Asia real assets: Need returns, will travel

Last year Germany's financial sector pensions provider decided to leave the eurozone. BVV, the country's second-largest pension fund with assets of EUR23 billion ($31.7 billion), identified global real estate opportunities as a strategy that could deliver the desired returns. It made its move in April, acquiring a Melbourne office tower from The Blackstone Group for A$70 million ($66 million).

Traditionally conservative German pension funds are among those being forced to diversify to meet their return targets. According AMP Capital's latest institutional investor research report, more capital is expected to move out of the public markets and into alternatives, with real estate, private equity and infrastructure the most popular assets. In addition, the current low yield environment is driving LPs, big and small, to shift allocation away from Europe and the US to emerging markets and Asia.

At the other end of the spectrum, the MGPA Asien Spezialfonds real estate vehicle offers smaller German institutional investors exposure to markets such as Japan, Australia, Hong Kong, Singapore and Malaysia for a $20-25 million minimum subscription.

In both cases, the strategies are similar - buying assets that either have an existing yield or can create a decent yield very quickly with minimal risk. This core strategy is expected to generate a 5-8% yield and a 10-12% IRR, whereas a 17-20% IRR and 1.8x equity multiple is typical of an opportunistic play.

"Post the 2008 financial crisis institutional investors have been very focussed on real estate core markets across Asia Pacific offering attractive income returns," says Tim Nation, AMP Capital's head of real estate capital. "The emphasis has been on sustainable income returns rather than capital returns."

Investors are also expected to move to infrastructure for better risk-adjusted returns. "Over time, smaller investors who haven't got exposure will start to put capital into Asian infrastructure," says Steve Gross, senior managing director, Macquarie Infrastructure and Real Assets (MIRA). "It will become more of a mainstream investment than in the past, where traditionally it's been the wheelhouse of the larger investors who already have a significant infrastructure portfolio."

A total of 17 Asia-focused real-estate funds were launched in the first half of 2013, seeking $5.9 billion between them, Preqin data show. Infrastructure vehicles have received $3.1 billion so far this year across eight funds.

Historically, real estate has attracted more of the funds allotted to real assets than infrastructure - largely because the latter is regarded as an emerging asset class and therefore falls under the opportunistic part of a foreign asset manager's portfolio. "If you look at investors who have gone into it, it's tended to be sovereign wealth funds, development finance institutions and pension funds, who would be the single biggest investor," Gross continues.

Emerging opportunities

Current yield or income, stable long-term returns, lack of correlation with traditional asset classes, inflation linkage and diversification are all reasons for investing in real assets and the choice is driven by regulation and the life cycle of the investor fund.

Those with asset liability matching considerations, such as insurance companies and pension funds, need cash flow for distributions. Others are more willing to take significant positions in more opportunistic plays, employing private equity-like strategies to grow their capital base.

Unlike developed markets, it is difficult to take a 10-20 year exposure in emerging Asian markets on any one particular investment because of political or regulatory risk, according to Vijay Pattabhiraman, managing director and chief investment officer for J.P. Morgan Asset Management Global Real Assets.

"A strategy could have a 20-year outlook but investments would normally not be held for 15-20 years in these markets," he adds.

However, there is a need for more equity for real assets. Most infrastructure projects in the region are funded by local currency and domestic banks and in some countries, including India, these banks have reached their exposure limits to the sector. Secondly, inflation is an issue in many parts of Asia and there has been a tightening in terms of interest rates and availability of money. In China and India real estate developers are finding it hard to raise money from traditional banks.

GPs have used the opportunity to invest in companies via hybrid structures such as mezzanine with warrants, preferred equity, and convertible debt.

"It's given us an ability to generate equity-type returns with debt downside protection because you're more senior in the capital structure," said Grant Kelley, CEO at Apollo Global Real Estate Asia Pacific, speaking at the AVCJ Real Assets forum in Singapore last month. "It's less a question of asset and more about entry point in the capital structure."

Apollo targets opportunistic gains of 15-25% in the region, predominantly targeting mass market projects in mainland China. According to Kelley, the strategy has evolved to focus on retail and residential segments that five years ago would have been considered second-tier but are increasingly good investment destinations.

"[However], in real estate the smartest strategy is to chase rental yield before you chase capital value," he added. That means buying based on income at about 200-400 basis points above the risk-free rate.

Markets such as Australia, Japan, Singapore and Hong Kong are more conducive to core strategies, and the last few years have seen a rise in intra-regional institutional investment from China, South Korea and Malaysia.

The Asia Pacific commercial property markets are expected to reach $120 billion in deal volume this year, according to Jones Lang LaSalle. That would put 2013 on par with 2007 as the strongest year ever by transaction volumes. The growth was predominantly led by Japan, China and Australia which, together account for 69% of transactions.

