Pension funds and insurers are pushing more and more into real estate debt. And their appetite will only get stronger, writes Florence Chong

South Korean investors fear asset bubbles. But they are also pushing headlong into alternatives on the look-out for income. The result has been a sideways drift from real estate equity to real estate debt.

Steven Craig, managing director of JLL in Korea, says: “It is quite clear that in 2016 debt was in ascendancy. You can see that from the statistics. The equity numbers showed that the amount of outbound capital placed by Korean funds in 2016 was 21% down from 2015.”

Craig says this does not suggest less money is leaving South Korea, but rather that Korean investors are de-risking by moving down the capital stack and taking positions on debt as an alternative to equity investment.

“That is why I think the total amount of money sent out for real estate last year probably was up, or stable at worst,” he says. “The money was placed in debt deals.”

He says the trend suggests that Korean investors are allocating equity and debt differently, between core office investments with stable income, and retail and logistics investments. In some cases, the former is being more equity-driven and the latter more debt-driven. 

Cho Yun Seok, head of business development for South Korea at AXA Investment Managers–Real Assets, says: “For downside protection many Korean investors will continue to invest in commercial real estate loans, including mezzanine debt, as debt investments provide greater risk-adjusted returns, in particular for insurance groups prioritising to meet their risk-based capital ratio.”

Based on data generated by local asset management companies, about US$8.7bn (€7.9bn) was invested overseas in various types of real estate assets by South Korean investors last year. The US received 66% of those investments, of which about 67% went to debt, comprising senior real estate loans, mezzanine and high-yield loans and project financing. 

Of the Korean capital that went to Europe, IPE Real Estate was told that the allocation is about 29% in debt and 60% in equity.

Korean fund managers say Korean investors like the depth and size of the US commercial real estate debt market.

Korean institutions invest in debt through either a debt fund, a club arrangement, or in partnership.

Last October, Samsung SRA, the real estate investment management arm of Samsung Life Insurance, raised KRW310bn (€250m) for its first blind-pool US debt fund. It was oversubscribed.

“For downside protection many Korean investors will continue to invest in commercial real estate loans”
Cho Yun Seok

When the fund closed, in October last year, Young Chai, CIO of Samsung SRA Asset Management, told IPE Real Estate: “In the end, we had to reduce the size of the raising because we didn’t want it (the fund) to get too big.”

The fund’s mandate was to acquire mezzanine notes collateralised by fully stabilised office buildings in US gateway cities. Samsung SRA is targeting mezzanine notes with a loan-to-value (LTV) ratio of up to 65%, and fixed rates up to 10 years. It closed its first deal for more than US$100m (€93.2m) upon closing the fund.

Another foreign fund manager who works with Korean investors to access offshore investment opportunities says Korean investors are quite specific in what they will invest. “They look for an all-in rate of at least 4% fixed for 10 years. This is what general and life insurers look for, because they need fixed constant returns.”

The US has a bigger market than others for mezzanine debt. There, investors can lend on an LTV ratio of 75% to 85% on high-yielding coupons. 

Last October, the leading Korean financial institution, Kiwoom Asset Management, formed a club of eight Korean limited partners, including NongHyup Financial Group, to lend Brookfield Property Partners KRW600bn against 200 Liberty Street in Lower Manhattan, New York City. 

Through the Dallas-based Civitas Capital Group, the club used a vehicle known as Kiwoom Milestone US Debt Professional Private Real Estate Trust 2 to invest in mortgage-backed debt on a 4% annual return.

The Korean Teachers Credit Union partnered with TH Real Estate in January to form a US$1bn joint venture to invest in US commercial real estate loans. The pension fund had co-invested with TH Real Estate in 2014 in US$950m worth of commercial mortgages backed by three office buildings located in New York and Houston.

Such opportunities are somewhat limited in other parts of the world, but Korean investors are keeping a watchful eye on market developments in the UK, Europe and Australia.

Although Korean investors have been talking to debt specialists in Australia for the past three years, they have yet to land a significant deal there.

“We have been talking to several Korean groups,” including the National Pension Scheme (NPS), “on and off for some time”, says an industry source in Australia. “But we have been unable to match them with a big enough deal.”

Those who spoke to IPE Real Estate believe that the trend to invest in debt will continue, noting, for instance, that the Kyobo insurance group – which has a joint venture with AXA Investment Managers – made its entry into the debt market with a US$40m loan this year.

“This is just a start for Kyobo,” says an executive close to AXA Investment Managers. 

Korean life and general insurance companies are relative newcomers to investing offshore, and they are taking their cue from Korean pension funds, the first of which have been investing overseas for a decade or so. 

Appetite to remain strong

Faced with declining returns and fierce competition for good assets in their home market, Korean insurers and pension funds are looking to diversify their assets to improve returns.

