Tokyo is expected to be the strongest market in Asia for real estate investment next year, according to Emerging Trends in Real Estate® Asia Pacific 2014, a real estate forecast jointly published by ULI and PwC. After the introduction of dramatic economic reforms, transaction volume picked up significantly in 2013. Buying is expected to continue next year, as Tokyo is ranked second for development prospects for 2014.

The report notes that, unlike other asset classes, real estate in Asia “barely flinched” this year in response to the tapering of the U.S. economic stimulus and expectations of higher interest rates. This is due, in part, to the increase in sovereign wealth and institutional capital being directed to Asian markets, as well as to the substantial volume of capital being exported from China, Singapore, and South Korea into real estate assets across the region.

“While Asia’s robust market has been accompanied by higher prices and lower yields for core products, investors have reacted not by pulling away from real estate in Asia, but by finding new ways to make the numbers work, including a focus on specialized property types such as senior care or logistics, and on opportunities in emerging markets,” says ULI North Asia chairman Raymond Chow. “We do expect some headwinds as rising interest rates compress yields further, but overall we are very encouraged by the optimistic view reflected in the report.”

“If we look at new ways to enhance returns, we can see investors are trying to enter at the development level, and an increasing number of co-invested development deals are now being struck,” says K.K. So, the Asia Pacific real estate tax leader at PwC Hong Kong. “Several large institutional players that have opened offices in Asia in order to gain access to direct deals have opted to co-invest in development sites as a means of securing core assets that would otherwise be unavailable or too expensive. This is something of a departure from normal practice at institutional funds, but is being driven mainly by necessity. Besides, we also see a trend toward lower opportunistic returns, and investors are opting for longer investment windows.”

The generally positive outlook for many markets throughout the Asia Pacific region is highlighted by the reemergence of Japan (after a five-year absence from the top rankings) as a favored market for investment and development. The country is one of the largest beneficiaries of capital flows from other regions within Asia, notes the report. Its increasing popularity is attributed to the government’s massive economic stimulus plan, which has resulted in a flurry of property purchases in anticipation of rapidly rising prices.

In addition to Tokyo, secondary cities in Japan, including Osaka, Fukuoka, and Sapporo, are gaining appeal among investors, notes the report. Outside of Japan, the survey found continuing interest in assets located in Asia’s emerging markets, including Jakarta and Manila. The reason, says Emerging Trends, is that as “cap rate compression continues to squeeze returns, and with higher interest rates seemingly just around the corner, investors are drifting to markets that can provide the kind of returns they are unable to tap elsewhere.”

Other Top Investment Markets for 2014

  • Shanghai: Described as an “evergreen” market for investors, Shanghai is ranked second for investment prospects. Despite cap rate compression and stagnant rental growth, real estate in the city continues to draw international investors because Shanghai is widely perceived as a well-known, low-risk market for those who are unwilling to venture into lesser-known cities. Shanghai offers a “level of comfort” to funds with a mandate to place money in China, says the report. The city is ranked fourth for development prospects.
  • Jakarta: Jakarta is ranked third for investment potential, despite a lack of market transparency, difficulties in obtaining entitlement, and competition from local businesses and individuals. Newly released office stock in Jakarta is of better quality than that released in previous years, and there continues to be strong demand from companies seeking space, including the currently undersupplied central business district. Jakarta is ranked first for development prospects.
  • Manila: Manila moves up to fourth place for 2014, the result of a fast-growing economy, the increasing popularity of the city as a destination for multinational corporations seeking outsourced services, and a growing awareness that the problems long associated with the lack of transparency and governance issues are improving. The city is also benefiting from a young demographic, strong capital inflows from local citizens working overseas, and a workforce with a cultural affinity with the West. Manila is ranked eighth for development potential.
  • Sydney: Sydney rounds out the top five markets, holding its appeal for both local and foreign institutional investors despite relatively weak fundamentals in its office and retail sectors, and some concerns over the financial and mining sectors. Still, with a limited supply of office space in the pipeline, investors are bullish about the city’s central business district; and Sydney’s residential sector has experienced a solid rebound. Sydney is ranked 11th for development prospects.

Investment Prospects by Property Type

  • Industrial/distribution: The industrial/distribution sector is the top-rated property sector for investment potential. Emerging Trends notes that the sector is undersupplied due to extra demand for storage facilities being fueled by increased online consumer spending in Asia. Best bets for investments in industrial properties include China’s secondary cities, as well as Shanghai and Guangzhou.
  • Residential: Residential ranks second, although the report cautions about high prices affecting housing affordability, the likelihood of higher home mortgage interest rates, and the ongoing impact of government intervention in China to control further price increases. Best bets for residential investments are Manila, Tokyo, and Jakarta.
  • Office: Office space is listed third for investment potential, with the mediocre ranking attributed to “fevered competition from too much investment capital fighting over the same deals, especially in core assets.” Best bets for office investments are Tokyo, Manila, and Jakarta.
  • Retail: The retail sector came in fourth for investment potential, with concerns being expressed about overbuilding in some secondary markets. However, opportunities in prime downtown locations still hold much promise. Best bets for retail investments are Manila, Jakarta, Tokyo, and Shanghai.
  • Hotels: While hotels ranked fifth for investment potential, the sector is still seen as generally solid due to a rapidly growing tourism industry and relatively high yields. Tokyo leads as the best bet for hotel investment, as the city begins preparations to host the 2020 Summer Olympics.