There has been no let-up in borrower demand for US commercial real estate debt. Data from property consultancy Newmark Knight Frank show that a record $703 billion in aggregate financing, which includes acquisition and construction loans as well as refinancing, was closed during 2019. This was up 17 percent on 2018’s total of $601 billion.
South Korean investors are among the sources of that capital. Although there is a lack of available industry data specifically tracking the volume of Korean commitments to US property debt, Real Estate Capital’s conversations with industry experts suggest the appetite has only increased over the past few years. This is due to Korean investors struggling to meet their return targets through an equity-focused overseas investment approach.
According to the Emerging Trends in Real Estate: Asia Pacific 2020 report, compiled by consultancy PwC and industry body the Urban Land Institute, South Korea was the only major market in Asia where year-on-year outflows increased in H1 2019. However, the focus shifted from the US to Europe, due to the dynamics of currency hedging. On the debt side, it seems the US still features prominently in investors’ overseas strategies.
Speaking on a panel at sister title PERE’s annual real estate forum, held in Seoul in November, Philip Yoon, former head of overseas corporate finance at Korean Teachers’ Credit Union, said the retirement savings fund has been “cautious in investing in equities because they seem overpriced”. Debt now accounts for 70 percent of KTCU’s overall real estate portfolio, with the remainder consisting of equity investments. Yoon said he expects the current ratio to continue over the next three years.
The sentiment was echoed by state-run Korea Post’s head of global real assets, Jinho Lee, who said the investor had been shying away from equity investment. In July 2019, news service The Korea Economic Daily reported that Korea Post had awarded a mandate to US investor Blackstone to manage its $100 million blind pool real estate debt fund, and that it had appointed Malaysian asset manager Principal Asset Management to invest in $50 million of mezzanine notes. At least half of the capital is targeted at the US market, according to the report.
“The interest out of Korea has been in the mezzanine space, driven by the fact that we are getting towards the end of the cycle, and mezzanine and preferred equity positions allow them to achieve desired yields,” adds Maggie Coleman, managing director and head of international capital at property consultancy JLL.
Although they continue to allocate capital in the subordinate debt or mezzanine parts of the capital stack, Korean brokerage houses and institutional investors are increasingly opting to lend against construction projects for a higher coupon.
Last April, for example, Seoul-based Hana Financial Investment provided $180 million for a mezzanine loan for a hotel development in Manhattan, in partnership with other firms. It also tied up with South Korean investment banking and stock brokerage company Mirae Asset Daewoo to provide $100 million of financing for a resort development in Las Vegas. The two firms reportedly took the mezzanine tranche of the financing from JPMorgan, according to a report in The Korea Economic Daily.
James Jeon, chief executive of Hangang Asset Management – a Seoul-headquartered asset management firm with $1 billion in real estate assets under management – says rising hedging costs have made Korean investors less competitive than US groups when bidding for subordinate debt on assets with long-term lease profiles – their preferred investment type prior to 2017.
Now, the focus is more on finding construction financing opportunities for hotels and housing developments.
In June, for example, Hangang provided a $133 million refinancing package to US developer the Chetrit Group for its development at 500 Metropolitan Avenue in Brooklyn, according to press reports.
“The interest out of Korea has been in the mezzanine space”
High hedging costs arising from an unfavourable dollar-South Korean won exchange rate have been among the biggest dampeners on Korean cross-border investments into the US since 2018. This has not only had an impact on Korean investors’ market competitiveness; it has also affected their returns. A year ago, Korean investors were typically losing 1.8 percent from their returns to meet hedging costs; today those costs have come down to around 1 percent.
According to Jeon, most Korean institutional investors have a requirement to achieve a minimum return target of 4 percent in Korean won terms, after accounting for fees, hedging costs and other expenses. Other capital market sources say cash-on-cash return targets have increased to north of 6 percent.
Jeon also believes Korean investors will be eyeing more portfolio loan opportunities instead of single-asset loans in 2020, because the former can yield an extra 100 basis points.
For most offshore lenders, including Korean investors, another key challenge is competing with domestic lenders during auctions, given the fast turnaround time for debt transactions.
Industry observers say service providers brokering debt deals typically ask for quotes within a window of five days to two weeks. This can be tough for investors, like the Koreans, that have long internal approval processes to sign off on deals.
As such, the syndication trend – whereby US banks originate loans and sell down the higher loan-to-value paper to lenders while holding on to the senior portion – is gaining popularity.
“We do know a few Korean asset managers who are well-heeled now and can run alongside domestics in a process,” says Coleman. “But many debt deals are being accessed post-closing through syndication. It gives them more time, and comfort in the fact the deal has been underwritten by a certain institution.
“This strategy allows for international investors to continue to source debt opportunities on assets and in markets where the competition is high.”
Construction financing in the US is popular among Korean investors chasing a higher coupon rate; Jeon says there is roughly one deal every month. But a recent high-profile default case, involving a Korean lender, might prompt more caution in the construction lending space.
In 2018, a group of lenders led by a unit of the French bank Natixis provided a $2 billion loan package to private US real estate company Maefield Development for its hotel and retail project at 20 Times Square in New York. The financing package was billed as the largest real estate loan made in Manhattan that year. The funding included a $650 million leasehold mortgage, which Natixis reportedly syndicated to other lenders, including South Korea’s IGIS Asset Management, according to The Wall Street Journal. However, in December 2019, the lender group filed a suit to foreclose the property. According to multiple press reports, the suit made a series of claims, including that Maefield had failed to lease the retail space by the 9 September deadline and that 90 percent had been vacant.
Many see Korea as a significant source of development finance in the US. However, the outcome of this foreclosure may determine the US’s appeal to some Korean investors.