Prolific South Korean capital is no longer focused only on major gateways such as London, Frankfurt, Paris and Berlin. Smaller European cities are now also on the radar as investors diversify more broadly across Europe, writes Robin Marriott.
Copenhagen may seem an unnatural starting point for analysis of where Korean investors are going in Europe. Yet a few weeks ago, Seoul-based AIP Asset Management surprised many by acquiring a business park in the Danish capital for €160 mln. According to AIP it is the first ever investment it has made in the Nordics, having so far invested in Belgium in 2015 and the UK in 2018.
Since Korean capital first washed up in Europe in 2009 - when NPS acquired the HSBC Tower in London’s Canary Wharf - many have followed suit. They are investing in droves and in ever wider locations than the favourites of London, Paris, Frankfurt and Berlin.
AIP’s CEO Dany Kim says the drop in Korean interest rates since 2009 has been the key motivator. The Korean interest rate has fallen from over 4% in 2009 to 1.5% (it only just went up to 1.75%), which has made it challenging for Korean institutions to make enough money from credit investments and domestic bonds. A triple A bond is delivering 2.5-3% but Korea’s insurance and pension funds require 3.5-4.5% just to reach their marginal break-even point. So, they have increased their alternatives exposure, but of course there is not enough real estate in Seoul to satisfy all the domestic demand for property. That is why the US and the European real estate markets are seeing so many Korean groups.
Kim says that in 2009 Korean real estate funds had put to work less than $5 bn outside of Korea. By the end of 2018, the figure had jumped to more than $35 bn and it is expected to reach $50 bn (€44 bn) within three years. In the past 12 months alone, at least 14 different Korean groups have fronted European deals in 2018 (see map over leaf). Flags have been planted as far apart as Helsinki, Brussels, Amsterdam, Madrid, Barcelona, Vienna and Prague.
Beyond Tier 2 cities
But not only have Korean investors begun deploying capital in non-Tier 1 gateway European cities, they are even venturing outside the centre of Tier 2 cities. For instance, the property AIP has acquired in Copenhagen is not even in the centre. The 50,000 m2 three-building office complex is in Søborg, located 10 km north of Copenhagen’s centre, a good 15-minute drive away by motorway.
Tonny Nielsen, CEO at Fokus Asset Management which is now AIP’s partner of choice for Danish real estate, says the property is more like an A minus location than A. However, he points to Copenhagen’s appeal. The city was ranked third in the world for ease of doing business by The World Bank in 2017 and second most desirable European city for property investment and development by PwC and the Urban Land Institute in 2018.
AIP pored over the opportunity when it arrived in the city to understand the reasons and nuances for the lease to pharmaceuticals company Novo Nordisk, which occupies the offices. The team also got to grips with how Copenhagen has not one CBD but a cluster of different ones.
Nielsen: ‘They spent a lot of time in our office and those of advisors to really understand the fundamentals. They are transparent, sophisticated investors, open-minded, unafraid to tell you what they think, and they have many questions. Normally when we have teams sitting around to discuss a deal and we ask whether there are any questions we might get one or two. But during a meeting for this deal, the Korean investors had 20 or 30 questions. That’s positive because they are considering everything to understand the risk of an asset.’
Of course, cities such as Copenhagen will never catch up with London, for example, in attracting Korean capital. Of the more than £4.71 bn (€5.3 bn) spent by Korean investors in Europe last year, the UK accounted for more than half. Neil Brookes, head of capital markets for Asia Pacific at Knight Frank, believes it was regulatory changes in 2015 that helped outbound investment from Korea and the bulk of that capital went to the US. But since the strengthening of the US dollar, that capital has focussed on Europe where currency hedging costs are cheaper. ‘This weight of capital compressed yields on prime assets in France and Germany over the last 18 months and made London assets look comparatively good value,’ he says.
