Asia-Pacific: APAC finds its core values
The concept of investing in core assets in Asia-Pacific is gaining traction, although so far much of the focus has been on Australia, writes Florence Chong
Real estate investment in the Asia-Pacific region has finally come of age. Global investors are now content to invest there in open-end core funds for the long term.
Investing in Asia-Pacific real estate is not new. Global investors have long chased Asia’s economic growth story. But a shift in mindset – from short-term opportunism to long-term strategy – is a relatively new phenomenon.
For the best part of a decade, PGIM Real Estate’s pan-regional retail fund and M&G Asia Property Fund have been the two vehicles that could best fit the description of open-end core funds in Asia. They have stood out against a myriad of closed-end, value-add and opportunistic funds.
If there was an identifiable market turning point, it was probably in 2014, when a new generation of Asia core open-ended funds came into being, led by US manager Invesco Real Estate. Invesco’s pan-Asia fund manages about US$1.5bn (€1.37bn) in assets in key markets, including Australia, South Korea and Japan.
Invesco was followed in quick succession by Morgan Stanley and JP Morgan, which launched their own Asian core products.
US managers are prevented by regulations from talking publicly about specific funds, but industry sources say that Morgan Stanley’s fund stood at around US$650m at the end of last year, while the JP Morgan fund was at about US$500m.
IPE Real Estate understands that Deutsche Asset Management is currently marketing a core fund in Asia, hoping to raise upwards of US$350m. The manager declined to comment.
Meanwhile, Savills Investment Management (Savills IM) is on track to launch a pan-Asia core-plus fund. Chief executive Justin O’Connor says the plan is to raise between US$300m and US$500m to acquire assets with a gross value of around US$1bn.
Regional fund managers have upgraded their offerings to include core products. The Singapore-based SC Capital has, so far, raised US$310m for its first core fund, known as SCORE (SC Capital Asia Core Fund). SCORE is expected to close this year at more than US$500m. The Hong Kong-based PAG last year raised US$1.3bn for its first pan-Asia core-plus fund, exceeding its initial target of US$1bn.
The trend shows an emerging consensus among the world’s most successful fund managers that Asian real estate has matured – and that prime assets in the region should be considered ‘core’.
From a diversification point of view, global investors can no longer overlook a region that is producing more core office towers, shopping centres and logistics facilities than any other market in the world. As Asia continues its growth trajectory, future global stock of core property will invariably come from mega cities dotted across the region.
Both M&G and PGIM Real Estate have shown that, with the right approach and active management, core assets in Asia are capable of delivering more than respectable returns.
PGIM first arrived in Asia in 1994. It now manages assets totalling US$5.8bn across Asia-Pacific, much of which is run through separate accounts for global investors. Benett Theseira, head of Asia-Pacific at PGIM Real Estate, is fond of saying: “Ultimately, investing in core assets in Asia is about investing in the future growth of Asia.”
Fund managers point out that China and Japan are the second and third-largest economies in the world, while Australia, Korea, Hong Kong and Singapore are each significant economies in their own right. “Asia is a higher growth region compared to other parts of the world,” says one head of Asia for a US fund manager, who asks not to be named.
The Singapore-based manager says: “Capital is better organised today in Asia, and the markets are more efficient. Some of the sovereign wealth funds, pension funds and financial institutions in this region are also growing in size. So it is a natural progression to create a strategy for Asia that is sufficiently mature.”
The managers concur that investors are “warming” to core funds in Asia. “As the concept grows in scale, people will give it more attention. Investors and consultants are spending a lot more time on the sector,” says one manager.
This was borne out in the 2017 ANREV/INREV/APREA investment intentions survey, which found that 51% of the capital raised for Asia-Pacific in 2016 was dedicated to core funds, compared with 30% for opportunity and 20% for value-added funds.
Amelie Delaunay, director of research and professional standards at ANREV, says core funds continue to attract a lot of investors in the region. Institutional investors indicate that they plan to invest up to US$10.3bn in Asian real estate in 2017, and that 40% of respondents view core investments as having the best risk-adjusted performance prospects in 2017 in Asia-Pacific.
Fund managers say they are seeing good support from global investors, who are starting to realise that the region offers good geographical diversification for their property portfolios. As an example, the California Public Employees’ Retirement System was a cornerstone investor in JP Morgan’s Asia core fund, committing US$250m.
New entrants are good for the industry and reinforce the thinking that Asia is now a core market place, says Ian Schilling, head of core funds and private accounts for Asia-Pacific at Invesco Real Estate.
While not prepared to confirm that it is planning to launch its own core fund, Victoria Sharpe, Deutsche Asset Management’s head of real estate Asia-Pacific, says: “I can confirm that a number of core open-end vehicles are being formed. Until now, a number of funds that offer Asia-Pacific assets were not really core.”
Sharpe has been investing in core real estate in Asia since 2005. Today, Deutsche Asset Management is responsible for more than US$2.5bn in core assets in Asia for its investors – mostly German clients – through separate accounts.
The current crop of managers bring with them – in many cases decades worth of – experience in running core funds, aiming to replicate their successful multi-billion-dollar core funds in the US.
Australia the first port of call
For core funds in Asia-Pacific, as a general rule of thumb, Australia and Japan each have a 30% weighting, with South Korea, Hong Kong and Singapore sharing the balance of fund allocations. In reality, however, pan-Asia core funds tend to have their exposure more heavily weighted towards Australia than to other regional markets.
Fund managers say it is not by design that their capital flows into Australia. It is of necessity, because Australian markets are deeper, more liquid and more transparent than other Asia-Pacific markets.
