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Asian Property Outlook & Strategy November 2007 Issue

Looking Beyond Sub-Prime: Outlook for 2008 Highlights

In this issue of APOS, we reiterate the earlier theme of the need to be more discriminating in Asia real estate investment. Looking ahead to 2008, the risks have escalated even more sharply than before as the sub-prime problem spreads, although thus far, the region has been relatively unscathed. The need for a differentiated approach is greater than ever.

■ Property markets are de-coupling. Some markets are showing tentative signs of consolidating, as supply concerns and government action begin to weigh in. At the same time, another form of decoupling is occurring. In some countries, the gap between the top end and the rest of the market has become pronounced, setting the stage for a possible catch up in the lower and medium end segments in 2008.

■ Excess liquidity rather than capital shortage still plague most Asia markets. High commodity and oil prices are also driving Asian central banks towards a monetary tightening stance to stave off inflation. At the same time, monetary policy elsewhere is likely to remain loose amidst the slowdown engendered by the US housing market weakness.

■ Cap rate compression has not ostensibly reversed. We expect capital flows into Asia property to hold up, and possibly even increase in 2008, but we believe that entry and exit cap rates will have to take into account the riskier global environment in the coming year.

■ China still attracts investment. China’s economy is arguably large enough to absorb any possible post-Olympics deflation experienced in other Olympic cities. The 2010 World Expo in Shanghai will be a further primer. But high property cost and more limited upside in principal cities like Shanghai and Beijing could drive real estate activity increasingly into the lower tier cities. New foreign investment guidelines introduced in mid November seem to restrict real estate activity, but the interpretation of these guidelines as in almost all previous cases, are unclear. Nevertheless, by itself, it does little to curb the fundamentally strong demand underpinning China’s real estate markets, although it has raised downside risks.

■ Japan’s recent weakness is not expected to derail investor interest. Tokyo and the major regional cities still face a limited supply of quality buildings. Prospects for office, retail and residential property over the next 2 years therefore remain bright, but yield spreads could narrow further.

■ Korea has entered the early stages of a consumption-led economic recovery. This has been aided by the unexpected good outcome from the recent North-South Korea Summit. Limited supply of quality office space and a maturing retail industry underpin prospects for both sectors, but the residential sector

November 2007 Research & Strategic Planning

Tay Kah Poh [email protected] (65) 6435-1386

Mark Ho [email protected] (65) 6435-1373 Vincent Shen [email protected] (8621) 5386-5682 Pacific Star Holdings Pte Ltd

www.pacificstar-asia.com

Contents Highlights Looking Beyond Sub-Prime: Outlook for 2008 1 Asia overview Sub Prime & Asia Property: Financial crisis redux? 3 Investment recommendations 8 Profiling the markets China 9 Hong Kong 14 Macau 17 Korea 19 Japan 24 Thailand 29 Singapore 33 Malaysia 36 Indonesia 39

Asian Property Outlook & Strategy—November 2007

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poses greater policy risks with prices slowing in response to intervention by the government to reduce rampant speculation.

■ Within S E Asia, Singapore’s real estate market should continue to sparkle. The market has responded very positively to the government’s economic re-structuring initiatives. But prices and rents in the office and residential sectors have run up considerably and at the upper-most end, have already surpassed the previous historical peaks. The government recently withdrew the deferred payment scheme for residential properties sold off-plan, a scheme which many believe to be responsible for fuelling speculative demand. The government has also “rushed” to release more land for commercial developments including sites on 15 year leases. There has also been sporadic news of a slightly more cautious business sentiment. Accordingly, we urge greater caution in the Singapore market. But the strong fundamentals are intact and going forward, we still expect more, but gradual, increases in both prices and rentals in 2008 and 2009.

■ The Malaysian property market deserves investor attention. The government’s active promotion of the Malaysian market and its stable and steady growth environment could propel it into the view of international investors. But the market still lacks depth and sophistication. There is limited supply of city centre office space which would favour this sector. New and sizeable shopping malls that recently opened will enlarge the retail market further. Prime residential developments are in ample supply but the top end luxury projects should perform well.

■ Thailand’s property prospects are still clouded by political uncertainty and inept economic administration. It is unclear when the clouds will lift despite the pledge of open elections at the end of the year. However, what is interesting is that real estate prices have broadly remained firm during the past 14 months after the military coup. Sales volume in the Bangkok condo market has fallen, but limited supply of luxury projects should protect the pricing power of the developers of such projects. Offices are also short of new supply.


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Sub Prime & Asia Property: Financial crisis redux? Differentiation is still the order of the day. The last issue of APOS in July 2007 adopted the theme of “differentiation.” Against a backdrop of the US sub-prime problem, Asian real estate markets have moved asynchronously. Astute investors need to be discriminating in their assessment of the opportunities and risks.

■ The risks have grown. Four months on, the picture has darkened even more. The sub-prime problem continues to plague financial markets. What was originally been an obscure and localized problem in the US housing market has now become a global credit tightening, and causing several large institutions to report sizeable write downs. In an unprecedented move not seen since the aftermath of Sep 11 2001, the Fed, ECB & BOJ collectively injected a total of US$240 billion into their respective banking systems to calm markets on 10 Aug 2007. Then, in another surprise move, Fed chief Mr Ben Bernanke cut rates by 50 bp from 5.75% to 5.25% on 18th September and again, by a further 25bp to 5% on 1 November. Most recently, Citigroup, Bank of America and JP Morgan Chase were reportedly setting up a US$80 billion SIV fund to purchase assets from investment vehicles hit by the crisis. These moves brought an initial measure of re-assurance back to western financial markets, but confidence remains fragile.

■ Ironically, this sub prime problem broke out some 20 years – almost to the month -- after Black Monday on 19 Oct 1987, when stock markets around the world went into free fall. It is also almost exactly ten years after the Asian financial crisis. Unlike 1997, however, Asia is far more resilient to a credit crunch than ever before.

■ The greatest danger, however, appears to be the impact of the US housing market weaknesses on private consumption, and ultimately, the US real economy. If prolonged, global growth would be hit. Additional risks to growth come from climbing oil prices – which hit US$96 per barrel in mid November – and which could spill over into higher inflation. Indeed, the evidence is that this is already happening.

Figure 1: Oil prices are climbing again

Source: Bloomberg

But Asia remains strong. Against this backdrop, the positive news is that Asia as a whole has been less impacted. At 9-10% pa growth, the economies of China and India are still firing strongly. With foreign reserves of US1.4 trillion, China will soon be a net exporter of capital. Vietnam’s growth rate is also catching up with these two. While Asia economies are still closely tied to the US, some decoupling of their economies has already occurred. Increasingly therefore, Asia is becoming more a source, rather than recipient, of global growth. Asian currencies are also strengthening against the USD although they have broadly weakened against the Euro. Collectively, these positives act as bulwark to shield Asia from the sub-prime problem.

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Indeed, Asia is grappling with a surfeit, not a shortage, of liquidity. This has arisen from record trade surpluses and high household savings. As a consequence, most Asian central banks are pursuing a gradual monetary tightening to stave off inflationary tendencies. Asia corporations also seem to prefer traditional bank loans against securitized forms of debt like CMBS or CDOs. Therefore, the risk of meltdown associated with sub-prime CDOs is more remote in Asia.

Figure 2: Asia still leads the world in growth prospects

Source: IMF, World Bank

Figure 3: Currencies are surging ahead against the USD

Source: Bloomberg

Figure 4: Asia central banks showing bias toward tightening

Source: Bloomberg

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Property outlook for 2008 Despite the sub prime problem, appetite for Asia property does not appear to have diminished. Jones Lang LaSalle reports that US$385 billion worth of direct real estate transactions were concluded in 1H2007, an increase of 25% YoY. Of this, US$54 billion (or 14%) flowed to Asia, an increase of 14%YoY. Notably, cross border investments accounted for 52% (vs 29% in 1H2006) of total investments. A recent survey by Urban Land Institute and PWC suggests that for 2008, the flow of capital into Asia could exceed that of 2007.

■ The sub prime problem may have the positive outcome of decreasing competition for assets from leveraged funds and private equity which hitherto have been more aggressive in property acquisitions using cheap debt than more tightly regulated listed REITS. Despite the credit crunch, the cost of capital in Asia has not risen significantly, and yields remain low. Enhanced capital inflows – underpinned by the positive growth story in Asia and poor investment alternatives elsewhere – could continue to keep yields low in 2008.

■ Over the longer term, Asia’s property fundamentals are still solid. But in the short term, over the next 12 months, we expect some pause and even mild correction in some markets. We do not believe that the hiccups being witnessed signal the start of a market downturn in Asia property. The evidence points otherwise. But, we continue to hold the view in our previous issue that investors need to exercise greater caution on account of greater risks from prices that have run up a great deal, and some markets facing potential glut over the next 2 years.

■ One trend that has become more prominent is the bifurcation of markets, with the top end having risen in prices considerably more than the lower and even mid end segment. This perhaps demonstrates the effects of globalization of Asia real estate markets -- capital flowing in massive quantities in the first instance into the highest quality assets in markets across the world. This is most noticeable in markets like Hong Kong, Singapore, Shanghai, Tokyo but increasingly being seen in lower tier cities like Kuala Lumpur. For 2008, the next wave of capital will seek better returns from lower quality assets and locations.

Across Asia, market performance will continue to vary. North Asia still leads the pack with its strong showing.

■ In Japan, volatile global economic conditions and risk of the domestic economy slipping back into deflation will most likely keep rates stable for the rest of 2007. But average land prices in Tokyo’s 23 wards are still only 60% of their peaks during the bubble years of the early 90s. Arguably they reflect the prospects for Japan’s recovery from the 15 years of recession. But interestingly, Mizuho Research Institute’s analysis reveal that the top 5% of land prices in Tokyo already exceeds the level seen during the last peak in 1991. The Tokyo office market remains very tight, and new buildings are quickly pre-committed. As the huge pool of savings gets unleashed with the gradual privatization of the postal bank, consumption should improve and underpin prospects for Tokyo retail. Tokyo property will remain core in the foreseeable future for many investors. We remain overweight Tokyo for all sectors, and suggest that attention will grow for other large cities like Nagoya and Fukuoka.

