home to more than half of the world’s population and the number will surpass 4 billion by the end of the decade.

    Watch Anuj Puri, Global Retail Agency Board Chairman, discuss the impact of urbanisation and population growth on the retail sector in Asia Pacific.

    A region of contrast…

    With an additional 40 million people living in cities across the region each year, the number of urban areas with a population of at least one million is set to rise by 48 to 268 in 2020 (United Nations, 2012). China and India will account for the vast majority of new people living in cities from now through 2020, due in part to the sheer size of their populations. However, notable increases in city populations are projected through the end of the decade for other countries in Asia Pacific such as Vietnam (21.1% growth in urban population) and Indonesia (16.3%) and even cities in highly urbanised countries such as Kuala Lumpur (19.4%) and Sydney (11.8%). It is important to keep in perspective that urbanisation rates across the region vary quite significantly as shown in Figure 1, with Japan and Australia amongst the most urbanised countries in the world while in most South Asian and Southeast Asian countries the majority of people still live in rural areas.

    Figure 1: Urbanisation rate by country

    Source: United Nations (Population Division; World Urbanization Prospects), 2012; JLL Research
    Note: Urbanisation rates are interpolated values based on 5-year interval estimates from the U.N. figures

    A more sophisticated shopper…

    With incomes for city dwellers generally surpassing those in rural areas and a growing agglomeration of people in cities across Asia Pacific, the middle class population is expanding and fuelling a rise in discretionary spending. While the region has many rapidly growing retail markets such as Delhi, Jakarta and Chongqing, Asia Pacific is also home to many large, mature markets such as Hong Kong, Singapore and Tokyo.

    Given these demographic and income trends, the demand for modern retailing facilities is growing strongly. Shopping centre stock has exploded in size over the past decade, largely driven by a substantial increase in China (Figure 2). However, with more discerning consumers, a growing presence of international retailers (A Magnet for Retail) and rapid adoption of technology, it is becoming increasingly important to focus on the all-around shopping experience. Asia Pacific’s huge population, rapid economic growth and rising wealth levels will act as a catalyst for further growth and evolution of the region’s retail markets.

    Figure 2: Shopping centre stock

    Source: JLL Research (Real Estate Intelligence Service), 1Q14
    Note: Total stock refers to Overall Prime and is on a net lettable basis. China includes 28 cities, Southeast Asia four capital cities, Australia & New Zealand eight cities and India seven cities.

    Further information on Urbanisation and Redefining Retail Places

    Redefining Retail Places: for further information on trends influencing the retail landscape

    Global: Discover how urbanisation and population growth are influencing retail real estate at a Global level
    Or visit JLL Global City Research Centre here.

    EMEA: Discover how urbanisation and population growth are influencing retail real estate in EMEA

    About the author
    Lee Fong is the Senior Manager, Asia Pacific Research for JLL, based in Hong Kong.

    How to Fill a 320,000 sqm Mall with People

    July 16th, 2014 by Daniel Odette

    Over this past weekend, I took a trip to the Global Harbor shopping mall in Shanghai. With a total GFA of 320,000 sqm, it became the second largest shopping centre in Shanghai when completed last year. I was curious to see how this massive new mall was performing at a time when there is a booming amount of new retail supply in Shanghai.

    My trip helped to reinforce my view on some major trends in retail and F&B:

