(Bloomberg) — A trip to the restaurant that sits atop the No.1 Poultry office building in London’s financial district is a chance to experience first-hand the tale of two cities that is shaking up the commercial property market.
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From the Silver Rooster’s vantage point, you can gaze upon a forest of new skyscrapers that developers hope will fetch big rents and even higher prices. For the South Korean owners of the former WeWork-occupied building downstairs, the future looks much bleaker.
Considering the view, Kaela Fenn Smith – ex-executive of real estate giant Land Securities, and now managing director of ESG consultancy CBRE Group – talks about the “huge flight to quality” transforming the office market where only “truly grade A space” will do. His comments come as flawless environmental credentials become a must for corporate tenants, many of whom are considering downsizing due to the WFH revolution.
This “super-bonus” hustle might be a boon for owners of these gleaming modern towers, but it’s bad news for older places like No. 1 Poultry. Across major cities, owners of these B-list office buildings face the prospect of hugely expensive renovations – or depressed sales.
South Korean investors, who panicked for five years on this second level of commercial buildings, seem particularly exposed. Seoul’s Hana Alternative Asset Management is set to relist the Poultry site, according to people familiar with the process. Her estimated worth is £125m ($164m), according to the same people – around a third less than what Hana paid. The firm declined to comment.
His unfortunate experience is far from unique. Prices for this type of property are plummeting all over the world, from midtown Manhattan to Hong Kong and Paris. While real estate is already reeling from the end of the lowest interest rates, a settling of scores is approaching for many owners and creditors.
But Hana’s fate also highlights something more specific: the common involvement of Korean money in buildings of this profile. The country’s asset managers have spent tens of billions of dollars on overseas offices and risky home loans in recent years – just before Covid and rate-hiking central bankers bulldozed the market.
In London alone, at least half a dozen large blocks owned by Korean companies are available for purchase, according to people familiar with the sales process. Most are struggling with depressed valuations.
South Korea joins a line of nations whose funds made bad real estate bets, from the Japanese in the early 1990s to the Irish just before the financial crisis. “The history of the City of London is made up of investors who come and then leave”, explains Michael Marx, ex-boss of owner Development Securities PLC, “Some have their fingers burnt and others to replace losses in their home market.”
The Korean Bad Bet
The genesis of the country’s overseas punt is quite recent. At the end of the last decade, lured by favorable exchange rates and higher returns than they could get at home, Seoul funds piled into what they hoped would be a treasure trove of hot buildings. In 2019, they were the largest external investors after the United States in European commercial real estate, completing 13 billion euros ($14.6 billion) in deals that year alone, according to data from MSCI Real Assets.
Between 2017 and 2022, investors snapped up more than 90 European properties at prices in excess of €200m each. Many were large blocks in the City of London and La Défense in Paris. Values in the two financial centers have fallen more than 20% in the past year, according to broker Savills Plc.
Koreans liked buildings with long-term leases from well-known tenants, like Amazon, so they focused less on prime locations or green ratings and worried more about the perceived quality of who was paying the rent. They also liked large sites, which cost more to fix when they become obsolete.
Rising construction costs to upgrade buildings to environmental standards will leave ghost and zombie office buildings behind and “severely value-destroying” for older commercial real estate, Fitch Ratings recently warned, without specifying Korean-owned assets.
“It will take a lot of investment,” as people wonder whether older offices could become stranded assets, Fenn Smith says, also generally. “When is your building going to start losing value because it falls off the net zero trajectory to 2050?”
unfortunate moment
Financially, the timing of the market meltdown couldn’t be much worse for Korean investors. About 30 trillion won ($24 billion) of their property funds mature through 2025, according to data provided by the national watchdog, the Financial Monitoring Service, to opposition party lawmaker Oh Gi-hyoung. That’s nearly 40% of the total, meaning a flood of commercial buildings could be about to hit the market at a time when demand has collapsed.
