ASIA ROUNDTABLE: Of core concern

Core real estate investing has become both a viable and necessary consideration for real estate investment managers in Asia. Across the rapidly maturing continent, institutional-grade real estate is springing up, and the participants at this year’s roundtable agree that a critical mass of core property markets now warrants a new batch of investment strategies to match it.

In reaction, the participants are acclimatizing quickly as more investors demand stabilized income generation in addition to the capital gains that traditionally have been expected from bricks and mortar in Asia. Indeed, aside from law firm Morrison & Foerster (MoFo), the roundtable’s host, each of the event’s participants is running a core real estate strategy for Asia or is considering the introduction of one.

Although at a nascent stage, core real estate investment vehicles have arrived – and not just for the continent’s more mature markets of Japan, Australia, Hong Kong and Singapore. Developing markets such as China frequently are included in the mix, as is Korea. In August, PERE even revealed plans by New Delhi-based private equity real estate firm Red Fort Capital for a core vehicle in India following prompts from its investors.

“The strong movement to core is recognition that there’s been a structural change in the region over the last 10 years,” says Scott Girard, chief executive and chief investment officer in Asia for M&G Investments. “Markets have matured rapidly, and today the bond element of real estate through reliable and sustainable income is a major determinant of returns in the region. That’s why investing in core makes sense.” 

Entry points 

Joining Girard for the roundtable discussion were Choy-Soon Chua, managing director at SEB Investment; Eric Piesner MoFo’s managing partner in Singapore; Olivier de Poulpiquet, co-chief executive and co-chief investment officer of Morgan Stanley Real Estate Investing (MSREI); and Richard van den Berg, head of China at CBRE Global Investors.

The participants observe how gateway cities in the US have become crowded with well-capitalized investors, pushing yields dangerously close to those obtainable from fixed-income products like domestic bonds. Meanwhile, Europe’s major financial centers are heading in a similar direction, they note. Consequently, the participants are seeing institutions increasingly asking them to find real estate in the Asia-Pacific region that is able to demonstrate similar defensive qualities.

For M&G’s Girard, this shift in focus is vindication of his firm’s early foray into the core space. Its Asia Property Fund was the first of its kind when it was introduced in the region in 2007, and today the vehicle with $1.2 billion invested remains popular among investors.

MSREI’s de Poulpiquet has no doubt that Asia should be considered part of an institution’s core real estate portfolio. “Asia clearly needs to be a key part,” he says. “It was all about opportunistic or high-octane development investment for the last 10 years. Now, however, the market has tripled in size, and it makes sense in terms of correlation between GDP growth in Asia and elsewhere and real estate prices in Asia and elsewhere.”
Nevertheless, by de Poulpiquet’s reckoning, international investors must be willing to accept entry points to core assets similar to those they experience in Western markets. The premium, however, comes in acquiring property in a part of the world still demonstrating meaningful, comparative growth. 

Indeed, according to the International Monetary Fund, pan-Asia GDP growth in 2014 is expected to average around 5.3 percent, with Southeast Asia averaging 6.5 percent. That compares favorably to GDP growth of 2.6 percent in the US, 1.4 percent in Germany and 1.9 percent in the UK. “You are coming in now on an equivalent yield perspective,” says de Poulpiquet. “But you’re getting very strong underlying growth, which supports income growth.”

As an example, de Poulpiquet points to a recent sale by MSREI in Shanghai executed at a 4.5 percent cap rate. “We have sold in London at an equivalent cap rate, so that begs the question: which is best. When you compare growth in Shanghai versus London, it probably makes more sense to buy in Shanghai.”

CBRE’s van den Berg agrees and similarly argues that institutions should reconsider how they view core real estate in Asia. “Cap rate compression generally is behind us,” he says. “However, there still is sufficient upside to the growth rates of the rental streams, which have a far lower risk profile than betting on cap rate compression and therefore are more in line with core investor risk profiles.”

Demand-supply imbalance  

All of the participants agree that one major problem is that, while the demand and creation of core real estate in Asia is in its ascendancy, there is more capital chasing such assets than there are opportunities to buy. Furthermore, that demand is showing little sign of abating.
According to the 2013 Investment Intentions Asia Pacific report by the Asian Association for Investors in Non-listed Real Estate Vehicles (ANREV), 43.8 percent of investors are interested in investing in core strategies versus just 12.5 percent in opportunistic strategies. The research also revealed how 42.9 percent intend to increase their allocation to core real estate in Asia in the next two years. Conversely, 25 percent intend to up their allocation to opportunistic investments.

The situation for these purveyors of international capital is made more complicated by an emergence of domestic money. In Japan, for instance, already sizable institutional and corporate competition for stabilized assets has been joined by a resurgence of retail capital via the J-REIT market. According to third quarter research by global real estate services firm Jones Lang LaSalle (JLL), 2013 volumes in the country totaled $29.5 billion by the end of the quarter, up 69 percent on a year-on year basis (the third quarter itself was up a huge 139 percent on a quarter-on-quarter basis).

