White Paper
Impact of a Bifurcated Global Economy on the APAC Real Estate Capital Market
More
Economic integration and bifurcation – a norm
The world has undergone several episodes of rise and fall in global trade and relations. Depending on whom you speak to, some would argue that globalisation is irreversible as it is fueled by technology and capital, which are themselves unalterable. On the other camp lies a broader definition which goes beyond technology and capital to social and political relations. By this definition, according to Roman Szul, globalisation would have started in the 1400s with Spain, Portugal and the Netherlands conquering new territories in the name of God, in pursuit of gold and rare commodities, and all for the glory of the empire. This first wave of globalisation was disrupted by the Napoleonic wars and new ideas represented by the French revolution. The second wave started in the 1800s, spurred by the United Kingdom, where the motivation was bringing European civilisation to Africa and Asia. Profits were gained on enslavement and exploitation of the cheap labour force in these lands. Glory to the kingdom. This second wave ended abruptly with the First World War in 1914, and global trade contracted for three decades after that.
The third wave started in the 1980s with the decline of communism and the rise of democracy and free market capitalism. Profit-taking was for the individual, and so was glory. This third wave of globalisation was driven mainly by Wall Street America and included trade and financial market integration. The rise of the internet in 1980, coupled with a relaxation of global capital control in 2000, further fueled the global integration of the financial markets. Like earlier periods, the future of this third wave of globalisation is now being challenged. The financial integration started to unravel in late 2010 when central banks adopted macroprudential policies to manage risk and excessive capital flow onshore from the Global Financial Crisis.
Global trade has also slowed since 2012, six years before the US-China trade war. The slowing trade was inevitable. Average global tariffs had already reached a historical low by about mid-2010, as most trade barriers were removed, leaving only trade-in services that were harder to agree on standard rules of practice. Aside from India, the world also lacks another successor country to China, whose entry into the WTO lifted global trade in 2001.
The slower global trade was further dragged by the US-China trade war and a technological drought. Since the coming of the internet in 1980, there has been an absence of another technological advancement to drive similar growth spurts.
The COVID-19 pandemic and the Russia-Ukraine war have recently convinced governments to retain strategic industries and operations onshore. The costs of supply chain disruptions and sudden stock depletion have far outweighed the benefits of just-in-time production and offshoring operations.
With the advent of recent events (trade war, pandemic, and Russia-Ukraine war), the once integrated global economy has started to fracture along the geopolitical tension line between China and US. A complete collapse of trade or financial relations would be unlikely. Unlike earlier periods, this third wave of globalisation has been driven mainly by the private market rather than evangelical or national pursuits Capital Economics investigated this issue and postulated that the world economy could divide into three major blocs US, China, and those in between. In Asia Pacific, the major economies of Japan, Australia, India, the Philippines, South Korea, Vietnam, and Taiwan are considered under the US bloc, while Indonesia, Malaysia, Thailand, and Singapore are sitting under the unaligned bloc. Hong Kong is, of course, within the China bloc. Based on the value-added data from Capital Economics, countries within the US bloc collectively have a more significant global economic footprint and an extensive trade network. China bloc is minor and remains highly connected to the US bloc.
Effect of a bifurcated economy on trade and financial linkages
The bifurcation of the global economy started with the trade spat between China and the US in 2018. This trade spat eventually became a trade war before relations deteriorated to what is increasingly described as a “cold war”. The differences in societal and economic ideologies have frozen the US- China relationship. The Taiwan issue is another delicate keystone that could collapse relations if not appropriately managed. The recent dialogue between US and China is a positive step, but we are not out of the woods.
With Xi’s reappointment, speculation is that he would visit this unification issue within his third term, elevating geopolitical risks in this region. While this paper does not intend to discuss the political problems, suffice it to say the cost of any misstep by either the US or China could have lasting damage to the APAC region.
Impact on trade
Based on value-added data, which captures the intermediate steps in production, the volume between China and the US is not that substantial contrary to common belief. According to Capital Economics, a quarter to one-third of the global trade occurs between US and China blocs, depending if unaligned blocs are being forced to take a side. This proportion is effectively the scale of the impact of a fractured global economy. Trade, as measured in value-added terms, removes the distortion of aggregated trade statistics that tend to overstate China’s importance.