■ Korea’s economy is accelerating, and the sub prime problems are unlikely to stall growth. Seoul’s multiple nuclei city structure offers many opportunities for investors which have been eagerly taken advantage of. Office and retail offer perhaps the best prospects, but residential remains under a cloud because of government policies. We therefore overweight Seoul office and retail but have an underweight call on Seoul residential.

■ For all the measures to crimp escalating prices, China’s property market is still buoyant. It has been observed that only 30% of house purchasers employ mortgage loans, making the residential market quite immune to the effects of the latest credit squeeze by PBOC on bank loans. In fact, taken as a whole, some of


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the supply measures introduced earlier are arguably ill conceived and will serve only to reduce future stock and drive prices further upwards, as the data indeed seems to show. China’s blistering pace of economic growth and rising incomes also underpin the demand for residential and retail real estate. But supply pressures are building up in the Beijing office and retail sectors in the run up to the 2008 Olympics. So, we expect some short term consolidation. There also remains the risk that the Chinese government will continue to introduce even more drastic measures to curb excess liquidity and slow price escalation in keeping with the 17th Communist Party Congress’ agenda to promote sustainable and people-oriented economic development. There has also been recent evidence that the central government’s edict to restrain foreign capital is causing some discomfort among listed developers that acquired projects from local or city governments whose actions do not always align with that of the central government. The government also published a revised list of foreign investment restrictions in mid November 2007, and a large swathe of the property sector is included. However, interpretation difficulties remain and it is not entirely clear how badly foreign investment will be affected, if at all. Despite continuing price increases in most cities, and a stable price and rental outlook for Beijing, we urge a selective approach to China residential in light of the continuing policy risks. But, we are positive on Shanghai for the office and retail sectors. For Beijing, despite the short term supply pressures, there is long term importance to this market given its capital city status. We therefore argue for selective investments for the Beijing office and but are still overweight retail.

■ Hong Kong continues to benefit from its close geographic and economic linkages to China. Indeed, like in the case of shares, mainland Chinese has, in recent months, become a significant source of demand for Hong Kong residential properties. The office market, particularly in Central, continues to soar with strong demand and very limited supply, but some decentralization is taking place as corporations seeking expansion space prefer to gravitate to more affordable suburban locations like Hong Kong East. Thus far, however, demand has more than kept pace with the new decentralized supply and rents remain firm, although there is expectation of some short term softening as the supply come on-stream from 2008 onwards. We remain neutral on Hong Kong offices but overweight Hong Kong retail and residential, the latter gaining from interest rates that have fallen in tandem with the Fed’s loose monetary policy.

S E Asia markets have been somewhat less volatile and generally overlooked by international investors, with the exception of Singapore. Real value remains to be unlocked.

■ Malaysia has been a steady performer. The Budget has also provided for massive infrastructure schemes and development zones in the Iskandar Development Region in the south, and the Northern development region centred on Penang Island. Toward the end of 2006, the government has actively sought to internationalize its residential market, removing the real property gains tax, and streamlining approval procedures for developers and purchasers. Prices for luxury housing have risen dramatically aided by strong Middle Eastern interest. But the thinness of the market remains a concern. Supply for office is fairly limited and this should underpin the office sector over the next 2 years. We are overweight Kuala Lumpur for all sectors.

■ In Thailand, there is growing expectation that when the elections do occur at the end of 2007, normalcy should return to the country and set the stage for a rebound in the property market. The Bangkok office sector remains very tight. Retail remains on a stable footing, and the residential sector should be the chief beneficiary of the upturn. The political maneuverings are still on-going, and there is fear that the country could remain mired in uncertainty. Of equal concern is the proposed amendment of the Foreign Business Act which limits foreign participation, although the latest incarnation of the draft legislation suggests that the government has taken note of investor concerns. Given the uncertainties, we remain neutral on Bangkok for all sectors.


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■ Singapore stands out as the star performer in S E Asia. The government’s re-structuring story has had outstanding success, and supply remains tight for all sectors. But prices are beginning to look stretched and more importantly, the government has expressed concern over cost competitiveness, and acted in curbing residential speculation by removing the deferred payment scheme, setting the stage for possibly a consolidation in the short term. Indeed, brokers have reported a slowdown in activity. We are neutral on Singapore for all sectors. But within residential, we expect the mid-end segment to out-perform.

■ Indonesia’s economy is expanding at a healthy clip, supported by improved private consumption and the overall business climate. The real estate market has also gained from recent legislation passed to extend the tenure of property rights and reduction of property tax. The broader issue is the sluggish pace of reforms which remains a block on more active foreign participation. We remain cautious on office given that oversupply still prevails, easing only from 2010 onwards. But we are selective on the residential and retail sectors, both of which could benefit from the improved economic conditions.

Conclusion The Asian property landscape has changed further from the middle of 2007. While the general economic outlook within Asia is still robust, risk factors have heightened further. The differentiation we have argued has played out in the bifurcation between the high end segment and the rest. Because prices have run up much faster for the former than the latter, driven by continued high levels of liquidity, even greater differentiation needs to be made.

Arguably, the sub-prime problem could cause a negative outcome from the re-assessment of risk in Asia real estate. So, far, it has not deterred investors. Yields spreads have not widened. Corporate owners are unlikely to cut prices sharply because of their under-gearing & strong balance sheets. This will help to buffer any possible downturn provided it is short-lived. However, should an unseemly and prolonged meltdown occur – and this cannot be ruled out -- there will be a magnificent buying opportunity.


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Investment recommendations for 2008-2009

Category Country City Real Estate Investment Class

Residential Retail Office

“Hibernating” Thailand Bangkok

“Awakening” Malaysia Kuala Lumpur

Indonesia Jakarta

Korea Seoul

Japan Tokyo

“Hyperactive” China Shanghai

Beijing

Hong Kong Hong Kong

Singapore Singapore

Legend

Overweight Add to investments

Neutral Selective acquisitions

Underweight Opportunistic buys

Avoid Stay clear


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Profiling Asia’s markets China China’s economy continues to expand despite numerous tightening measures. China’s 2Q07 GDP expanded 11.9% YoY, the fastest rate in 12 years. With such sterling growth, the World Bank has also revised its full year forecast of China’s GDP growth to 11.3% from 10.4% previously. Inflation has surged past the central bank’s comfort level of 3% to 6.5% in August, due mainly to sharp increase in pork prices as a disease has rendered most of the pig population unsuitable for consumption. But, stripping away the enormous growth in food prices, inflation actually increased a mere 1%.

The 17th Chinese Communist Congress Party held in mid October this year reiterated the government’s earlier position to pursue people-centred growth, environmental sustainability and promote domestic consumption to balance an over-dependence on exports. Given the Olympics to be held next year, and the World Expo in 2010, we can expect political stability to continue well beyond 2008.

Figure 5: Stable growth ahead

Source: CEIC, World Bank, EIU

Figure 6: Inflation for food far outstrips overall inflation

Source: CEIC

While global markets are grappling with credit tightening issues, China has woes at the other end of the spectrum. Excess liquidity remains a concern as growth in M2 consistently breached the central bank’s target of 15%. In reality, the growth rate of money supply should be pegged to China’s long term economic growth. With an economy which is already expanding at an alarming double digit rate, it is unwise to target money supply growth at above GDP growth, as inflation pressures will mount. This is clearly evidenced by the 6.5% growth in August’s CPI.

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The government recently allowed its citizens to invest in the Hong Kong stock market so as to encourage capital outflow and to divert focus away from external pressure to allow the RMB to appreciate. But, while this may be a useful way to increase capital outflow, profits from the stock market can still be brought back to the mainland, exacerbating the liquidity issue.

Other attempts to curb liquidity include increasing the 1 year lending rate the 5th time this year to 7.29% and increasing the one-year RMB deposit rate 3.87% to encourage savings. We expect another round of rate increase before the end of the year especially since the inflation rate already exceeds the deposit rate, yielding a negative real interest rate. Open market operations such as the recent sale of RMB 200 billion of bonds by the Chinese central bank to the major banks and retail investors are also attempts of the government to soak up excess liquidity.

China is also seeking ways to invest its US$1.4 trillion in foreign currency reserves and part of it has been used to capitalize a US$200 billion investment fund. A large portion of the reserves have been invested in safe but low-yielding U.S. Treasuries. US$3 billion has also been invested in Blackstone Group. With investments of such massive proportions, it may not be long till China becomes a net exporter of capital.

Figure 7: Growth in M2 breaches PBOC’s comfort zone

Source: CEIC China’s real estate market is still drawing significant interest from foreign investors. It continues to grow relentlessly despite the numerous measures implemented to slow it. Real estate FDI as a percentage of the aggregate FDI has increased from 7.5% in 2005 to 11.4% in 2006, indicating the strong inflow of capital to the real estate sector. However, in recent months, the government has introduced several measures to cool down foreign investors’ interest. Foreign investors now have to go through more rigourous red tape and central government approvals before they can invest in the real estate sector. Moreover, foreigners are banned from borrowing offshore when investing in China’s real estate. Most recently, the central government also announced an updated “negative list” of sectors which are restricted to foreign investors. A large swathe of the property sector falls within the list. However, interpretation issues remain and it is not entirely clear how this latest round of measures will affect the market in the short term.

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Figure 8: Real estate still piquing foreign interest

Source: CEIC China’s strong economic growth is sustaining demand for offices in key cities. Shanghai’s GDP jumped 13% YoY to RMB556.2 billion in 1H07, driven mainly by the services sector which reported a 12% YoY increase, surpassing that of the manufacturing sector for the first time since 2001. This growth rate goes beyond that of China’s 11.5% and is the fastest Shanghai has experienced in 3 years. Beijing, buoyed by the impending Olympic Games as well as positive market sentiment, is also one of the top locations in China for investors.

