Given the risks associated with investing in developing Asia, alternative real estate investing might seem a step too far. After all, why compound the dangers of committing money to developing economies with the risk of investing in a property type as yet untested by institutions?
Still, since the start of the global financial crisis, a volley of alternative real estate investments has been made by managers that see things in a different light. For example, Singapore-based AEP Investment Management launched an open-ended fund in 2009 to invest solely in data centers across Asia. In August 2012, Sydney-based fund manager Folkestone acquired four social real estate funds, which include investments in childcare centers and courthouses. And, in February, Algemene Pensioen Groep and China Resources Capital each committed $120 million to a vehicle focused solely on car parks in China (see Parking their capital, opposite page).
These alternative property types benefit from little formal research as they have been around less than a decade, making it hard for institutions to track their performance. That is something that investors, especially international ones, want. Furthermore, how can investors gauge demand for such properties either?
Those fund managers that have invested in such ‘new’ property types, however, do not see their investment strategy as being any more risky than a focus on traditional sectors, such as office or residential. In fact, some suggest that alternative real estate in Asia actually is more stable while offering even higher return potential.
The secret ingredient seems to be the first-movers’ advantage. Indeed, alternative real estate has very little competition in terms of investment and assets, and investors in such assets are alive to that fact.
Fund managers of alternative real estate also claim they benefit from having some of the most stable tenants in the region, including governments and global corporations. Counter-intuitively, the tenants of such assets can turn out to be more reliable than the tenants of Grade A office buildings, according to Nick Anagnostou, chief executive of Folkestone, which manages childcare and courthouse property funds.
For example, the only tenants that Folkestone can get for its nine police stations and two courthouse investments is the Australian government, and that’s a tenant that investors are very comfortable with. “The government is more reliable [as a tenant] – it always pays on the first of every month, whereas I would have to give incentives to office tenants every few years,” Anagnostou tells PERE.
While Anagnostou worked in Australia’s office sector, he found the average income return for Grade A offices to be between 6 percent and 6.5 percent. For courthouses, on the other hand, he says yields so far have been closer to 8 percent. In addition, government leases tend to be around 20 years long. As such, they are more a “defensive” investment than a risky one, he adds.
The data center investments of AEP have similar characteristics. Although a new concept in Asia, a properly managed data center is “mission-critical” for large Internet companies like Yahoo or Facebook, as well as financial institutions like banks. If the data center fails, the business shuts down. As such, stability is crucial for their operations, and tenants will often sign five- to 15-year contracts, according to Jonathan King, principal and director of AEP.
“The data center literally must have no down time for the computers in it to function properly,” King insists. That includes extensive infrastructure like cooling, security and Internet connectivity.
To be sure the data center is operating at peak capacity, many tenants also will invest a good deal in the infrastructure of the property themselves, and hence they are fairly reluctant to move. “It makes for much ‘stickier’ customers that can’t move easily, while a company in an office building is willing to move if it can save on its rent,” King says.
Stable tenants do come with a trade-off in terms of the returns that investors can get, Anagnostou admits, adding that capital returns of the property will be lower. Even as rent and income returns are stable and higher than average, the value of the building will not appreciate much over time, so investors will need to get used to a different kind of return profile in alternative real estate – one that is more fixed-income in nature.
“It probably shouldn’t form the bulk of [a firm’s] real estate investments, but alternative real estate can be a defensive strategy,” Anagnostou adds.
Caution and competition
When investing in alternative real estate in Asia, there are some additional factors that need to be kept in mind, investors point out. Since the leases tend to be longer, the property needs to be in a location that won’t change in value much over a longer period. A lot can happen in 20 years, Anagnostou warns.
When approaching investors about Folkestone’s funds, Anagnostou also finds that many are most concerned about ensuring a good tenant for the asset. This is especially true since there are fewer organizations that can occupy niche properties as operators. In Folkestone’s case, the government backing of its courthouse, police station and childcare investments goes a long way towards reassuring those investors, he insists.
King adds that his firm’s LPs also are quite interested in the supply-demand story of AEP’s data centers. Once the demand for data centers is tied to the growth in digital data being produced, it becomes much easier to show investors how the growth story also can be a real estate play.
“It actually becomes a fairly easy sell,” says Bruno Lopez, chief executive of Keppel Data Centers, the joint venture partner in AEP’s data center fund. “They’ve seen it in the developed world, and there’s no reason it shouldn’t happen in Asia.”
The fact that the penetration rate in Asia remains between 20 percent and 25 percent also is an enticing prospect for data centers. Still, the awareness gap can take some time to bridge, King acknowledges. “It does take longer for investors to get their heads around these kinds of real estate investments,” Anagnostou adds.
In Asia, however, that ignorance also can represent a certain advantage, given there is very little competition to capture or create these assets at present. Fund managers specifically need to have a certain level of knowledge about the alternative real estate asset – general knowledge about real estate like offices and apartments won’t cut it for assets like data centers, King says.
The tenants of data centers need to be sure the center they let can be maintained appropriately, and thus there is a high barrier to entry for data center investors. Without a proven track record, it is hard to convince blue-chip occupiers like Google to take a chance on new operators. Given that data connectivity has become almost as essential as electric power supply, first-movers seem to keep winning, Lopez says.
The dearth of quality alternative real estate also gives investors in Asia an advantage with tenants. Such tenants need specialized facilities, as opposed to office and industrial assets that have fewer considerations.
Those already invested in alternative property in Asia think competition will come as the segment matures. Anagnostou has “no doubt” that alternative real estate will become more common in the investment thesis – it simply needs to build a track record. And King already is seeing more players knocking on AEP’s door.
In the meantime, the first-movers in Asia’s alternative real estate space say they are counting their blessings – and dollars.
Parking their capital
An international set of investors have given themselves first-mover advantage in regards to China’s car parks
When Dutch pension administrator Algemene Pensioen Groep joined forces with China Resources Capital, the financial services arm of state-owned conglomerate China Resources, to form a fund focused solely on investments in car parks, there were a few raised eyebrows. Each committed $120 million to the China Resources Car Park Investment Partnership, a club fund intended to build “a scaled and diversified portfolio of car park assets in city center locations in China.”
A few other prominent investors were drawn to the proposal as well. Macquarie Capital, the investment advisory arm of Australia’s Macquarie Group, and Wilson Parking Hong Kong, a car parking manager and operator wholly owned by a Hong Kong-listed Sun Hung Kai Properties, together committed $25 million to the fund.
To observers, this could seem like a risky, untested strategy as international investors typically have focused on mainstream property types in China, such as office or retail. However, China Resources Capital managing director Derek Cheng believes that the consortium “is uniquely positioned to be the market leader” in this new space, thanks to its defined investment strategy and to the fact that it is “the first-mover in China’s car park market.”
China currently sells more than 60,000 new cars every day, the greatest number worldwide. Still, most Tier 1 and Tier 2 cities in China already have shortfalls in parking spaces of between 400,000 and 700,000. In Beijing, the problem is even worse as the city requires at least another 2 million spots.
“The China car park market is in its early stages of development, and the market forces as well as the social infrastructure requirements will continue driving up parking rates and capital value,” Cheng tells PERE.
Although many private equity real estate firms had been considering forays into China’s alternative real estate space – including care homes and student accommodation – little capital had been raised before this announcement.
“We believe this initiative is groundbreaking and envision ourselves to be the leading car park investment manager in China,” Cheng adds. “We look forward to delivering the value to our partners while playing our part in China’s urban development.”