Belgium’s largest ever single asset deal was completed in January when Valesco Group, a London-headquartered manager, executed the acquisition of Brussels Finance Tower on behalf of Korea’s Meritz Securities for circa €1.2 billion. The off-market transaction marked several firsts, including being the largest equity check committed by a Korean investor in mainland Europe to date.

Korean institutional investors, including pension funds and insurers, have been increasingly active cross-border buyers of commercial property since the late 2000s. But the last couple of years have seen the emergence of a new source of Korean capital: securities companies. These brokerages operate like typical investment banks. Their prominence has grown at breakneck speed.

As of the end of June 2019, the top eight securities firms’ total cross-border alternative assets investment exposure was 13.9 trillion won ($11.78 billion; €10.82 billion) a dizzying 278 percent increase from the 3.7 trillion won at the end of 2017, according to a report from Korea Investors Service, a subsidiary of ratings agency Moody’s. Real Capital Analytics estimates South Korean capital was Asia’s biggest real estate capital exporter in 2019; eight of the country’s top 10 buyers were securities firms.

Notably, the scale of the deals Korean securities firms are willing to engage in is increasing in size and spreading geographically. A Mirae Asset Financial Group-led consortium paid around $5.5 billion to win the coveted bid for Anbang’s US luxury hotel portfolio in September. In Europe, outlays large and small have happened in London, Paris, Vienna, Dublin, Poland, Slovakia and most recently Finland, with the $530 million reported acquisition of Gebhardinaukio 1, an office asset, by a consortium including Korean securities firm NH Investment & Securities in February.

With this increasing prominence has come an uptick in scrutiny. Specifically, Korean securities firms’ aggressive buying appetite is prompting closer examination of their business model, fees and underwriting standards.

Andrew Shin, head of investments for Korea at London-based consultant Willis Towers Watson, says investors are becoming concerned over “early signs of overheating.” Relaying a recent conversation, he says: “I heard from the market there was a property in France for which all the final bidders were Korean securities firms. Korean institutional investors are concerned that if the securities firms are competing against each other for assets like this, they will end up overpaying more than any local buyer would have offered.”

Business model

From being almost anonymous in international real estate markets, Korean securities firms have grown to prominence by recognizing a demand for bridge equity in cross-border deals.

In a typical transaction, sellers require the final bidder to submit a letter of commitment or intent before closing. But most Korean investors have been investing via asset managers that are either unwilling to demonstrate their commitment by issuing such letters during the bidding process itself, or else require lots of time to get their internal investment committees’ sign-off. This drawn-out process and accompanying uncertainty reduce the manager’s relative competitiveness during bidding.

This is where Korea’s securities firms have stepped in. With sizeable balance sheets, they are able to buy assets on their books, then syndicate to investors post-completion. “Through this bridge equity business, they are giving comfort to the seller and more time to the buyer to review the deal,” says an executive at one of Korea’s largest asset manages.

For successful syndications, assets should match the investment criteria of Korean investors. A Seoul-based advisor working at one US placement agent
says all Korean investors have a 5 percent minimum cash-on-cash hurdle and 7 percent equity hurdle for any overseas asset. Securities firms hunt for appropriate assets with a local partner and earn fees as high as 1-3 percent by syndicating.

According to publicly available information, Valesco has partnered on at least four European deals with Korean securities companies since 2018. For all these deals, Valesco operates in a sourcing and asset managing capacity in return for carried interest and a performance fee. It structures transactions via single-asset funds with five- to seven-year holding periods.

“Every asset we have bought was at a price lower than the market valuation, achieved because of our ability to deliver deal security and speed, whilst capitalizing on pricing dislocations,” says Shiraz Jiwa, founder and chief executive of Valesco. “That has been hugely sought after by Korean investors, especially Korean securities houses that are looking to some degree to syndicate.”

As a partner, Jiwa does not find the syndication, and the changes in the end equity investor pool, challenging. “In terms of deliverability and managing parties, it is an efficient structure. No syndication can take place without a clear process and knowledge of the GP. The investors will notify us; there is also a requirement under the lending facilities. At any point in time, we know who our end investors are. It is not a challenge to manage this. Everything is registered in terms of the unitholders.”

