Beginning Of The End

It is easy to get distracted and miss the forest for the trees, especially now.?There are cyclical forces at work, evolving megatrends and the fight against residual complacency that must be overcome.?Today’s headline is what happened prior.?A sustainable winning strategy calls for focusing on what’s coming and needs a continued, relentless pursuit of evidence as the cycle prepares to turn.?

This is a decadal opportunity to position strategically for the opportunities in Asian real estate investing.

?Bottoming Process

·???????Recent evidence is unambiguous; Data Centre demand is recovering stronger than anticipated, for-sale Housing remains strong, Logistics and Life Sciences demand is early-mid cycle and evolving. ?Office and Retail remain a split story while Rental housing continues to benefit from megatrends.

·???????Cyclical market bottoming happens upon fulfilment of enabling conditions, key amongst those being certainty of demand parameters and compelling valuation reflecting appropriate return for assumed risk. ?

·???????Monetary and Fiscal Policy responses are increasingly reactive, lagging and preventive in nature, especially after the UK pension fund crisis. ?Liquidity in government issued securities remains patchy creating challenges of balancing response to ongoing inflationary and slacking aggregate demand pressures.

·???????Leading Economic Indicators (LEI) are at cyclical lows pointing to little respite from risks of a downward shift towards anemic global growth at best or a protracted global recession at worst.

Headlines & Interpretations

-???????The tech sector is undergoing a prolonged melt-down.

True, mostly.?If one was a HODL[1] tech investor via listed equities or bought into tech PE/ VC funds which chased growth at the cost of profitability, current valuations suggest a 50-90% haircut depending on timing and the specific security one has exposure to.

The reality is that investments in Digital assets is growing, pushing into large emerging markets and from a real asset investing perspective the triangulation between delivery of these new connectivity and productivity solutions through Fibre (optic fibre), Airwaves (5G/6G by 2030?), Public and on-prem[2] cloud networks, and Subsea cables is rapidly unfolding.?Worldwide spend on Data Centres increased 12% in 2022 and expected to grow 17% in 2023.?At the last count, there is uncommitted capital of over $15 BN seeking deployment across Asia.

-???????Office market is Dead and Residential is about to crash, like the GFC[3]

For sure, residential prices are moderating in response to decadal mortgage rates which have doubled in some markets.?Large markets such as Australia and China are the forefront of this moderation.?Japan and Singapore pricing has held steady and in the case of the latter continued asset price inflation has induced more restrictive policy response.?As an outlier, residential rentals in Singapore are up 30-50% and sale prices between 20-50% since the pandemic and. In India, residential sales are at a decadal peak and prices are keeping pace with inflation.

The reality is that homeowners in most markets are sitting on large unrealised equity gains, LTV[4] was lower in this cycle than the GFC and high employment rates (thus far) continue to provide household cash flows to support mortgage payments.?

There will be increasing stress if the housing mortgage rates remain at current levels for another 2-3 years and there will be accelerating mortgagee sales later in the cycle.?Not now, and certainly not a systemic crisis aka the GFC.?

In a perverse way, the current uncertainty will reduce future housing supply which in turn will increase tailwinds for Rental housing as the absolute level of unaffordability continues to grow. ?Hail the rise of BTR[5] / Multifamily for Asia.?It is here to stay and poised to rapidly grab more market share of the overall residential pie.

Offices are faced with structural demand changes as a hybrid work model takes hold with some tech enabled workplaces rapidly embracing the new normal. Cities in developed economies which have a combination of the most liberal social values, commute distances and skilled labour shortages are seeing persistent reluctance to turn up in offices.?For occupier CEOs and CFOs, while this presents operational challengers there are also incentives to take out long entrenched operating costs.

As a contrast, established offshoring markets such as India and Philippines are seeing record levels of outsourced work land on their shores, at par or exceeding decadal highs. ?Vacancy levels in most Asian office markets remain at par or tighter than decadal averages.

-???????The banking industry is in deep trouble.

There are many challenging sectors that Asian banks are currently dealing with the macro backdrop remaining murky.?However, banks are better capitalized that ever and have favorable policy responses on accounting for unrealized losses on held to maturity securities. ?