Brookes adds that higher yields in London due to market concerns over Brexit coupled with a weaker pound made core assets compelling buying for the Korean pension funds. ‘These pension funds typically adopt a defensive investment strategy, focussed on long-term leases to high-quality tenants in markets where the currency hedging and debt costs can be locked in for the investment period to meet their required returns.’
Moving beyond London
Emma Steele of Savills, which like Knight Frank has advised on a number of London trades with Korean groups, agrees London remains attractive. As a member of the cross-border capital markets team, she has also noticed a potential need in the immediate future for Korean investors to diversify more broadly across wider Europe, due to some rhetoric around potential indigestion in relation to London assets. ‘The concern was what will happen should all the active Korean companies continue to invest in the same location such as London at the same moment?’ Typically, a Korean asset manager fronts a securities firm from Seoul which will then warehouse the asset and sell a portion down to local pension funds, insurance companies and the like. With so much activity in London, the question became how would firms that securitise assets be able to sell into what is already quite a thin pool of capital? Deals got completed, so the problem did not seem to materialise.
Nevertheless, Steele notices not so much the effect of yield compression in London as a driver for Korean firms to look at other locations but currency exchange rates. ‘They are starting to look at Tier 2 cities and are being successful,’ she says. Steele explains: ‘In terms of their focus for 2019, Paris sits at the top of the list, closely followed by the largest cities in Germany. However, we are seeing more and more groups willing to look at “new” locations such as Austria, Poland, Czech Republic etc. In Germany, they would love to find an asset in Frankfurt, Berlin and Munich, but depending on how hot those markets continue to be, they will have to start looking at other locations such as Hamburg and Stuttgart.’
Cash on cash returns are the deciding factor
Assuming an asset is stable and income-generating, exactly where a Korean investor will go depends on where it can get the requisite cash-on-cash returns. AIP’s Kim explains that in his case, the group is looking for stable income-generating assets capable of meeting a target return of 7-9%.
He explains the financial factors important to such groups via a live example of deals he is looking at. For some available prime assets in La Défense in Paris, the yield is 4.25-4.5% but a German lender or French life insurance group can provide a loan lower than 1.5% for the senior loan portion up to 60% LTV. At the same time, there is a currency kicker. It can get a 50-70 basis points premium on the foreign exchange. Putting the property and currency premium together, it can easily achieve cash-on-cash returns on the overall investment in the high 7%s or low 8%s, thus meeting its 7-9% target. Listening to such financial metrics, it becomes obvious that for Korean investors the dominant factor is not always going to be whether an asset is located in a gateway city. It is going to be led by where it can achieve such cash-on-cash returns on a property that exhibits the right fundamentals. That could mean industrial property, of course, which by definition will not be in a city unless it is a last-mile distribution facility.
Asked if AIP will only ever stick to cities, Kim says: ‘For office assets it is cities we look at, but we are expecting to expand into logistics centres which of course do not have to be in a city.’
Shiraz Jiwa is CEO of The Valesco Group, one of three asset management companies in Europe so far selected by AIP (the other two being Fokus for Danish deals, and Patrizia for Belgium). He can foresee a time when a Korean investor’s Europe portfolio is split 50/50 between offices and industrial. At press time, Korean investors were said to have entered into exclusive talks on a sale-and-leaseback of Amazon centres in Bristol, Barcelona and Paris known as Project Neptune at a yield of 4%. And so, the march to industrial begins.
Savills’ Steele believes it is also conceivable that Korean investors will expand into alternative asset classes including various forms of residential property, which implies different parts of a bustling city than an office-led CBD, and Jiwa provides more clues: ‘There are many micro locations scattered across mainland Europe with strong infrastructure that are sitting within the realm of what I call pricing dislocations. We are not talking about the main gateway cities of Germany, for example, where there will continue to be good activity, but there are locations further afield.’
For an overview of where Korean investors are putting their capital in Europe, read our special report in the February issue of PropertyEU Magazine