Value-add: Adding value in Asia
International investors are leaning towards value-add funds for Asia. But strategies and definitions can vary, writes Florence Chong
With core asset prices reaching new heights in Asia-Pacific gateway cities from Sydney to Seoul, investors are now taking the value-add route in building their portfolios.
Half of all institutional investors who were asked – including pension and sovereign funds – told ANREV in a recently published survey that they prefer value-add in terms of risk-adjusted performance prospects for their 2018 investments. And 46.7% of fund managers in the survey said they prefer value-add to other strategies.
Collectively, they have planned investments amounting to US$57bn (€46bn), says Amelie Delauney, ANREV’s director of research. The response on value-add is a “noteworthy change” compared with previous surveys, she says. In the past, investors preferred core assets – and this is still the case – “but core assets have become expensive – and there is a lack of supply”.
Delauney notes, too, that many US investors investing in Asia have traditionally looked to value-add or opportunistic investing – and continue to do so.
Calvin Chou, Invesco Real Estate’s head of opportunistic funds, says: “There has been a shift in strategy towards investing in Asia. Our clients are focusing on the best risk-adjusted returns across Asia and many are shying away from strategies or markets that they might deem too risky. They see more balance in a value-add strategy.”
Managers, he says, are largely driven by clients. If they are looking for value-add returns, managers will provide the vehicles. “Ours is a symbiotic relationship [with investors],” Chou says.
Global managers in the sector include Blackstone, CBRE Global Investors, Heitman, AEW, and LaSalle Investment Management. Regional groups include PAG, Gaw Capital and Pamfleet, all based in Hong Kong, along with Alpha Investment Partners and ARA Asset Management from Singapore, and Secured Capital from Japan. Secured Capital is now owned by PAG which recently sold a minority stake to Blackstone.
CBRE Global Investors has raised US$2.5bn for value-add strategies in Asia-Pacific across its investment vehicles. Its strategy is to focus on creating core assets to sell to institutional buyers, according to Adrian Baker, CIO of CBRE Global Investors Asia-Pacific.
“Over the last 24 months, pan-Asian core funds have proliferated,” he says. “As a result, international investors are now content to come to Asia for core assets to benefit from diversification rather than simply chase excess returns. We are receiving offers for our core assets as soon as we create them.”
Baker cites experience with its latest Asia-Pacific fund, Asia Partners IV, which acquired a large industrial portfolio in Japan. “We sold over half of those assets to Japanese institutions at a significant spread in terms of yield on entry and exit after we extended the leases from five to 15 years,” he says. “At that point, they became a very core asset.”
Along with logistics, data centres and cold storage are coming into the focus of value-add managers as they become one of a trio of assets set to benefit from the explosive growth of e-commerce in the region.
“We are largely selling to domestic core buyers,” says Baker. “We have also seen regional institutions increasingly targeting core real estate. Low bond yields have driven these investors to seek additional yield in their portfolio from core real estate.
“Pan-Asian core finds and domestic regional groups are chasing the same assets. That has seen the pricing of core assets increase dramatically – and yields have fallen.”
Unlike developed markets, Asia has a relatively low supply of core assets. Increasingly, it falls upon value-add managers to create supply to feed growing demand.
Chou says: “When you talk about value-add, our approach is to find markets with favourable fundamentals – supply-and-demand imbalance, prospects of rental growth, demographic trends, and so on.”
Invesco has focused on developed markets and gateway cities, acquiring assets in key Australian cities, and in Seoul and Tokyo. Chou regards the high prices in Singapore and Hong Kong as “challenging”.
He says: “We believe we can execute value and value-add transactions in areas even outside traditional CBDs. As a value-add investor, we will go to sub-districts of a city when the central business districts become expensive.”
Invesco recently reconfigured the lobby, lower office floors and car parks to add flagship retail space to the office building it bought outside the Seoul central business district. The conversion helped capitalise on the building’s main-street position and proximity to a busy subway station in a growing retail destination.