The country’s funds typically invest for five years, less than the international average, making it harder to pull back and ride out a downturn, says Yoon Jaewon, head of international investment advisory at Savills Korea Co.
Adding to the stress, many of the loans used to buy properties are coming due just as lenders are pulling out and borrowing costs are skyrocketing. Banks also require additional equity from homeowners before granting loans.
The FSS is closely monitoring the situation, talking to the companies and will discuss the issue at a meeting on Thursday, according to two officials who asked not to be identified because they are not authorized to speak publicly.
As the watchdog worries about potential losses for domestic investors, a third official said there would be no rush to withdraw money as Koreans usually have to wait for a fund to run out. Most are backed by institutional money, which is less likely to panic, the person adds.
Lawmaker Oh says that’s too complacent: “Financial authorities should thoroughly inspect the situation and prepare for it, not keep saying there isn’t much risk.”
There’s another reason for Korea’s vulnerability: Europeans were sometimes hesitant to sell to investors in the country because buyers typically included multiple institutions in a syndicate, people familiar with the matter say, prolonging negotiations and risking collapse. This prompted buyers to bid more, sometimes paying premiums of 10% or more.
There was almost a herd mentality among yield-hungry asset managers, says a banker who worked with borrowers on a few of these deals.
The misery of the mezzanine
In the United States and elsewhere, Korean investors have pressured risky mezzanine loans against real estate, offering junior loans that would be hit first when valuations fall. The appetite was so high that they sometimes accepted a lower return than the market, in some cases making transactions at 6% rather than the 8% or so that others demanded, the banker said.
Some of the loan bets are turning sour.
Payments to mezzanine lenders for a struggling project at 20 Times Square in New York City, which includes a hotel and an NFL Experience store, ceased in December, according to a report compiled by Computershare. The Korea Herald reported in 2020 that some of the debt providers are Korean.
In Hong Kong, a unit of Korea’s Mirae Asset is slashing the value of a fund that provided more than $240 million in mezzanine financing to the Goldin Financial Global Center by 80-100%, according to local media. A spokesperson for Mirae says it is focused on recovering money.
Appointed Receivers
Back in London, receivers have been appointed to the former headquarters of BP’s oil trading unit at 20 Canada Square in Canary Wharf. It was acquired by China’s Cheung Kei in 2017 and funded in part by a mezzanine facility from Seoul’s Hanwha Asset Management. Hanwha declined to comment.
A presentation prepared by broker Jones Lang LaSalle Inc., who was trying to sell the property for Cheung Kei, advised approaching an initial shortlist of potential buyers offering the building for £250million, well below the value of even senior debt.
In all honesty, Korean funds aren’t the only ones suffering overseas. Several Chinese companies have also struggled, including another Canary Wharf failure. Some Seoul investors have done well in international real estate bets: Korea’s National Pension Service has shown good judgment and has been rewarded for it, says the banker who has worked on Korean deals.
Investors were also slightly protected by the European approach to real estate valuations, which does not take market sentiment into account. With sales largely frozen, there have been few transactions to gauge the true drop in values. Inflation-related rent increases also helped.
Nevertheless, opportunists are circling, ready to offer expensive new debt to refinance buildings whose owners cannot inject capital. Oaktree and other alternative finance providers have been in talks with Korean asset managers about significant loan facilities to allow owners to restructure their investments, according to a person familiar with the talks. Oaktree declined to comment.
Funds under pressure to extend the maturity of their borrowings are looking to inject more capital or invite mezzanine investments rather than selling assets cheaply, says Savills’ Yoon, who adds that a few have drawn sales. Increasingly, however, owners are following the path of the No.1 poultry and having another chance to sell after several failed attempts last year – as seen with the exit rush in London.
In Seoul, meanwhile, there is growing unease about how the endgame will unfold for domestic investors. “With declining commercial real estate assets overseas, there are serious concerns about the distress,” says Oh.
–With the help of Daedo Kim.
(Updates with more details on the sale of the Canary Wharf building in the second paragraph below subtitle named by receivers)
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