  • Casual dining restaurants are becoming extremely popular. Similar to the “affordable-luxury” phenomenon in fashion, where people want to buy high quality products without splurging on the best-of the-best, mid-to-high-end restaurants targeting meals of around RMB100-200 per person – although expensive – are extremely popular. The more expensive “banquet-style” restaurants in Shanghai, on the other hand, appear to be suffering of late. Growth in the restaurant industry is now going to come mainly from those that cater to the middle and upper-middle classes, just as fast fashion and affordable-luxury retailers have usurped traditional luxury brands as the most active players in fashion.
  • High-end restaurants are closing branches to concentrate on smaller and more affordable restaurants. We saw the closure of 14 restaurants with GFA of more than 1,000 sqm in the last year. Many restaurant chains are refocusing their efforts on smaller, more affordable sub-brands, like the very popular The Dining Room brand from high-end chain Shanghai Min. Likewise, Pankoo has closed several of its large locations (1,000sqm+) this quarter but opened a newly-designed 560 sqm location in Global Harbor that seemed very popular.
  • New chains are expanding rapidly, but only the cream will rise to the top. Looking around in Global Harbor, I saw some familiar names from back in the U.S. like Pizza Hut, which has branches all over China, and Outback Steakhouse, a more recent arrival. Despite its high price-point, Outback was completely filled with customers, as were most restaurants at a similar price point, such as Simply Thai. One floor below, however, a new Mexican restaurant was nearly empty. If restaurants cannot create an attractive, family-friendly environment and adjust their menus to the local palate, they will not succeed.
  • Landlords need to go even further with F&B. Global Harbor was fairly conservative with their allocation to F&B, at around 22% of occupied NLA, roughly in line with the average for non-prime shopping malls. In the future, I think malls in China will have a much higher likelihood of success if they allocate a similar or greater amount of space to F&B offerings. Even though these tenants pay lower rents, the alternative for landlords will be empty malls as customers seek out competing malls for their dinner time excursions. If future malls decide to forego on F&B tenants, it is also hard to renovate later to add more F&B space if the necessary infrastructure is not included in the original design of the mall.
  • China is a golden opportunity for chain restaurants. Middle class customers are plentiful, rents are affordable, and there are hundreds of new shopping centre locations to choose from across all of China’s major cities. As people’s incomes grow and they become global travellers, they are becoming more enthusiastic diners as well, and restaurant chains of all types should be able to capitalise on their hunger for more interesting flavours and variety.
  • About the author
    Daniel Odette is a Senior Manager in JLL’s research team in China, based in Shanghai.

    Easing Singapore’s labour crunch – the retailers’ way

    July 15th, 2014 by Angelia Phua

    Businesses in Singapore continue to grapple with a manpower crunch and escalating labour cost issues as the Government continues to tighten foreign worker inflows in a move to reduce public discontent over the perceived over-crowding in public spaces. Effective 1 July, 2014, another round of foreign worker levy hikes came into force and labour-intensive businesses, such as food and beverage and retail, will bear the brunt of this. While the long-term prospects of rising consumer demand led by population growth and rising wages sound attractive, in the immediate-to-short-term, retailers with labour shortages have scaled down their operations if not deferred their expansion plans in Singapore. This could dampen demand for retail space, rein in rental growth and lead to an increase in the vacancy rate of retail space in Singapore.

    However, with mind-set changes and training, there are ways to ease this labour crunch challenge.

    Overcome age-prejudice and train older workers. Singapore has one of the world’s highest life expectancies at 84 years compared to the global average of about 72 years, according to the Department of Statistics. With a longer life expectancy and rising healthcare costs, older people are also motivated to seek or continue employment. Opening up employment opportunities to older people through training and the re-shaping of job scopes similar to what McDonald’s Corporation has done, would help to ease the labour crunch. Such employees would also be considered as additional local head counts under the Dependency Ratio Ceiling, providing employers with the right to hire additional foreign workers.

    Attract young people from Generation Y and Z into the workforce. There are an increasing number of students seeking part-time employment to finance their lifestyles and gain work experience. Employers could tap into this potential source of labour by redesigning job scopes to offer flexibility to students.

    Open training and employment opportunities to physically-challenged individuals. With greater acceptance and proper training, physically-challenged people can become economically independent. For example, in the food and beverage business there are many jobs available that require simple skills, such as serving food, or clearing plates. Han’s Café and Starbucks are examples of food and beverage companies that have opened doors to the disabled in recent years while fashion retailer Uniqlo has also introduced this initiative. Such workers further contribute to the Dependency Ratio Ceiling for the hiring of additional foreign workers.

    In the near term, these are practical ways for companies to hire locals through job re-design and maintain access to foreign workers. In the long term, jobs will need to be re-designed to enable greater productivity and higher wages for locals to reduce long-term dependence on foreign workers.

    About the author
    Angelia Phua is the Associate Director for JLL Research, based in Singapore.

