From Korean warehouses to Chinese hospitals, investors’ holding periods are growing in Asia. But in a market awash with liquidity, so is competition for assets. Our panel in Hong Kong discuss real estate investment. Suzanne Callister (regional executive Asia-Pacific and country executive Hong Kong & China, Alter Domus)
Alan Dalgleish (chief executive, The Asian Association for Investors in Non-listed Real Estate Vehicles)
Chris Chow (managing director, LaSalle Investment Management) Funds Global – What is your outlook for real estate investment globally and in Asia given the new US presidency, Brexit, elections in Europe and fears of the market overheating in China? Alan Dalgleish, ANREV – There are some natural concerns which have been present in the market for some time as well as elevated perceptions of risk, given where we are in the cycle, so that’s something we’re trying to address. There’s an awful lot of liquidity still. Yields are low and in some cases could go lower. How do you position your portfolio in those circumstances? Then there’s a layer of potential geopolitical uncertainty. There are many questions about what all this might do to real estate. Suzanne Callister, Alter Domus – In the case of Brexit, I remember that in my office here in Hong Kong, all the Brits were concerned by the vote. But the rest of my staff were busy trading sterling. If you look at recent real estate transactions in London, it is predominantly Chinese investors. The Chinese are definitely looking at Brexit as a buying opportunity. ‘Uncertainty as an opportunity’ is the way Asian investors look sometimes. Chris Chow, LaSalle – It’s fair point regarding the US presidency and Brexit but as for China, I don’t believe the market is overheating. It’s still growing in a modest, well-controlled manner. If you look at Asia as a whole, and China in particular, governments have the ability to put in stimulus if needed and to hold back if needed as well. In this region, the economy is healthy and we continue to deploy capital into China. Out of all asset classes, real estate has one of the longest holding periods. If you look at the US presidency, it might last a couple of years, maximum eight. The holding period for real estate could be much longer. A lot of our clients are institutional investors, they could be sovereign wealth funds and insurance companies. They are underwriting for ten years or more holding period. We did a comparison between real estate and other asset classes and on a relative basis, we are still creating a lot of comparative advantage right now. Some of our investors have increased allocation to real estate. Of course there are things to watch out for – interest rates, for instance. Our advice to investors is, you need to be disciplined in terms of the risk you take. You may not want to take additional risk at this point of the cycle, so you may have to accept slightly lower returns, but we advise them not to do the reverse, meaning that you don’t want to increase the risk but keep the same level of returns. That’s something fundamental you can do to protect your real estate investments globally. Funds Global – In which countries and/or cities are Asian investors seeking to invest? What types of property are in demand? Dalgleish – At ANREV, we did a survey of investors, fund-of-funds managers and fund managers about their preferred investment destination this year. The most popular cities are Sydney, Melbourne, Tokyo and the tier-one cities in China such as Beijing, Shanghai and Tianjin. You’ve then got a whole bunch of regional gateway cities. These are, by and large, big, investable markets with the liquidity for you to get in and get out. To return to an earlier point, I agree that the market is not overheating in China. A speaker at one of our conferences made the point that in the short term, the outlook is very positive, though there may be some challenges in the longer term. Per capita housing in China has grown enormously as people’s living standards have improved, but is reaching a threshold where it may not grow much more as a long-term trend. Mortgage lending is potentially a worry in the longer term because construction accounts for something like 30% of GDP, and if that slows and contracts that will potentially impact overall GDP. However, when people see headlines saying, ‘China GDP slowing to 6.7%’, I want to point out that many countries would look at that growth rate enviously. Chow – Target market depends on each individual investor but, to generalise, the gateway cities in the US, Europe and Asia and usually commercial assets will be the first point of landing for these investors. As they become more comfortable for these locations and for these asset types, they may expand their footprint and the type of assets. From our experience, investors may first come to us through our funds. We have pan-regional core funds in the US and Europe. These are a convenient and effective way for new investors to come into play. As investors become more sophisticated, then they can go into higher-return funds or sector-specific funds. For example, in Asia-Pacific, we have a pan-Asian fund which invests across asset types, but we also have a Japan logistics fund which is a single country/single sector programme. At a certain point, investors need to balance their portfolio and expand