“The J-REITs present significant competition for assets in Japan,” adds MoFo’s Piesner. “Without an experienced team on the ground or a strong domestic partner, it is challenging for international buyers to find opportunities in that market.”

Similarly, China is allowing its colossal insurance and pension industries into the marketplace, and the ripple effect for transaction volumes has been telling. JLL reports that the country saw transactions total $16.6 billion by the third quarter, 34 percent more than the same time last year. Chinese property will soon become more readily – and, arguably, more reliably – available to retail investors as well as the government passes REIT legislation. Those factors are likely to make future competition for assets stiffer as international buyers seeking a premium for investing abroad are outgunned by local buyers that see less risk in buying at home and are seeking only to better domestic bonds (currently around 4 percent) on Grade A assets or interest rates (currently 6 percent) on Grade B assets.

“The sheer weight of domestic capital in most Asian markets and its perception of lower risk when compared to foreign investors, particularly in China, will continue to put downside pressure on yields,” van den Berg submits. “That is further exacerbated by a scarcity of investment product. One way around that is to manufacture core, but clearly a longer-term investment horizon is required than is acceptable for most fund investors.”
Added to the challenge from domestic capital, international managers are facing growing competition from state investment funds, not least from Asia. “Look at the institutional capital emanating from within the region,” Girard notes. “The Thais or the Malaysian institutional investors, for example, are finding core opportunities limited in their own countries, but they are growing their allocations because their investment pools are growing. They must diversify.”

SEB’s Chua sees the competition for Asia’s lower-risk properties escalating. “The competitive arena for core is getting harder and the dynamics are changing,” he says. “Once you have it, you might not have it again if you sell.”

That is why Chua admits that, once SEB’s value-added funds have created core real estate and are in a position to sell, he regularly considers whether the firm really should sell. Mindful of not provoking a conflict of interest between SEB’s core and value-added funds, he nonetheless confides: “We are getting reluctant to sell.” 

Chua’s experience is not isolated, and other firms actually have restructured their investment vehicles in order to retain control of their core assets. The participants discuss how, in late 2011, Pramerica Real Estate Investors consolidated S$3 billion (€1.79 billion; $2.4 billion) of retail assets in Singapore and Malaysia held in two closed-ended development funds into one open-ended vehicle after investors urged the firm not to exit the assets. In a separate situation, PERE reported in August how India’s Red Fort had been approached by investors in its opportunity funds to retain management of approximately $1.5 billion of stabilized offices due to fears they might not see such assets again anytime soon.

Nevertheless, as van den Berg points out, increased demand for core real estate also means better optionality when it comes to exiting assets. Pointing to various financial groups within China that recently have been enabled by the government to acquire more real estate, he says: “Exits become less of a risk than in the past as regulatory changes now allow institutions like insurance companies and pension plans to increase their allocations to real estate from the low 2 percent to 3 percent range to up to 15 percent.”

Stretching the definition. 

Given the limited amount of core real estate in Asia as defined by Western standards, the roundtable promotes the notion of investors tweaking the definition of a core strategy when pondering their equity commitments. Girard maintains that, fundamentally, at least 50 percent of returns from a core strategy in Asia should be derived from distributable income. “If you can’t regularly distribute income from investment holding structures, it makes it difficult to deliver what investors want, which is sustainable and dependable income,” he adds.

Contrary to common belief, however, such income is not isolated to ‘trophy’ office assets in gateway cities. “For us, that is a very small component of what core is,” Girard notes. “Durable, sustainable income can be found in different sectors and in different markets.”
Furthermore, de Poulpiquet suggests investors should consider sector-agnostic, pan-regional strategies versus country- or property type-specific strategies when considering core investments in Asia. “One of the biggest impediments has been that most core products have focused on singular markets and not throughout Asia,” he contends. “I do think there’s benefit to looking at the entire region.” 

de Poulpiquet continues: “If you are only seeking current income, there are only two places where you can get it: Australia and Japan. As such, investors need to compromise a little on their definition of core. You might need to take a little risk to build a core portfolio.” 

Given the open-ended nature of many core funds (including all of those in Asia currently), de Poulpiquet predicts that investors willing to assume a little extra investment risk today are likely to benefit more than those who stay on the sidelines waiting for the region to mature. “In the US, investors are pickier about their core investments, but that market has existed for 40 years now,” he adds, arguing that investors cannot expect to simply project their expectations about core real estate in Western economies onto Asia just yet.

CBRE’s van den Berg believes institutional investors should draw perhaps the most comfort about making investments in core real estate strategies in Asia from the region’s macroeconomic trajectory. “The basis of a core real estate market is a growing middle class,” he says. “For example, China’s core market is still quite small relative to its GDP, so there’s room for development within the core space in virtually all sectors, particularly retail as consumption increases and offices as a result of a growing services sector.”