Net banking asset formations by households remains steady, NIM[6] s are at increasingly healthy levels and increased digitisation is helping with legacy cost and risk challenges.

However, bank loan growths are stalling reflecting borrower trepidation.?These factors create massive opportunities for Credit funds and Private lending.?In a world where equity risks are elevated, risk adjusted returns for Credit are at a decadal high especially as assets need to be refinanced and prudential norms for banks create pressure on the capital stack.

The crisis in lending is not with primary lending, which to be fair is stalling.?It is in the Refinancing market.??Asset backed loans are being revalued reflecting higher costs reflected in the risk-free rates. And as the market rolls through the refinancing issues, there is no option for asset owners but to take a charge against unrealised gains at best or against equity at worst. The valuation cycle is creating nightmares as well as massively lucrative opportunities for Recapitalisation and Secondary trades.

-???????Interest rates have peaked and will materially decline.

All else being equal, Central banks have no immediate urgency to aggressively reduce interest rates given the backdrop of the crisis in domestic bond markets headlined by the near collapse of the UK pension fund industry.?All underlying factors which led to the rapid rise in benchmark rates seem to be still in place, including stubborn inflation, excessive speculation in pockets of the financial markets, wage inflationary pressures and so forth.

An estimated $1 trillion of liquidity[7] has been created by central banks since Q4 last year, led by the PBoC and BoJ, and the Central banks have zero appetite for any mistakes which will break the pricing/ liquidity confidence in their sovereign bond markets.?

Easing financial conditions lead to more spending which will sustain continued pricing pressure, though off-peak levels from 2022.?

After an epochal 35–40-year fixed income bull market underpinned by secular declining interest rates, a new pricing regime is possibly here for many years.?A prayer for collapse in rates from here will be in response to a recessionary or geopolitical crisis, not a macroeconomic improvement in underlying conditions.?As the saying goes, be careful what you wish for.

-???????Policy responses will lead to a soft landing.

?Far from it.?Policy makers are far behind the curve and Central banks are fighting yesterday’s war.?Historically that’s how it has always been.?Both from Monetary (central banks) and Fiscal (treasury/government) impulse sources.?Policy making works with a lag because the evidence is always in the rearview mirror, and it takes time to weigh the evidence and adjust responses.

The reality is the major economies are witnessing an increasingly steep Disinflationary environment. ?Consider latest PPI,?ISM, Import and composite CPI data from EU, USA and China.?It may be hard to digest that the world has gone from the highest inflation in a generation to a collapse in demand, but the evidence is flowing through faster than the market is pricing in. ?

The unprecedented inversion in the US treasury is a tell all sign.?The global economy is entering a slow growth phase which calls for increasing active management and risk avoidance. It is perhaps possible that a reset is accompanied by a blow up in spreads and the long end of the yield curve finally reflecting the growing malaise in economic conditions. It is also an anomaly that high yield bonds currently trading at relatively low 400-500 bps spread over comparable IG[8] bonds to a 700-1000 bps range in line with periods historically associated with rising risks of default.

For real estate investors and asset owners, the basic disciplinary pillars still hold good and demand relentless attention.

-???????Cash management

-???????Demand discipline

-???????Duration risk avoidance

-???????Operating excellence improvements

-???????Enhanced portfolio Risk management

Markets are split, there is no one size fits all.?Some sectors such as Data Centres, Rental Housing, Warehousing/ Logistics, Private Credit and Lifesciences tend naturally to perform better long term once approached as a global skill and competence set.?

Headlines are yesterday’s news.?Responding strategically to changing underlying conditions and economic processes can point to the future more accurately.?For when the markets do finally bottom, all everyone will talk about are certain event(s) that finally put the pain behind us.?

(views expressed are personal)

[1] Popular acronym for Hold One for Dear Life attributed to crypto currency enthusiasts.

[2] On premises solutions which are typically located in customer facilities and hardware.

[3] Global Financial Crisis of 2008-09

[4] Loan to Value

[5] Built to Rent

[6] Net Interest Margin

[7] source: www.crossbordercapital.com

[8] Investment Grade