outside of the crowded area, which is the key gateway cities we mentioned. Some of the sophisticated investors may be attracted to medical offices in the US, which we do, or Korean logistics, which is getting a lot of attention. They may be comfortable with that. For new entrants, they may not have the sufficient capacity or bandwidth to underwrite those investments. Their investment strategy really depends on which point of the evolution they are at. Callister – I agree, in the real estate area, that the gateway cities are still very much on the radar of Asian investors. Investors usually start with commercial property and then branch out into more exciting opportunities, for instance self-storage units, old age facilities, hospitals or student housing. Dalgleish – Our research has responded to the development of these new sectors. In the past, we’d simply focus on the four key sectors – office, retail, a bit of residential and a bit of industrial logistics. But the dynamic has changed quite a lot. Logistics has come up very strongly. At one stage, the story was all about retail in China, but that’s died down. There’s a lot of interest now in smaller sectors such as student accommodation or healthcare. Funds Global – What’s pushing Asian investors’ demand for real estate and what will be the main drivers in the year ahead? Dalgleish – Again, this has been covered by our research. The top result given was diversification benefits followed by income return, the desire to enhance returns, risk-adjusted performance over other asset types, and inflation hedge. Chow – Historically, these are all correct. One point to add is the comparison of relative attractiveness between other asset types. After the financial crisis, things changed a lot. I’m not an expert in fixed income but we’ve seen so much government paper issued that market interest rates are now at negative levels for some of them. Institutional investors have to look at their whole portfolio to see whether their asset allocation has to be adjusted in response to these pricings. That’s no different in Asia, where investors have been investing across asset classes, and if you look at the performance from the crisis to now, real estate stands out pretty well. Everything has been on on the rise, but real estate still has some good characteristics. Callister – I agree with Alan and Chris on the drivers of Asian investors and I have a question for you both: Are you seeing holding periods for assets in Asia lengthening? Are, perhaps, the days of divesting the asset within a short period of time one, especially in countries like China? Chow – It’s mixed. It depends on the investment strategy the investor started with. If they are starting with the long-term hold, the holding period could be infinite. As I said, a lot of these investors have an extremely long-term liability or holding period, like insurance company or sovereign wealth fund. But there are also investors who will take advantage in terms of short-term volatility. In addition to long-term core investing, we also do opportunistic investing. To give you an example, in our pan-Asian fund we would buy, fix and create a core asset and exit in a certain time frame. So for that purpose, we have to trade in and out of assets. The important thing is the value creation in between. If you just buy something and flip it, you probably don’t add much value. We try to implement a business plan on the asset to open a bigger buyer pool when we are ready to dispose of it. Trading works, but the value-add is critical. Dalgleish – I’ve seen some data that suggests the average holding period has increased quite a bit in Asia. That is interesting because it puts pressure on the market. All of this money is at play and there aren’t enough assets to go round. As people hold the assets for longer, it shrinks the pool further. Callister – As an administrator, we are seeing Asian assets held for longer than previously. The market is maturing. Some international fund managers are a little cautious on China because there is so much liquidity and so few assets and there is always the question, “Do we really know the ins and outs of the Chinese market?” The Chinese government seems to be guiding investors with opportunities such as the belt and road infrastructure initiative. I’ve also seen data suggesting Chinese outbound investment will be targeting less US and Europe and move more towards opportunities in Asia-Pacific in the next two years, which is interesting. Funds Global – What types of vehicles are investors using for their real estate investments and which domiciles? Dalgleish – According to our research, the biggest increases in allocations are expected to come from non-listed real estate funds and from joint ventures and club deals. After that comes directly held real estate, separate accounts, listed/non-listed real estate debts, fund of funds and others. There’s a couple of points here. After the global financial crisis, a lot of investors wanted more control over their destiny, so there was an increased desire to go for joint ventures and club deals rather than put money in a blind pool fund, wave goodbye to it and potentially never see it again. That said, finding joint ventures and club deals is easier said than done. Our research suggests a desire which might not be fulfilled in reality.
