Depending on who you talk to, ESR Group is either a little-known firm or a heavyweight in private real estate.
Ask industry professionals in the US and Europe about ESR, and you will get responses like, “I’m generally familiar with them, but I don’t see their name a lot.” Or, simply, “I haven’t heard of ESR.”
But in Asia-Pacific, it is a different story. “They might be a small player in Europe and the US, but they’re one of the biggest within Asia itself,” says Xavier Lee, an equity analyst at Chicago- based research firm Morningstar.
Indeed, since the firm completed the $5.2 billion acquisition of rival ARA Asset Management 18 months ago, Hong Kong-based ESR has become the third-largest listed real estate investment manager globally with gross assets under management of $156 billion.
The transaction also created a new fundraising powerhouse in private real estate, catapulting ESR from 31 on the PERE 100 ranking in 2021 into the top 10 last year. Crucially, the deal paved the way for the firm’s expansion into discretionary funds.
ESR, whose predecessor entity e-Shang was co-founded by New York-based private equity firm Warburg Pincus and Chinese entrepreneurs Jeffrey Shen and Sun Dongping in 2011, is no stranger to the fund management business. In fact, e-Shang raised its first third-party capital in 2014, when the firm launched e-Shang Star, a China-focused logistics development fund, which Dutch pension investor APG Asset Management backed with a $500 million commitment.
“There are a lot of opportunities that are coming through the door to solve for gaps in the capital structure”
Jeffrey Perlman, ESR
But “ESR really hadn’t raised discretionary funds, while historically, ARA had,” explains Jeffrey Perlman, ESR chairman and head of Southeast Asia and Asia-Pacific real estate at Warburg Pincus, speaking with PERE from Warburg Pincus’s Singapore offices in late February. “Post-merger, we’ve now raised a few discretionary vehicles.”
Click here to read Perlman’s take on why investors are underallocated to APAC real estate
These include ESR LOGOS Pan Asia Logistics Core+ Venture, the firm’s pan-Asian core-plus logistics fund with former ARA subsidiary LOGOS, which gathered $250 million of initial equity commitments in October; and the China-ASEAN Investment Cooperation Fund II, a $1 billion infrastructure fund that ARA closed in November in partnership with the Export-Import Bank of China.
“Every firm wants to add in a component of discretionary capital into the business,” adds Perlman, who joined Warburg Pincus in 2006. “So it’s something that we want to increasingly look to build out further, because we think these can become very sizable mandates over time.”
Non-discretionary business
Even as ESR plans to expand its discretionary fund business, the firm will continue to work with its existing group of top-tier investors on non-discretionary mandates. Indeed, among non-APAC groups, those that tend to be most familiar with ESR are investors.
“At least as of the first half of the year, I think we had 12 of the top 20 global capital partners [by capital allocated to real estate] on our platform, in most cases working with us across either multiple geographies or multiple products,” Perlman says. “I wouldn’t be surprised if that rose to 14 or 15 of the top 20 over the course of 2023.”
Among the firm’s latest non-discretionary capital raises, ESR announced the first close of more than $1 billion for its inaugural Data Centre Fund in July; and also raised A$600 million ($401 million; €368 million) in equity commitments through its partnership with GIC on the ESR Australia Logistics Partnership III, a core-plus logistics strategy, in October.
ESR also has multiple fundraising pursuits in China, including the launch of a core income fund in partnership with a sovereign wealth fund; ESR is selling down $1.5 billion in balance sheet assets in China into the vehicle. Additionally, the firm is looking at raising a new renminbi core fund from Chinese insurance companies with the aim of selling down its stabilized assets in China into the vehicle.
Additionally, the firm received approval in March from the Stock Exchange of Hong Kong to spin out three logistics projects located in China’s Jiangsu Province through a C-REIT on the Shanghai Stock Exchange. The C-REIT – the firm’s first – is expected to launch in the first half of this year. “Fundamentally, the capital raising momentum has been very strong during the last few years in China,” says Shen, who, along with Stuart Gibson, is co-founder and co-chief executive of ESR.
