Property debt demand swells but Asia lacks opportunities
With banks lending less and returns on traditional real estate steadily falling, institutional investors are increasingly eyeing property financing as a source of income yield.
Though the best opportunities are to be found outside of Asia, insurance companies and pension funds are looking at such assets across the region as well as beyond, given their attractiveness from a risk-return perspective under risk-based capital rules.
In addition, more funds are being raised to invest in Asia-Pacific property debt.
“Debt is now considered a very interesting way of accessing certain property markets – particularly the more developed ones, such as Japan, China and Australia,” Graeme Torre, Asia-Pacific head of private real estate at Dutch pension fund manager APG Asset Management, told AsianInvestor:
While APG is ostensibly focused on property equity, he said, it will contemplate debt strategies in certain countries.
“Generally, as equity returns get tighter and tighter, if you can achieve a similar return with lower risk by investing in the debt portion of an asset, it’s an obvious proposition when viewed on a risk-return basis,” Torre said.
Three to four years ago a core income-producing real estate asset in Asia would have generated a total internal rate return of 10% to 12%, but now 7% to 10% is a more realistic expectation, said Louise Kavanagh, Asia-Pacific head of real estate funds management at Nuveen, the investment manager of US pension fund TIAA.
Property debt in core markets can provide returns as high as 7% if one invests in specific tranches, Ed Collinge, UK head of insurance at US fund house Invesco, said last month at a forum in London hosted by the FT called 'Managing Assets for Insurers'.
He noted that many insurers are invested in debt on commercial real estate with loan-to-value ratios of up to 65% and getting a yield of just 2.5% to 3%, but if they were to invest in the 50% to 65% tranche they could get as much as 6% to 7%.
The amount raised globally by private closed-end investment funds targeting real estate debt has been growing quickly (see graph below), hitting $30.6 billion in 2017, up from $22.2 billion the year before, according to figures from data provider Preqin.
(Click for full view; Source: Preqin)
SHORTAGE OF OPPORTUNITIES
However, Asia remains a very small fraction of the total when it comes to geographic focus, with the US dominating.
As the Asia-Pacific head of real estate at one big US asset manager told AsianInvestor: “Real estate debt hasn’t been a big a focus for us [because of the lack of opportunities in the space in Asia].”
In Japan, for instance, “real estate debt is dominated by local banks, and Japanese government bonds are trading at yields of 10 basis points, so there’s not really a lending market for local players”, he said.
Australia is probably the most viable market in the region for real estate debt, said the unnamed executive. “It could be interesting but is not a huge opportunity. There are some firms raising property debt funds, but we don’t see a huge amount of activity.”
In its Emerging Trends in Real Estate Asia Pacific 2018 report, consultancy PwC said a number of debt funds had been established in Asia, particularly in Southeast Asia, many of them with local capital.
But it added that most were small-scale and had so far (the report was published in November 2017) met with limited success, partly because structuring debt deals in Asia is far from straightforward and partly because of competition from banks, which were still largely willing to provide liquidity.
One Hong Kong-based fund manager quoted in the in the report said: “We see them (debt funds), but we haven’t really seen them deploying capital — it’s quite difficult for them to make their pricing attractive in Hong Kong.”
Some heavyweight players, nonetheless, feel the region has some potential as a market for alternative lenders. Allianz Real Estate, the property investment arm of German insurer Allianz, is considering setting up a lending franchise in the region, starting in Australia. But it is taking its time to examine the possibilities, Rushabh Desai, the group's Asia-Pacific chief executive, told AsianInvestor in March.
Meanwhile, British insurer Aviva has been fast increasing its £51 billion ($69 billion) UK annuity investment portfolio’s exposure to private credit, including property debt. Asia remains a small fraction of the total, but its exposure to the region is likely to grow, noted Ashish Dafria, UK life chief investment officer, speaking last month at an industry forum.
In addition, HSBC Insurance’s chief investment officer for Hong Kong, William Chan, told AsianInvestor recently that the firm has been looking at commercial real estate loans and bank loans, among other types of private debt in recent years.