The Rise And Pause Of South Korea’s Deal-Hungry Investors

From a standing start in 2010, South Korean investors became a global real estate investment powerhouse, dominating the list of big transactions in some of the world’s gateway cities.

But now, a series of very particular circumstances to do with travel bans, currency hedging and a scandal at a local hedge fund mean the cohort of acquisitive investors has had to put its deal-making on hold, or start looking at new markets — particularly the U.S.

“There is still a lot of capital wanting to invest overseas that isn’t satisfied with returns in the domestic market,” said Jonghan Kim, Cushman & Wakefield partner and head of the Korea Desk for EMEA Capital Markets. “But there are some issues today.”

The story of Korean outbound investment is a remarkable one. In 2010, Korean investors deployed just €622M ($733M) in European real estate, according to Real Capital Analytics. In the preceding years there had been a few one-off deals, such as pension fund NPS’ acquisition of HSBC’s London HQ from a distressed investor for £775M in 2008, but transactions were rare, in Europe or the U.S.

By 2019, that European investment figure had reached €11B, RCA said, making Korean investors the second-largest non-European investors in the region after those from the U.S. The trend reached a high point when a consortium of investors headed by Valesco bought the 2.2M SF Finance Tower in Brussels for €1.2B in January this year.

There were a number of unique reasons for this growth, Kim said. Investors saw the success that pioneers like NPS had (it sold the HSBC tower for £1.1B a few years later) and wanted a piece of the action. And they had a weight of capital behind them. The annual investment volume in the Seoul property market is about $10B, Kim said, the same as Amsterdam’s. But Korea has a population of 52 million people, and a culture of saving, giving local pension funds huge pools of capital to invest.

Doing so in the domestic market was increasingly competitive, driving down returns: Yields in Seoul for prime assets are around 4%, and industrial yields about 5%, meaning cash-on-cash returns are about 6% to 8% for good quality home assets.

The U.S. and Europe offered higher returns, with an added bonus: The cost of hedging the local currency, the Korean won, against other currencies when investors used debt added abut 200 basis points to returns. The currency play disappeared in the U.S. due to movements of the won against the dollar, meaning Europe and the UK became the playground of Korean investors.

To encourage financial institutions and pension funds to diversify their assets overseas, around 2010 the Korean government encouraged a group of eight or so local investment banks to increase their balance sheets and buy overseas assets. At the same time, it deregulated the asset management world, meaning that anyone with more than $2M and experience in financial markets could set up their own asset manager.

“Suddenly, every high net worth investor had his own asset management company,” Kim said, and there are now more than 300 in Korea.

When investing in real estate, asset managers and investment banks typically work together, buying an asset using their combined balance sheet and then syndicating the equity to pension funds and high net worth investors.

Even before the pandemic, there were signs the model did not always function smoothly. In 2019 Bloomberg reported on a number of deals in London where the buyers of an asset had been unable to syndicate the equity to new investors, leaving them with an overhang. Brexit uncertainty was cited, but it was not the only market where this happened. 

“There are a number of deals in Paris that haven’t sold down,” said Penny Hacking, a principal in Avison Young's capital markets group. “They will get sold down, but if you went and bought 100 assets, there is only so much French real estate institutions want at one time.”

The potential problem these equity overhangs might cause for individual firms has drawn attention from Korea’s Financial Supervisory Service, which is asking asset management firms and investment banks to undertake an internal audit on their exposure to overseas property assets and their risk management processes. 

The FSS is paying particularly close attention to investment firms after an investigation was opened into whether hedge fund Lime Asset Management might have lost as much as $1B of clients’ money. This was in sectors other than real estate, but the question of whether financial institutions have been properly informing their clients about the risk of what they are buying is on the regulator's radar, Kim said. He doesn’t expect increased regulation to have too big an impact on real estate investment.

“This is not a situation like China, where the regulator has the power to tell companies to stop investing,” he said. 

What is stopping investors right now, particularly when looking at the UK, is quarantine laws. Today, citizens returning from abroad to Korea have to quarantine for two weeks. Travellers to London today have to quarantine for 14 days as well and other European countries have similar regulations in place. That means investors have to either quarantine for a month in order to come and view a property, or buy a building without seeing it. 

“No investor is going to commit $100M or $500M to a deal without physically inspecting a building,” Kim said. “Right now that makes it difficult to do deals.”

Hacking also pointed to the lack of availability of debt in Europe as a result of the pandemic, which nullifies the boost to returns provided by hedging costs, and currency movements have reduced the pick up on returns as well.

“Without the availability of debt, it is not as attractive; Korean investors are very sensitive to currency movements,” she said.

Both of these factors are leading to an increased interest in the U.S. for Korean investors, Hacking and Kim said. The U.S. does not have such stringent quarantine rules, making it easier for investors to go and view deals. 

The currency has moved in the favour of the U.S. as well. Whereas in 2015 the cost of hedging the won against the dollar might have reduced returns in the U.S. by around 200 basis points, today that has dropped to a reduction of 40 basis points, making the country more attractive. 

Hacking pointed out that Korean investors had been particularly active in European logistics deals in recent years, drawn by the long leases, and investors she had spoken to had run the rule over a number of Amazon-let logistics facilities up for sale in the U.S. right now. 

Korean investors still have unbridled appetite for overseas investment. But right now, the stars are somewhat aligned against them.