Transactions at eye-popping earnings multiples and buyers taking risky bets across Asia contingent on heavy lifting, a few veteran investors in the market are bewildered and looking to sell into pockets of demand.
“We are in the late stage of the real estate cycle. The market is filled with a lot of artificial liquidity,” said Collin Lau, founder of Asian real estate firm BEI Capital. He noted that quantitative easing by central banks has been distorting prices. “I would be a net seller and second I would be delevered.”
The warnings by Lau and others come at a time of growing interest in real estate from global institutional investors.
A new survey by asset manager BlackRock found 42% of 224 of its institutional clients globally, representing $7.4 trillion in assets, plan to increase their allocation to deals in the private property sector in 2018 in the face of low interest rates.
“Frankly, we’ve been net sellers,” said Broderick Storie, a partner at alternative investment manager PAG, which has $6 billion of assets under management.
Storie recalled that 12 to 18 months after making one particular investment, PAG had received an offer at a price it had expected to achieve only after five to seven years of hard work.
Real estate was the top M&A sector based on the value of deals across China and Hong Kong in 2017 with $87.7 billion worth of transactions, according to data provider MergerMarket’s analysis.
Hong Kong saw the world’s highest transaction for a single office block when tycoon Li Ka-shing’s The Center changed hands for HK$40.2 billion last year.
In another example of a highly valued transaction, Link Reit agreed in November to sell a portfolio of local Hong Kong shopping malls to private equity firm Gaw Capital and the investment arm of Goldman Sachs for HS$23 billion ($2.9 billion). The sale price represented a 52% premium to the appraised value of the portfolio as of September 30.
To achieve a respectable return the investors would need to make a lot of improvements to the properties, which could prove tricky.
“Lots of hands-on-work to do with very local, local shopping centres,” said Lau noting it would not be easy dealing with owners of wet markets, car parks as well as elderly people who may not welcome change.
“It didn’t attract our appetite – that would be an understatement,” said PAG’s Storie, who said he was familiar with this portfolio of assets, during the HKVCA Asia Private Equity Forum 2018.
Calvin Chou, a managing director at Invesco Real Estate, which manages about $5.5 billion of capital, agreed the asset class is in the later stage of the investment cycle.
“We don’t want to invest on a leverage play nor assume that cap rates are going to compress any further,” said Cho, adding that Invesco is targeting more defensive assets such as “core” real estate, which is typically low risk, unlevered, grade A office space.
DEFENSIVE STRATEGIES
What should investors do in such a frothy market?
“The first thing we look at is capital structures; the second thing is what assets we should divest,” said PAG’s Storie. “[We’re] making sure the portfolio has defensive qualities.”
BEI Capital’s Lau, previously head of global real estate and head of European private equity at China Investment Corporation, said in the next 18 months “we will be very cautious and we are looking at a strategy that works across multiple cycles rather than just filling asset allocation targets".
He is focusing on tailoring living and working spaces in new ways for consumers. Lau says his firm no longer values this type of property in terms of the rent it could achieve per the size of unit, but on what potential services it could offer.
“Increasingly we will be dealing with operational real estate – alternative real estate,” Lau said.
Property agent JLL Asia Pacific noted in its 2018 outlook that demand was outstripping supply in Asia for alternative property, including sectors such as retirement homes, student housing, data centres and self-storage facilities, to diversify their portfolios, and for long-term growth.
Lau is also keeping an eye out for distressed sellers of property in China.
“I think there is real possibility of distress,” due to changes in Chinese government policy, which is actively pushing over-leveraged companies to sell assets. He also sees volatility in China’s stock market, characteristic of the end of a bull run in equities, hitting sentiment in China’s real estate markets.
Daisuke Hayashi of Phoenix Property, which has $8 billion of assets under management noted that in Japan, Tokyo grade A office space vacancy rates remain low and the risk of interest rates rising any time soon was minimal.
“The BOJ [Bank of Japan] will keep the rate as low as possible for at least two years,” said Hayashi who has been investing in property for about 15 years.
Phoenix Property thinks in Japan the particularly attractive sub-sectors are: B class offices in Tokyo; regional offices where there is limited supply; the hotel sector due to growing tourism.
Key advice would be to take advantage of pockets of demand.
“There is a changing landscape in terms of capital appetite for investment grade real estate that will create opportunities. There will be more buyers domestically in China over the next five to 10 years,” said PAG’s Storie.
Invesco is searching for areas where Chinese companies will look to buy assets in around three years time, when he thinks rules on their outbound investment will have relaxed. Those areas include Australian housing: “If Australia will take the money,” said Invesco’s Chou in a nod to the rising protectionism globally against cross-border M&A.
