Why is South Korea unable to support the weight of money that its investors have to spend?
On the supply side, the investable real estate market is simply too small (for example, volumes are a fraction of that of equivalent more established markets). South Korea only opened up to investment in 1999 after the Asian financial crisis, even after this it took a few years for favourable tax efficient structures to appear. Therefore, a huge percentage of real estate is still owner occupied by cash-rich conglomerates.
Furthermore, there are new end users acquiring stock, which further suppresses supply.
Excluding logistics and dominant regional retail assets, outside the Seoul Metropolitan area there is very little investment activity, as replacement costs typically exceed investment values.
Turning to demand, real estate is still a new asset class (in relative terms) to many Korean investors who require exposure to alternatives as part of a diversified portfolio.
South Korea is the world’s 11th largest economy and has accumulated almost unprecedented wealth in less than two generations. That money needs somewhere to go to match liabilities, and real estate still offers some of the best risk-adjusted income returns.
Is the lack of open-ended listed real estate funds in South Korea an issue?
Open-ended funds would certainly help improve market transparency, which some international investors struggle with. The main problem is that private investors looking to invest in commercial real estate have very limited options. What we are now seeing is initial public offerings on single assets, but these offer no diversification (asset, location or often covenant), liquidity constraints (limited secondaries market) and concentrated exit risk as they tend to have a fixed fund life. Furthermore, they do not offer access to sector-specialist expertise, future development pipelines or the very best real estate, all of which are often hallmarks of the pre-eminent REITs or equivalent open-ended funds in other countries.
There has been some talk of open-ended vehicles for Korean real estate being launched in Hong Kong or Singapore, but nothing has yet come to fruition. Our view is that it is only a matter of time, but this will require some regulatory change and is likely to start with a portfolio providing the seed assets for any fund.
How useful are securities houses proving for bridging and underwriting deals? Is there anything new investors need to know about this set-up to get the most out of it?
Securities houses provide a very useful strategy for investors who are up against discretionary capital or find themselves in competitive bidding situations, largely due to their ability to expedite execution. Korean institutional investors still typically syndicate on deals, with one anchor investor and multiple minority investors, and each institution can have multiple investment committees to go through. This can often lead to a laborious process.
As a rule of thumb, an institutional investor could take up to eight weeks to be in a position to bid, whereas a securities company could do so in four weeks. In fast-paced markets, such mobility is essential. The main downside with securities companies is that the hefty fees they charge are effectively passed onto the end investors who they sell down to, which ultimately diminishes returns.
How active are South Korean pension funds in real estate investment? What are they targeting?
Pension funds are still the most active Korean players in real estate investment, both domestically and internationally, albeit retail investors are becoming an increasing force. NPS is the world’s third-largest pension fund by assets under management and is a huge domestic player. After a period of focusing overseas, NPS is aggressively pursuing domestic opportunities and has closed a number of large-scale trades in the last nine months (office, retail and logistics).
Typically, when investing directly, pension funds are chasing yield and covenant deals. Location is also a primary factor. They are targeting both equity and debt, with their preference often being led by both yield spreads and hedging costs for any particular market when looking offshore. An increasing amount of pension fund capital is being allocated as discretionary capital or ‘blind funds’ to third-party asset management companies or general partners. Domestically, these deals still tend to be focused on core and core-plus, whereas, when going overseas, this is where you see some of the larger, more established players moving up the risk spectrum into value-add or even opportunistic territory.
What about international investors?
International investors are seeking opportunities in all asset classes and across the risk spectrum. With more than 50 existing international buyers in South Korea, it is hard to generalise on requirements. There are currently eight different overseas buyers with deals under offer and they are buying offices, retail, logistics, hotels and even non-performing loans. Lot sizes range from $30 million to $300 million.
Those who have entered the market that possess the requisite firepower seek scale. Traditionally, internal rate of return-driven international capital has been especially successful given the income-focused nature of domestic buyers. However, there have been some exceptions to this, with high-net worth wealth preservation buyers and pan-regional core funds seeking more defensive product. We are currently selling a prime development site in the middle of Myeongdong (South Korea’s top retail destination) where all of the top four bidders were backed by either value-add or opportunistic international capital. Offices tended to be the favoured market entry point for international players, however logistics is becoming increasingly popular as is the global trend.
What are the fundraising opportunities that have caught the attention of overseas property companies?
The sheer weight of capital looking to be deployed into real estate and ever growing overseas allocations makes Korean institutions an obvious target. The real estate teams at many Korean companies are relatively small and, therefore, in order to diversify and remove any asset management requirements, they prefer to invest indirectly. They also like to work with familiar brands, sector specialists and counterparties with strong track records. Co-investment is often imperative, especially for a first deal. Incentivising one of the leading Korean groups (KIC, NPS, Samsung Life and so on) into a deal or fund tends to result in multiple other investors looking for participation. A number of the world’s leading investment managers have successfully raised vast sums from Korean institutions—many either have Korean employees or a dedicated office in Seoul focused on fundraising. Once these relationships have generated positive results, there tends to be significant loyalty and repeat business follows.