Europe has had an influx of Asian capital recently. The phenomenon is likely to get more pronounced, write Mark Evans and Will Ridley.
Europe has become more dependent on inflows from cross-regional capital, with capital from outside Europe accounting for 19% of all investment since 2007. This has traditionally been dominated by North America, but increasingly Europe is attracting capital from Asia.
Since 2008, Asian investors have consistently invested more year-on-year in Europe, and are growing in influence. Asian investment in 2008 was €500m, and with €9.9bn of transactions in 2013 and €4.9bn in 2012 (figures 1 and 2), this trend has continued.
Capital raising for European real estate has now become a truly global business, as capital moves quicker than ever, seeking a balanced, well-diversified global real estate portfolio. Compared with the Canadians, investment into Europe from Asia is relatively new, and being pioneered by the region’s sovereign wealth funds (SWFs) and pension funds with sovereign status, such as China Investment Corporation (CIC) in 2012, and National Pension Service of Korea (NPS) in 2009. It is probably also going to be deeper and more sustainable, as strong push- pull factors are attracting institutional investors – life insurers, pension funds (public and corporate) and mutual aid associations – to core real estate opportunities in Europe.
Capital raising for European real estate has now become a truly global business, as capital moves quicker than ever.
The past 18 months have been dominated Europe has had an influx of Asian capital recently. The phenomenon is likely to get more pronounced, write Mark Evans and Will Ridley by Malaysian and South Korean institutional inflows, with Chinese institutions more recently getting in on the act. This has been particularly focused on London but more recently this focus is being drawn to the UK regions, top-seven German cities and Paris.
Europe’s exposure to non-domestic sources of capital is far greater than other global regions. For European fund and asset managers, this presents a great opportunity to diversify investor bases. However, success is dependent on understanding the manner in which this capital invests, which varies significantly according to its source.
Investment from Asia has been pioneered by SWFs and large national pension funds with sovereign status from the region – such as CIC, Government of Singapore Investment Corporation (GIC) and NPS – via direct investment and corporate tie-ups.
This has been followed more recently by successive waves of Asian institutional investors from Malaysia, South Korea and China. Thai investment is being made, and Taiwanese investors are expected. This investment has typically been direct investment or quasi-direct (joint ventures, co-investments or club investments), as opposed to indirect investment through listed or unlisted vehicles. It is often assisted by European investment advisers or retained segregated account managers to underwrite the deals locally. Investment has been concentrated in a relatively small number of central business districts, with a strong preference for the UK (80%), and is also highly concentrated in the office sector (72%). Notably, investors from Asia have one of the largest average lot size for their transactions (€110m), and rarely take portfolio exposure, as it is more complex to underwrite.
Malaysian institutional investors tend to invest alone. It is likely that this will be the favoured approach of the Chinese institutions as appetite grows, and is also relevant to a few of the larger South Korean pension funds and insurers that are capable of making equity investments of more than €100m, and will invest alongside other global institutions. However, a more common approach for South Korean institutions is to club together. Typically, a larger institution capable of a €50-75m investment will act as cornerstone investor, taking the lead to a wider South Korean club, pulled together from investors committing €10- 30m. As momentum gathers for a deal, more investors are attracted to join the club.
This South Korean club approach provides diversification to the investors and saves in transaction and management costs. It is a mentality partly borne out of the South Korean culture, but is also the result of a relatively small domestic institutional investment market, which compels even small institutional investors to invest overseas. It can have the result of tying up large numbers of South Korean outbound investor teams once a due diligence process is under way.
South Korean investor clubs are also a function of the fact that most investors are affected by a regulatory requirement to invest outbound either through overseas funds regulated and registered by the South Korean regulator, the Financial Supervisory Service (FSS) – costly and difficult where there are no seed assets – or through a South Korean vehicle (more typical), arranged and managed by an FSS-authorised asset management company.
Leaving aside the Asian sovereign wealth funds that have the capacity to act fast, the institutions tend to need extended time for deal due diligence and the ongoing comfort of transaction exclusivity to maintain momentum. These requirements lead them to be more attracted to off-market opportunities where they feel the playing field is levelled versus more responsive domestic, intra-regional and North American investors. This results in a higher degree of co-investments and backing into existing owner- ships via equity shares.
Principal pull factors
The main driver of significant cross-regional investment flows is a high level of savings and pension contributions in a particular country. This is amplified if that country also has a relatively small domestic market and is therefore unable to accommodate the investment of those savings. The drivers of these excess savings, and the extent to which future sources of cross regional investment can be predicted, depend on five key factors: limited domestic property markets; regulatory changes; the growth and evolution of SWFs; and debut allocations to real estate.
Asian institutional investors, unlike their counterparts in other regions, have a preference for well-located, core office assets, providing secure income streams. However, few assets of this type are accessible for investment within the region. Developed Asia Pacific accounts for just 17% of the global real estate investment universe, while developed Europe and North America collectively account for more than half of the global total. Furthermore, a large proportion of investable assets in Asia are tightly held by large property companies, which tend to ‘build and hold’, and are therefore not regularly traded. In addition, the strong investment demand for core assets in Asia has pushed down yields over the past few years. This means that foreign markets offer a yield premium relative to Hong Kong, Shanghai and Singapore.
