Korea's institutional investors’ mounting desire to make commercial real estate acquisitions into new markets in Central and Eastern Europe (CEE) is forcing them to grapple with a new set of risks and frustrations.
Investors from the country have been increasingly eyeing investment opportunities in countries such as the Czech Republic, Slovakia, and Hungary, attracted by higher rental yields and lower valuations.
However, it’s not all plain sailing in these markets. Commercial brokers and advisers told AsianInvestor that Korean investors face higher asset volatility and lower degrees of institutionalisation in terms of investment opportunities than they are used to from their developed market investments.
The investors have to consider the risk these issues raise and the time it takes to deal with them against the potential upside of investments in these markets as they mature.
Joel Rothstein, who chairs the Asia real estate practice at US-based law firm Greenberg Traurig, explained that the tax rules and foreign investor ownership restrictions and other requirements may vary greatly from country to country.
“The markets in Central and Eastern Europe tend to be smaller. Thus, there may be greater risks and issues with respect to market volatility as well as issues to deal with in terms of market liquidity which could impact deal exit timing and strategies,” Rothstein said.
There are myriad problems. Investment teams at Korean asset owners don’t typically have internal expertise on central and Eastern European markets, so they have to ask for external advice on the best tax and legal structures to acquire and own onshore assets in these nations, Rothstein said. One consideration is whether to do so onshore or via an offshore holding company, for example.
The investors also have to learn about local market standards and practices from terms of purchase and sale agreements to lease terms and conventions. Getting up to speed can be time-consuming and costly.
One Hong Kong-based adviser familiar with Korean investors’ real assets strategies told AsianInvestor that there a big questions over the entire strategy of venturing into CEE countries. Since some Korean investors rely on Korean securities companies to source assets, they often lack the knowledge over how to invest into new markets with different dynamics than markets in Western Europe or the US.
The appeal of investing into CEE is understandable. Investments there often offer relatively higher investment yields than those offered by similar properties in Western European countries. In addition, the lion’s share of the assets bought so far have either renowned international corporations or governments as a major anchor tenant.
According to data from commercial real estate broker Cushman & Wakefield, prime office yields in and Paris were 3% at the end of June, while those in Amsterdam offered 3.25% at the end of 2018. In comparison, Poland’s Warsaw and Krakow prime office yields were 4.75% and 5.75% respectively at the end of March 2019.
Data also showed that Budapest’s prime office yield was 5.15% by the end of 2018, the lowest in 10 years.
Nevertheless, finding good opportunities is not simple, and the risk associated with possessing them might undermine the overall investment strategy.
“Many of the Korean end-investors are looking to hold onto these assets for five to seven years and then sell them with a profit,” the adviser explained under condition of anonymity. “If a recession hits and the real estate markets go down the liquidity of the assets will go down too, regardless of strong tenants. That jeopardises the investors’ investment model.”
RISK VS. RETURNS
Another factor that Korean institutional investors need to consider when making investments is the risks associated with the type of property that is available.
The adviser noted that a recent example of an overtly appealing by potentially risky asset becoming available took place in Austria. In July three Korean financial companies acquired Hotel Vienna, the country’s largest hotel. They reportedly intend to sell the stakes in the asset to domestic institutional investors through a fund launched by Seoul-based Mastern Investment Management. It is targeting an annual return of around 7.5%.
“Hotels are renowned as a relatively volatile asset type within commercial real estate, as it principally involves one major tenant and alternative use instead of hotel business will require a high level of capital expenditure,” said the adviser. “Investors should always ask themselves whether their returns reflect the risk they are taking.”
Other types of specialised property have also been gaining the attention of Korean investors. Rothstein said asset owners from the country have increasingly been looking to diversify investment targets as competition for income producing and core office buildings in major cities intensifies, resulting in diminishing yields.
According to Cushman & Wakefield, prime office yields in Paris have dropped from 6% to 3% since 2009. Amsterdam yields dropped from 7% to 3.25% over the same period. Meanwhile, prime office yields in Warsaw and Krakow have fallen from 7.5% and 8.5% respectively in 2009 to 4.75% and 5.75% today, and dropped from 7.75% to 5.15% in Budapest.
He said the investors are increasingly turning to other property types such as logistics facilities, data centres and residential projects – including senior housing and student housing. These can still offer relatively attractive yields above that of prime office assets.
Anthony Selman, head of CEE investment at global commercial property broker CBRE, agrees that emerging markets are harder to navigate than more developed countries in Europe or the US. However, he believes that central and Eastern European markets are catching up fast.
“The CEE markets are still relatively small compared to Western Europe. That said the quality of the property and the quality of the tenants together with the CEE growth story mean that Central Europe is steadfastly becoming a part of the consolidated European market,” he said.
In July, Sweden-based developer Skanska for the first time sold an CEE project, an office asset in Hungary capital Budapest, to JR AMC, a South Korean real estate investment trust. Adrian Karczewicz, head of divestment at Skanska’s commercial development business unit in CEE, said Korean investors are also keen to get exposure to long leased and often new developed CBD (central business district) properties in the region.
“In the first mover cities of Warsaw and Prague we now see more appetite for risk with Korean investors bidding for shorter waults (weighted average unexpired lease terms) and more rent reversion upside,” Karczewicz said.
He also believes that CEE markets will keep developing to the standards needed to facilitate the demands from international investors.
“We have to recognise the difference between capital cities in central and Eastern Europe and maturity of these markets and hence countries. The biggest concern for investors is liquidity,” Karczewicz said. “However, in cities like Warsaw followed by Prague and Budapest it is on a very high level. That’s why investors are so interested in these markets.”