“Geopolitically, that capital is all stuck in China right now, especially the big insurance companies,” adds Perlman. “As we look at this year, it’s going to be very domestic-focused in terms of the capital raising within China.”
ESR will have a fairly clear-cut approach to determining whether a new strategy will be discretionary or not. “If they are more pan-Asia offerings, we think those are probably geared more towards discretionary funds,” Perlman says. “A lot of those investors aren’t necessarily looking to just pick single-country risk or single- product risk necessarily. In a bunch of those instances, they would prefer that diversification. So I think that’s where we see continued avenues of growth on the discretionary funds side.”
Creating a powerhouse
The next stage of integrating the ESR and ARA platforms will be the potential launch of a Korea-focused capital solutions fund, which will seek to capitalize on opportunities expected to emerge from borrowers under pressure amid spiking interest rates in the country. The vehicle is expected to incorporate the traditional property sector focus of ARA with ESR’s new economy sector focus, which includes logistics, data centers and life sciences.
“Between both the ESR business and the ARA Korea business, there are a lot of opportunities that are coming through the door to solve for gaps in the capital structure, which have been caused by aggressive rate increases over the past year,” Perlman says.
“And so that vehicle includes both the traditional ARA areas of expertise, as well as the new economy piece that obviously the ESR element brings to the table. And I think what that does is it opens up a number of investors that otherwise may not have looked at that kind of product, in terms of covering enough of the areas that they wanted to see in the vehicle.”
The fundraise will also bring together the platforms’ two different capital sources. ARA previously went to local investors to raise capital for country-specific strategies. However, “we think actually that in this opportunity, while there’s maybe some local capital, it’s actually the foreign capital that’s going to really fill the gap in the capital structure in the market in a bigger way over the next 12-18 months,” Perlman believes.
ESR plans to initially target $300 million to $500 million for the fund, with an initial close expected sometime this year. “And then we’ll continue to upsize from there based on the opportunity set,” he says.
When ESR assessed the priority areas of the integration with ARA, the firm started with fundraising, consolidating all capital raising resources of ARA and LOGOS under the leadership of Josh Daitch, group head of capital and new economy fund management. “We want to make sure we’re speaking with one voice,” Perlman remarks.
Integration has also taken place in key markets where the firm has determined a combination makes sense. For example, ESR combined its two REITs in Singapore, as well as its development activities in that country, China and Indonesia.
However, the firm does not have a uniform approach when it comes to branding products, Perlman explains. “If it’s in a market or an area where there’s a specific track record, or rationale to retain the brand, we think that makes sense,” he says. “And so we’ve continued to leverage that. Separately where that doesn’t make as much sense to do, then we fold under the ESR Group branding.”
Private funds driving growth
ESR is embarking on all of these new vehicles after raising $7.6 billion globally through 28 additional or upsized funds and mandates in 2022, according to its fiscal year 2022 annual report. The firm achieved this feat despite global fundraising for private real estate funds dropping by 24 percent to $168.7 billion amid rising interest rates and high inflation last year, according to PERE’s FY 2022 report. In stark contrast, Asia-Pacific-focused fundraising volumes hit an all-time high of $34.6 billion in 2022, PERE data showed.
In fact, ESR raised 31 percent more capital in 2022 compared with the previous year, according to Lee. He says the firm’s fundraising power comes partly from its development funds, which accounted for 39 percent of its capital haul in 2022. Core and core-plus funds meanwhile represented 41 percent and other funds claimed the remainder, according to the firm’s annual report.
Crucial to the success of development funds are strong tenant relationships. “If you take a look at most of the developments that ESR has undertaken, their leasing capability and performance has been quite strong,” Lee says. Meanwhile, ESR’s managed REIT platform provides investors with confidence that the firm can achieve a potential exit through one of the REITs on the platform, he adds.
Lee does not expect ESR to beat last year’s capital raising volume, however, given the fundraising environment has become more challenging in the face of economic uncertainty. “I think it’s hard for them to maintain that sort of growth rate,” he says. “But I do think that in the scheme of things, they should still be one of the leaders when it comes to fundraising in this current environment.”