In October 2012, the Chinese Insurance Regulatory Commission relaxed its restrictions on overseas investment by domestic insurance companies. Chinese insurers are now permitted to invest in completed commercial properties in the gateway cities of 45 designated countries. China Life Insurance and Ping An Insurance have already acquired property overseas.
Discussions about permitting Taiwanese insurance companies to invest in real estate offshore have been ongoing. In November 2012, in response to concerns about an overheating Taiwanese commercial real estate market dominated by insurers (40% of transaction volume), regulators increased the minimum annualised yield on commercial property acquisitions by insurance companies from 2.125% to 2.875% and restricted onwards sale within five years of purchase. As a result, Taiwanese insurers have been inactive in the domestic market, and have begun to assess opportunities offshore.
It is thought that leading insurers will move South America fairly quickly following any rule change regarding overseas investment. Most will establish overseas business arms. It is unlikely that this will result in significant overseas investment initially, as regulations remain quite restrictive, such as in relation to capital ratios required to invest outbound and types of investments permitted. However, it should be noted that insurers’ real estate investment assets have grown by 13% per annum since 2006 to $20bn (€14.6bn).
As a footnote on Asian insurers, it is notable that Japanese insurers make up 14 of the top 25 insurers by assets under management (AUM) in Asia, reflecting the depth and maturity of their insurance market. Almost all of these are significantly larger by AUM than other Asian insurers, but few are active overseas investors. If the Abenomics stimulus package takes a firm hold, expectations would be for more Japanese insurers to follow suit.
Meanwhile, AUM by global SWFs has grown from an aggregate $1.2trn at the end of 2002 to almost $6trn by 2012. They continue to be acquisitive, but have also looked to make changes in allocation to real estate as a result of underperforming fixed income markets.
Several Asian countries, such as China and Singapore, have had and continue to have substantial and long-term trade surpluses or significant foreign exchange reserves, such as China and South Korea. They have set up non- commodity-based sovereign wealth vehicles to invest this surplus. Institutional investors have tended to be followers of sovereign wealth investors, often restricted by domestic regulation, so as sovereign wealth investors from Asia focus more widely in Europe, institutional investors will be expected to follow.
On a global basis, while the rate of growth may be less dramatic, existing pension funds control far more capital than SWFs. It is estimated that in 2011 total pension fund AUM globally was more than six times higher than that of SWFs. Pension funds have traditionally been domestic investors, but it is expected that they will follow the internationalisation of wider capital markets.
Global pension fund assets are in the order of $29.8trn but are very concentrated in a small number of countries. The US stands above the rest with total pension fund assets estimated at $16-18trn2, with the next largest national totals being for Japan ($3-4trn) and the UK ($2.5-3trn).
Of the countries with the highest pension fund assets, Japan stands out as the one where the proportion held in real estate is lowest. In the US, UK, Australia, Canada and the Netherlands, pension funds typically have a significant allocation to real estate already. For example, CalPERS has an 8% allocation to property (with a strategic target of 9%), ABP has a 9% target and CPPIB is at over 10%4.
This compares with the Government Pension Investment Fund (GPIF) of Japan, the world’s largest pension fund, with assets of $1.2trn5, and the Local Government Officials Pension Fund, also in the top 10 of global pension funds with assets of $200bn, both of which have only limited exposure to foreign markets (less than 10%) and almost none to real estate (either foreign or domestic). If the rest of the deep and established Japanese pension fund market is similarly allocated, a re-allocation to real estate both domestic and overseas, combined with growing pension funds in emerging Asian markets, will have a marked impact on the capacity for Asian institutional cross-regional investment.
Although demographic and socio-economic factors can have an effect on international investment separately, it is when the two reinforce one another that their effect becomes greatest. In both cases, it is the net level of long-term saving being generated in an economy that is the driving force. As a result, the most rapid growth in long-term savings will normally be seen in populations where both of the following apply: the age structure is biased towards middle-age and there has been a recent growth in living standards (meaning that this large middle-aged population has spare income that can be saved). Clear examples of this are South Korea and Malaysia, which have both been significant sources in cross-regional capital in recent years.
In addition to existing sources of cross-regional investment, China will be a source of cross-regional real estate investment in the near and medium term, due mainly to its sheer size and to the relatively small amount of overseas investment compared with that at home.
The rapid increase in GDP per head is expected to continue in the medium term, and growing urbanisation should lead to strong growth in personal long-term saving. However, strict laws aimed at population control introduced in the late-1970s mean that the working- age population is at its peak as a proportion of the population.
Thailand and Malaysia have also experienced rapid growth in GDP per head in recent years, growth that is expected to continue in the near term.
At just under $11,000 per head, the GDP per head in Malaysia is almost twice that in Thailand and, on the basis of that measure alone, Malaysia is a more obvious candidate to generate capital outflows.
Indeed, there have already been significant real estate acquisitions by Malaysian pension funds in the European market. However, the total population of Thailand is more than twice that of Malaysia and is more biased towards the 35-55 age group, which will counterbalance this to some extent.
Mark Evans is executive director and Will Ridley is director at CBRE Real Estate Finance