South Korea’s pension pool, growing at 10-15% annually, stood at US$640bn at the end of 2015, acccording to most recent figures.

As these funds get bigger, so will their allocations to real estate, says Craig. It follows that, as allocations increase, they will seek to diversify risks from their domestic market to overseas. “For Korean institutional investors, the data shows 25% allocation to alternatives,” he says. “This is then allocated 32% to direct real estate funds, the rest to infrastructure funds and private equity and hedge funds.”

Last August, the Korean Ministry of Strategy and Finance amended legislation to allow Korean pension funds to significantly increase exposure to offshore and alternative investments. Song Eon-seok, strategy and finance vice-minister, said the increase in overseas and alternative investments was inevitable to secure higher returns. 

The country’s investment management industry welcomed the move, saying it was in line with other pension funds around the world, which are also increasingly looking abroad for alternative investments. Institutional investors need to diversify away from lacklustre bond and equity markets.

Government guidelines apply to such groups as NPS, the Government Employee Pension Service, Korean Teachers Pension, the National Health Insurance Service and Korean Worker’s Compensation and Wealth Services.

The ministry said NPS would raise its allocation for overseas and alternatives to 31.3% in 2017 (from 28.6% in 2016). By 2021, that figure will rise to 40%.

top 10 outbound investments by korean institutions in 2016

At the same time, the Government Employee Pension Service will increase its overseas and alternative investment allocation to 35.9% this year, rising to 44% in five years’ time. 

And, from this year, the Korean Teachers’ Pension weighting to overseas and alternative investment will rise to 36.6%. 

Craig says that, at current levels, outbound Korean real estate investment is commensurate with the size of its economy in world – it is the fourth largest in Asia and the 11th largest in the world.

“In cross-border outbound investment, Korea has ranked somewhere around the 10th or 11th (largest market) consistently over the past few years – that is very much in line with the size of its economy,” he says. According to the International Monetary Fund, the South Korean economy is projected to reach US$1.67trn in 2017.

“If you look at 2007, investment totalled US$313m,” he says. “It peaked at US$5.5bn in 2015. That is fairly explosive growth.” 

Craig explains that his statistics cover only equity investment – the figure dipped to US$4.3bn in 2016. 

He says Korean investors tend to focus on the US, UK or European markets because they offer good diversification. They have lower correlations with Korean or other Asian markets.

Korean institutions usually invest through their domestic asset management companies, such as Samsung SRA and Mirae Asset Management. Often they use a Korean asset management company to liaise with a foreign counterpart. 

For example, Korea Teachers Pension acquired a Brisbane office for AUD200m (€140m) recently through Eureka, the Australian platform of AXA Investment Managers, by working with Samsung SRA.

The bulk of South Korean equity investment in the past year has gone into office buildings, such as Samsung SRA’s purchase for €650m of an office owned by Commerzreal – the largest single transaction involving a Korean buyer in 2016.

Property agents say their Korean buyers look for quality buildings in core locations on long leases – preferably with government tenants and located in capital cities. South Korean investors know what they want.

Competition at home

The South Korean commercial real estate market faces increasing competition from foreign buyers as well as a new type of purchaser. Korean retail funds are so hungry for assets they will accept lower yields.

Last year, foreign investors were the largest buyers of Korean office buildings, with international fund managers seeking assets for their pan-Asia funds.

In a survey released in February, Cushman & Wakefield said the ratio of foreign investment topped 50% for the first time since 2007, with office transactions totalling a record KRW9.5trn (€7.62bn) for the year.

Property professionals say office yields have fallen to 4% – and, in some instances, below this – setting a new benchmark for the market.

Price, however, is not deterring investors. Brookfield led a consortium, which included China Investment Corporation, in November to buy the IFC Centre in Youido, Seoul’s main financial district, for more than KWR3trn.

GIC, Singapore’s sovereign wealth fund, an established player in the market, made two acquisitions in 2016 for a combined US$266m (€248m).

Blackstone made its first investment in Korea’s prime office building market in June 2016, purchasing Capital Tower in Yeoksamdong, southern Seoul, for KRW470bn.

M&G Real Estate, which has a presence in Seoul, recently acquired a shopping centre at Ulsan City, one of South Korea’s busiest shopping areas, for KRW158bn – for its Asia core fund.

The foreign buying spree has continued into 2017, with PGIM snapping up an office tower near Seoul Station for KRW184bn in March. 

Others, such as Invesco and AEW , are looking for value-add assets to acquire for their pan-Asia funds.

The emergence of Korean retail funds has sharpened competition further.

Mirae Asset management and Samsung SRA have begun offering property funds to retail investors, including high-net-worth individuals.

And, industry experts say, unlike institutional investors, these retail funds are prepared to accept spreads of 30-40bps lower than institutional investors.

It is little wonder then that larger Korean buyers are looking elsewhere to invest their capital

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