Failure to syndicate

The model sounds like a win-win for everyone involved. But a growing pile of unsold real estate assets at some of the securities firms is raising feasibility questions. In its September 2019 report, Korea Investors Service estimated the amount of cross-border alternative investments left on the books of the eight securities firms had more than trebled to $11.6 billion from 2017 to the end of June 2019. Of these, investments  unsold for more than six months were valued at $1.1 billion. Real estate assets in Europe make up the bulk of these unsold assets, the agency noted.

“Because of excessive competition, the risk of resale failure is growing,” the report said. “If the current investment trends continue, securities companies will end up with liquidity deterioration and investment losses.” It adding that this could affect the future credit rating of these firms.

Some recent deal missteps have compounded the cautionary attitude towards securities firms. In September, KB Securities and JB Asset Management announced legal action against Australia’s LBA Capital for allegedly misusing capital it had borrowed from
JB Asset Management’s JB Australia NDIS Fund.

If a securities house is later unable to syndicate a portion of their equity, they would just remain at the cap table for longer than they expect – Shiraz Jiwa, Valesco

According to The Korea Herald, KB Securities had raised 236 billion won from institutional investors and 90.4 billion won from individual investors for funds including the JB Australia NDIS Fund to purchase specialist disability accommodation assets. Consequently, in December, some of the fund investors, including Korean Reinsurance Company, The Korea Federation of Community Credit Cooperative and the National Forestry Cooperative Federation, reportedly filed a lawsuit against the two Korean firms, claiming damages.

Valesco’s Jiwa, meanwhile, says none of the deals done by his firm have had any syndication challenges. Given the firm’s focus on ensuring deal security and speed, he says he does not work with securities firms that need to syndicate prior to completion of the acquisition.

In case of a hypothetical failed syndication, he also does not see any risks for the GP.

“If a securities house is later unable to syndicate a portion of their equity, they would just remain at the cap table for longer than they expect,” he says. “That is really a commercial risk for them to manage, but it is not a legal risk in any way. There is no complication for a GP.”

Investor concern

But while international managers like Valesco are comfortable with how securities firms operate, some domestic real estate executives are becoming less so.  Kimin Chung, JLL’s head of international capital for Korea, says certain securities companies, especially those unable to hold assets till the maturity of their holding vehicle, might need to consider selling down unsold assets at discount.

From PERE’s conversations with three unnamed Korean investors, reluctance to partner with securities firms is largely influenced by inadequate underwriting standards and high fees. These investors feel the syndication process does not give them full visibility into returns generated from an investment after discounting the profits for securities companies.

“I prefer not to [use securities firms], because it is very expensive,” the head of real estate at one Korean public pension fund tells PERE. “They sell down to us because it takes more than two months for us to make a decision if we try to do a deal directly. But they take a 3 percent fee, and we don’t even know how much return we should have got [from the investment] because we are not the original buyer.”

A team head at a South Korean insurer notes: “When [securities companies] come to us, they give us a price. European mezzanine, for instance, is at a 5-6 percent return; US mezzanine is pitched at 7-8 percent. I was not satisfied with this approach, so decided to take on the extra work and do a deal directly in Australian debt. The returns we are getting for that direct investment are 8.25 percent, but if I had done it with a securities firm, it might have been 5-6 percent.”

This preference to pursue deals directly as opposed to buying through syndications could become an industry-wide trend, according to Chung. “There is a change in appetite from Korean investors,” he says. “The traditional top Korean pension funds and sovereign wealth funds have built a very good track record over time, and they have their own network to do a deal with local partners.”

Others, like the former head of real estate at a Korean public pension fund, worry these security companies are “not asset managers” and lack necessary expertise.

A broker tells PERE how a European office acquisition was underwritten to ensure successful syndication. At the time of completing the deal, the asset was still in the stabilization phase, which meant it would not match the stabilized cash-on-cash yield requirement of Korean investors.

To get over this hurdle, the securities firm over funded its equity commitment to the asset so that they could use this amount to meet quarterly distributions to the end investors until the asset became fully stabilized and income- generating. “They are not looking to underwrite a deal in terms of making the biggest bang for your buck, but just matching the investment hurdles of Korean investors,” the broker says.

Korean securities firms are relative newbies in private real estate and are finding their first hurdles to overcome. If the unsold assets pile up, initial practices such as syndication could well be in line for refinement.

Additional reporting by Christie Ou.