As the world trade bifurcates into China and US blocs, there is more to lose in the China camp. The US markets are still more extensive in terms of GDP, although in population terms, it is smaller than the China bloc. The end demand for exports in the China bloc is from the US and its allies. The intra-trade in the China bloc is not substantial to cushion this fallout.
However, not all trade will be decoupled. This bifurcation is driven by the government and is thus not likely to be widespread or as clean-cut. It is not in the US’ or China’s interest to have a general decoupling of trade since the economic cost would be too high.
Furthermore, the economic network of trade is too diverse and extensive for a complete decoupling to occur. Instead, the dissociatio will likely happen in politically sensitive or strategically important sectors such as technology-related and semiconductor, pharmaceutical and healthcare-related, and defence. Even then, the decoupling will be slower to unfold. Firms are likely to work around the trade policies in search of profit. For example, resulting from the US sanctions, existing firms such as Biren Technology and Alibaba have reportedly tweaked the advanced chip designs to reduce the processing speeds and avoid the US-imposed sanction. Nvidia has also reportedly offered a new advanced chip in China that would technically meet the export control rules set by the US government. This chip is the first reported effort by a US semiconductor company to create advanced processors for the China market following new US trade rules.
The US bloc is more mature and technologically advanced. The financial markets are also more developed compared to the China bloc. So collectively, the US bloc should be more resilient in the decoupling. China bloc would face challenges in finding alternative trading partners, especially in technology. However, the China bloc controls most of the essential minerals for green technology, which could severely impact the developed economies of the West.
For the China bloc, the currently traded products, especially in the semiconductor industry, are usually on the lower end of the production spectrum. The higher-end and value-add remain in the US and US allies. The commonly cited example is the production of the iPhone, where much of the equipment is produced in Japan, South Korea and Taiwan before the final assemblage in China.
Any relocation of production from China would likely end up in the emerging markets within the US blocs, i.e. friend shoring rather than re-shoring to the US or the developed markets. The cost competitiveness of these friendlier developing markets, such as Mexico, Vietnam, and India, would make more economic sense.
In fact, toward this end, we have seen foreign businesses in China adopting a China plus one (either Vietnam or Thailand) strategy. While there would surely be some loss in productivity and output, as we have seen during the initial phase of the US-China trade war, the overall impact on the entire region is lower.
The cost of the dislocation from this economic bifurcation would be higher for China and its allies in the short term. However, the determination of the Chinese government, especially in the Made in China economic policy first unveiled in 2015, could take greater prominence going forward. We can expect continual domestic capital investment into the infrastructure and industrial sector to support this economic policy in the midterm.
Impact on capital flows
As mentioned earlier, this 3rd wave of globalisation has been marked by a pronounced financial market integration, supported by the adoption of digital and ICT technologies and shifts in central bank policies toward more openness to cross-border financial flows.
However, since the global financial crisis, the policy environment has shifted and become less supportive of financial market integration.
As we advance, the demand for cross-border capital flow should begin to slow alongside weaker trade activity. FDIs should likewise decline as investors favour home or friendlier ground in a complex and unstable world. Inter-bloc capital flow will shift in favour of intra-bloc transactions as global trade bifurcates into the US and China bloc, especially in sensitive sectors such as technology and defence.
China’s existing financial links with the US will expectedly shrink. There is the risk of an unwinding of existing financial claims, such as China’s holding of US Treasuries. The impact, however, should be limited given that the majority of the outstanding claims are within the US bloc.
Nonetheless, the impact of a bifurcation of trade should result in lower productivity as China and the US decouple and seek new partners. The lower productivity and more significant uncertainty surrounding the economic policies should lead to lower real equilibrium interest rates, all things being equal. This could help support the growth of the domestic economy and construction sector.
The impact of decoupling of financial links between the US and China should not significantly impact the real estate investment (income) market other than the lowering of asset holdings in China, especially those supporting strategic industries such as pharmaceutical and technology. The bulk of the foreign capital in China real estate has been in offices, retail projects and development sites based on RCA data from 2012.
What does this mean for real estate demand
Real estate is a derived demand. Impact on the economy will inevitably impact the real estate sector; it is just a matter of time and magnitude, dependent on the interplay between micro-market demand and supply.
