US interest rates and Asian real estateAugust 21, 2018 / By
Economic conditions in the US continue along a path of steady improvement, with the latest GDP growth rate of 4.1% (annualized), signifying the strongest rate of growth in four years. Robust economic growth teamed with strong employment data and upward pressure on inflation suggest the likelihood of further rate hikes over the course of the year. US interest rate futures indicate traders are pricing in a 94% probability of a rate hike in September to 2.00%-2.25%, with a further 68% probability of an additional hike in December to 2.25%-2.50%.
Emerging markets currencies are becoming more volatile
Continued upward movements of US interest rates are starting to impact Asian real estate markets in a number of ways. With monetary policy positions in the Asia Pacific region sitting across a wide spectrum, the impact has been quite market specific. Firstly, some of the emerging markets (EMs) are experiencing more volatility around their capital inflows and outflows, as USD fixed-income assets start to look more attractive. This has put a lot of pressure on EMs currencies, which have depreciated against the USD. As a result, we have seen a number of EMs supporting their currencies and stemming FX induced inflation, with India, Indonesia and the Philippines all shifting rates higher.
Hong Kong currency peg is placing upward pressure on rates
Hong Kong on the other hand is feeling some pressure due to the HKD / USD currency peg. Short term rates in Hong Kong have lifted over the past 6 to 12 months, but should the Hibor / US Libor spread widen, the HKMA will likely undertake a bill issuance to mop up excess liquidity and defend the currency peg. On the real estate front, tight controls around leverage have left the market as a largely equity driven investment. However, if interest rates continue to shift higher, the proposition for leveraging real estate is likely to deteriorate further given that most core assets yields are already below typical financing costs.
Australia hedging costs have fallen
Interest rates in Australia are expected to remain stable for the time being. This is causing some concern around the Australian dollar. The USD interest rate curve now sits at a premium to the AUD curve for the first time since 2002. Given the escalating trade tensions between the US and China, Australia also remains exposed from a commodity and trade perspective. Nevertheless, real estate assets and financing costs have been less affected in Australia, and cross border investment demand remains healthy – potentially supported by more favorable FX hedging cost. While domestic regulatory oversight has opened up some lending gaps, much of the alternative finance continues to focus on high yield mezzanine loans. Opportunities in this segment of the market will become more difficult to come by, particularly with the residential development cycle starting to mature. Foreign bank lending volumes have also accelerated quite significantly over the past 18 months which is providing investors with some diversification of their lending sources. These offshore banks may also look to provide more flexible forms of finance, particularly with longer tenors or slightly higher LTV ratios. The emerging built-to-rent sector may also open up a few opportunities in the core development space.
Japanese interest rate conditions remain stable
Japanese investors continue to enjoy the extremely accommodative monetary policies in place, with real estate finance remaining highly accretive. There has been some suggestion that the regulators have stepped up their oversight on aggressive lending practices of some banks, however this remains limited to some of the more opportunistic lending practices. The yen has been somewhat volatile over the course of the year, as widening interest rate spreads relative to the US have been offset by the safe haven nature of the Japanese yen. With little movement across the Japanese yield curve, FX hedging conditions continue to improve for USD based investors.
Chinese regulators have stepped up their oversight
Credit conditions in China are also being impacted, not only by global interest rate hikes but also domestic regulatory changes. Developers were active in the bond markets in Q1, but borrowing cost have been increasing over the course of the year in both onshore and offshore markets. Regulators have also stepped up their oversight on the ABS (Asset backed securities) market as part of their deleveraging campaign. We have seen a pullback in en-bloc deal flow more recently as well as financing costs are impacting underwriting times. Banks have also been cleaning up their balance sheets which has been putting some NPL opportunities into the market. The Yuan has been allowed to depreciate by almost 10% relative to the USD over the course of the year, as trade tensions and US tariffs threaten the current account balance. In fact, in Q1 China ran their first current account deficit since joining the World Trade Organization in 2001.
Korean investors redirecting their investment strategies
In Korea, global rate movements are starting to flow through to cross-border investment decisions. Foreign investors are becoming more aggressive in Korea as they seek out higher yielding investment opportunities in a market with improving liquidity and attractive financing terms. Korean investors have also put more of their focus back on their own market with a number of large institutional investors making commitments to domestic asset managers for Korean real estate strategies. Outbound investment sentiment is also shifting and higher USD rates are increasing hedging costs into the US. As a result, a number of Korean investors are now switching their focus towards Euro and Sterling denominated markets, given the more favorable hedging positions and accretive financing conditions.