Korean securities companies are snapping up overseas real estate assets on an increasingly large scale, both equity and debt, to then sell on to syndicates of Korean asset owners.
But in doing so they are casting an ever-widening net trying to source the kinds of properties that meet the needs of Korean asset owners, which is leading them to take on increasing amounts of risk .
Many outbound Korean investor syndicates are led by asset management companies in the form of club deals. These club deals require time to put together and may require inputs from several parties to close.
That slows down the process and creates an opportunity for more nimble securities companies to step in and lock down the assets.
But now, as a consequence of waning asset owner appetite, the average holding period of assets for securities companies has increased from between three and six months to between nine and 12 months, industry sources tell AsianInvestor.
As a result, the scale of assets on brokerage company balance sheets is also increasing, according to one senior investment professional at a Korean securities company.
“It seems like some securities companies have been overeating real estate investments, simply getting too greedy without considering the chances of selling down assets to Korean asset owners,” the investment professional told AsianInvestor on condition of anonymity. “Now, they start to experience constipation, and some might even have to pass some of the assets on to other securities companies at a discount.”
Joel Rothstein, who chairs the Asia real estate practice at US-based law firm Greenberg Traurig, recognises the trend of Korean securities companies aggressively jumping into the cross-border real estate investment market. Over the last two years, he has seen a growing appetite from Korean securities companies for outbound real estate deals – particularly in Europe.
“Now, whenever there are prime assets coming to the market in key gateway cities, certain Korean securities firms will now be amongst the first potential bidders shown the deal along with other usual-suspect international real estate investors such as major sovereign wealth funds and large global private equity funds,” Rothstein told AsianInvestor.
He explained that the fundamentals for underwriting a deal are not substantially different because the investor is a securities company. Nevertheless, the fact that the acquisition doesn't depend on the actions of club or syndicate members to close means the Korean securities company can act more quickly.
“That being said, it is taking on risk because it needs to sell down [the asset] after closing,” Rothstein said.
So if there is insufficient investor interest due to defects unearthed during the underwriting process, say, the securities companies may be left holding an asset that it acquired at an above-market price, he added.
As previously described by AsianInvestor, Korean securities companies are often bidding against each other for the same deals, thus driving prices up. Different investment teams are sometimes even bidding internally, the investment professional said.
With real estate yields, which measure a property's annual rental income in proportion to its capital cost, too low in the US and Western Europe, demand has shifted to new markets – including real estate debt but also less institutionalised markets in Central and Eastern Europe.
As part of a wider push overseas by Korean investors, commercial property deals involving Korea-based buyers have totalled $1.98 billion in Austria, Poland, Czech Republic, Slovakia and Hungary so far in 2019*, according to data collated by Real Capital Analytics.
Of these deals, eight of the largest Korean securities companies have been involved in deals worth $1.18 billion, or 59.3% of all deals involving Korean-based buyers.
In the rest of Europe, Korean-based investors have been involved in deals totalling $8.47 billion so far in 2019, which is already over 40% more than in all of 2018. Well over a third of these deals by value have involved one or more of the eight largest Korean securities companies.
“As Korean investors have increasingly turned their attention to Europe, the securities companies have followed,” Rothstein said. This, however, comes with increased risks.
The sourcing model has worked to date because some Korean asset owners prefer direct ownership to commingled fund vehicles with an asset manager as a general partner.
That enables capital to be invested straight away. It also suits investors who look for yield first.
“The asset owners want to avoid dry powder that does not provide any returns and does not reflect the size of assets under management,” the investment professional said. “The securities companies also need to be able to earn a fee, so that increases the need for high-yielding investments.”
However, by investing directly in lumpy, high-value assets like whole buildings, they are not diversifying their risks.
AsianInvestor knows of one case where a Korean insurer was presented with the opportunity to invest in a US real estate debt fund as a limited partner. Instead, the insurer decided only to invest directly in the debt of one specific condominium project among the investments in the fund.
As the anonymous investment professional explained, this could be because US real estate debt investments need to provide a return of 4.5% to 5% after all costs for Korean asset owners to be interested. To account for currency hedging costs and the fees they pay the securities companies, they therefore typically need to look for higher-risk investments paying a yield of 8% or more.
“Such an investment contains a high level of risk,” said a Hong Kong-based investment consultant familiar with Korean investors, who also declined to be named. “If the retail housing market drops, the condominiums might not be sold at the projected prices, or they may not all get in the first place.”
“Then the investor might face a longer-term asset management challenge to lease out these units, rather than collecting the return on the original debt investment,” the consultant added.
* Up until September 18