Here in the capital markets business, we have been busy doing deals, as investors look to diversify away from the volatility of the stock markets. We are witnessing increasing interest in real estate from institutional investors, attracted by the stable cash flows offered by this investment class.

Our recent deals closed over the last couple of weeks include a prime office development under construction in Shanghai, an industrial property in Suzhou, and a data center sale and lease back in Japan. These will add toward our next-quarter investment volumes ending in the September quarter. Our figures from the mid-year show that investment volumes at a half-year total are at USD 46.2 billion, up 12.6% y-o-y, and in the second quarter were USD 19 billion, up 11.1% y-o-y. These figures are in line with expectations of USD 100 billion by year-end, despite the fall in Japan volumes by 75% in the second quarter year-on-year. The volumes were made up by big rises on the same quarter last year with Australia (109%), China (146%), Singapore (225%), and South Korea (51%).

As one of two Asia Pacific economies with AAA credit ratings, Australia was the top favorite for inter-regional investors drawn by good fundamentals of transparent real estate markets and economic links to the rest of Asia. (If you were wondering, the other is Singapore.) Several sizeable deals with buyers from Canada, Switzerland, US, and global funds pushed the total inter-regional inflow to Australia to USD 1.2 billion up a whopping 442% y-o-y. Inter-regional buyers also snapped up a couple of deals in Singapore and South Korea. But the bulk of the USD 19 billion spent was Asia Pacific money, made up of domestic deals at USD 11.2 billion and cross-border Asia money at USD 4.5 billion with inter-regional deals making up the total at USD 3.3 billion.

This year to date, we have seen evidence of this sustained demand by tenants in the form of stable or rising rents. This has been backed up by an equally solid demand by investors for those rent streams, with compressing yields. Rents rose most in markets where vacancies fell rapidly, primarily in Beijing and Jakarta, both at 15% q-o-q. Other major cities followed suit including Hong Kong at 6.6% q-o-q, Shanghai at 4.6% q-o-q, and Singapore at 1.7% q-o-q. The outlook from Dr Jane Murray’s research team is for rent rises to continue through the rest of 2011 with 10–15% rent growth in Beijing and 5–10% in these other major cities.

Looking at yields available to investors, our Global Market Perspective ranks office markets in Asia Pacific cities against the global cities. These compare favorably. For office yields, we are quoting Shanghai 6.1%, Singapore 4.2%, Sydney 6.9%, and Tokyo 3% compared to London 4% and New York at 4.7%. Like other investment classes, investor activity is driven by the costs of borrowing. Our estimates show all in borrowing costs are lower than office yields in Sydney, Melbourne, Singapore, Seoul, and Tokyo. Given the higher rates of economic growth expected in this part of the world, and the likelihood of continuing low interest rates out of the US and currencies appreciation by some Asia Pacific currencies, these yields look highly attractive to international investors.

With the current economic outlook elsewhere, we expect international capital to continue to flow to this part of the world. While there had been a concern that investors would be deterred by strong currencies for example in Australia, the evidence is that there are international investors with equally strong currencies that can and are investing. Canada and Singapore money is headed for Australia, two currencies likely to do as well as the Aussie dollar; the Canadian dollar is also supported by commodities and Singapore is supported by its links into international trade with China. Investors with other strong home currencies are also likely to buy in this region, for example Switzerland.

Whether the ongoing economic uncertainty will derail the markets by year-end is not clear. The benefits of diversification, both by asset class and geography, suggest investors will continue to put their money into Asia Pacific real estate. The compositional shift in economic growth to domestic demand in emerging Asia and economies that benefit from emerging Asia, will continue to support the investment markets in the short term.

Clearly, the downgrade of the US credit rating by Standard and Poor has affected sentiment. Add to that the on-going Euro debt crisis and Japan’s continuing recovery from its disasters, and the markets are going to exhibit high degrees of volatility.

However we are, and are likely to remain, in the middle of a fundamental shift of economic and therefore political power from the west to Asia Pacific. One must keep sight of the fact that Asia Pacific is driven primarily by what happens in China. Australia’s GDP growth has a much closer correlation with China than it does with the US.

While we will see the potential for higher borrowing costs on risk premiums, the US is likely to keep interest rates low. That will continue to push real interest rates in Asia Pacific into negative territory, underpinning investment demand for real estate. The low-interest-rate environment and weaker economic outlook in the west, is likely to continue to reduce the value of the US dollar and the euro against Asia Pacific currencies.

In the long term, occupier demand for Asia Pacific real estate will endure based on population growth driving economic growth and urbanization. With sentiment coming off, stabilization of rent and capital value growth down a little from 20% plus range toward a sustainable rate of growth in-line with nominal GDP will benefit markets. There may be bargains in the short term.