The other important point is that by virtue of the size of the region, the opportunity, and all the liquidity that’s floating around, you have to be flexible about how you put your capital to work. There are many means of allocation to real estate, but it will depend on your risk appetite and strategic considerations as to which one you take. There is also a bit more interest in debt products. At a recent conference in Korea, we asked the audience, “Who’s interested in debt in the US?” and 80% of them said, “We are.” Callister – In terms of which domiciles are popular, we really are still in a Cayman Islands-dominated arena when it comes to fund vehicles. Some managers are trying Singapore and Jersey structures, but I’d say 95% of the fund vehicles are still Cayman as the cost, turnaround time and familiarity are attractive to Asian general and limited partners. In Asia, people like to have something that’s tried and tested. They don’t necessarily want to strike out and do something that could potentially be a little bit cheaper but against the norm. Also, the professional support to the industry such as the bankers, accountants and the lawyers all understand and have a familiarity with the Cayman Islands. It’s very much a go-to jurisdiction. Singapore has been doing some interesting things to try to attract more real estate business, so we should watch this space. On the actual real estate asset holding entities or ‘propco’ entities, the jurisdiction choice of these vehicles will depend upon the asset’s location. For example, Japanese properties are commonly held as a TMK [tokutei mokuteki kaisha, a special purpose company]. It is important to understand the complexities of propco and all the different moving parts in its administration. We have just hired a head of propco for the region as this is a large area of business for us and we want to keep our fund managers compliant with accurate reporting. We have seen an increase in separate accounts in the last year and, in the last six months, a lot of enquiries around debt funds. Maybe it’s because we’re one of the few administrators that can deal with a debt fund. Pretty much every other enquiry we have coming through the door right now is around debt and real estate debt. Funds Global – What kinds of skills are required to administer that kind of fund? Callister – Our Asia-Pacific team have benefited from the expertise of our European team, who have a well-respected debt fund administration team. To handle this very different alternative asset class, we have a specialised module in our fund administration system to handle debt, and we pay particular attention to study the loan documents so we can assist the manager to monitor covenants. Funds Global – Is it plausible that Singapore will eventually come to rival the Cayman Islands as a domicile for real estate funds? Callister – Singapore is innovating and in March 2017 released a consultation paper for Singapore Variable Capital Companies (S-VACC) plus a draft S-VACC Act. I personally hope Hong Kong will also step up to rival Cayman. As well-respected asset management centres, Hong Kong and Singapore have the ability to do this – with government support – but, as Cayman is pretty entrenched, it will be pretty difficult. There needs to be increased awareness of the importance of the funds industry so that we can have more legislation that’s conducive to asset management. There is a chance for a new domicile to emerge strongly as a rival to Cayman as there are people in the Monetary Authority of Singapore sitting down and looking at real estate funds specifically, Tokyo is looking at creating a conducive regime for the asset management industry and Australia has a strong focus on the industry. In terms of European domiciles, Luxembourg and Dublin are used as feeders to Asian real estate funds. German limited partners have a tendency to come through a Luxembourg feeder. Do we see any Luxembourg funds? Yes, we do have one or two Luxembourg Asian real estate funds. Malta is another alternative that can be used as a feeder for European investors. Funds Global – There has been a reported rise in institutional investors buying real estate as part of an increase in allocations to illiquid alternatives. How has this influx of institutional money influenced the market, if at all? Chow – A decade ago, if you wanted to sell your assets within Asia you would have had a lot of buyers who were foreign funds or foreign investors. They’re still there but there’s a strong wave of capital coming domestically across the region, in China, Japan, Korea, Australia. Because of that addition of domestic investors, when we are disposing of assets we have a new pool of potential buyers. That gives the manager a lot of flexibility. For example, when we structure a deal in our China investments, we have an offshore structure but we also have an onshore structure and we make a decision at the point of exit