South Korean investors pivot to real estate debt funds

Many institutions have retreated from direct lending in favor of the investment risk diversification offered by credit vehicles.

As real estate credit has become a more popular strategy, South Korean investors have shown more interest in investing in real estate debt through commingled funds than through direct lending.

Song Ah Lee, director, alternative investment division at Kyobo AXA Investment Managers, told PERE that South Korean investors are pivoting away from direct lending to funds as they recognize the importance of diversifying investment risk. Lee spoke with PERE in a follow-up conversation after appearing on a real estate panel at last week’s Private Debt Investor Seoul Forum.

“Project financing for a single asset was one of the most popular options when it came to overseas real estate debt for Korean investors,” she explained. “But over time, they realized if something goes wrong with the loan, it is very difficult for them to solve the issue by themselves. So the capacity of a local partner to negotiate with the borrower becomes more important.” Debt funds therefore can help to provide risk diversification in Kyobo’s portfolio, Lee added.

CY Chew, APAC head, special situations advisory and capital solutions at Deloitte, also noted South Korean investors are devoting significantly less time on direct lending opportunities in the US and UK markets these days.

“I remember back in 2015-18, I often met with Korean investors – mainly asset management arms at Korean financial institutions, securities houses, life insurers and pension funds – and I would place debt positions with them directly,” said Chew, who at the time was based in London and structuring UK and European real estate finance transactions at Citigroup. “These investors all had credit investment teams that focused on participating directly in senior, stretch senior and mezzanine positions in capital structures in the Western real estate debt markets.” He recalled there was a trend, particularly among US and European banks, to place higher-yielding junior or mezzanine debt positions with South Korean investors.

“A lot of these loans had complicated capital structures and untested intercreditor arrangements, and some of these things had gone wrong unfortunately. But since the Korean investors didn’t have people on the ground to asset-manage distressed situations, they struggled. So I think a lot of them are retreating into doing senior secured financing alongside banks and funds or just committing funds as LPs into strong real estate credit funds in the US, UK and European markets,” he said.

Rok Kim, senior manager, real estate investment team at the Korean Teachers’ Credit Union, also prefers investing in funds to making direct investments for overseas real estate debt. “We want to make an investment alongside GPs who have [a] very consistent investment strategy and [are] localized. Real estate investment is a highly localized business. For example, the office market in Asia is still flourishing compared to the market in the US. We do not have any offices outside of South Korea, so the best way to invest efficiently and effectively is to partner with the funds,” he explained.

Lee also pointed out that while some South Korean institutional investors continue to invest in real estate debt for diversification, they are considering investment options that offer more liquidity and flexibility, such as open-end funds or commercial mortgage-backed securities. “This is because investors experienced some liquidity issues due to the denominator effect earlier,” she explained.

Chew believed real estate credit will be an attractive investment opportunity for many South Korean and other Asian investors, due to the funding gap in today’s real estate debt capital markets, the downside protection of real estate collateral and clearer asset valuations as compared with corporate credit.