PAG: Asian real estate is ‘a different world’

The article is sponsored by PAG Real Assets.

PAG is an alternative investment firm focused on Asia-Pacific, with three core strategies: credit and markets, private equity, and real assets. Broderick Storie and Phi Le are the co-heads of the real assets business. PAG has been investing in Asian real estate since 1997, and the two co-heads have worked together for 11 years across APAC, with Japan serving as a core market focus, accounting for roughly 65 percent of assets.

The firm also focuses on investment in Australia and New Zealand, South Korea, Hong Kong and Singapore. One area PAG Real Assets has limited exposure to is China, from which Storie and Le began to shift away as early as 2018 and which now represents less than 3 percent of the portfolio. They discuss their recipe for success in the region and how APAC differs from other investment environments.

What in particular does it take for a manager to be successful when operating in Asia-Pacific?

Broderick Storie: It is a combination of several things. First, our people: our ability to retain talent and to be truly local in our markets. Second, we as individuals put our own money in alongside our investors, aligning ourselves in the truest way possible.

We have a ‘principal mentality’ – we see ourselves as genuine partners and owner-operators for our investors.

We have a 27-year investment track record that gives us confidence that our operating formula, as simple as it is, works and aligns with our investors’ interests.

In terms of our approach to the region, we are very much a ‘bottom-up’ manager, recognizing the idiosyncratic nature of each of our markets. That is key, because these Asian markets are offering tremendous opportunities right now, but each one has its own specific market conditions in both property type and location.

Asia is a very different place to 20 – or even 10 – years ago, both in terms of the way countries have changed and in a global context. The political, economic and social stability demonstrated by most Asian markets is becoming increasingly attractive as we see greater instability emerging elsewhere in the world.

Phi Le: That is exactly right. What is going on in Asia is radically different from the rest of the world, particularly the US and Europe.

What is it that makes Asia so ‘radically different’?

PL: Inflation and interest rates are the starting point. Particularly in Japan, which is an outlier globally. Having suffered deflation for years, inflation is a relative positive.

Outside of Japan, we are seeing the impact of high interest rates, inflation and a general contraction in liquidity, but it varies from market to market. For example, South Korea and Australia have been more impacted than other markets by high interest rates, as evidenced by their low transaction activity.

There may be individual examples of situations where you have a weak seller who is caught by poor cashflows and refinancing risk at a time when lenders and equity providers are clearly being conservative. But this distress creates opportunities.

A big difference, though, between Asia and other global markets is that the underlying real estate fundamentals are still very attractive, meaning that even when we are looking at distressed opportunities, we are doing so in an environment with positive market trends and generally less downside risk.

BS: We currently see value in most of our key markets. Again, given their highly idiosyncratic nature, opportunities tend to emerge depending on where each market and submarket is cyclically. But one of the attractive things about our platform is that we are able to move across markets to capture these opportunities as they occur.

Importantly, we are not seeing the level of distress that is emerging in US, particularly in office, and do not expect to.

What is happening to valuations?

PL: Valuations in private markets are always going to lag, but across the region there is simply nothing like the pressure on valuations which we are seeing in Europe and the US, with the exception to this being China and to a lesser degree Australia and New Zealand. Interest rates have risen quickly over the past year ex-Japan, and this has led to a significant decline in transactions, but overall I would say, as we move through a period of price discovery, we are expecting more moderate reductions partly because the strength in occupier markets will offset cap rate increases.

In Australia, which we believe is the market likely to be most affected, we are looking at about a 10 percent drop in valuations – potentially more. But that is still considerably lower than what is feared in the West.

BS: Yes, across our key markets we are seeing considerable rental growth, which is helping offset (to varying degrees) any change in cap rates. Appraisals will take this into consideration.

Is strong rental growth a theme across Asia?

BS: Trends are highly localized, but in most of our markets we are seeing some level of rental growth in the types of assets we buy, with the exceptions of Hong Kong, Shanghai and Beijing. In some cities such as Singapore, and in the right assets, we are even seeing double digit rental growth.

The core of our portfolio is in office, which now represents 53 percent of our book. We are seeing rental growth in nearly every market over the last three years, despite covid and increasing levels of market uncertainty.

Is your office portfolio not challenged by the work-from-home phenomenon?

PL: Work from home is not a phenomenon in Asia, with the exception of Australia and New Zealand. However, even in those two countries people are largely back to work now. In Tokyo, Singapore, Hong Kong and Seoul, work from home is not a material factor.

This major difference from other global regions is due to a range of reasons: cultural differences, smaller home sizes, workplace attitudes and corporate practices. As a result, companies in Asia were far more successful at getting their workforces back into the office than in other global markets. Most key markets are back to pre-covid levels.

“The political, economic and social stability demonstrated by most Asian markets is becoming increasingly attractive as we see greater instability emerging elsewhere”

Broderick Storie

BS: Yes, even in the depths of covid we were still getting positive rental growth, and since summer 2022, we have pretty much seen a full return to the office across our portfolio. In Australia and New Zealand there is some evidence of growth in hybrid working, but nothing like on the scale in the US and Europe.

To some extent this is probably due to the power imbalance favoring employers in Asia compared with the US or Europe, but as Phi says, there are also cultural differences and differing work attitudes.

Which of the sectors are you most excited about in APAC?

PL: Data centers are an important focus. We have high conviction around the asset class, particularly in Japan and South Korea, which we think are the most interesting of the developed markets.

The industry is not as mature in these markets as in places like Australia or Singapore, and offers the best risk-adjusted returns and room for growth. We may move into other markets including Southeast Asia, but this growth would be customer-led and targeted.

BS: Office continues to be attractive, partly because it is not a ‘flavor of the month.’ We also like Japan infill logistics and solar energy development in the region, particularly in Japan. I would stress that sector considerations vary by market and location, and this factor coupled with our capability to execute locally frames our investment focus.

How would you characterize the future outlook for these idiosyncratic markets?

BS: There is a lot of investor concern about China at present, which affects the perception of Asia as a whole. But Asia is not just China, and we see enormous opportunities in the rest of our key markets and remain very positive.

As we say, even in those pockets where we are seeing a contraction of liquidity and/or broader uncertainties, there are opportunities provided they are priced correctly. Where there is distress, it is a question of pricing an asset correctly at entry and then managing it properly against the right forward earnings and valuation outlook – be it negative or positive.

You do not need an ‘up market’ to make money. From a top-down perspective, we anticipate Asia will continue to offer relative stability and growth.

How is environmental regulation affecting the region?

PL: Limited impact, and, if anything, environmental factors are a positive.

From a regulatory perspective, environmental, social and governance issues are perhaps not as advanced as in the US and Europe, but increasingly this dynamic is changing. Markets like Australia and New Zealand have well-developed environmental practices and regulation, while markets like Japan and Korea lag.

However, all markets are on a growth trajectory for ESG awareness and implementation. What is interesting is that this change is being driven outside of government, as landlords and occupiers seek to address their own underlying ESG objectives.

BS: We are seeing occupiers increasingly seeking a minimum level of ESG credentials in their workplace requirement. As an example, we recently refurbished a building in Seoul that included adding both rooftop solar power and water capture, which reduced building OPEX and appealed to a broader pool of potential corporate occupiers. This type of dynamic creates opportunities to increase investment value through a robust ESG program.

Our primary purpose is to make money with less risk. What we want to do is try to apply things that will work toward the greater good while also driving better economic outcomes.