Korean investors shift to debt

With property markets peaking, Korean investors are increasingly moving from equity to debt, writes Thomas Duffell of Real Estate Capital’s sister title, PERE.

As many of the world’s property markets are at or near historic peaks, market frothiness is a key concern for institutional investors.

Indeed, being at the top of a market cycle was identified as the top fear among investors in a survey published last month by placement agent Probitas Partners. Such capital sources are less willing to make an equity bet and take a lump sum from a property sale, which may not hit return expectations if the current frothy pricing in many real estate markets corrects in the coming years.

One tactic for investing in such a market is to follow the example of many Korean investors: instead of taking equity stakes in commercial real estate deals, they are using portions of their alternatives allocation to look further up the capital stack and become more active real estate lenders globally.

Just last month, South Korea’s Public Official Benefit Association and the Government Employees Pension Service signalled they would allocate a total of $120 million and $160 million, respectively, to private real estate debt strategies in Europe and the US.

Earlier this year, a survey conducted at ANREV’s Korea conference revealed that 88 percent of investors and fund managers plan to invest in real estate debt over the next 12-18 months – with a significant number of those respondents intending to target mezzanine debt in particular.

Mezzanine financing has traditionally been the purview of smaller, more nimble lenders.Typically conservative Korean investors have undertaken several high profile investments into mezzanine debt in the past year, including a group of five Korean insurance companies committing $196.62 million worth of mezzanine debt into Vertex’s Boston headquarters, and Shinhan BNP Paribas Asset Management and Hyundai Asset Management’s joint investment of $350 million in mezzanine loans for 10 Hudson Yards in Manhattan.

Smaller Korean players are also seeking out private debt investment managers to get into the space. The US office mezzanine debt fund from Samsung SRA, which was launched in October 2016, closed last month oversubscribed on 310 billion won (€250 million). Korea’s KTB Asset Management has also been pooling small consortiums to make mezzanine debt investments in New York.

The US and certain European real estate debt markets are attractive to Korean investors due to the high transparency and liquidity of the property markets, as well as a constant pipeline of investment opportunities and comparatively low currency hedging costs.

The mezzanine market opportunity is also increasing as many traditional lenders are pulling back from construction lending, which often employs mezzanine financing. However, mezzanine lending is also becoming more common in stabilised deals on existing buildings not undergoing a significant renovation or redevelopment.

Mezzanine debt investment also satisfies a demand among Korean investors for a steady stream of income, while offering obvious potential downside protection and preferable tax treatment. The desire for greater income has increased in the current low interest rate environment, with Korean bonds yielding under 2 percent.

Due to this increased appetite for income, Korean investors are also willing to undercut other investors to get the deal done, sources have said. Domestic debt investors may price the deal with a return of around 8 percent in mind, while the Koreans can go as low as 5 percent for unsecured mezzanine debt, investment manager sources have told PERE.

The trend is set to continue after Korea’s government and regulators made it easier for many investors to increase their overseas exposure to alternatives last year. While a market peak is clearly a concern for many, Korean institutions aren’t letting that fear get in the way of broadening their reach in the asset class.