Figure 9: Improving business climate bodes well for the office sector

Source: CEIC

Shanghai continues to face a supply crunch from the severe lack of quality Grade A office buildings. With no new supply in 2Q07, the vacancy rate was pushed down to 3%. In Puxi, pre-leasing activity was more robust as compared to Pudong’s due to the higher rental expectations by landlords in the latter. Under a revised development plan, a new central business district will be formed in a few years by joining North Bund, The Bund and Lujiazui. This will be another stimulus to Shanghai’s already booming office market. This positive outlook is expected to carry over to 2008 and 2009 given the promising economic fundamentals and the continuous flow of FDI.

Many state owned enterprises choose Beijing as their headquarters and increasingly, foreign enterprises have also made it a point to make their presence felt in Beijing. NYSE has just received approval to set up a representative office in Beijing to assist the listing of Chinese companies in the US market. This shows the increasing perception of Beijing as a conducive and suitable location for business. Consequently, demand for office space Beijing in 1H07 far surpassed that in the whole of 2006, with the CBD micro-market continuing to lead in terms of take up and rent increases. But, while demand is encouraging,

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Shanghai’s office sector is facing a supply crunch and demand remains vigorous on the back of strong FDI

Beijing’s office outlook post 2008 looks favourable as new developments are curtailed


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the supply that is coming on stream is also significant, although we expect the situation to take a better turn in late 2008 as all construction activity is banned due to the Olympic Games. A slower increase in supply will therefore help bring the market back to equilibrium over the next few years.

Policy risks remain pronounced in the residential sector. The regulatory environment for the residential market remains potentially difficult as the government has not relented in implementing new measures to curtail rampant growth. Monthly data from the National Bureau of Statistics do not show signs of cooling off.

Shanghai’s residential market is abuzz with activity fueled by foreign investors, as evidenced by recent acquisitions and development projects. Goldman Sachs acquired Garden Plaza, consisting of 564 residential units in Changning. CapitaLand completed its acquisition of a development company with the right to acquire and develop a prime residential site in Qingpu. But new government measures continue to be introduced. Presales are now required to be launched in batches of 30,000sqm to prevent developers from deliberately holding back supply to push up prices. While we do not expect a decline in the market as demand and buyer sentiment is still relatively strong, there is unlikely to be meaningful upside as well. The Shanghai residential sector in 2008 will still be buoyed by strong demand and positive buyer sentiment, but at current values, significant appreciation in value in 2008 is unlikely and with the measures being implemented so frequently, policy risks are high.

Beijing’s residential transactions volume experienced a slight slowdown in 2Q07 although capital values still managed to edge up. The inflow of expatriates also helped maintain the rental rates of serviced apartments. The Westin Executive Residences in Xicheng and Oakwood Apartments in Chaoyang are the major supply of serviced apartments in 2Q07, adding approximately 400 units to the market. While current rental rates are strong, we believe that it is somewhat artificially boosted by the Olympics as foreigners are booking some apartments in advance so as to secure accommodation in Beijing during the Games. After the Olympics, a slight decline in values could be expected. However, in the longer term (beyond 2008), the residential market should start to recover as supply shrinks during the Olympics season.

Rising consumption is reflected in encouraging retail sales growth. China’s economy has been largely driven by exports and the government has been eager to spur domestic consumption to moderate the country’s massive trade surplus. Currently, domestic consumption only takes up approximately 34% of GDP, compared to 60-70% for more advanced economies. There is much more potential to be realized in this area.

Shanghai’s composite share price index rose some 87% year to date and is now trading at a PE ratio of approximately 50 times, significantly higher than other bourses in the region. This, coupled with rising disposable incomes, has generated positive wealth effects to spur spending.

China’s residential sector still faces policy risks but prices in 1st tier cities are still edging up

China’s private consumption still has ample space for growth


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Figure 10: The stock market in Shanghai surges to new highs

Source: CEIC

In 1H07, Shanghai's total retail sales of consumer goods increased by 14.2% YoY. New retailers across all tenant groups are actively seeking to establish a foothold in Shanghai, arguably the most well known city in China, before branching out to other cities. Existing retailers are also eager to expand their businesses which helped drive demand for retail space. Against this backdrop, demand is expected to outpace supply up till 2009, which will result in upward pressure on values for the next few years.

With disposable incomes and retail sales rising steeply, Beijing’s retail sector is also in its boom phase. Retail expansion is accelerating in Beijing with pre-leasing activities maintaining its strong momentum as foreign brands continue to make their debut in the capital city. Although demand is strong, supply is equally in abundance. Beijing is expecting approximately 2 million sqm of retail space for the next few years, with the bulk of the supply coming on stream in 2007 and 2008. While this could likely moderate the growth trajectory, we remain confident in the purchasing power of the capital city which will help buoy the retail sector.

Figure 11: Retail sales on strong growth trajectories

Source: CEIC We are positive on Shanghai offices and retail and Beijing retail, but remain neutral on China residential and Beijing office. Looking beyond tier 1 cities. China’s industry, investment and export based growth model has become increasingly problematic because of the trade friction and environmental degradation it has created. Moreover, if driven by accumulation of capital alone, growth will in the end run out of steam. So the government is consciously steering growth away from heavy reliance on industry and investment and toward domestic consumption.

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Positive wealth effect in China due to rising incomes and strong growth in the stock market has aided the retail sector

China still holds many opportunities, although one should look beyond the high profile 1st tier cities


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In the context of the real estate sector, Tier I cities such as Shanghai, Beijing and Guangzhou still remain attractive due to its large population base and significantly higher incomes per capita. However, real estate investment opportunities are rapidly diminishing as a result of increased competition and market saturation. Property prices are also no longer cheap in Tier I cities. A case in point is the tender for a site -- Lot 163 – along Shanghai’s Nanjing Road, which attracted 10 bids. In contrast, Tier II and Tier III cities are up and coming with growing incomes, rapid urbanization, and infrastructure. Property prices are still relatively lower. Such qualities create ample opportunities for real estate investment in these cities. Hong Kong SAR 2Q07 GDP growth has surprised on the upside but a slowdown in growth for the whole of 2007 is expected. As it celebrates 10 years of its return to China, Hong Kong’s mature economy is still ahead of China’s by leaps and bounds. In 2Q07, the economy expanded briskly at 6.9% YoY, bringing 1H07 growth to 6.3%. Full year forecast has been revised upwards to 6%, indicating a slight slowdown in 2H07 amidst global volatility. With profit tax to be reduced 100 basis points to 16.5%, economic growth is expected to be stable for the next 2 years, although it will be lower than the 6-7% growth it has been enjoying the last 2 years.

Figure 12: Slight slowdown in growth expected

Source: CEIC Hong Kong’s growth in 1H07 was boosted by robust exports, higher

consumption, and increased investment spending. External trade remained strong as Hong Kong’s main market China also experienced sterling economic growth. Exports to other markets also showed positive performance, amplifying total exports of goods by 11.3% YoY in 2Q07.

External trade is not the only main contributor to Hong Kong’s economy.

Domestic consumption spending experienced a marked increase, supported by rising labour income, better job prospects and improved household financial positions. Seasonally adjusted unemployment decreased to 4.2% in June 2007, the lowest since mid 1998 while wages and earnings rose higher year-on-year in March 2007. In addition to the profits tax cut, Chief Executive Donald Tsang has also announced that income tax will be reduced to 15%. As such, we can expect the already strong domestic consumption to be further boosted by this tax cut.

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Figure 13: Labour market remains bright

Source: CEIC China’s pilot scheme of allowing mainland-Chinese residents to invest directly

in Hong Kong's stock market will provide long term stimulus to the local bourse and will also be beneficial to the economy as the wealth effect from the strong growth in the stock market will help stimulate domestic consumption. There is arguably a great deal of froth in this investment but the scheme should still be beneficial.

Hong Kong will remain competitive but there are still issues to watch out for. In the lead up to the Asian financial crisis, HK’s real effective exchange rate rose sharply, as reflected in consistently high CPI, rapid wage growth and property price inflation which fuelled cost pressures. Post crisis, the real effective exchange rate has been on a steep downward trend which helped HK regain its price competitiveness lost due to the crisis. Rising economic efficiency as HK moves into a higher value added services will also aid the economy going forward. In order to maintain its attractiveness to investors, HK will need to tackle pollution, and streamline business regulations and preserve its flexible and open markets. Pollution, in particular, is hurting the attractiveness of the city in attracting longer term expatriates. The property market is set to remain firm in 2008 on the back a stable economy. Continuing capital inflows from overseas and the Mainland as well as expected decisive government action on infrastructure spending will broadly support the market. Depreciation in the value of the Hong Kong currency, linked as it is to the falling US dollar, will also help to spur exports. The expected increase in inflation due to rising rents and the reappearance of negative interest rates due to the recent Federal Funds rate cut of 50 bp will bolster interest rate sensitive sectors such as real estate. Demand indicators remain strong for the office sector. HK’s office sector is

still commanding high rentals spurred by strong demand led by the banking and financial sector. Encouraging economic conditions boosted business sentiment and sparked off a broad based expansion in activity which extended beyond the banking and financial sector and into office locations other than Central.

Central continues to lead the various office micro-markets in HK in terms of

rentals and capital values. But Wanchai/Causeway Bay and Hong Kong East areas are also up and coming markets experiencing strong demand from tenants not in the financial sector as well as relocation of tenants previously located in Central and are unable to stomach the ever increasing rentals or find enough contiguous space to expand. Among the high-profile proposed relocations out of Central are Morgan Stanley’s shift of 350,000 sq ft of space to International Commerce Center (ICC) in Kowloon West, and DBS Bank’s 160,000 sq ft lease at One Island East.