The impact of this bifurcation of global trade should result in some reallocation of economic activity. As the focus of this decoupling is likely to be on select strategic industries, the fallout should be equally limited. Nonetheless, the need for self-sufficiency as the trade network decouples will drive the demand for new production hubs in selected countries within the US and China bloc.
As indicated earlier, the re-shoring of production activities from China is not likely to be onto the developed but the emerging markets within each bloc on the mere basis of cost competitiveness. Firms have already adopted this strategy of China plus one. For American firms, anecdotal data suggests that they have, if not already, made relocation plans for their operations in China. In Asia Pacific, the major emerging markets that could benefit from the friend-shoring from China to the US bloc are India, the Philippines, Vietnam, and Taiwan. Malaysia and Thailand, while unaligned, could also receive some of the re-shoring of operations especially given their high connectivity according to the UNCTAD Liner Shipping Connectivity Index.
From the business competitiveness and overall connectivity perspectives, the emerging APAC countries ideal for re-shoring are as tabulated. Vietnam is a strong candidate with its high connectivity, alignment to the US bloc, proximity to China, low labour cost advantage, and an existing plethora of free trade agreements.
| Country | IMD Global Competitiveness Ranking 2022 | UNCTAD Liner Shipping Connectivity Index (3Q22) |
|---|---|---|
| Malaysia | 32 | 100 |
| Vietnam | NA | 82 |
| Thailand | 33 | 71 |
| Indonesia | 44 | 40 |
| Philipines | 48 | 29 |
Besides construction opportunities in these countries, as production centres move in search of a more stable environment, leasing demand for ready-built logistics should continue to rise.
In a separate study conducted by the Center for Strategic & International Studies, over a quarter of the Taiwanese firms in China surveyed had already moved some of their production out of China. Another third are considering a similar move. Of the places they have relocated to or planning to relocate to, Southeast Asia emerges as a preferred destination.
The period of just-in-time production has retreated in favour of just-in-case. The service failure and higher cost of merchandise resulting from supply chain disruption meeting low inventory-to-sales ratio have convinced firms to move to a just-in-case production strategy. As mentioned before, we can expect the demand for storage to rise incrementally over time as the market decouples, particularly in sensitive sectors.
Gateway markets such as Tokyo and Singapore should perform well as global financial centres supporting the region’s capital needs. Singapore will benefit as it plays to both US and China blocs.
APAC real estate capital market slows amid global uncertainty
Meanwhile, the real estate investment market in APAC is consolidating. Rising geopolitical uncertainty, weakening external demand, and inflationary pressure have not only rattled global investors’ confidence but dragged the weakening real estate market since the beginning of 2022.
According to RCA data, overall transaction value has declined by 6% y-y (9M2022), with income properties registering a more considerable decline of 16% compared to the 2% for development purposes. Fear of the ability to raise income in line with inflation has kept investors at bay, resulting in the most significant third-quarter decline of 38% in a decade.
Accommodation-related (hotel, apartment, and senior care homes) continue to show substantial gains. Office buckled the trend with an uptick of 3% y-y in 1H22 but weakened in 2H22, alongside retail and industrial sectors. The tightened spread of asset yields with 10Y government bonds across APAC, which have risen 150-250 bps, has kept some investors away. Besides Japan, China is another market where borrowing costs have been maintained. While this has held yields stable, the liquidity squeeze has also paralysed acquisitions by non-institutional domestic players.
With rising rates and growing recessionary threats, and slowing global demand in sight, investment activity should remain soft through 2023. Investors, however, will continue moving towards defensive sectors such as health and aged care, apartments, education, and data centres.
| Transaction Activity in APAC | ||||
|---|---|---|---|---|
| Q3’22 Volume | YTD Volume | |||
| $b | YOY | $b | YOY | |
| Office | 14.9 | -45% | 60.0 | -12% |
| Industrial | 8.7 | -24% | 29.2 | -30% |
| Retail | 4.2 | -54% | 22.2 | -27% |
| All Commercial | 27.8 | -42% | 111.4 | -20% |
| Hotel | 2.4 | -8% | 11.6 | -19% |
| Apartment | 1.6 | -13% | 7.0 | 16% |
| Seniors Housing & Care | 0.8 | 241% | 2.0 | 105% |
| Income Properties | 32.6 | -38% | 132.0 | -16% |
| Dev Site | 174.1 | 2% | 436.1 | -2% |
| Grand Total | 206.7 | -8% | 568.1 | -6% |
The bifurcation of the market should add further downside pressure to the real estate investment market in the short term as uncertainty dampens investor confidence. As economic policies align with geopolitics, we can expect the development sector (construction) to improve as firms relocate their China operations to emerging markets in Asia.
