Why Asian property’s strong rental growth is a double-edged sword

Rental growth is a cause for concern in Asia’s residential property market, but it is also a key driver of returns in the commercial sector

Nicholas Spiro

Published: 4:30pm, 1 Jul 2024

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Not that long ago, rents in Singapore’s private residential property market were going through the roof. In 2022, average rents for all private properties increased a staggering 29.7 per cent, the fastest rate since 2007. In the luxury market, Singapore supplanted New York as the city with the strongest rental growth, according to Knight Frank’s prime global rental index, which tracks prime rents across leading global housing markets.

While the breakneck growth in rents hit expatriates – who account for about two-thirds of all rented properties – the hardest, it became a hot-button issue. It raised questions about access to affordable housing for Singaporeans ineligible for government-subsidised flats and adding to cost-of-living pressures that cast doubt over the city state’s appeal as a financial hub.

Although rents began to fall in the final quarter of last year, they are still up 52 per cent since the end of 2020. Yet at least Singapore has a world-class public housing system that houses 80 per cent of Singaporeans, the vast majority of whom are owner-occupiers.

Moreover, the government ensures that supply keeps up with demand. This year, it will offer 10 sites for private housing development – many of them outside the central region which is more affordable for homebuyers – amounting to 11,110 units, the highest annual new supply since 2013.

The same cannot be said for Australia. Only 172,000 dwellings were completed last year, the lowest annual number in a decade. A migration-fuelled surge in housing demand has collided with a restrictive planning system that constrains supply to cause rents to rise 35 per cent since the start of 2020.

Other factors, notably high construction costs and a sharp tightening in monetary policy that might not yet have run its course, have exacerbated what the government’s National Housing Supply and Affordability Council calls a “long-standing [housing] crisis”.

Newly constructed blocks of flats located in the Sydney suburb of Mascot on June 16. Photo: AFP

The share of median income that is required to service median new rents reached an all-time high of 32.2 per cent in March. For low-income households, the median income-to-rent ratio has risen to a crushing 54.3 per cent, according to data from CoreLogic and Australia and New Zealand Banking Group.

Although rental growth has slowed in recent months, it averaged 9.1 per cent a year in the last three years compared with an average annual rate of 2.1 per cent in the previous decade, according to CoreLogic. The housing crisis has politicised the regulatory framework for Australia’s nascent build-to-rent (BTR), or multifamily, sector.

While strong rental growth is a contentious issue in the residential market, it is a source of resilience in commercial real estate. Gone are the days when investors could rely on persistent falls in rental yields and ultra-low borrowing costs to generate attractive returns. Interest rates have risen sharply in the past two years, putting upward pressure on property yields and contributing to the steep decline in investment transactions.

Asian commercial real estate, however, has been slower to reprice, partly because of stronger fundamentals in the region. The relatively minor adjustment in property yields has resulted in a negative or negligible spread over the cost of debt in most markets, putting a premium on income growth as the driver of returns instead of yield compression.

Shoppers pass through a shopping centre in the city centre of Sydney, Australia. Photo: Reuters

Henry Chin, head of research, Asia-Pacific, at CBRE, said “total returns will be driven by net operating income”, or a property’s total revenue minus its operating costs. The only market in Asia likely to experience a renewed decline in property yields any time soon is Australia, which repriced faster, especially the country’s shopping centres. “Australia is close to the bottom,” Chin said.

The importance of income generation and preservation has significant implications for investment strategies, asset allocation and the performance of properties. High-quality assets in sectors enjoying favourable supply-demand dynamics are best placed to benefit from strong rental growth. Seoul’s thriving office market, where average effective rents grew 15 per cent last year, is a prime example.

Moreover, many investors are willing to take more risks to achieve their desired returns. Value-add strategies – which seek to generate higher returns by improving or repositioning properties – are the most popular in Asia. “Investors are doing a lot more heavy lifting,” said Pamela Ambler, head of investor intelligence, Asia-Pacific, at JLL.

With a large share of office space in Asia in need of some form of upgrading or enhancement, there is huge scope for refurbishing older buildings into sustainable ones with more amenities as a post-pandemic “flight to quality” in the sector continues apace. Research from JLL found that offices with green credentials enjoyed a rental premium, particularly in markets with lower levels of green-certified stock.

Tightly packed homes on the western edges of Shinjuku in central Tokyo on June 12. Photo: AFP

Yet nowhere is rental growth under more scrutiny than in Japan. Having suffered from decades of deflation and meagre rent increases, Asia’s second-largest economy is now experiencing an unprecedented rise in inflation and wages. Japan is emerging as an unlikely source of rental growth, a boon for the multifamily sector where yields have fallen sharply in the past decade.

“My [Japanese] partner has not seen inflation in 30 years,” said Angel Li, founding partner at Avatar Capital Partners, a new Asia-based asset management platform that last month purchased a luxury residential development in central Tokyo that it expects to lease up during the next year or so.

Rental growth is a cause for concern in Asia’s residential property market, particularly in Australia, but it is also the key driver of investment returns in the commercial sector. This double-edged sword is likely to persist for some time.

Nicholas Spiro is a partner at Lauressa Advisory

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