    Ever increasing equity allocations brings US$700 billion into view

    July 11th, 2014 by David Green-Morgan

    Does anybody else feel like we are in 2006 again? It’s a world cup year, Germany performs well, England’s players are already on the beach, a player has left the tournament in disgrace (Suarez in 2014, Zidane in 2006) and the global property markets are alive with investment activity.

    For Q2 2014 preliminary global investment volumes are at US$158 billion, which is almost 30% higher than the second quarter of 2013. Over the first half of the year investment activity is 27% higher than H1 2013 at US$294 billion. Europe and the Americas are leading the surge in transactional activity with 43% and 34% growth respectively, with Asia Pacific looking to be on track to match last year’s volumes. A notable feature of the markets in 2014 is the broadening of investors focus, the large markets like the US, UK, Germany, France, Japan, China and Australia are seeing increasing levels of investor interest but so are the smaller markets such as Mexico, Brazil, Southern and Eastern Europe, Thailand, Malaysia and South Korea. Within these countries secondary cities are also competing successfully with the core cities for investor capital; but with more capital to go around everyone is benefiting.

    So back to 2006 when transactional activity reached US$700 billion, driven by easy debt and imaginative capital structures. This time is different; in 2014 we have a wall of equity targeting direct commercial real estate with a significant increase in the number of new investors into the sector and an equally large increase in allocations from the long term traditional property investors. While the sources and structure of the capital is different the result is similar, in 2014 we estimate that global investment volumes could once again reach and surpass US$700 billion; and a European team to win the world cup?

    About the author
    David Green-Morgan is Global Capital Markets Research Director in JLL, based in Singapore.

    The magnetic retail landscape of Asia Pacific

    July 10th, 2014 by Lee Fong

    As I check my emails every morning, I often come across news articles highlighting the arrival of new international retailers to Asia Pacific. With an influx of retailers and growth of store networks, I had often found myself wondering what factors are drawing retailers to the region. In our recent retail report, “A Magnet for Retail”, we look at major underlying factors attracting retailers and also the presence of 100 top global brands, both luxury and mid-tier across AP.

    Although each retail market has its own intricacies and appeal, there are drivers such as urbanisation, a growing middle class population and rising tourism that are influencing much of the region. In emerging Asia, rapid urbanisation is seeing 40 million more people living in cities each year and helping drive wealth creation. Currently, AP accounts for around one-third of the world’s middle class population and this is projected to reach 46% (1.32 billion people) by 2020. Though staggering figures, this really just helps put in perspective the huge potential the region presents for retailers.

    Rising income levels and greater ease in travel are also seeing more people go abroad, most notably Mainland Chinese. In 2013, an estimated 97 million Chinese tourists spent USD 129 billion on tourism abroad. Aside from supporting retail sales, tourists are influencing local retail landscapes with their tastes and needs. I have certainly noticed such changes on my recent travels around Asia Pacific and even Canada, from hearing Mandarin spoken around me to having retailers accepting my UnionPay bank card.

    The map below shows AP city rankings by retailer presence. Anyone who has ever walked through the streets or malls in Causeway Bay or Tsim Sha Tsui in Hong Kong can certainly understand Hong Kong’s position at the top of the list. These areas are adorned with an array of global retailers catering to all types of consumers. Another interesting observation from the map is the subregional variation, with Greater China and North Asia generally having the highest presence of international retailers while Australia and India have the lowest. Further insights are in our report “A Magnet for Retail”.

    About the author
    Lee Fong is the Senior Manager, Asia Pacific Research for JLL, based in Hong Kong.

    What you need to know about China’s housing market

    July 8th, 2014 by Michael Klibaner

    Through much of the first half of 2014 analysts have cited the housing sector as the biggest risk to growth in China’s economy. However, over the last six to eight weeks we have grown more confident about the outlook for the sector based on what we have seen on the ground and by actions taken by the central and local governments.