After all, ESR’s fund assets under management – which refers to the AUM relating to the firm’s private funds, investment vehicles and listed REITs – more than quadrupled from $36 billion to $152 billion following the ARA acquisition. “That is a huge proportion of their entire business,” Lee notes. “Before the ARA merger, the fund management business was probably about a quarter of their group’s results, and now it’s about half. It’s a driver for the company’s growth.”
In an October research note, JPMorgan analyst Mervin Song made a similar assessment, predicting ESR’s fund AUM to grow 10 percent over the next three years. “The growth is projected to arise mainly from the private fund business,” he wrote.
Laser focus on Asia
ESR’s relative lack of brand recognition outside of Asia-Pacific has much to do with the firm’s target markets. Among the top 10 firms in the PERE 100 ranking, ESR is the only manager with a dominant focus on Asia-Pacific.
“We’re laser-focused on Asia, because it’s such a huge overall market,” Perlman says. “For investors who are probably upwards of 30 percent underallocated [to] Asia, we are a great conduit for them to get exposed to and access the growth in this part of the world. If you look at the last decade – and it’s something that’s not lost on us – China, India and Southeast Asia alone represented over 50 percent of global growth. And these markets will continue to grow and expand.”
ESR’s website touts the firm’s “expanding presence in Europe and US,” but that ex-Asia presence remains relatively small by comparison.
The firm’s ex-Asia holdings, which were assumed through the ARA acquisition, will help ESR to address the cross-border investment needs of its Asian investors. “But we know where our strength lies, and that is in delivering for really the largest investors around the world, trying to get them that exposure to Asia. And where we could be helpful elsewhere, certainly, we do that and make sure we have the right platform in place to assist where we can.”
The mystery of ESR’s declining share price
When PERE contacted an ESR investor for this story, the first issue mentioned was not in relation to the firm’s funds or investments, but rather its stock performance.
“I think everyone wants to see the share price go up, and everyone wants to get root of why the share price hasn’t gone up,” the investor said.
ESR’s share price had plummeted 50 percent to HK$11.80 ($1.53; €1.41) a share year-on-year as of May 12, according to Morningstar data. By comparison, Blackstone’s share price fell 16.66 percent to $82.86 over the same period.
“I think ESR underperformed almost every other real estate investment fund manager under our coverage, including Goodman Group, Charter Hall Group and Blackstone,” says Morningstar equity analyst Xavier Lee.
The reason for that underperformance, however, is difficult to determine. “I feel like it’s hard to pin down a specific reason,” Lee says. “It could be the rising interest rates, or there are also concerns that, post-merger, some of the ARA investors that roll over to become ESR Group’s investors might cash out.”
Currency is another potential factor, with Lee estimating the firm’s profits would have been 14 percent higher without currency headwinds. He anticipates earnings growth will remain sluggish at 6.6 percent this year but will rebound by 31.5 percent in 2024 as the business environment improves next year.
“I think the company’s fundamentals are really strong,” Lee says. “They should be able to ride out this high interest rate environment. It’s in our view that the stock is highly undervalued presently.”
In the context of the firm’s fundraising, ESR’s falling share price has led some industry observers to question ESR’s ability to continue to commit capital to its private funds business.
Perlman, however, says the price decline will not impact the firm’s ability to commit capital to its private funds business. He notes the company has not raised public capital since its initial public offering, with the exception of issuing equity as part of the ARA acquisition.
“This is a business that’s essentially self-funding today, ie, the cashflow that’s generated can support the continued growth of co-investments that we have across all of our fund mandates, as well as in our REIT vehicles,” he says.
Perlman points out that ESR has committed a total of $5 billion in equity to both its funds and REIT vehicles. “I think our capital partners highly appreciate the size and scale [of our co-investments],” he adds. “And the ability to know that they have a very strong funding partner alongside of them, that has real skin in the game, I think is a real differentiator for us.
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