(Bloomberg) — A trip to the restaurant perched atop No. 1 Poultry Office Building in London’s financial district is a chance to experience first-hand the tale of two cities that is upending the commercial property market.
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From Coq d’Argent’s vantage point, you can behold a forest of new skyscrapers that developers hope will fetch great rents and even bigger prices. For the South Korean owners of the older building occupied by WeWork below, the future looks even bleaker.
With that in mind, Kaela Fenn Smith—former CEO at giant Land Securities, now managing director of CBRE Group’s ESG advisory firm—talks of a “huge journey toward quality” transforming the office market where “truly first-class space” will do. Her comments come as impeccable environmental credentials have become a must for corporate renters, many of whom are considering downsizing because of the WFH revolution.
This “super” scramble may be a boon for the owners of those flashy modern towers, but it’s bad news for older places like No. 1 Poultry. In big cities everywhere, owners of these Class B office blocks face the prospect of expensive renovations — or down sales.
South Korean investors, who spent five years partying on this second level of commercial building, look particularly exposed. Hana Alternative Asset Management in Seoul is preparing to re-site poultry for sale, say people familiar with the process. It’s worth an estimated £125 million ($164 million), according to the people themselves — about a third less than what Hannah was paid. The company declined to comment.
Her unhappy experience is far from unique. Prices for this type of property are dropping all over the world, from midtown Manhattan to Hong Kong and Paris. With real estate already reeling from the end of rock-bottom interest rates, reckoning is coming for many landlords and managers.
But Hana’s plight also highlights something more specific: the joint involvement of Korean funds in the premises of this profile. The country’s asset managers have poured tens of billions of dollars into offshore desks and risky mortgages in recent years — before Covid and rate-hiking central bankers drove a bulldozer into the market.
People familiar with the London sales alone say that at least six large blocks owned by Korean companies are available for purchase. Most of them suffer from low ratings.
South Korea joins a group of countries whose money has made bad real estate bets, from the Japanese in the early 1990s to the Irish before the financial crisis. “The history of the City of London is one of investors arriving and then leaving,” says Michael Marks, former chairman of landlord Development Securities PLC.
Korea’s bad bet
The origination of punt abroad is fairly recent. At the end of the last decade, propelled by favorable exchange rates and higher yields than they could get back home, Seoulites piled money into what they hoped would be a treasure trove of hot buildings. In 2019, they were the largest outside investors after the United States in commercial real estate in Europe, making deals worth 13 billion euros ($14.6 billion) that year alone, according to MSCI Real Assets data.
Between 2017 and 2022, investors snapped up more than 90 European properties with prices in excess of €200 million each. Many were large blocks in the City of London and La Defense in Paris. Values in both financial centers have fallen more than 20% in the past year, according to broker Savills Plc.
Koreans have been fond of buildings with long leases to popular tenants, such as Amazon, so they focus less on ideal locations or green ratings and worry more about the perceived quality of who pays the rent. They also liked the large sites, which are more expensive to repair when they get old.
Fitch Ratings recently warned that rising construction costs in order to bring buildings to environmental zero would leave behind ghost and zombie office properties and “be severely destructive to the value” of older commercial properties, without specifying Korea-owned assets.
“There will be a lot of capital expenditures,” says Finn Smith, who also speaks publicly because people are looking into whether old desks might become stranded assets. “When will your building start to lose value as it goes off a net-zero path through 2050?”
Unfortunate timing
Financially, the timing of the market shake-up couldn’t be much worse for Korean investors. About 30 trillion won ($24 billion) of their real estate funds are due until 2025, according to data provided by the National Financial Supervisory Authority to opposition party lawmaker Oh Ji-hyung. This is nearly 40% of the total, which means that a flood of commercial buildings could be about to hit the market at a time of low demand.
Typically, state funds are invested for five years, less than the international average, which makes it difficult to seek and weather deflation, says Yoon Jaewon, head of international investment advisory at Savills Korea Co.
Adding to the tension, many of the loans used to purchase real estate come from falling lenders and rising borrowing costs. Banks also demand additional equity from owners before making loans.
The FSS is monitoring the situation closely, talking to the companies and will discuss the issue at a meeting Thursday, according to two officials who asked not to be identified because they are not authorized to speak publicly.
While the watchdog is worried about potential losses to local investors, a third official says there will be no rush to withdraw money because Koreans usually have to wait for the fund to finish. Most of them are backed by institutional money, the person adds, which is unlikely to spark panic.
Legislator Oh says this is complacent: “Financial authorities should thoroughly examine and prepare for the situation, and not continue to say that there are not too many risks.”
There is another reason for Korea’s weakness: Europeans have sometimes been reluctant to sell to the country’s investors because buyers usually include multiple institutions in a consortium, people familiar with the matter say, making negotiations protracted and at risk of collapse. This prompted buyers to bid more, sometimes paying installments of 10% or higher.
An almost herd mentality was set in by a banker who has worked with borrowers on a few of these deals, among asset managers eager to make a return.
Mezzanine misery
In the United States and elsewhere, Korean investors have pushed hard into risky mezzanine lending against real estate, offering microloans that will take the first hit when valuations plummet. The appetite has been so high, says the banker, that they sometimes accept a below-market yield, and in a few cases strike deals at 6% instead of the 8% or so others have asked for.
Some bets on loans are going bad.
Payments to mezzanine lenders for a troubled project at 20 Times Square in New York, which includes a hotel and an NFL Experience store, stopped 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 has written down 80-100% of the value of a fund that provided more than $240 million in mezzanine financing to the Golden Financial Global Center, according to local media. A Mirae spokesperson says it’s focused on refunds.
Appointed reception
Back in London, the receivers were assigned to the former home of BP’s oil trading unit at 20 Canada Square in Canary Wharf. It was acquired by Cheung Kei of China in 2017 and funded in part through a mezzanine facility from Hanwha Asset Management in Seoul. Hanwha declined to comment.
The presentation by broker Jones Lang LaSalle, who was trying to sell the property to Cheung Kei, advised him to approach an initial shortlist of potential buyers offering the building for £250m, well below the substantial debt value.
In fairness, Korean funds aren’t the only ones suffering overseas. Many Chinese companies have also suffered, including another failure at Canary Wharf. Some Seoul investors have done well on international real estate bets: Korea’s National Pension Service has been outstanding and rewarded for it, says the banker who worked on Korean deals.
Investors were also slightly shielded by Europe’s approach to property valuation, which does not take market sentiment into account. With sales largely frozen, there were few deals to gauge the real drop in values. Inflation-related rent increases also helped.
However, opportunists are moving in, ready to introduce expensive new debt to refinance buildings whose owners can’t afford an injection of capital. Oaktree and other alternative financing providers have been in talks with Korean asset managers about large loan facilities to allow realtors to restructure investments, according to a person familiar with the discussions. Oaktree declined to comment.
Funds under pressure to extend the maturities of their loans are looking to inject more capital or invite investment into the mezzanine rather than dumping assets on the cheap, says Savills’ Yoon, who adds that few have pulled sales. However, the owners are increasingly following the No. 1 poultry route and have yet another crack at selling after several failed attempts last year – as seen with the rush to exit in London.
Meanwhile, in Seoul, there is growing concern about how the end game will play out for local investors. “With the decline in overseas commercial real estate assets, there are major concerns about distress,” Oh says.
– With the help of Daedo Kim.
(Updates with more details on the sale of the Canary Wharf building in the second paragraph below the receivers subheading)
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