3.0

4.5

6.0

7.5

9.0

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Unemployment Rate Seasonally Adjusted Unemployment Rate

%

Lower interest rates will aid growth in real estate

Unemployment is at an all time low


16

Figure 14: Central leads the pack in the surging office sector

Source: JLL The residential market continues to be buoyed by the economy. Hong Kong’s

residential market is expected to end the year on a higher note as demand for residential units rise due to growth in corporate headcount and increase in wealth. This strong demand outstripped the new supply in 2Q07 and this imbalance is expected to last till 2009. Residential sales transactions are expected to hit 11,000 units in August, the highest volume in 27 months. The opening of the West Corridor, which links Shenzhen to Hong Kong, has also aided the market as it managed to attract many Mainland investors to buy secondary homes in the New Territories. With interest rates on the gradual decline, the residential market will continue to yield strong returns in 2008.

Table 1: Hong Kong Residential Primary and Secondary Sales Comparison

Year Month No. of Primary Residential Transaction

No. of Secondary Transactions

Aug 1,171 5,864 Sep 3,773 6,028 Oct 1,007 5,325 Nov 758 6,363

2006 Dec 1,489 5,763 Jan 857 6,621 Feb 1,124 6,681 Mar 728 7,289 Apr 2,100 7,250 May 1,685 9,151 Jun 1,015 8.843 Jul 1,201 8,183

2007 Aug 1,155 8,806

Source: Knight Frank Aug 2007 transactions are tabulated up till 28th Aug Retail sector to experience strong growth. Retail sales have grown

consistently. With a favourable labour market backed by low unemployment and rising wages, the retail market, and especially the luxury goods sector, stands to gain. Tourism, especially from China, continues to grow at a rapid pace, adding support to Hong Kong’s retail growth. Optimism in the retail market is expected to spillover to 2008 with the economy still portraying relatively strong albeit slower growth. Continued arrival of new brands also indicates stronger demand for retail space especially in high traffic street shops in prime areas such as Causeway Bay and Mongkok.

0

3,000

6,000

9,000

12,000

1988

1990

1992

1994

1996

1998

2000

2002

2004

2005

2005

2006

2006

2007

Central Effectiv e Rent Wanchai Effectiv e Rent Tsim Sha Tsui Effectiv e RentHK East Effectiv e Rent Kow loon East Effectiv e Rent

Effectiv e Rent; HK$/Sqm/YearStrong demand for office space in Hong Kong has caused spikes in rental rates

Home buying is also on the rise with increasing incomes and attractive mortgage rates


17

Figure 15: Higher wages bolsters retail sales

Source: CEIC We are overweight Hong Kong retail and residential but neutral on offices.

Macau SAR Macau continues to draw attention from investors. With 2Q07 GDP YoY growth of 31.9% and 1H07 growth of 23.9%, Macau is gaining considerable publicity and arguably, hype, especially with the recent opening of Venetian Macau. Once again, growth has been fuelled by gaming revenues. Exports declined as the manufacturing sector was sidelined by the glamorous gaming industry. While private consumption showed healthy QoQ growth of 8.4% in 2Q, it still lagged significantly behind the growth of the economy. While it is certainly encouraging to see such growth statistics, one cannot ignore the perils that lie behind them. A large portion of the growth stems from the construction industry, propelled mainly be the various casinos, residential and commercial developments. It is estimated that approximately 10,000 new residential units will be constructed in the next few years. Consequently, maintaining a GDP growth rate of approximately 15% for the next 2 years should be achievable.

Figure 16: Strong growth ahead

Source: CEIC, Goldman Sachs Luxury residential prices soar but mass market transactions have softened on changes to immigration scheme. Following the announcement of the suspension of Fixed Asset Investment Residency Policy in April 2007, residential sale transactions declined 11% QoQ in 2Q07. Despite fewer transactions, luxury property prices continue to climb as more quality developments flowed into the market. In 2Q07, average residential transacted price increased 13.7% QoQ to MOP 1,314 psf, driven mainly by the high end residential sector which saw The Manhattan in the Cotai Strip fetching record prices of HKD 6,000 psf.

144

146

148

150

152

Mar-0

2

Jul-0

2

Nov-0

2

Mar-0

3

Jul-0

3

Nov-0

3

Mar-0

4

Jul-0

4

Nov-0

4

Mar-0

5

Jul-0

5

Nov-0

5

Mar-0

6

Jul-0

6

Nov-0

6

Mar-0

7

Hong Kong Wage Index

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

2002 2003 2004 2005 2006 2007F 2008F

Macau GDP Grow th RateStrong growth in Macau’s economy is aided mainly by the construction and gaming sector


18

The most recent launch of luxury residential, One Grantai, is also selling for more than HKD 6,000 psf. Demand for housing will also increase due to job creation from the new hotels and casinos. As the labour market tightens and as wages climb, residents will also be prompted to upgrade to better housing, thus creating demand for better quality residential units. Investors are also attracted to Macau’s property market due to its relatively low prices compared to other cities in the region. In light of this, increasingly more property launches are also coming on line.

Table 2: Developers capitalize on the positive market sentiment for residences

Year Project Name Location Est. No. of Units

Prince Flower City Taipa 576 The Pacifica Garden Taipa 294

Golden Bay Peninsula 700 Nova City Phase 2A Taipa 696

2008E

Chun U Villa Taipa 78 Le Royal Arc Peninsula 360

The Praia Peninsula 1,288 One Central Peninsula 800

2009E Nan Vam Lake Proj Peninsula 300

Source: Colliers Gamblers are not the only big rollers in Macau. While casinos may be the biggest draw in Macau, not everybody visits Macau for that sole purpose. Retail is also one of Macau’s significant attractions as retailers compete for a slice of the lucrative pie. There are many strong drivers behind the retail sector: increasing wages, higher tourist arrivals as well as an increase in population due to opening of various hotels and casinos. In fact, the Institute for Tourism Studies estimates that Macau would need an additional 100,000 workers to support the new hotels and casinos. The retail sector should gain strong momentum in the coming quarters with earnings rising steadily and increased tourist receipts.

Figure 17: Earnings fuel an upward trend in retail sales

Source: CEIC Strong expansion in 2008. Macau’s growth will be partly buoyed by China’s. As it stands, the average Chinese tourist spends approximately twice that of the average tourist in Macau. With China’s economy expected to grow at 8-9% in the next 3 years, Macau’s tourism would certainly stand to gain. The lure of the casinos will be another factor in boosting tourism and consumption in Macau. In 2005, there were only 17 casinos. By 2Q07, there are 26 casinos with 3,100 gaming tables and 8,200 slot machines. Casino revenue in the 2Q07 grew 48.9 per cent YoY to MOP 19.5 billion. With the addition of Venetian Macau in late August, we expect the booming gaming sector to continue to be one of the main drivers for the economy.

0

2,000

4,000

6,000

8,000

10,000

2001 2002 2003 2004 2005 2006 2007

0

700

1,400

2,100

2,800

3,500

Median Monthly Earnings Retail Sales Value

Median Monthly Earnings, MOP Retail Sales Value, MOP

Robust pipeline of residential launches as prices increase due to stronger demand

Tourism and higher earnings fuel the retail sector


19

Figure 18: Tourists from China are significant contributors to tourist receipts

Source: CEIC

Korea Korea’s economy is growing. Korea’s economic growth accelerated by 5% YoY in 2Q 2007, up from 4% YoY in the preceding quarter. The 2Q growth outcome was broad based, driven by both exports (+14.2% YoY) and rising capital investment (+11.9% YoY). Shipbuilding, in which Korea is reportedly the world’s number one supplier in terms of vessel orders, enjoyed robust conditions. Indeed, neither the slowdown in the US economy nor the strong won materially affected exports as this was largely offset by demand from China and Europe.

Figure 19: Korea’s growth is broad-based

Source: CEIC

■ Labour market conditions improved further as the household debt problem receded, and but private consumption remained lackluster, rising by a meagre 4.1% YoY in 2Q07. Construction growth was also slower on account of the effects of curbs on real estate speculation but this should not derail the country’s economic performance for the rest of this year.

0

3,000

6,000

9,000

12,000

15,000

2000 2001 2002 2003 2004 2005 2006

Average Overall Tourist Spending Average China Tourist Spending

MOP

-5%

5%

15%

25%

2000 2001 2002 2003 2004 2005 2006 1H2007

Priv ate ConsumptionGFCFEx portsGDP

% YoY

Korea’s economy is growing steadily…

Both exports and private consumption have improved…


20

Figure 20: Labour market conditions are favourable

Source: CEIC

Figure 21: Consumer confidence continues to improve, albeit slowly

Source: CEIC

■ Reflecting the positive mood of the economy, the Korea stock market surged strongly. This was also partly the outcome of money flowing out of a more subdued housing sector into the stock market as the anti-speculation curbs bit. To prick a potential stock market bubble, Bank of Korea (BOK) raised the policy rate by 0.25% each for two consecutive months in July and August 2007. But it left the rate unchanged in September in the midst of the worsening sub prime problem. Looking ahead, BOK, like Central Banks elsewhere, will continue to tread a narrow path between forestalling inflation and managing the strength of the won on one hand, and ensuring liquidity does not dry up on the other hand.

Figure 22: KOSPI sets new high…before the sub-prime problem erupted

Source: CEIC

2.5

3.5

4.5

80

100

120

140

Real w age indexUnemplolyment rate

2002 2006200520042003

80

100

120

140

Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07

BOK Consumer confidence index

500

900

1300

1700

2100KOSPI Index

2002 2006200520042003

Supported by favourable labour market conditions and rising consumer confidence

KOSPI at record levels reflect the improved business climate


21

Figure 23: BOK pursues monetary tightening

Source: CEIC

Figure 24: The KRW strengthens further against USD but is more stable against EUR

Source: CEIC

■ The outlook for the remaining months of 2007 and whole of 2008 is positive, with full year growth estimated at 4.5% in 2007, and rising to 5% in 2008. Traditional manufacturing as well as the upturn in the global electronics cycle will continue to underpin export growth. Export demand will come not only from US but increasingly China and other developing countries as well. The KORUS FTA recently concluded will also help to spur trade. The unexpected rapprochement with N Korea has also helped to lift sentiment.

