China property yet to touch bottom: Baring Asia

The private equity real estate investor sees a further slide in mainland property prices, even as Beijing acts to prop up the market.

Chinese property markets are near to finding a floor, so the ideal time to begin investing is within sight, the head of Baring Private Equity Asia’s real estate arm said on Tuesday.

BPE Asia Real Estate, which has closed its first-ever private equity real estate fund with $365 million in investor commitments, plans to put the money to work across Asia over the coming three years, giving it the necessary wiggle room to watch property prices in China fall a bit further.  

“The pain that China is going through and the restructuring of the real estate market means we’re almost at a point where we would want to invest,” said Mark Fogle, BPE Asia’s head of real estate and former AIG executive in an interview with FinanceAsia

The BPE Asia Real Estate Fund comes as China’s real estate prices continue to sag due to high inventory levels and as some developers such as Kaisa in Shenzhen struggle to secure funds. Beijing acted on Monday to help ease the pain by loosening mortgage lending conditions for homebuyers and relaxing tax rules, adding to last year's raft of policy measures aimed at boosting demand.

Home sales in January and February fell by 16.7% year-over-year while the number of cities registering home price declines of more than 5% year-on-year increased to 52 in February from 38 in January, according to official data.

Fogle noted that many foreign China-dedicated funds are continuing to invest in China even though some large local real estate investors are diversifying rapidly overseas. Dalian Wanda, for one, has been buying up property globally for the last two years. Most recently it said it would invest about $1 billion in a development in Sydney harbour. 

“Why is so much domestic capital leaving China for other parts of the world and yet foreign funds are buying heavily in China. It’s a concern,” said Fogle, who has worked in Asian real estate since 1989. 

Fogle foresees “very structured deals, tied to hard assets” in China when prices fall to an attractive-enough level. He is also considering working with a local partner to buy a weaker property developer. 

Singapore, Japan corrections

Fogle also sees the market in office and residential buildings continuing to correct in Singapore, where he is based. 

In Japan he sees worrying signs of excessive leverage, with financing available for up to 95% of the property’s value. “I consider that kind of leverage financial engineering… at some point that will correct as it has in previous cycles.” Fogle said. “For me it’s a bit déjà vu.” 

From 1997 to 2006, Fogle was a managing director at AIG Global Real Estate, which was active in Japan prior to the 2008 financial crisis. 

Blackstone last year bought GE Capital’s residential real estate business in Japan for over ¥190 billion. The deal was highly leveraged.

BPE Asia’s team collectively has completed over 120 deals and never given an asset back to investors. The terms of its debut fund caps leverage at 60% on each deal, helping to reassure investors they will not have to give the keys of a building back to the bank through the investment cycle.

Fogle joined Baring Asia in 2011 and has since put together a team of roughly a dozen real estate professionals backed up by 12 to 15 analysts, compliance officers, lawyers, and financiers who are shared resources within Baring Asia.

The maiden fund aims to double the money it invests in each deal, which generally equates to an internal rate of return of around 20% depending on hold periods. BPE Asia plans to invest heavily in the office and residential space and very selectively in the retail, hotel, logistics and industrial property sectors.   

“You definitely have to work for your supper [to achieve such returns],” Fogle said.

The new fund's target size for deals is from about $30 million to $75 million of equity, or $100 million to $200 million including debt, a price range where there is plenty of competition in Asia.  

However, many of BPE Asia's potential competitors spend their time scouring the more developed and relatively transparent Australian and Japanese markets. Adverse foreign exchange movements and heavy taxes have hit some of these foreign funds and cap rates have compressed particularly in Japan.

“We’ve been fortunate to not have invested in those two markets in recent years and it’s been the right call,” Fogle said. “We only invest in markets where we see domestic capital as our exit.”

Deals

BPE Asia Real Estate Fund’s first close was about 18 months ago, so it has already completed a couple of transactions.

In South Korea it invested $30 million mid-last year in four operating assets using mezzanine debt for a local operating partner at 60% of replacement cost.

“The gap in Korea is that there is no liquidity for developers or for mez debt. It’s amazing the lack of competition,” Fogle said, adding that many funds were badly burnt in Korea during the 2008 financial crisis and that banks which had provided them with financing have since pulled out.

Fogel himself served as chief investment officer in Asia Pacific at RREEF, the alternative investment and asset management arm of Deutsche Bank, between 2007 and 2010.

“We’re very much brick-and-mortar investors, so we look at price per square foot rather than [on the basis of an asset being] 30% below what it was,” said Fogle.

In the Philippines, BPE Asia also invested $25 million in July in a Class A office block. He didn't specify where but said it had leases that were 30% to 40% below market rates and an average lease life that was only 2-1/2 years. Back to his point about domestic demand, this building had 20 local players interested in buying.     

“The Philippines has the strongest Class A office market outside of Tokyo – it absorbed 4 million square feet last year of office space and has a 1% occupancy rate,” said Fogle.

Most boutique real estate debut funds seek capital from high net worth individuals and funds-of-funds. Instead BPE Asia attracted 70% to 80% of its investors from previous funds that the team or Baring Private Equity Asia had managed and most of it was institutional capital from life insurers to corporate pension funds.   

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