on which buyer gives us the best economics. Dalgleish – There has been an influx in capital, but according to our research, current allocations are lower than target for many investors, so there is still more to come. How has the influx influenced the market? As we discussed, there’s an awful lot of liquidity and there’s not enough decent assets to buy, so it’s causing some pressures. I’ve seen some research suggesting that transaction yields for Asian investors were 50-75 basis points lower than for investors from the US or Europe. Either Asian investors really want to get their money to work and are being aggressive to do so or they’re focused on lower-yielding assets, or maybe it’s a combination of the two. Then you have the likes of the Government Pension Investment Fund in Japan and others who are already allocating but massively gearing up. They’re just in the process of appointing a consultant to advise them on increasing their allocation to alternatives. That’s going to toss fuel on the fire. Callister – Maybe as a result of this, there will be potentially longer holding of assets and more pressure to get the returns. There’s been a lot more open-ended real estate funds happening. Certainly, we’ve seen a lot less closed and a lot more open, and that could be a reaction to this discussion as well. Funds Global – Real estate investment has in the past been the domain of specialist managers, however mainstream asset managers are now developing investment capacity in this area. How will these new entrants change the market? Chow – Before the financial crisis there were a lot of new entrants coming into real estate investment management. The crisis gave a shock to the market, and many of those who at that point were relatively new decided to exit the market. For us, the key is that real estate is such a niche asset type. Those who are 100% focused on this asset class may have an edge. For instance, our company is able to expand our strategy as we develop more skill sets. We do debt in European investing. For the US, we also invest in niche asset types such as medical office. In Asia, we are doing a lot of regional logistics development. Callister – We’re seeing a lot of insurance companies getting into this area, which is an interesting move for them. It makes a lot of sense, but they have some potential conflicts which might limit what they can do. Dalgleish – The key is access to expert management. Investors are looking for managers who know the business and have a track record. For a smaller or a newer player, or even a bunch of experienced guys who might leave a strong existing player and set up their own shop, when the investor comes along and says, “Well show me your strategy, what’s your plan?”, they personally might have a lengthy track record but the firm has zero. It’s quite hard for them to get a fund away. If they can do that, by the time fund four comes along they’re laughing, but post-financial crisis, it’s pretty tough, especially when you’ve got a regulatory burden and all that compliance stuff, which is expensive for them. Funds Global – Looking to the future, what is your level of optimism for the real estate investment sector, globally and in Asia? Callister – We’re all optimistic, right? Especially in Asia. However, managers must work harder, given the shortage of assets and the high level of liquidity. As Chris said, the value-add that you put into the projects, the ESG [environmental, social and governance] impacts and so on, will become more important. You just have to be creative with what you do with your asset. Chow – Our analysis suggests that, in terms of risk and return, Asian real estate stands above the other asset types. On that basis, if you are coming with the right risk management before a deal, and with the correct business plan, the outlook for the market is still healthy. But as I said before, we are in a late part of the cycle, so the risk management part has become more important than before. Dalgleish – To my shock it’s nearly 35 years for me in Asia, which doesn’t make me an expert, but does mean I’m gradually overcoming my pessimistic Scottish roots. I’m optimistic for a couple of reasons. Asia-Pacific is huge and it’s not often that well understood. There are many investors that come to the region who need it to be explained from the word go, which is in itself interesting. From our standpoint as an industry association, we have a reasonable suite of indices and we track a hundred billion US dollars of assets. It’s still not perfect but at least the industry can benchmark what’s going on, and six years ago it couldn’t. The region is not without its problems, and again experience will show that nasty things happen – SARS, Fukushima, the China outgoing capital tap closing unexpectedly. You have to be experienced and nimble and all the rest of it, but if you understand the market there is plenty of opportunity. 2017 funds global asia