South Korean institutional investors, one of aggressive cross-border buyers of US and European real estate in recent years, are quickly shifting toward non-UK European commercial real estate away from US properties, on expectations of better yields and further asset price gains driven by prolonged low interest rates in the continent.
Deepening competition and rising valuations in Europe’s real estate and the sliding won could lower expected returns from European properties, which are currently around 7~8% a year, amid political uncertainty ahead of key elections in 2017. But Korean asset owners are likely to continue their push into European real estate, excluding the UK, on the quest for safe-haven investment and steady income stream.
In comparison, their buying spree in US properties is fizzling out as fast US mortgage rate rises in the wake of the election of Donald Trump and the Fed’s rate hike late last year has lifted borrowing costs. Sharp price increases in US real estate also weigh on investors.
Vestas Asset Management Co. Ltd., a South Korea investment firm, is teaming up with Hyundai Marine and Fire Insurance Co. Ltd. and other domestic institutional investors to buy an office tower of Allianz Group under construction in Berlin, Germany for $317 million. The investment company was also named as the preferred buyer of an office building of L’Oréal near Paris, So Ouest Plaza and is tapping domestic insurers including Hyundai Marine to fund the $500 million acquisition.
Separately, a consortium of Korea Investment & Securities Co. Ltd. and Hana Asset Management Co. Ltd. was selected as the preferred negotiator for a building in Brussels worth $224 million which the European Parliament will continue to lease for the next 11 years.
It is also known that South Korean savings funds and insurers were recently presented with three to four other property investments in Europe which lures investors with tight supply and low vacancy rates in office buildings.
LEVERAGE EFFECT, SWAP PREMIUM
The interest rate differential between Europe and South Korea will boost investment returns thanks to the leverage effect, or the difference between borrowing costs and returns on assets, for Korean buyers who finance a chunk of offshore property deals through loans.
Cross-currency swap premiums paid to Korean investors will also rise because of the interest rate disparity. The European Central Bank has kept rates on hold at zero and prolonged its quantitative easing program, while South Korea’s policy rate has been steady at 1.25% since a quarter-point raise in June 2016.
“For example, assuming that we borrow 100 million euros in Europe to buy 200-million-euro property for a period of five years, we can expect to earn 6~7% annual returns. Reflecting swap premiums, the expected returns will rise to 7~8% a year,” said a Korea Investment & Securities source.
The move of European headquarters of global companies after the Brexit vote to Berlin, Frankfurt, Paris, Brussels or Amsterdam is another appealing factor for non-UK real estate, fanning expectations of asset price increases in those cities.
Preqin, a research firm, said in a report that many investors saw Europe as presenting the best real estate investment opportunities. It expected that competition for European real estate would deepen further despite rising valuations, making it harder to identify attractive deals.
With respect to US real estate, however, a cautious mood began to set in. South Korea’s Meritz Securities Co. Ltd. has recently abandoned plans to buy about 40 outlets of Walmart Stores Inc. in the US for $500 million due to lowered expected returns.
KTB Asset Management had walked away from the deal to buy the NASA head office building in Washington D.C late last year because of soaring funding costs. Instead, a consortium of Korea Investment & Securities and Hana Asset Management snapped up the property deal after adjusting the financing conditions of the acquisition. The yield on five-year US Treasuries, the benchmark for US mortgage rates, has recently climbed to 1.9% from around 1% last summer.
“When interest rates rise, building prices tend to be lower. But the interest rate changes are not reflected in the current prices,” said a domestic brokerage’s alternative investment team official. “Thus, the atmosphere among local institutions is let’s wait and see for the time being.”
Total transaction volumes in European and US real estate declined last year after a record-breaking year in 2015. But net cross-border acquisitions of properties by South Korean investors, excluding Asia, were estimated at a record $7.1 billion in 2016, including transactions pending as of early December, according to Real Capital Analytics, a research firm, in its latest reports.
Meanwhile, a top Korean insurance firm’s chief investment officer voiced concerns about the rush into Europe’s real estate.
“Political uncertainty remains huge in Europe, not only because of the Brexit, but also ahead of a series of elections scheduled for this year, including the presidential election in France (April) and one in Germany (October),” the CIO told the Korea Economic Daily. “Swap premiums, which take the bulk of investment returns, are very volatile, so they need to be viewed as a risk factor, rather than an advantage.”
By Daehun Kim and Chang Jae Yoo
<Edited by Yeonhee Kim>