Investors must contend with risk on three fronts

Oversupply persists in a number of markets, for example China’s retail sector.

The decade following the global financial crisis was a golden age for real estate investors all over the world. Economies were growing, in part thanks to very cheap debt, which also made real estate extremely attractive. Buying real estate with a 5% yield using debt costing 3% (or less) made solid returns achievable for minimal risk.

Today, underwriting a real estate purchase involves a lot more head-scratching and very little prospect that that ‘natural’ direction of the market will smooth out any mistakes in your calculations. Have you sensibly accounted for the impact of inflation, regulation, geopolitical instability, faltering growth, changing consumer habits, changing investor requirements and a host of other factors?

Most risks facing Asia Pacific real estate investors can be assigned to three categories: structural, cyclical and market risk.

Structural

The main structural change worldwide remains the digitalisation of our working and social lives. Cloud computing, online shopping, video streaming and social media mean we do far more online today than ever before.

This trend was boosted by the pandemic, but it is by no means over. For example, South Korea is already one of the most digital retail markets, with 37% of transactions online in 2022, but this is predicted to rise to 45% in five years. Other markets have even more room for growth. This will boost demand for logistics and data centres, but add pressure to retail properties.

Asia Pacific’s developed markets are ageing rapidly and have been joined by China, which will change the demographic outlook for the region. Meanwhile, the rise of Asia, particularly China, in political and economic power is triggering geopolitical instability here and further afield.

Finally, the growing importance of environmental, social and governance issues should be seen as a structural risk which will drive legislation and investor activity.

Cyclical

The major cyclical risk facing real estate investors in Asia Pacific and the rest of the world is inflation. Interest rate rises in Australia and South Korea in particular have pushed up property yields. On the positive side, inflation seems to be easing, in Australia it fell to 6.8% in March, from an 8.4% peak in December. However, higher interest rates and increasing materials and labour costs will continue to dog property investors.

In tandem with rising interest rates is the risk of weaker growth. The IMF expects global GDP growth to fall to 2.7% this year, from 3.2% in 2022 and 6% in 2021. If high interest rates persist in some markets, there is the risk of stifling growth.

Market

The prime market risk for real estate is always oversupply, which has been a feature of every property-led recession. Oversupply persists in a number of markets, for example China’s retail sector.

Other market risks include regulation in China – real estate investors need to pay close attention to government activity there than anywhere else and lack of transparency in emerging markets, such as Indonesia. Political instability continues to be a barrier for investment in Thailand, while the rest of the region tends to be stable.

Market risk can also be very local; the risk factors for two different city districts or even city blocks can be very different.

To some extent, risks overlap these categories and the boundaries between them may be blurred. However, in an uncertain global environment, measured thinking about risk is the best way to avoid it.