Schilling explains that the choice of investment destination in Asia-Pacific is very strategic, based upon relative risk-adjusted returns in the region.
The Morgan Stanley Asia core fund was seeded in May 2016 with Sydney’s AUD525m One Shelley Street office tower, home to Macquarie Bank.
JP Morgan’s pan-Asian fund began acquiring assets in Australia last year in quick succession, buying both a Melbourne office building and a Melbourne retail market for a total of AUD533m.
Invesco Real Estate has acquired four Australian assets with a total value of AUD610m since launching its core strategy in 2014. Invesco has also purchased a number of assets in Japan and South Korea.
Although other managers of Asia core funds have also been striking deals in Japan, they describe it as “a more opaque market” dominated by domestic buyers.
South Korea is increasingly a favoured market. Foreigners are now competing head-to-head with Korean buyers.
South Korea has been a fertile hunting ground for some groups, such as M&G Real Estate, and PGIM. Others, like AEW, are said to be particularly active.
Because of the nature of the Japanese and South Korean markets, it is managers with the strongest local networks that have been most successful in clinching assets in off-market deals.
In comparison, Singapore and Hong Kong are tightly-held, and, in time, some managers are expected to look to first-tier Chinese cities, especially Shanghai and Beijing.
Sharpe believes that, as core assets become more expensive, fund managers will need to be more flexible. While her preference is to buy core assets in, say, Tokyo, she may look to other cities like Osaka. But she will not go to regional Japanese cities that do not have solid core fundamentals in size, liquidity and transparency.
Similarly, in Australia her focus is on Sydney and Melbourne. Only if there were a compelling asset would she go to Brisbane, and if office is too expensive, she may look at logistics.
Schilling says that, unquestionably, increased competition for assets in the region has seen cap rates decline in recent years.
“As a result, Asian cap rates are consistent with global trends – they are now at their lowest point in many Asian markets,” he says.
“But I think we and our investors still see value in Asia because, compared with other regions of the world, the spread to bonds is reasonable. There is still a buffer – if bond rates start to rise.”
Case study: M&G’s oldest core Asia-Pacific fund
M&G Asia Fund, Asia’s largest – and oldest – open-ended core fund, celebrates its 10th anniversary this year with a significant milestone: US$3bn (€2.76bn) in assets under management.
At the end of December, total assets came in at US$2.9bn. In January, M&G Asia settled the US$165m purchase of an Australian shopping centre.
While it has taken a decade to reach this milestone, M&G Asia may reach its the next target – US$5bn in assets under management – in short time.
Ng Chiang Ling, chief executive of M&G Real Estate Asia, says: “We continue to develop our strength in the core fund space. Of course, our strategy could be to become a US$5bn fund in the next couple of years, but it is more important that we manage that growth well.
“We have very good support from our shareholders, and we hope we can bring more shareholders on board. Our core clients are still looking to top up on their Asia exposure, while new European and American-based clients are looking for a taste of Asia through a balanced core fund.”
M&G Asia says it has generated consistent, continual cash flow for clients. “Our strategy delivers net returns north of 4% to 4.5% in yield, boosted by capital gains,” says Ng.
The fund has a diversified approach, both in terms of geographical location and asset type. Ng says it invests in five core markets in Asia-Pacific: Australia, Japan, South Korea, Hong Kong and Singapore. Within these markets, it has equity in office blocks, shopping centres, logistics facilities and hotels.
When the core property strategy was established by the property investment arm of UK insurance company Prudential in 2007, it had no peers.
“Most of our peers had a good product range,” Ng says. “But we only focus on our core product, our single core fund. And we tried to look for opportunities that would secure future growth and profitability – three years out or more. We do not need to show results in the first year or two because our portfolio is very well entrenched. In fact, two-thirds of our income has fixed escalation clauses.”
More importantly, Ng adds, M&G Asia has permanence of capital – namely its parent. “A good part of our investor base is our internal client meeting its requirements in real estate in Asia. So we have a lot of skin in the game alongside long-term investors.
She told IPE Real Estate: “We think this is not something that is prevalent among other core funds in the region. Their managers tend to evolve from managing other investment strategies to core funds.”
As M&G Real Estate Asia moves into its second decade, it plans to broaden its fund management platform to include investing on behalf of other institutions outside of the fund.
“Our strategy with some of these investors may well be through club deals structured to meet both our and our investors’ requirement for core assets,” she says, adding that Asian clients require bespoke strategies to secure core assets. This will be a departure from M&G Asia’s current mandate. “Historically, I would say we have been quite single-minded in serving our parent company.”
While the shift in strategy has been mooted, Ng says it is still early days. The Asian operation has not yet implemented the strategy. M&G Asia is in the throes of upgrading its systems to manage anticipated growth in assets under management, and to take into account managing assets for new investors.
“We are always open for new investors, and we are always looking for ideas to invest more capital,” says Ng. An important differentiator in the market is to be able to deploy capital “in good time”, she adds. “We don’t want capital sitting in the queue.”
North Asia, especially Korea and Japan, is seen as an obvious market for new mandates or separate accounts.
Japanese and Korean pension funds are seeking to expand overseas to diversify from domestic and traditional assets, such as bonds and equities. `
“Given the bond yield today, they are encouraged to look at other ways to get returns to feed the sort of liabilities they are supporting,” says Ng.
M&G has a long-established footprint in both Japan and Korea, where it employs locals who speak the language and have local networks and market intelligence.
The key priorities for Japanese (or Koreans) going offshore are Europe and North America, Ng says, “but that does not stop them from having conversations with us,” she says, adding: “We just need to show them good ideas.”