    You may recall my colleague Joe Zhou, JLL’s Head of Research for Shanghai, wrote a blog at the end of May on the parallels between the current performance in residential market with the dynamics in the 2011 – 2012 period. In the past several months we have seen the following significant actions:

    1. The PBoC has urged banks to increase mortgage availability for first time home buyers
    2. Local governments in some cities have eased restrictive measures in districts with the most challenging market conditions and they have increased the limits on borrowing from the Public Housing Fund
    3. In cities where developers have offered price discounts, buyers have been lured back into the showroom

    Collectively, we believe these housing market supports, along with the various ‘mini-stimulus’ actions by the central government, will be sufficient to stabilise transaction volumes in the months ahead. If we are right, then the government has done enough to reduce the likelihood that the housing sector is a big risk to GDP growth reaching the targeted ‘floor’ of 7% in 2014.

    To be clear, we expect price indicators to continue to show declines in most Chinese cities, but as long as mortgage availability remains supportive, these discounts will continue to attract buyers and transaction volumes in the coming months will stabilise. It will be on the back of this stable demand that property developers will have the confidence to maintain activity in their pipeline. And this leads us to have confidence in GDP growth coming in on-target in the low 7%s (in January, my forecast for GDP growth in 2014 was a below-consensus 7.3%).

    Of course risks remain:

  • Credit availability for developers is still constrained and may lead them to slow-down activity
  • Last years’ most active source of capital – the trust lending market – is at a virtual stand-still now
  • Equity offerings could fail, thereby limiting capital for development and industry consolidation
  • By permitting some small, local developers to default, the central government could undermine buyer’s confidence to buy pre-sales
  • The failure of a wealth-management product or trust product held by individual investors could make buyers more risk averse
  • But we do not see these things as being likely, or if they do happen, we don’t expect them to destabilise the market or buyer confidence in the second half of 2014.

    About the author
    Michael Klibaner is the Head of Research for Jones Lang LaSalle in Greater China, based in Hong Kong.

    Australia’s post-budget blues should disappear

    July 7th, 2014 by Leigh Warner

    The mood of Australian consumers has been out of step with broader economic indicators over recent times. Through much of 2013, the consumer sentiment index was well above a neutral level (of 100), despite the fact that GDP growth slipped below trend and the labour market was softening.

    More recently the opposite case has prevailed. That is, GDP growth has been surprisingly strong over the past two quarters (rising to 3.5% in 1Q14), the labour market has stabilised and other economic indicators have improved. Yet consumer sentiment has fallen to its lowest level in three years.

    The initial steady slide in the sentiment index, from 110.3 in November 2013 to 99.7% in April 2014, no doubt reflected the lagged impact of the softening labour market and rising job insecurity. Nevertheless, employment grew by a solid 0.6% over the three months to May 2014 and unemployment fell to 5.8% after peaking at 6.0% in February.

    The significantly weaker consumer sentiment in May (92.9) and June (93.2) was heavily influenced by a contractionary Federal Government budget. The conservative Australian government in its first budget proposed wide-ranging expenditure cuts, plus a ‘debt levy’ on high income earners, aimed at getting the budget to surplus over the next few years and reducing the Federal debt level it inherited. Almost 60% of respondents to the May sentiment survey felt the budget would have a negative impact on their personal finances.

    Anecdotally, this fall in sentiment has been reflected in preliminary retail sales numbers in some major retail portfolios from May onwards. So the big question is whether this is just a temporary case of ‘post-budget blues’; or is it something long lasting?

    We believe it will prove relatively temporary. Firstly, it should be noted that the size of the post-budget fall in confidence is not unusual. The 6.8% fall in the index in May compares to a 7% decline in May 2013, which was not as large a change in fiscal policy direction. There have also been many examples of similar sized declines in the index following the delivery of previous budgets. It is also not unusual for sentiment to be seasonal and lower through the winter months.

    Importantly, business confidence has been much more resilient to the budget and was stable at positive levels in May. The business community is generally much more supportive of the fiscal consolidation and the strategy should prove supportive of private sector investment and hiring if the recovery in the real domestic economy evident in 1Q14 continues.

    From a financial position, Australian households are in a healthy position. Households have conservatively saved and paid down debt over recent years, while both house and equity price growth has built household balance sheets and net wealth back up to record levels. So if business confidence can be maintained and, improved hiring boosts job security, then consumer confidence should bounce back to positive levels in the second half of the year.

    About the author
    Leigh Warner is a Director of Research for JLL, based in Brisbane, Australia.