■ The major uncertainty is the development of the sub-prime problem which, if prolonged, could threaten the real economy in US and crimp export demand and domestic spending. But a positive outcome could be the slowing down of the won appreciation caused by a flight to US bonds amidst the global financial turbulence.

Seoul property market Offices will continue to out-perform. The Seoul office market remained exceedingly tight, with vacancy rates below 2% for all 3 core locations in the CBD, Gangnam and Yoido. Against a backdrop of limited new supply because of city centre land assembly issues, strong demand from a buoyant services sector (especially financial services) are driving heavy pre-commitments.

The prognosis over the next 2 years remains very good. Indeed, Morgan Stanley’s recent acquisition of Daewoo Engineering & Construction’s HQ building for close to US$1 billion attests to the continued strong interest among institutional investors for high quality assets in this increasingly core market. However, we expect the pace of yield compression to slow given the bias toward monetary tightening. Current EBITDA yields of 6.0% are inching close to the 5-year Treasury bond yield of around 5.5%, but the weight of capital will keep spreads tight.

3

3.5

4

4.5

5BOK overnight call rate

2002 2006200520042003

900

1,100

1,300

1,500

KRW to EUR

KRW to USD

2002 2006200520042003

The KRW strengthens…..

BOK has held rates in light of the sub prime crisis, but the bias is toward tightening

The outlook for 2008 is good…..

Offices remain a good bet….


22

Figure 25: Financial services activity drive strong office demand

Source: CEIC

Figure 26: Office vacancy rates are exceedingly low…

Source: JLL

Figure 27: Rents are trending steadily upwards in more sustainable fashion

Source: JLL

100

120

140

160Service industry activity index, 2000=100

2002 20072006200520042003

Overall index

Financial instititutions & insurance

0%

5%

10%

15%

Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07

Seoul prime office v acancy rate, %

CBD Yoido

Gangnam

40,000

60,000

80,000

100,000Seoul prime office rent KRW/py ugn pm

CBD

Yoido

Gangnam

2002 20022002200220022002

Due to strong business expansion from financial services…


23

Figure 28: Future supply is still limited over the next 3 years

Source: JLL

Retail sector also shows promise. Specific data on Seoul’s retail property market is scarce, but it is possible to infer from the broader indicators that the retail market is poised to do well in the coming two years. Domestic consumption has lagged the rest of the economy, but there are signs that the situation may improve.

■ Retail sales, for example, continue to gain traction. The participation of major retail operator/developers such as Simon Property Group into the high end segment and the development of large scale mixed use developments such as Skylan and AIG’s International Financial Centre will introduce more revolutionary concepts into the market.

■ A recent development has been the government’s plans to create various 15 zones in Seoul to promote international business and cultural exchange. The Myeongdong area is one such zone designated for IT. This will help to entrench the traditional strengths of this lifestyle driven sub-market.

■ Samsung’s relocation of its main offices to Gangnam with the phased completion of its massive Samsung Town project has re-cast the complexion of the retail landscape, favouring the Gangnam area, particularly around the Gangnam station with its enlarged base of office workers and established residential amenities.

Figure 29: Retail sales remain robust…

Source: CEIC

Residential market is cooling. Housing price appreciation in Seoul since 2004 has proven to be a sensitive political issue for the government. The gains in prices has arisen from a variety of factors – difficulty in securing sites for housing, regulatory inefficiencies, and strong demand for the highly desirable amenities of areas such as Gangnam. As a consequence, the government has introduced a package of measures – credit controls on loan to value ratios, a variety of property-related taxes, expansion of public housing programme, etc. There is some concern that the government's persistent efforts to deflate the property bubble may trigger a hard landing in the real

-150,000

0

150,000

300,000

2001 2002 2003 2004 2005 2006 2007F 2008F 2009F 2010F 2011F

CBD Yoido Gangnam

Supply (sqm)

110

120

130

140Retail Sales Value Index

2002 2006200520042003

And limited supply till 2010 …

Stronger consumer spending will bolster the retail sector

But the housing market is slowing in response to government measures to curb speculation


24

estate market. The evidence thus far, however, is a gradual slowing in price growth. But core areas such as Gangnam given its attractive environment will continue to be resilient over the next one to two years.

Figure 30: Housing prices begin to stabilize

Source: CEIC

Overall, we are overweight on Seoul office and retail, but underweight on residential.

Japan Japan has encountered some headwinds. A pension fund scandal, allegations of misdeeds by several cabinet ministers, as well as ill-health led to the shock resignation of Prime Minister Shinzo Abe on 12 Sep 2007. Yasuo Fukuda, widely recognized to be a moderate, subsequently won the leadership of the Liberal Democratic Party (LDP) and assumed the premiership on 24 Sep 2007 after a battle with the opposition-dominated upper house which elected Ichiro Ozawa for the position.

Against this backdrop, Japan’s economy suffered an unexpected 0.5% contraction YoY in 2Q07. On an annualized basis, the shrinkage was 1.2%. While corporate profitability (especially of large and medium sized enterprises) remains robust, the first three of the four economic engines – personal consumption, capital investment, public spending, and exports -- showed signs of slowing. Only exports remained strong, but even this may be threatened by the slowdown in the US and the strengthening JPY.

Figure 31: Japan’s GDP contracts in 2Q07

Source: CEIC

80

100

120

140Seoul housing indices (Kookmin)

2002 20072006200520042003

housing price

housing rent

-10%

-5%

0%

5%

10%

Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07

-2.5%

-1.5%

-0.5%

0.5%

1.5%

2.5%GDP % chg YoY %

% chg YoY

Domestic demand

GFCF

Japan’s growth showed some signs of weakening in recent weeks


25

Figure 32: But exports are still robust

Source: CEIC

Figure 33: And the corporate sector is still in the pink of health

Source: CEIC

Acting in concert with the US Fed and European Central Bank, Bank of Japan (BOJ) predictably left its policy overnight call rate at 0.5% in September, unchanged for the last seven months, claiming that the economy is expanding “moderately.” Yet, the rate environment is clearly tightening.

Figure 34: BOJ opts to hold rates, but trend suggests tightening bias

Source: CEIC

Japan however is less likely to be impacted by the sub-prime problem, largely on account of its risk aversion from the painful lessons learnt during the bubble economy years. While Japan’s financial markets were latecomers to the frenzied innovation and sharp growth in investments that characterized markets elsewhere, it has limited exposure to the sub prime segment and has escaped unscathed from the

-5%

8%

20%

33%

45%

Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07

Change in trade % YoY

Exports

Imports

4,000

5,250

6,500

7,750

9,000

Mar-01 Dec-01 Sep-02 Jun-03 Mar-04 Dec-04 Sep-05 Jun-06 Mar-073.0%

3.8%

4.5%

5.3%

6.0%Operating profits of large companies (turnover>JPY 1 billion), JPY billion

Profit to sales ratio

0.0

1.0

2.0

3.0

Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07

%

BOJ discount rate

5 year swap (JPY)

Interbank

But the corporate sector remains profitable and robust

The sub-prime problem is causing BOJ to hold rate increases


26

current turbulence. This is reflected in the stable JPY. Overall, full year 2007 growth estimates have been trimmed by 0.1% to 1.8%.

Tokyo property That urban land prices have staged past the long deflationary phase is no longer in question. Instead, there has been some concern expressed recently by some quarters – notably Daiwa Securities -- that a new bubble may be building up. The evidence, however, is not conclusive. In a research note published in September 2007, Mizuho Research Institute reported that average land prices for Tokyo’s 23 wards in 2007 were hovering at 60% of the 1991 levels at the height of the bubble period, the top 5% of land prices in choice locations such as Ginza have already exceeded them. But it can be argued that this merely illustrates the bifurcation of asset prices between the very top quality ones and the remnant that has taken place in many large cities around the world.

Tokyo offices still offer excellent future growth prospects. The market in the central 3 wards (“ku’s”) remains exceedingly tight, and attractive to investors. Indeed, vacancy rates for all of the 3 central ku’s are currently at an astounding 1% or less. Aggressive pre-commitments already extend to 2008 and 2009. There is also distinct preference for newer buildings. Given the rapid institutionalization and securitization of real estate through REIT vehicles, the exit options are increasing, making Japanese property even more attractive to international investors. This will be further augmented by the JPY 650 billion allocation to real estate announced by the Pension Fund Association in Tokyo in August.

Figure 35: Tokyo office market remains extremely tight

Source: CEIC

■ The choicest locations at Marunouchi & Otemachi still dominate, but the severe shortage of space is driving tenants to alternative prime areas. Akasaka, Roppongi, Shibuya and Shinjuku have also benefited from the spillover demand because of the new stock of quality buildings, such as Tokyo Midtown.

■ Monthly rents have already hit JPY80,000 per tsubo, although most prime rents in the 5 central wards of Chuo-ku, Minato-ku, Chiyoda-ku, Shibuya-ku and Shinjuku-ku range between JPY 40,000 to 60,000 per tsubo.

■ With supply still limited till 2011, there is wide expectation that rents will continue to rise – albeit at a more moderate pace – over the next few years. Indeed, Ikoma Data System Service (IDSS) forecasts that prime office rents will increase by 17% over a 4 year period from 2007 to 2011, representing a steady rate of rental growth.