Roundtable participants are priming themselves for a future in which they’ll be acquiring stabilized assets in addition to creating new ones, and the evidence suggests institutional investors increasingly are encouraging them to do so. The message today is that, while core real estate is spouting up frequently, it will take time before we see any meaningful correlation between demand and supply. The question investors must ask themselves is whether they are willing to bend their definitions of core for a first-move advantage. The participants of this roundtable hope that answer is yes. 

Eric Piesner
Managing partner
Morrison & Foerster

Piesner recently opened Morrison & Foerster’s Singapore office following a 10-year stint practicing law in the firm’s bigger Tokyo office. A managing partner and head of Asia, he specializes in cross-border real estate transactions, including joint and multi-party ventures, fund formation and restructuring, real estate finance and strategic M&A and private equity deals focused on real estate.

Olivier de Poulpiquet
Co-chief executive and co-chief investment officer
Morgan Stanley Real Estate Investing

As joint head of Morgan Stanley Real Estate Investing, de Poulpiquet shares his time between Europe and Asia, although he is based in Singapore. In Asia, he leads a team of 92 staff working for a platform that today is responsible for about one-third of the firm’s $35 billion in assets under management. The firm predominantly invests in the region via its opportunistic fund series, but it is considering plans to start investing via core strategies as well.

Richard van den Berg
Managing director and head of China
CBRE Global Investors

At CBRE Global Investors, van den Berg is part of a 100-person investment management platform focused on Asia. He leads the group’s activities in greater China, where the firm invests via an opportunity fund series, and regionally via a combination of value-added and opportunistic funds and core-focused separate accounts. The firm has served institutional investors in the Asia-Pacific region since 1996 and currently manages assets valued at up to $4 billion.

Choy-Soon Chua
Managing director
SEB Investment

Chua currently is the global head of real estate for acquisitions and divestments at SEB Investment and is responsible for growing the firm’s presence in Asia, where it has been present since 2006. He oversees a team of 10 staff and a real estate portfolio, invested via core and value-added strategies, valued at approximately €1.6 billion. In Asia, the firm is principally focused on Australia, Japan, China and Singapore, although it currently is most active in Japan and Australia. 

Scott Girard
Chief executive and chief investment officer for Asia
M&G Investments

Girard is responsible for M&G Investments’ real estate investment activities in Asia, where the firm currently manages approximately $1.7 billion of assets. He presides over a 34-

person platform operating out of Japan, Singapore and Korea and is responsible for the region’s oldest core real estate fund, the Asia Property Fund. The open-ended fund was launched in 2007 and today manages $1.2 billion in equity commitments.

When ignorance was bliss

When PERE asked the roundtable participants what keeps them up at night, one of the concerns that provoked a response was corruption 

According to the roundtable, corruption today is more apparent and increasingly to blame for deals being rejected. On the surface, it seemed odd that a region that is maturing so quickly should still be facing such problems.

In fact, instances of corruption may not be on the rise at all, roundtable participants note. Actually, vetting processes have become so much more efficient that detecting corruption is occurring more frequently, they say.

For Morrison & Foerster’s Eric Piesner, anti-corruption risk has become one of the biggest threats for his clients. “We spend time in every transaction on anti-corruption, making sure we take steps to evaluate and minimize this risk,” he says. “In some markets, there is such a challenge to mitigate those risks to the point where you start to question if you can even do the deal.”

Piesner’s experience chimes with the rest of the participants. “The percentage of deals that fail on the basis of such due diligence is higher in the region than anywhere else in the world,” says Olivier de Poulpiquet, joint head of Morgan Stanley Real Estate Investing. “Still, it is not higher than before. It is just that we all have a higher bar than before. The risks haven’t changed; we have.”

Scott Girard of M&G Investments says the issue brings counterparties into focus. “Today, there is an increasing onus on with whom you transact,” he explains. “Ten years ago, that was less of a concern as deals were getting done.”

Richard van den Berg of CBRE Global Investors is certain that one of the main reasons for better corruption detection is the increasing flow of information, which is leading to greater market transparency. “Just look what you can find on the Internet,” he says. “Back then, it was difficult to obtain information on a lot of people. Now, it is easier, although the way to minimize the risk is to always work with reputable partners and consultants that also have their own compliance requirements.”

Furthermore, van den Berg notes that Asia’s various governments are alive to the issue of corruption. Keen to maintain their growth, he believes they will be “clamping down hard” in an effort to alter adverse perception.

Still, SEB Investment’s Choy-Soon Chua says that, because corruption detection has become easier, many deals are rejected long before they reach committee stage, keeping lost time to a minimum. “We would rarely go into due diligence and then kill the deal,” he adds