Decoding the ‘core’ in M&G’s $1bn vacant Centropolis deal

M&G has taken on a major leasing risk with its acquisition of twin office towers in Seoul, raising questions about what is interpreted as a core strategy in the industry.

M&G’s $1.05 billion acquisition of the Centropolis Towers in Seoul, made in partnership with two Korean pension funds last week, ticks many boxes of a landmark core deal. The price tag, the nature of capital that financed the purchase, and the prime location of the Grade A asset being the key ones.

It is one unchecked box, however, that has provoked the real estate industry’s attention.

At the time of closing the deal, the newly built twin office towers, each with 26 stories, were vacant. PERE understands that there is a master lease on the retail portion of the complex, but there has been no official word on a confirmed tenant for the office space. And it is this leasing risk that is prompting questions about whether Centropolis can be truly called a core deal.

Indeed, the lion’s share of the equity for this transaction is believed to have come from the M&G Asia Property Fund, the London-headquartered investment manager’s open-ended pan Asia core vehicle, and a co-investment sidecar with one of the fund’s LPs.

It is also interesting to note that M&G competed with both core and opportunistic managers during the bidding, a rare case of two investment strategies at the opposite ends of the spectrum eyeing the same asset. One person involved in the sale told PERE that some institutional investors, with a core and long-term hold strategy, were in fact backing bids by opportunistic managers, given the risk involved.

Price negotiations aside, the transaction brings the spotlight back on the fundamental question of what is interpreted as a core strategy in the industry.

In M&G’s case, it is pursuing a “lease to core” strategy with Centropolis, with the expectation of turning it into a stabilized core asset over a long-term hold.

As part of the structuring of the deal with the Korean developer CTCore, that used Savills as its selling agent, M&G and the other investors have also gotten an income guarantee. It is also worth noting that typically not a lot of pre-commitments in leasing occur in Seoul, whereas they are more standard practice elsewhere.

The firm, which has long been investing in Seoul’s real estate market, is placing its confidence in its leasing capabilities and a strong uptick in the market. Research by property services firm Savills shows the prime office market in Seoul experienced a positive net absorption of nearly 1.5 million square feet in the second quarter of 2018, almost 90 percent of the five-year annual average.

PERE has learned, for example from one source that Brookfield Asset Management has successfully leased up to 12 floors of its three office towers at IFC Seoul in just this year to date. The buildings were 62 percent occupied when Brookfield acquired them in 2016, according to data provider Real Capital Analytics.

M&G told PERE earlier this week that its investor base has been supportive of the deal. By bringing in two more co-investors, the firm has also avoided a concentration risk for its Asia core fund.

As one observer pointed out, the deal shows a change in attitude of domestic investors towards core products. This is believed to be the first time local investors like Korea Teachers Credit Union and the Public Officials Benefit Association, which are co-investors in the deal, have taken on such a risk. Typically, as the person explained, Korean investors prefer to underwrite deals with a five- to seven-year holding period and ones that have recurring cashflow income from day one.

The ultimate litmus test that these investors and market observers are keenly awaiting, is when and how quickly the asset gets leased up. While no one can predict whether M&G will be able to successfully execute its lease-to-core strategy, deals such as IFC Seoul are one indicator that it can be done.

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