■ With 5 year JGB yields hovering just over 1% in recent auctions, Tokyo prime office spreads exceed 200bp and remain very attractive, in comparison with other markets such as London, Paris and New York and Frankfurt. In fact, global funds and J-REIT activity will drive yields further downwards, although the tightening bias in BOJ’s policy stance will moderate this compression. Rental upside will be more pronounced for the scarcer large floor plate and

12,500

13,000

13,500

14,000

14,500

Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07

0.0

2.0

4.0

6.0

8.0Tokyo 23 ku's average office rent JPY per tsubo pm Vacancy rate %

Tokyo offices are still very attractive

Large floor plate buildings are in limited supply and are particularly attractive to occupiers


27

newer buildings which are tightly held by the large Japanese corporations. We continue to overweight Tokyo offices for the next 2 years.

Figure 36: Prime office rents in Tokyo’s Central 5 ku’s have risen strongly

Source: Miki Shoji

Tokyo prime residential also shows promise. The broad case for Tokyo housing stems from several factors: (1) the shortage of modern earthquake-resistant structures, (2) the influx of Japanese into major cities in search of employment and (3) the rise of the single person households. All these factors imply that demand for urban housing will increase at least over the next 5 to 10 years. But, the National Institute for Population and Social Security Research expects that the rapid ageing in Japanese society will progressively offset the impact of these factors and eventually shrink the number of households in Tokyo from 2015 onwards. The number of foreigners taking up residence has also risen, further fuelling the demand for housing.

Figure 37: Tokyo’s demographic shifts favour the housing sector in the next few years

Source: Ken Corporation

15,000

17,500

20,000

22,500

2001 2002 2003 2004 2005 2006 1H2007

Chiyoda Chuo Minato Shunjuku Shibuya

Change in average rent by district, JPY per tsubo pm

-100,000

0

100,000

200,000

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Change in city population

Tokyo metropolitan area

Tokyo 23 wards

Central Tokyo rents are still rising

Japan’s demographics lend support to the Tokyo housing market


28

Figure 38: Foreigners also fuel demand for housing

Source: Ken Corporation

■ Rental apartments will perform moderately well. Data from Ken Corporation reveal that as at June 2007, the vacancy rate of high grade apartments in Tokyo’s 9 major wards – Chiyoda, Chuo, Minato, Shinjuku, Shibuya, Shinagawa, Meguro, Ota & Setagaya – hover around 7%. For the preceding 7 years or so, it has fluctuated within a fairly narrow band of 3.5% to just below 11%. Rents have, in tandem with this, moved gradually upwards.

■ We expect very gradual – around 10% -- increase in rents over the next 3-4 years, taking into account the archaic but dominant structure in residential leases which still favour tenants. Likewise, indicators for the condominium sales market also show positive momentum.

All things considered, we remain mildly positive about the Tokyo residential sector.

Figure 39: Apartment rents are steady

-15,000

-5,000

5,000

15,000

25,000

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Change in number of registered foreigners in Tokyo's 23 wards

14,500

15,000

15,500

16,000

16,500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Average monthly rent of high grade apts in Tokyo 9 major wards JPY per tsubo

Apartment rents are steady and may trend up mildly over the next few years


29

Figure 40: Condominium sales fairly brisk

Source: CEIC

Figure 41: Prices are also inching up

Source: CEIC

Thailand Thailand has now entered the final lap, en-route to a return to democracy. The majority approval of the military-backed constitution in August’s referendum allayed fears of protracted political instability. The incumbent government’s announcement that the general elections will be held on 23rd December, pending the approval of three organic laws required under the new constitution, will restore some confidence in the economy.

There are reasons to expect an indecisive general election and a consequently fragmented political landscape – the dissolution of the hugely popular Thai Rak Thai, lower-than-expected referendum turnout, weak support for the new constitution despite massive efforts to ensure acceptance, as well as tightened checks and balances built into the new constitution. Although the effectiveness of a coalition government with diluted parliamentary power could be a concern, there are other more pressing issues shouting for attention now.

Foreign investors remain edgy as uncertainties over a stricter version of the Foreign Business Act (FBA) remain unresolved. In addition to shareholding restrictions, further constraints on voting rights and a contentious clause preventing foreign investors from exercising control over the management are being considered. With only a few months to go before the elections, investors are hoping that the FBA would not be passed within the term of this government. The Democrat Party, Thailand’s biggest political party after the break-up of Thai Rak Thai, is expected to form the core of the next government and the leaders have up till now been opposed to the proposed amendments to the FBA.

Headwinds have been building on the external front. Exports had been the sole engine powering the Thai economy in the past year, but a strong Baht and slowing

500

1,500

2,500

3,500

4,500

Jan-03 Jan-04 Jan-05 Jan-06 Jan-0760

70

80

90

100New condominium units marketed Contract ratio, %

35

45

55

65

75

Jan-03 Jan-04 Jan-05 Jan-06 Jan-07

Average Tokyo new condominium price per unit JPY million

Spotlight is on the FBA now that political uncertainties have eased

Continued appreciation of the Baht will impair Thailand’s competitiveness

The prospect of political normalcy has improved…

…But a fragmented political landscape is expected


30

US economy are expected to place a drag on export growth in the coming months. The Baht has gained close to 9% against the US dollar this year, the second most in Asia after the Indian Rupee. In response, the government adopted a series of measures that include encouraging overseas investment by Thai companies and cutting the benchmark policy rate for the fifth time this year to 3.25%. August and September saw a mild reversal of the Baht’s appreciation trend. Notwithstanding continued upwards pressures on the Baht, Thailand is in a good position to manage their currency with official reserves reaching a record high of more than USD74 billion in August while the low inflation rate leaves room for further response.

Figure 42: Appreciating Thai Baht poses a threat to export growth

Source: CEIC

Export performance has been shaky in recent months and the jolts underlined the economy’s vulnerability to the external environment. Against a softening global outlook, the revival of domestic demand becomes more urgent than ever if Thailand is to get its economic recovery on track. Authorities have estimated full year GDP growth to be in the region of 4-4.5%, a range that leaves little margin for error, in our view.

Consumer and business sentiments appear to be bottoming out. Recent survey results by the University of Thai Chamber of Commerce (UTCC) showed the Consumer Confidence Index displaying its first recovery after declining for a year. While we do not expect a dramatic rebound before the elections, leading consumption indicators point towards the prospects of improved private consumption in the months to come. Similarly for investment, higher imports in 2H07 suggest it could increase in the near future. In addition, the speeding up of government budget disbursements and the upcoming election spending should further support the economy in the last quarter.

Figure 43: Modest recovery of confidence augur well for domestic demand recovery

Source: CEIC, UTCC

0

5

10

15

20

25

32

34

36

38

40

42THB/USDEx port grow th, % y /y

1Q06 2Q06 4Q06 3Q073Q06 1Q07 2Q07

70

74

78

82

86

90

38

40

42

44

46

48Index

1Q06 3Q06 4Q06 1Q07

Consumer Confidence Index

Consumer confidence (Ex pectation) Index

2Q06 2Q07 3Q07

Business sentiment index

Recent export performance raised the need of reviving domestic demand urgently

Consumer confidence and business sentiment displayed modest recovery recently


31

Figure 44: Higher imports in 2H07 suggest improving investment

Source: CEIC

Overall, we recommend a neutral weighting on Thailand’s macro fundamentals in the near-term as global growth softens while business and consumer sentiments are only just bottoming out. We maintain an optimistic outlook of Thailand’s economy from 2H08 onwards when the nation enters a more stabilized phase in politics. Key to the scenario are a corresponding recovery in consumer and business confidence, a favourable resolution to the FBA debate and accelerated public spending as the government presses ahead with mega-infrastructure investments. On the external front, a weaker global outlook might see some offset from increasingly liberalised trade - business potential can expect a boost from the Japan-Thailand Economic Partnership Agreement (JTEPA) that will come into effect in November as well as an FTA with India that is expected to conclude by year-end.

■ The broad residential sector in Bangkok remained soft as most developers registered lower profits for 1H07. Only 2,692 new condo units were launched in 1H07 compared to 4,282 in 1H06 while the total value of condos sold fell by a corresponding 33%. In addition to less launches, price growth across all geographic regions within inner-city Bangkok fell to 0.5% y-o-y or less.

■ Demand for the broad residential sector is expected to pick up next year following the general elections but overall price and rental growth will be moderated by matching new supply entering the market, especially in the low to mid-end segments. Despite this, bright spots remain in Bangkok’s heterogeneous residential market. Well-positioned projects in the high-end segment stand to be significant beneficiaries once the political uncertainties clear as prices of prime properties are still a fraction of neighbouring countries’. This would also be contingent upon a favourable resolution of the FBA issue, given that a notable portion of this segment is supported by foreign interest.

Figure 45: Number of launches and value of condos sold dwindled in 1H07

Source: Raimon Land Plc

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Soft economy reflected by lacklustre demand for condos in 1H07

Consumer confidence and business sentiment displayed modest recovery recently


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Figure 46: Disappointing price growth registered across inner-city Bangkok

Source: DTZ

■ Grade B office segment appears to have the highest upside in rental and price growth in the near term. As mentioned in the last APOS in July, we project a shortage of overall office supply from 2008 onwards. However, for the Grade A segment, new supply coming on-stream appears more adequate in matching anticipated take-up and vacancy rates for this segment should remain stable. Foreign companies in the service sector make up a significant portion of tenants in the Grade A segment and these are the companies that are most likely to be affected by the FBA. Without a fast and favourable resolution on the FBA, the demand for Grade A space is unlikely to experience a marked improvement even with the lifting of political clouds. On the other hand, domestic companies that have been putting off expansion plans due to political uncertainties are likely to provide support for Grade B office space from 2008 onwards.

Figure 47: Grade A office space expected to remain stable

Source: DTZ

■ Rentals and capital values have been broadly stable in most retail centres. Take-up in the downtown area rose 10.8% y-o-y owing to the absorption of vacant space at new shopping mall, CentralWorld Plaza, as retailers continue to seek retail space in good locations. However, weak consumer confidence and ailing retail sales have limited landlords’ ability to increase rentals during this difficult period. We would not be expecting any meaningful pick-up in the retail property segment until the election is over and domestic consumption recovers. In the longer run, Thailand’s retail segment can expect to benefit from favourable growth of tourism in the region while being supported by the nation’s sound fundamentals. We hold a neutral call on Bangkok’s retail sector over the next year.