Asian-Pacific investors accounted for most of the deals across the region, investing $56.2 billion during the first half of the year, while European buyers acquired $1.4 billion worth of properties.

Investment in Japan was up 50% year on year to $20.8 billion in the first six months. The rebound has seen investors take on risk by buying property in smaller towns. For example, in Fukuoka, Japan's seventh-largest city, buyers of old office buildings have included Morgan Stanley and Goldman Sachs.

Australia's core office, retail and industrial sectors have also held investor interest because there is insufficient supply to meet demand. Those who have set up shop in the country this year include Ontario Municipal Employees Retirement System's Borealis infrastructure unit, Morgan Stanley Infrastructure Partners and Canada's OPSEU Pension Trust.

The country has seen global capital inflows due to its strong relative macroeconomic fundamentals and some of the highest yielding core real estate in the world. "Unlike just about every other core market globally, Australian yields have not had the same level of yield compression and are still throwing off attractive income returns," says AMP's Nation.

He expects that as core real estate starts becoming difficult to access or less attractive from a pricing point of view, this is likely to push investors up the risk curve, potentially towards private equity-style real estate investing.

The logistics angle

On the infrastructure side, "now could be a good time in the economic cycle to consider investments in GDP-related infrastructure as economies recover and global growth increases," adds John Julian, senior manager at AMP Capital's infrastructure preferred strategies unit. These include assets such as airports, seaports, toll roads, rail and logistics.

Logistics in China has emerged as a particular target. "There is unsatisfied demand for good managers in that space," says MIRA's Gross. "We're seeing a lot of LPs interested in that and in Chinese retail shopping malls."

China's fragmented logistics industry has long been a source of frustration for suppliers and distributors looking to reach deeper into the country's hinterlands. This has created investment opportunities ranging from warehousing to refrigerated food transportation.

The Carlyle Group is collaborating with real-estate investment manager Townsend Group and warehouse developer and operator Shanghai Yupei Group, to invest a total of $400 million in 17 warehouses in China that will be leased to firms including retailers and e-commerce companies.

Meeting the needs of the burgeoning e-commerce industry has become a sizeable challenge on its own as the growth in orders far outpaces expansion of the infrastructure required to execute them.

According to KPMG, there are more than 10,000 players in China's express delivery industry, and the eight largest are dominant. A consortium including CITIC Capital Holdings and state-owned China Merchants Group bought an up to 25% stake in one of the eight - S.F. Express.

Macquarie Everbright Greater China Infrastructure Fund, meanwhile, is one of numerous investors to pursue a more specialist approach, putting $44.3 million in Hengyang Petrochemical Logistics.

There are also opportunities to combine infrastructure with real estate. With airports, for example, investors can enjoy steady traffic-based returns while simultaneously leveraging the expansion plans of S.F. Express or other logistics providers by leasing them space.

"Every airport has roughly 30-60% government regulated revenues that come from landing and what we call the ‘airside' charges," Andrew Yee, global head of infrastructure at Standard Chartered Bank's principal finance division, said at the AVCJ Real Assets event.

"But then, the upside comes from the real estate. This could be duty-free retail, adjoining properties for logistics centers and offices or the car park."
The Philippines plans to constructs airports through public-private partnerships and Japan wants to privatise a series of national airports.

Other blended opportunities could arise from building new alignment, according to Pattabhiraman. "Especially in new build projects there are situations where you can build a road in a place where there were none before, set up power, water systems and other infrastructure and then that land looks very different in terms of valuation," he says.

Once the infrastructure is developed, the land starts to become more valuable, there is more development on the land such as apartments and offices which then increase utilization of the infrastructure, and the process builds a virtuous cycle.

The drive for diversification means investors are looking to invest across Asia to mitigate risk. Local currency risk, for example, is difficult to hedge. While the Indian rupee fell to record lows this year, the renminbi has gone up 10.4% against the US dollar. A regional portfolio reduces the hit from a single economy.

While large LPs with sizeable teams can do single country funds because they have enough money to put a few hundred million into each economy and get a quasi-pan Asian kind of exposure, the smaller investors are likely to invest in regional funds. GPs like Macquarie, known for its single country funds, are now looking to offer that diversification as well.

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• Topics
• Real estate
• Infrastructure
• Real estate
• Infrastructure
• LPs
• Australasia
• North Asia
• South Asia
• Greater China
• Infrastructure
• Real estate
• Macquarie Group
• AMP Capital Investors
• Australia
• China
• Japan
• India
• Standard Chartered Private Equity
• J.P.Morgan Asset Management