SPECIAL REPORT: Relief in the lion city

On 14 May, the investment advisory committee for the second largest private equity real estate fund ever raised for Asian investments, circulated a confidential note to its investors outlining the vehicle’s prospects for the future. The contents of the note were enough to convince certain of the fund’s investors to sell their positions. The fund was BlackRock Asia Fund III (Fund III).

It was raised by Asia and Europe-focused private equity real estate firm MGPA in 2008, just months before the global financial crisis precipitated the crash of Wall Street investment bank Lehman Brothers. At $3.9 billion of committed equity, it represented the biggest pool of institutional capital ever raised for private real estate investments in Asia – a record that stood until The Blackstone Group bettered it earlier this year.

Fund III was marketed to investors with a pan-regional remit, taking in mature real estate markets like Singapore, Australia and Japan and less developed markets like Malaysia, Taiwan and Thailand alike. But it sparked controversy when S$2.97 billion (E1.84 billion; $2.33 billion) of it was invested into two tracts of land at Singapore’s Marina Bay that would ultimately come to represent 90 percent of its net asset value (NAV).

MGPA’s leadership was criticized for ploughing more than half the fund’s capital into effectively one scheme in one market, the price it paid for it, and, also for not securing joint venture partners to share the investment and risk. As a consequence, the fund became one the most traded vehicles in Asia on the real estate secondaries market. To dampen its prospect further, as rents in Singapore’s office market fell following the crisis, so did return expectations within Fund III’s investor pool and that led to units trading for prices reflecting some steep discounts to NAV. Some trades even are understood to have happened at a discount of more than 50 percent.

Today, however, the fund’s outlook is far rosier. The land has been developed into Asia Square Towers One and Two, offices that have been recognized widely for their structural quality. Of the platinum-certified Leadership in Energy & Environmental Design Core & Shell (LEED-CS) buildings, one Singapore-based property broker remarked: “I’ve been doing leasing in Asia for 10 years and this has to be the best building I’ve ever seen.” Crucially for its investors, however, is that from previously negative premonitions concerning their occupation, more than 89 percent of Asia Square Tower One is now leased, as is more than 64 percent of Tower two. And at rents well above the market’s recent trough levels.

Few onlookers have expected Fund III to turn a profit, let alone break even. Alongside many of its vintage peers, it has long formed part of a dark chapter for private equity real estate funds of scale worldwide. But the note circulated in May by its advisory committee to its investors contains light in the form of return projections that, if they transpire, offer both relief and vindication for the firm and those investors that have stuck with their holdings. For other investors, it offered a suitable window through which to exit. For one firm in particular, it offered an opportunity to mop up their stakes.

Zug-based private markets investment firm Partners Group brought its acquisitions in Fund III via the secondaries market to around $400 million of the original equity. Starting with a heavily-discounted purchase in 2010, steadfast in the belief the lion city’s office market would recover, the firm steadily built up its presence in the vehicle. It made at least two purchases since the publication of the note. One of those acquisitions was understood to have been agreed at a discount of just 7 percent, another at par, further underlining the renewed optimism currently being felt towards the market and, subsequently, the fund.

Said one source familiar with the vehicle: “There was a call that the Singapore office market was bottoming out and would take off from last year. There had been some really big discounts for this fund but gradually they have been dwindling away.” He said: “For its vintage, the fund might actually end up being pretty good.” 

Work to be done

Barring unforeseen circumstances, Fund III will not hit its original intended returns. However, according to the note, BlackRock is projecting that when the vehicle terminates it would generate an IRR of between 6.5 percent and 9 percent and an equity multiple of between 1.5x and 1.8x.

“1.5x is not too bad for an opportunistic fund of that vintage,” commented one former Fund III investor. “Ok, some have done better. But others have done an awful lot worse.”

There is still work to be done, however, before BlackRock can rest easy. While the majority of Tower One and a large share of Tower Two already is leased, the average rent achieved for the space is between S$10 and S$11 per square foot. BlackRock is underwriting at rents for the remaining space at S$14 a square foot, a level that has met with some skepticism in the marketplace. One Singapore-based real estate investment manager said: “I think S$12 might be achievable. S$14 should be a bit tough.”

Much will depend on timing. BlackRock has the best part of two years in which to add tenants before competition for premium office space is slated to intensify. Currently, Asia Square competes with two other premium offices for occupiers: CapitaGreen, a 40-storey tower offering 700,000 square foot, owned by Singapore REIT CapitaCommercial Trust, which is expected to complete at the end of the year; and South Beach Tower, a 34-storey tower with 495,000 square feet of space, owned by developers City Developments and IOI Group.

According to Jones Lang LaSalle (JLL), the global property services firm marketing Asia Square’s vacant space, there is no new office supply expected in 2015. But at the end of 2016, however, there is expected to be a veritable wave of approximately 4 million square feet. Agreeing with that forecast, the investment manager said: “The consensus view is that between 2016 and 2017 there will be pressure on rents.”

Another Fund III investor which has sold its position said it was that pressure which prompted its sale. “I’m worried there’s a lot of new supply coming on. We just decided to take our money off the table,” he said.

Whether such fears are warranted remain to be seen. JLL is understood actually to have already achieved lettings at S$14 and even S$15 a square foot already, albeit for small amounts of space. The firm’s research states that Singapore’s 20-year average take up is in the region of 1.5 million square feet a year. Theoretically then, total occupation of the two towers should be possible, at high enough rents, and before the deluge of supply arrives. “If you speak to any major investor or consultant in town, you’ll see rents have been going northwards for the last few quarters and are likely to do so for next few,” said the broker.

Which door?

Renting the Asia Square towers is, nonetheless, one of two important challenges ahead of BlackRock. The other is selling them. According to the note, the firm is underwriting an exit of Tower One at a certain level that would make it the most expensive office tower in Asia ever.

BlackRock also must determine how it exits from Asia Square. With few institutional investors able to buy the towers alone a consortium bid is more likely. But that could bring the price paid per square foot to below BlackRock’s targets. Said the investment manager: “Assuming it sold the floors individually, then yes they might be possible. But en bloc it’s hard to see them reach (the targeted) number.”

The former Fund III investor said there was once co-investment interest in the developments but it dissipated with the global financial crisis – a sore point for many concerned. “You can’t get away from the criticism of overexposure. It was a bad thing. But there was an element of bad luck, or possibly judgment, in not getting the co-investment away.”

On the other hand, should BlackRock opt to strata-sell Asia Square, it might achieve its target price per square foot. But then it would unlikely attract large institutions which, typically, do not like investing into buildings with multiple ownerships on account of the lack of control that method of investing brings. In December, the firm did sell the 305-room Singapore Westin Hotel in Tower 2 to Daisho Group, a Japanese developer, for S$468 million. The deal, lauded as a good start by the fund’s investors, is unlikely to deter institutional bids for the main offices as hotels typically require markedly different management that would not conflict with their ownership.

There might be other options for the offices besides. In the note, BlackRock listed exiting into another, this-time core-strategy fund as one – that option would enable it to continue to earn fees from the assets too, albeit from a lower basis. A capital markets exit is another option should they prove accommodating before Fund III’s expiry. As one onlooker said: “Those buildings are extremely REITable.”

Whichever route ultimately is taken, the ramifications for the platform formerly known as MGPA will be less keenly felt than they might have been now that it has been consumed by BlackRock. “A lot of people were saying that MGPA would struggle to recover from that fund,” the former investor said. “My personal view is that it won’t be a bad result at the end of the day.” Partners Group and those other Fund III investors sticking around evidently agree.