■ The trend is towards well-designed and stylish community malls, the likes of J-Avenue on Thong Lor. A change in city lifestyle amongst Bangkok’s younger population has encouraged developers to foray into this relatively new retail

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While overall office space is in short supply, uncertainty over the FBA is likely to put a drag on the Grade A segment

The retail sector is constrained by low consumer confidence but longer term prospects remain supported by sound fundamentals


33

concept with Siam Future, Tesco Lotus and Central being the key players. As Bangkok’s mass transit infrastructure and new condo clusters are being developed, retail players are betting on exploiting emerging suburban centres.

Singapore Robust economic growth is expected for Singapore in the near-term, but cracks are showing up after a period of rapid GDP growth. Following the release of strong 3Q07 GDP growth figures, the government upgraded its full-year growth forecast for the third time this year to 7.0-8.0%. Singapore’s economic expansion has been characterised by quality, broad-based gains across all sectors, particularly the financial services and construction sectors.

Figure 48: Advanced estimates show GDP growth accelerated in 3Q07 to 9.4% YoY

Source: CEIC

Table 3: Growth in total demand at 2000 market prices (% change YoY) 2006 2007 2007 2nd Qtr 3rd Qtr 4th Qtr Annual 1st Qtr 2nd Qtr Total Demand 11.2 10.0 4.5 9.5 7.7 6.8 Total Domestic Demand 3.3 10.3 8.6 6.6 9.5 11.6 Final Domestic Demand 4.9 6.9 7.5 6.4 6.4 11.3 Consumption Expenditure 3.4 5.3 3.0 4.2 1.9 4.7 Public 8.7 18.7 3.8 11.2 0.2 (0.4) Private 2.3 2.4 2.7 2.5 2.5 5.8 Gross Fixed Capital Formation 8.3 10.3 17.1 11.5 17.5 26.0 Public (12.2) (6.4) (10.6) (11.8) (3.1) (6.3) Private 11.8 13.1 21.8 16.3 22.3 30.4 Changes in Inventories (1.2) 1.9 0.5 (0.1) 1.9 0.1 External Demand 13.6 9.9 3.4 10.4 7.1 5.4 Source: DOS

But capacity constraints are evident, with unemployment rate at a 6-year low and inflation picking up momentum recently. Singapore’s consumer prices in July rose at their fastest pace in 12 years. Pressure from various sources – increase in goods and services tax, filtering of surging housing prices down to the mass market, rising transport costs due to high oil prices, capacity constraints – will continue to play out in the coming months. Consequently, official forecast for full-year inflation rate was adjusted upwards to 1.5-2.0% from 1.0-2.0%. Expressing concern over the growing threat of inflation, the central bank reiterated its policy of modest currency appreciation to contain import costs.

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Inflationary pressures are building up after sustained high growth and external sources


34

Figure 49: Inflation reached a 12-year high in July 2007

Source: CEIC

Over the longer horizon, economic reforms over the last 5 years have strengthened Singapore’s economic fundamentals. The government consequently upgraded Singapore’s medium-term growth potential to an average of 4.0-6.0%, up from an initially estimated 3.0-5.0%, on the basis of higher labour force growth and productivity. In the context of the real estate market, we believe that given these fundamental changes, historical comparisons are now more useful as base-case scenarios. Notwithstanding the enhanced growth potential, downside risks have heightened and it remains unclear if the on-going credit crisis would spark a change in the economic cycle or merely slow economic growth, although we think the latter scenario appears more likely. Overall, we remain sanguine of Singapore’s short to medium term prospects but would remain vigilant of the growing risks.

■ Demand-supply imbalance will continue to underpin office rents in the near-term. As at the end of 2Q07, official data show a total of about 6.4m sqft of uncompleted office projects that will enter the market between 2007 and 2011. Based conservatively on historical average take-up of 1.8m sqft since 1991 and considering that most of the oncoming supply is back-end loaded, the supply shortage situation will persist till 2010. Recent uncertainties in the financial sector would take some pressure off demand but in view of the low office vacancy rate, we anticipate rents to appreciate by 10-20% and peak in 2009. There is already evidence of growing caution on the part of tenants and even investors, seen in the more measured bids for commercial land sites released by the government. Amidst the current credit market turmoil, we believe that, apart from the sale of 15-year leasehold office sites for rapid alleviation of the space crunch, the government is less compelled to cool rentals now.

■ Despite rising rents, yields are being compressed further as competition from foreign funds intensifies. Recent acquisitions have been dominated by mostly foreign private equity keen to deploy capital here. Notable acquisitions such as Chevron House, 1 Finlayson Green, SIA Building and Temasek Tower have all transacted at sub-3% entry yields, below the yield of even 10-year Singapore government bonds. As sovereign spreads narrow or enter negative territory, there will be less room for maneuvering and we anticipate capital value growth to slow. Overall, we have a neutral call on Singapore’s office market.

■ A similar structural supply shortage picture is playing out in the residential sector. About 42,183 private residential units (currently planned or under construction) are scheduled for completion between now and 2010. Again, the supply being back-end loaded creates a supply gap in the near term. Adopting a conservative demand projection based on historical average take-up since 2004, we expect average prices and rents to escalate a further 10-20%, before softening in 2009. The analysis took into account a CAGR 2% population growth in the last 10 years plus the fact that approximately 19,500 units of the on-coming supply have already been sold.

979899

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But we remain optimistic over Singapore’s long term economic prospects on account of strengthened fundamentals

Supply shortage would drive office rents until 2009

But as yield compression worsens, capital value growth will be increasingly constrained

The residential sector is facing a demand-supply imbalance, similar to the office sector


35

Figure 50: Supply shortage will only see some relief in 2009

Source: URA

■ Prices for mid-market segment are expected to outpace the high-end segment as the current up-cycle matures. Using sub-indices for the geographical regions – Core Central Region (CCR), Rest of Central Region (RCR) and Outside Central Region (OCR) – as rough proxies for the high-end, mid and mass market segments respectively, Figure 51 shows that the residential sector had been a game of two halves. Price increases in the high-end segment have been leading the market while those of the mass and mid-end markets only started to gain traction in 2007. Looking ahead, we expect filtering down of price pressures from the high-end market to feature strongly in the mass and mid-end markets.

■ The appreciable price increases of mass and mid-end markets this year have prompted the government to install cooling measures. The most significant of which was the removal of the deferred payment scheme – a move which would dampen sentiments somewhat, but would not reverse price trends. Regulatory risks would heighten if price growth in the residential market continues unabated. We are neutral on the overall Singapore residential market but remain optimistic over the mid-end segment.

Figure 51: Mid-end and mass markets only started catching up in 2007

Source: CEIC, URA

■ Prices and rents of retail space will be moderated by ample upcoming supply, as 5.8m sqft of retail space is anticipated to enter the market during the 2007-2009 period. Compared to the average annual demand of just 1m sqft since 1990, this appears to be a retail space glut over the next 3 years. However, as mentioned previously, historical comparisons remain only a base-case guideline at best, given the significant changes in economic fundamentals. With tourist arrivals at record levels, a healthy labour market and added buzz from the upcoming integrated resorts and F1 races, we expect retail rents and prices to

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After the huge run-up in luxury residential prices, the mid-end market is poised to play catch up…

…But the government stands ready to moderate price increases of these segments, especially for the mass market segment

The fundamentals underlying the retail sector are stronger than ever before, but some consolidation should follow the introduction of significant new supply in 2008


36

climb slightly further this year before stabilising in 2008. Overall, we hold a neutral view towards the retail sector.

Malaysia The Malaysian economy remains on a steady growth path, expanding by 5.7% in 2Q07. Private sector consumption and investment spending combined to offset a slight softening of the external environment while increased public spending provided added support to growth. Malaysia’s diversified economic base will support sustained growth momentum in the near-term while stable prices and an accommodative fiscal policy would attract further investments.

Figure 52: Malaysian GDP on a consistent and sustainable growth path

Source: CEIC

Figure 53: Strong domestic demand boosts resilience of Malaysia’s economy

Source: CEIC

Figure 54: Favourable investment environment

Source: CEIC

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The Malaysian economy continues to register consistent and robust growth, supported by broad-based contributions


37

Through the ambitious 9th Malaysia Plan, Malaysia aims to lift its long-term growth potential in order to achieve its goal of becoming a developed country by 2020. The announcement of new development plans1 by the government recently would spread growth and jobs across the country and we anticipate follow-on effects to flow into the property sector. More directly, the real estate industry would benefit from the government’s push to make Malaysia an international property destination. Since the start of the year, there has been a series of measures aimed at lifting the real estate industry: ■ Abolition of real property gains tax

■ Matching grant of RM50m between government and private sector for international promotion of Malaysian properties

■ Relaxation of Foreign Investment Committee regulations on foreign purchases of residential properties priced above RM250,000

■ Formation of Joint Management Body and appointment of Commissioner of Buildings to safeguard individual property buyers against abuse of maintenance and sinking funds by errant Management Committees

■ Homeowners are allowed to service mortgages using their pension funds

■ 50% stamp duty exemptions on purchases of homes worth up to RM250,000

■ Allow up to 70% foreign ownership in REITs, up from 49%

■ Removal of the limit of 3 residential or commercial property loans foreigners could take up

It is widely anticipated that more measures to boost REITs are next in line to further liberalise the property sector. Moving ahead, we see Malaysia’s real estate industry broadening and deepening further with different measures targeted at various segments falling in place and piquing investor interest further.

