By Joseph Pacini
The turn of phrase having a roof over your head is supposed to refer to the basic need of shelter. For Asian investors though, it could refer to a basic part of their portfolios.
From luxury dwellings to modern office high rises, real estate has been a popular choice for the region’s investors. Finding bargains in overseas property markets has become even more commonplace for investors in high-growth, savings-rich Asia following the global financial crisis.
The share of property in London purchased for investment by Asians went from 2 percent in 2000-2007 to 11 percent in 2008-2011, according to CBRE Group, a commercial real estate broker. In the three years after Lehman Brothers failed in 2008 and triggered widespread market volatility, South Korea’s National Pension Service has been the largest foreign public sector buyer of London property, with 1.04 billion pounds in purchases.
Some of Asia’s richest businesspeople have also been active in the market, with Malaysian tycoon Ananda Krishnan and Hong Kong’s billionaire Kwok family both announcing high-profile deals in London late last year.
Attractive prices for high quality properties were probably the biggest draw following the widespread market dislocations. From the peak of the credit boom to the trough of the global financial crisis, prime U.K. property valuations declined 30 percent.
However, in the rush to plough fresh equity into heavily discounted real estate in Europe, are Asian investors overlooking debt?
Some of the current opportunities available to invest in real estate junior debt, which has a lower priority than other kinds of debt in terms of a claim on an asset, have relatively attractive yields compared with many other fixed income securities. The chart below shows that yields of real estate mezzanine debt, loans positioned between equity and senior debt in the capital structure, are above their historical average, unlike U.S. Treasuries and high yield bonds.
With sovereign bond yields very low — or even negative — and equity returns mediocre, conventional asset classes are simply not sufficient to meet future objectives. Introducing alternative investments such as real estate debt to a portfolio can be a way to boost returns, particularly for Asian investors who would like to diversify and augment their sources of income.
So what makes European real estate debt yields so attractive right now? Commercial property developers in Europe have in the past relied almost entirely on banks for their financing. In the wake of the continent’s debt crisis though, banks aren’t lending nearly as much as they used to. They are very cautious about both the economic outlook as well as tightening financial sector regulations. Meanwhile, borrowers in the real estate industry have loans maturing and will be trying to roll them over.
As a result, the gap between maturing real estate debt and new financing expected to replace it is expected to nearly double to 150 billion euros by 2013, comprising the majority of the global debt funding shortfall, DTZ Research data showed. New capital reserve rules from the European Banking Authority are expected to contribute significantly to the forecast shortfall. That basically means that demand for non-bank sources of financing will continue to be large in Europe.
There are of course risks with real estate debt. It is an illiquid and opaque market. Property assets have low liquidity relative to assets that are traded more frequently such as fixed income, equities and commodities. Plus, when investing in real estate debt, understanding the counterparty risks and the differences in legal protections on an investment are crucial. The bar for market access tends to be high.
Nevertheless, the hunt for bargainsbrought Asian investors to Europe after the financial crisis and it may be the hunger for yield that keeps them interested in European real estate. Asian investors will have to focus more on debt rather than equity if they want to aim for potentially higher yields.
Joseph Pacini is the head of Black-Rock’s Alternative Investment Strategy Group, Asia Pacific.