“The building upgrades and conversion ultimately attracted a high-quality anchor retail tenant while improving the overall NOI [net operating income] of the building over 30% from acquisition, less than a year prior.”
Henry Chin, head of research at CBRE Asia Pacific, estimates that value-add funds have about US$10bn to spend on acquisitions over the next three years. He says that, between 2014 and 2017, commingled funds raised US$42bn for real estate investment in Asia-Pacific. With leverage, they had US$116bn in “gross dry powder” available for investment.
In the paper, The Next Wave of Capital Deployment, Chin found that US$63bn of the US$116bn has been deployed, leaving a further US$53bn available for investment. He says: “We dived deep to look at strategy and identified around US$10bn which will go into value-add, with the balance going into opportunistic acquisitions.”
LaSalle, which raised more than US$1bn for LaSalle Asia Opportunity V, runs what are ostensibly opportunistic funds in Asia, but are arguably more in line with a value-add definition. The LaSalle Asia Opportunity fund series has invested more than US$10bn over the years.
“Our flagship funds have been labelled opportunistic,” says Mark Gabbay, LaSalle’s Asia-Pacific CEO and CIO. “We did debate changing the name. We are at the opportunistic side of value-add. We turn around buildings, we work on enhancing and repositioning them into core-type assets.
“The definition of value-add is different to different people. The traditional definition is based on target returns, in the 11-14% range with gearing of 50-60%. The difference between value-add and opportunistic in Asia-Pacific is that the latter started with non-Asian investors who sought higher returns to compensate for higher risks in both currencies and developing markets.”
As a consequence, Gabbay says, the return target is about 18%, substantially higher than typical value-add returns, and at a level normally associated with opportunistic strategy in the US or Europe. But “you need to offer this type of return to attract capital from non-Asian institutional investors”, he says.
While some fund managers classify development as ‘too risky’ and therefore not part of their value-add strategy, Gabbay has a different view. Development, he says, does not necessarily have to be risky, especially when leveraged to about 50%. “There is always development opportunity. We see it as being at the higher end of a value-add [strategy]”.
LaSalle allocates up to 25% of its capital to development, but targets specific sectors such as logistics projects in China and South Korea. These have outperformed, with returns of 18%, he says.
“Typically, the opportunistic investor looks for distressed cycles, non-performing loans, and an overbuilt market,” Gabbay says. “There have been three periods of distressed markets in Asia: in late-1990s, early-2000s and late-2010s. So there is some difference about what is opportunistic, what is value-add, and where the managers’ individual strategies fall in that spectrum.”
Baker says cycles in the real estate market determine investment strategy. “The type of deals we did in 2009 were very different to those of today,” he says. “In 2009, in the wake of the global financial crisis, you could buy good-quality core assets from distressed buyers. So you could get distressed pricing and then sell as the cycle moved along.”
This is a strategy that worked for CBRE Global Investors’ Asian funds – all of which are value-add vehicles. The reality today is that the definition of whether a fund refers to its strategy as value-add or opportunistic boils down to simple semantics.
Based on CBRE’s research, Chin says the best value-add opportunities will come from taking risks on leasing in Shanghai, Seoul and Hong Kong. “For example, the average vacancy rate in Shanghai will reach 21% by the end of this year, against an historical average of 12-13%. We are bullish for future demand for Shanghai office.”
Similarly, the vacancy rate for Seoul CBD and surrounding commercial centres is 12% against the five-year average of 9%. And Hong Kong currently has a vacancy across the territory of 8% – more than double the historical average of 3-4%.
“The value of office buildings in these markets will rise when vacancies start to shrink,” says Chin.
As part of asset enhancement, he sees a new trend emerging to create co-working facilities within office buildings. “Our studies show that more occupiers are using co-working facilities. They are starting to look for more flexible working space.”