The latest Federal Budget is expected to sharpen the nation’s competitive edge and spur private investment. The budget of RM176.9b is the costliest ever in Malaysia’s five decades of independence, with a sizeable development spending of RM50b that is aimed at raising overall economic efficiency and productive capacity. However, we note that Malaysia’s target budget deficit figure is highly sensitive to international oil prices with 40-50% of government revenue derived from oil-and-gas-related income. While unlikely, a sudden fall in oil prices would derail the government’s grand plans.

We believe that Malaysia is taking steps in the right direction with structural reforms aimed at lifting its economic prospects. However, the country’s lack of credible track record in delivering on mega-plans is a concern and more has to be done by the government to instill confidence in investors.

■ We expect prices and rentals in the broad KL residential sector to grow very moderately over the next few years as the supply of luxury condos is set to more than double over the next 3 years. The top-end of the market in the Golden Triangle area should see more benchmark prices being set with momentum from continued foreign interest staying strong as well as landmark projects such as The Binjai and Four Seasons entering the market. However, there is some concern over mid-end properties as we anticipate this segment to see the biggest bulge in supply. The recent measure to allow using part of the pension fund to service mortgages for properties up to RM 250,000 could possibly soften the lower-end of the market as mass market homebuyers take advantage of the new incentive and opt for properties below this price range. Overall, we would expect to see further widening between the top-end segment with the rest of KL’s

1 Three Economic Corridors: Iskandar Development Region (IDR): Property-focused and FDI-driven; Northern Economic Region (NCER): Centers on infrastructure; PFI funding; Eastern Economic Region (ECER): Petrochemical, agriculture and tourism-centric; Petronas-driven

Malaysia is in the early stages of major economic re-structuring efforts aimed at lifting long-term growth potential

Recently announced expansionary budget is expected to further boost the economy

Ample new supply threatens the overall residential sector but high-end projects in good locations remain buoyed by sustained foreign interest


38

residential sector, similar to the phenomenon that had been played out in Singapore. We are moderately bullish on KL’s top-end luxury residential segment, especially within the Golden Triangle, as foreign interest is likely to be sustained in the near-to-mid-term.

Figure 55: Significant completions would double current residential supply by 2009

Source: DTZ

■ Prime office is the brightest spot for the KL real estate industry, in our view. Foreign funds continued to spill over into KL from the region, attracted by relatively under-valued property prices, transparent land laws and increasing demand for office space as Malaysia further liberalise its financial markets. While office transactions involving foreigners accounted for just 1.9% and 19.3% in 2004 and 2005 respectively, it shot up to 45% in 2006 and the proportion can only increase with the proliferation of private equity funds and further development of the REIT market.

■ The overall office sector is staring at a possible supply overhang in 2009 as new completions double to more than 4.5m sqft. However, the lack of good investment grade office building persists. With occupancy rates of top-grade office space within the Golden Triangle and Damansara Heights topping 90%, this segment presents the best prospects with supply remaining limited, as opposed to the broader market.

Figure 56: Possible office space glut in 2009

Source: DTZ

■ Prices and rents are expected to hold stable or appreciate modestly for KL retail space over the next few years. Bargaining power shifted in favour of prospective tenants as over 3m sqft of new retail space will enter the market by the end of this year. However, most of the oncoming malls with exciting new concepts have reported very healthy pre-commitments by retailers. Furthermore, future supply is very limited and a host of positive factors – strong labour market, healthy economy, buoyant consumer confidence – would provide

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The office sector is poised to deepen further with increased participation from foreign funds and development of REIT market

The KL retail sector has reached critical mass and is expected to perform well in the medium-term amidst a healthy economic backdrop


39

support for retail properties. We are positive towards the retail sector in the medium-term as we expect the buoyant economy to remain sustained.

Figure 57: Consolidation period for retail sector after spike in new supply this year

Source: DTZ

Figure 58: Projected modest capital value and rent appreciation

Source: DTZ Asia Forecasting

Indonesia The economy advanced 6.3% YoY in 2Q, its strongest performance in 2 years. Steady private consumption growth, higher FDI and solid expansion in net exports augur well for Indonesia’s economic prospects over the next few years. In the face of a softening external environment, we favour an economic structure that features higher contributions from domestic demand. With private consumption making up 60% of GDP, the Indonesian economy is less susceptible to a global downturn as compared to other economies in the region.

Figure 59: Recovery from slowdown in 1H06 well supported by private consumption

Source: CEIC

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40

Figure 60: Furthermore, consumption leading indicators are improving

Source: CEIC

Overall business environment and investment climate have improved. Inflation has retreated significantly from the double-digits range caused by removal of fuel subsidies and spike in fuel prices. With inflation under control, the central bank eased its monetary stance and slashed the policy rate aggressively from 12.75% in April last year to the current 8.25% to boost investment. Further to that, Parliament passed a new investment law in March that is expected to strengthen Indonesia’s push to attract foreign investments. Key items of the law include according equal legal status and treatment to both domestic and foreign investors, extending residency permits for foreign investors, a framework for international arbitration in the event of disputes between the government and foreign investors and a more transparent investment negative list. In particular, the real estate sector would gain from stronger property rights granted to investors in specified areas – building right to 80 years (now 30) and land-use title to 75 years (now 25), accelerated depreciation and a reduction in property tax.

Figure 61: Inflation has eased dramatically since 2006…

Source: CEIC

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41

Figure 62: …leaving room for rate cuts to boost investment

Source: CEIC

Growth is expected to continue at the same pace for the rest of the year and pick up modestly over the medium term, driven by domestic demand. This assumes a significant increase in investment, especially in infrastructure to address growth bottlenecks. The acceleration of capital goods imports since the start of this year is an encouraging sign that growth momentum is picking up. On the external front, net exports should see some moderation due to a weaker global environment. But greater trade access and investment flows from the recently concluded economic partnership agreement with Japan, Indonesia’s largest trade partner, would offset some of the slowdown.

Figure 63: Growing capital goods imports suggest faster growth ahead

Source: CEIC

Positive developments aside, Indonesia still faces significant challenges. The government’s ability to implement projects remains questionable as spending continued to run below budget. Earlier this year, regional governments were holding an estimated 2.5% of GDP in cash deposits, reflecting their weak capacity to carry out projects. Also, progress in economic reforms continues to be disjointed for a government that is prone to policy stalling and backsliding. As a case in point, the new investment law took a year to be passed after the first draft was submitted to Parliament. Compared to other developing economies like Vietnam, the pace of economic reforms is lagging severely. With the next presidential election in 2009 approaching, the window for the present government to push through with their plans is closing fast.

■ The office sector will benefit from the government’s efforts to revitalise the economy. Although we expect healthy absorption, especially from the banking, telecommunication and energy industries, the office sector would undergo some consolidation as it adjusts to massive new supply entering the market in the near-term. Overall office market performance would grow modestly, given healthy upfront commitments of tenancy for the buildings under construction. We

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Despite healthy absorption, the office sector will be weighed down by ample new supply until 2010


42

anticipate significant price and rental increase to begin only from 2010 onwards when vacancy rate falls. In addition, we think yields will maintain in the short-term due to slow price and rental growth and compress moderately as risk premium falls in line with improvements in business environment over time. Top-quality buildings with professional security and building management system should outperform the market, supported by an increased flow of new businesses from overseas in the coming quarters.

Figure 64: Huge supply of new Grade A office space between 2007 and 2009

Source: JLL

■ The pick-up in business activity and interest from foreign businesses will have a positive knock-on effect for Jakarta’s luxury condo sector. Appreciable rental gains are expected to be concentrated in quality projects catering to expatriates near the CBD. Already, the leasing market is seeing a turnaround since the start of this year with net absorption moving into positive territory. Leasing momentum should gain traction over the next few quarters, in line with buoyant economic activity. For the broader sector, price and rental gains are likely to be modest as new supply entering the market this year offsets demand spurred by easing interest rates.

■ Jakarta’s retail sector is promising in the medium-term as demand generators continue their strong recovery while overall market dynamics remain favourable. As mentioned, leading consumption indicators are picking up (Figure 60) and the recovery in consumer spending is key to market revival. Short-term demand is seen to come primarily from major retailers with strong cash flows as they are likely to continue seeking prime space in new projects to expand their presence. With a large amount of new retail space entering the market this year, vacancy rate is projected to rise to about 15% while competition among landlords will likely limit rental growth. But as retail demand growth outstrips that of supply from next year onwards, rents are expected to rise more rapidly from late 2008 onwards. We think Jakarta’s prime retail segment should perform well in the medium-term, riding on the wave of rising middle-income wealth.

■ The retail market is dominated by prominent local developers operating their own shopping malls. Moving ahead, we would expect increasing involvement of foreign investors, alongside the gradual improvement in economic structure and business environment.

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43

Figure 65: Retail market performance to soften first before turning up in medium-term

Source: JLL

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Disclaimer & Other Important Disclosures This report is prepared and published for information purposes only. This report and the information contained herein (“Information”) (collectively, “Publication”) is not offered as, and should not be regarded, used or relied upon as advice on any matter. It shall not constitute or be construed as a recommendation, inducement, solicitation or offer on the part of the authors, and no legal commitment or obligation shall arise by reason of this Publication. You are responsible for making your own independent assessment and this Publication is not a substitute for obtaining independent advice from your advisers. The authors shall not accept, and hereby disclaim, all responsibility and liability to all persons and entities for all consequences arising out of any use or reliance on the whole or any part of this Publication. This Publication should not be reproduced or disclosed without the authors’ express consent. It is not intended for distribution in any jurisdiction in which this would be prohibited. This Publication has been prepared based on information made available to the authors. The authors do not accept responsibility for, or make any warranty or representation (express or implied) with respect to, the accuracy or completeness of the Information, and none of the authors shall have any liability whatsoever and howsoever arising in connection with the Information and the Publication or the supply or disclosure thereof. Unless otherwise stated, any views, forecasts, or estimates contained in the Publication are solely those of the authors as at the date of this Publication, and are subject to change without notice.

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