FEATURE: Treasure hunt

It is not often that a towering skyscraper, with an enviable tenant roster, located in Singapore's prime business district, is brought to the market. Yet, it has been almost a year since the 1.28 million square foot blue-glass Asia Square Tower I was officially put on sale by BlackRock Real Estate, and there is still no visible sign of a buyer.

To be sure the office-cum-retail tower is grappling with vacancy issues amid a surge in office supply in the business district and its fringes that partly explains the tepid investor interest. The continuing struggle to attract core buyers however is also indicative of how much pricing risk investors are really willing to take to get their hands on a trophy asset.

At a time when fewer core assets are trading at low yields globally, investors and their investment managers are adopting innovative ways to acquire assets instead of simply relying on the conventional market auction process.

“There are two different camps that want to access core assets today,” says Eric Wurtzebach, senior managing director in the North American real estate group of Macquarie Capital. “One that is looking to 'build or create core' because prices for core assets are high and the bidding is competitive. The other is the 'buy core' camp that will structurally do something complex to get core assets. It is different than just paying top dollars for assets.”

Accessing core deals

There is a sea of dry powder waiting to be invested in core assets, making the task of finding appropriate opportunities even harder. According to property consultancy CBRE's 2016 Global Investor Intentions Survey, which polled 1,255 real estate industry professionals, more than $1 trillion of capital is potentially available to be deployed into the property sector this year. The survey also reveals a jump in preference towards core assets. Close to 34 percent of the respondents said they have a preference for investing in the low risk and return strategy compared to the 27 percent who wanted core deals in 2015. However asset pricing and the availability of assets have been cited as the two biggest obstacles to making investments, especially in the Asia-Pacific region, followed by competition from other investors.

Quantitative easing and the adoption of low interest rates in many markets globally has compounded these challenges further. As Nick Crockett, executive director of CBRE, points out sellers are now realizing that selling may not be the best option and it certainly isn't the only option.

In February, for instance, a consortium of investors led by Asia Pacific Land shelved plans to sell the landmark Shiba Park Building in Tokyo, and instead refinanced as much as ¥135 billion ($1.2 billion; €1 billion) in five-year debt.

In such a scenario, structured transactions and capital partnerships that became a trend post the global financial crises are making a comeback.

“A lot of core investors are looking at subordinate equity deals. They are happy to accept a lower return on core deals, but on the condition that they have downside protection. They want to know if they can structure deals in a different way and get a preferred position,” Crockett explains. “Investors want to know if they will be able to exit. They are looking through the cycle now.”

An example of how to do such a deal is Blackstone's S$367 million investment in a unique S$1.5 billion investment platform created by the Singapore-based developer City Developments Limited (CDL) in December 2014. The investment, made via its special situations Tactical Opportunities Fund, was essentially made based on the present and future cash flows of a luxury resort asset being developed by CDL in the idyllic Sentosa Island. Under the deal CDL retained ownership of the properties and their asset management. In return, Blackstone, and other investors in the vehicle, were promised a fixed coupon of 5 percent for the five-year tenure of the instrument in addition to the cash flows generated from the asset.

Calling the structure a “quasi-securitization,” Kishore Moorjani, head of tactical opportunities for Blackstone Asia, told PERE at the time that this deal was not a distressed call by CDL but rather a capital solution. He said having a combination of some coupon and other elements had reduced the risk for Blackstone to a degree that the firm was “comfortable tolerating a slightly lower return that it normally would in the private equity real estate business.”

For other investors fierce competition for limited assets is forcing them to move up the risk spectrum. This could be in the form of taking greater leasing risk by purchasing a core asset in a secondary city, or taking development risk by doing build-to-core deals.

In February last year the Paris-based AXA Investment Managers – Real Assets, then known as AXA Real Estate Investment Managers, agreed to acquire 22 Bishopgate, a half-built commercial tower in a deal reportedly valued at £220 million ($320 million; €286 million). The firm is acting as the development and asset manager on behalf of an international consortium of investors for the project.

PERE has recently also caught wind of a Canadian public pension fund seeking to hire people with development expertise to monitor the work of their operating partners as it increases exposure to retail, student housing and office development projects. Property brokers say such hiring is now commonplace in many state funds and pension funds globally.

“The vast majority of investors recognize that at this point in the cycle value will be created by growing NOI, not by cap rate compression. So if you are acquiring a core asset, in say Manhattan, the best value is to be in at a lower cost basis through development or value-add,” says Wurtzebach.

In his view it is challenging for a foreign investor in the US to win a sought-after asset via a public auction involving large domestic bidders. Portfolio transactions and structured deals, including debt, therefore become a compelling proposition.

China's second-largest insurance company PingAn Insurance was part of a similar bespoke transaction, that Macquarie Capital advised on, in November last year when it formed a $1 billion joint venture with Blumberg Investment Partners (BIP) to acquire newly-built industrial assets across the country. As part of the deal, PingAn negotiated a forward-purchase agreement in which the ownership of the assets would be transferred from BIP to PingAn only on delivery through 2016.

The bulk of the construction ongoing in some European cities is also for development projects backed by institutional funding, according to Will Rowson, London-based partner of Hodes Weill & Associates. However the financial success of such an investment depends on whether the investor is also the end-owner of the property post-completion.

“You make assumptions when you buy a site and you won't know you are right or wrong until two to three years,” he says. “It is slightly easier if the investor is going to be the ultimate owner and has a long term view, and is not looking for a one-off value.”

Buying distressed debt or non-performing loans (NPLs) is another route for some core investors. Rowson says the NPL sales and privatization of REITs reached a peak in early 2015, when “ludicrous portfolios were bought just to create scale.”

Later in the year the German insurer Allianz and the UK REIT Hammerson jointly acquired a €1.85 billion portfolio of loans from Ireland's National Asset Management Agency (NAMA). The 'Project Jewel' portfolio comprised loans secured against retail assets, including the Dundrum shopping mall, a 1.5 million square feet retail center in Dublin. While the unconventional deal helped Allianz access core property in Ireland it also had to contend with the inherent risks involved, given the loans were taken by borrowers with varied economic interests.

Rowson, however, says portfolio and NPL transactions in the UK have petered out to a degree now. He says there have been instances when some $2 billion worth of portfolios were unable to sell and had to be broken up.

“The property market has cooled and people are realizing it is not worth taking the risk of a lesser quality asset entering the portfolio,” he says. “NPLs are also difficult to price. You need to make assumptions about the price per asset, or take a 70 percent sample and price that, which creates disparity in pricing.”

CBRE's Crockett adds: “Markets move relatively quickly and come in and out of cycles. One has got to be patient and disciplined but one also needs to be creative. There is no way to be quick at the moment.”

Greater risk is undoubtedly becoming part of a core manager's investment blueprint. The question is how creative it can get to minimize the risk but still get its hands on the best quality assets.