Equally, within China, there could be an uptick in development capital to support the government’s policy to decouple from the West in strategic and sensitive industries. We know that FDI is one of the critical pillars of economic and developmental growth, especially in emerging markets. With the return of geopolitics, we expect FDI into China to decline within the sensitive sectors that the US and the European counterparts have indicated, such as semiconductors, high-capacity batteries, critical minerals, and pharmaceuticals.
Foreign investment in the real estate sector, especially in China, has been weakening. These foreign capital prefer to be in the friendlier and more transparent markets of Australia, Japan, and Singapore. According to RCA data, the proportion of cross-border capital (on a 4-quarter rolling basis) has risen to almost 29%, with Australia, Japan, and Singapore receiving the bulk of the cross-border capital. This recent year-on-year uptick in cross-border activity is a welcome respite from the continual decline recorded since the peak of 35% in 2020 when the borders were closed.
This recovery further confirms our view that the decoupling of financial links between the US and China would have minimal impact on overall capital flow in APAC in the short term. The real estate market in APAC has matured. Institutional investors would allocate a portion of their capital to the real estate sector as part of their diversification strategy. However, global capital, especially US-aligned capital, will seek out friendlier and safer locations, such as the developed APAC markets, as part of their portfolio diversification.
Equally, China has indicated intentions to move towards more self-sufficiency as laid out in the Made in China roadmap in 2015. Aside from those overlapping with the US, the identified sectors include aerospace, information technology, robotics, operating systems, new energy vehicle, and ocean engineering. Without the FDI, development growth will be slower. But the greater political motivation to make this transformation work means there could be more significant domestic capital investments, especially in related infrastructure and real estate, to support these activities, especially in Tier 2 or 3 cities going forward. For example, SMIC – Hong Kong-listed Hua Hong Semiconductor, 2nd largest chip maker in China, has received regulatory approval for its 2.5 billion initial public offering in Shanghai. It plans to raise RM 18 billion to fund its expansion plans to its plants in Wuxi – the semiconductor heartland of China.
We can expect domestic capital to be active going forward. The proportion of cross-border capital in China’s real estate market has also been hovering at about 20% in 2022, below the long-term trend of 33% since 2017. The strict social measures and geopolitical environment have affected foreign investors’ confidence. But with the relaxation of measures, we can expect a rebound, especially among the intra-regional cross- border capital. Cross-border capital originating from outside of APAC will continue to find its way into China but likely at a lower level, given the uncertainty of policies and geopolitical issues.
References
Capital Economics, The Fracturing of the Global Economy, Oct 2022
Scott Kenned , CS S, t’s Movin Time, Oct 2022.
Roman Szul, The end of a new quality of the third wave of globalisation? in Beyond Globalisation:
Exploring the Limits of Globalisation in the Regional Context (conference proceedings), 2010.
Ian Bremmer, Globalisation isn’t Dead, Forei n Affairs, Oct 2022
China Economic Review, various.
About the Author
Dr Chua Yang Liang
Dr Chua Yang Liang heads up the Group Research & Analytics team at ESR. He is responsible for monitoring the economic and property markets across the Asia Pacific, and providing strategic data analytics to the Firm.
Dr Chua has almost 20 years of experience in the research and planning-related field. His most recent stint was with JLL where he headed their research teams across South-East Asia.
Trained as an urban planner, Dr Chua brings to the Firm a different perspective to property market research and he publishes original papers on property market trends as well as investment issues.
Dr Chua obtained his doctorate and Masters in City Planning from the University of Pennsylvania, USA, where he developed agent- based simulation for modelling the behaviours of real estate market. He has a Bachelor of Science (Estate Management) First Class Honours, from the National University of Singapore.
