Institutional Real Estate Asia Pacific

October 1, 2023: Vol. 15, Number 9

From the Current Issue

Asia Pacific

AI.O.U. The property industry presents a specific set of challenges as well as abundant opportunity for the judicious use of artificial intelligence

Both in the evaluation of investment ideas and in the design of buildings, not to mention their operation, artificial intelligence holds distinct promise. But is AI the “new ESG”, an acronym thrown around so much that it loses its power, and does not fulfil its promise? It is highly unlikely. Like it or not, AI is already changing our lives, and will surely shape the future of most property professions. Beyond all the novelty and scaremongering, there is more to “like” about AI than “not”. Big data and proprietary models already inform the investment decisions at firms such as CenterSquare Investment Management. That’s true both for the company’s investment into property stocks as well as its direct investment into real estate itself. The equity analysis looks at how property stocks perform in different market conditions, while asset-specific data helps inform the identification of properties that stand to out­perform in terms of returns. There’s still a human piloting the decision. But CenterSquare’s Joachim Kehr, portfolio and regional manager, real estate securities for Asia Pacific, anticipates that our comfort with letting AI take the wheel may chart a similar course to that of self-driving cars. “The complete use of AI in investment decision making will take some time to penetrate the market, but it is not a matter of ‘if’ but ‘when,’” notes Kehr. However, there’s a fiduciary duty for an investment manager that is always going to necessitate human knowledge built up over years of investment experience. “That knowledge and experience are going to take some time for machines to replicate and prove out,” adds Kehr. AI elements are far likelier to “invade” aspects of data gathering and processing long before a computer system is making totally automated investment decisions. Cutting out the overdesign On the operational side, the uses of AI are far more obvious. In fact, the “sustainability” sliver of ESG stands to benefit greatly from the use of AI, combining last year’s issue of the day with the current meta. Alex Bent, managing partner at Undivided Ventures, looks to invest in companies that use tech and innovation that are “solving for a sustainability pain point in the real estate or infrastructure sectors,” he explains. While excited about the potential of AI, he’s aware it may render some companies or innovations irrelevant as long-term investment targets. Ultimately, he’s confident most property professionals can grow with and adapt to AI. “There is a lot of waste in terms of time and resources in the real estate industry, with day-to-day operating decisions, construction decisions and financial decisions, and these conclusions can be more effectively generated with AI,” says Bent. His company has also recently invested into StructurePal, a company that uses AI to cut down on the over­design excess built into the building process, cutting back both costs and carbon emissions. That should help improve the ratings buildings achieve, certifying their green or tech credentials. The company WiredScore offers both its eponymous WiredScore certification rating a building’s digital connectivity and its SmartScore certification reflecting the smart functionality of buildings including how well they can capture and analyse data. Both certifications are intended to inform the decisions of occupiers, operators, owners and investors. “We are in an age of implementation with AI solutions,” says Thomasin Crowley, WiredScore’s global director for the Asia Pacific region, something she sees growing as systems become more cost effective and accurate. “Landlords are becoming increasingly aware that they need to future-proof their assets to keep up with the evolving needs of occupiers,” she continues. “All in all, the core aim of AI application is to minimise manual input, processing time, and amplify human productivity. And I think we’re unanimously striving for this across the real estate sector.” The proliferation of digital twins In other words, it’s an exciting rather than scary time. Kehr is particularly excited about the use of “digital twins”, the creation of virtual 3D models of real-world buildings. Those “will be incredibly influential in how we plan, build, transact and operate real estate in the future,” says Kehr. Jonathan Hannam, managing partner at Taronga Ventures, agrees. His company has invested into Open­Space, a San Francisco–based software company that has created technology to project a real-world “digital reality” of a construction site or building onto building plans and models. This can help detect deviation away from the plan and red flag construction errors in real time, before they get out of hand. OpenSpace is also building its data pool of construction work, with 17 billion images of construction on file, and growing. That is “teaching” the OpenSpace system how to identify the kind of costly mistakes that drive up construction costs in real estate and extend completion times. As it stands, all too often, the slight error isn’t detected until well after it is built into the site, necessitating expensive reworks. For “pen and paper” property construction, about as traditional a business as you can get, “the digitisation of plans has been a key enabler step for the industry,” says Hannam. And it sets up the implementation of new tech not only in construction, but also building management and financial management. “Let’s say you are acquiring an asset in the future,” notes Hannam. The purchase will also include the digital twin, showing a rendition, original plans and how the building was really built. “This will also be valuable for insurers, who are likely to offer lower premiums based on the higher level of knowledge, and to bankers providing mortgages.” Digital real estate becomes a real asset. On the marketing side, it is easier and quicker to “tour” a virtual building in 3D, and explore it from wherever you happen to be. For operations, digital twins can also demonstrate the back-of-house systems running the building, to help demonstrate potential savings from — or upgrades to — water, heating and waste-management systems, adds Kehr. You’re already using AI Crowley notes that AI is already all around in the real estate industry. Sustainability has been the first step, relying on carbon-emissions reporting tools to improve operations, but she expects computer automation will extend throughout the early planning stages through to times when a property nears its end of use. For institutional investors, the bottom line will be return on investment. While investors realise the relevance of high-quality digital infrastructure and smart technology in their properties, they are still harnessing the data output. With a large portfolio of buildings, “evaluating the performance of each building can be resource intensive,” Crowley points out. “The development of AI will make it much more efficient for them to make a persuasive argument on ROI.” With its full implementation, investors may be able to identify current problems and anticipate future issues within an operating property portfolio, just as building managers can use AI for predictive maintenance. AI has the potential to “readily support property-management roles by streamlining tedious administrative tasks across functions and reducing human error,” adds Crowley. “We’re also predicting significant adoption of generative AI by architects to quickly generate drawings and by construction and city planning to conduct site feasibility studies.” Taronga Ventures invests into emerging tech companies that affect the real estate sector. As such, “you can imagine that the potential impact of AI is dominating many of our discussions with investors in our funds, and within the emerging tech companies in which we invest,” says Hannam. “Yet, AI technology has been a part of the real estate sector for many years, often embedded in the technologies digitising the operations of this sector.” Point vs generative AI The systems already running in the property sector typically involve “point” AI, notes Hannam, serving a specific location. Those uses include facial-recognition software providing security at entry points, enhancing safety at construction sites, and detecting water leaks within a building. Taronga Ventures has invested in companies such as Presien, WINT and OpenSpace serving those functions. What has captured the public imagination in recent months is the possibilities behind “generative” AI, so these uses are normally what springs to mind when we say “AI”. Those models have also existed for some time, says Hannam, but have recently improved and become cheaper to use. That makes them more useful and more accessible. “These new models now far outperform older machine-learning models on most tasks, even simple engagements such as suggesting the next words in an email,” states Hannam. “This is driven by the fact that these are larger models with more parameters and that they are more flexible,” able to be fine-tuned quite easily and switched from one task to another. Those generative uses are likely to have applications for property professionals, aiding in property design and architecture on the creative side, as well as in marketing properties for lease or sale. And it looks like those uses will be both meaningful and here to stay. “My sense is that, unlike crypto and blockchain, which have struggled to gain widespread acceptance, the use of AI is going to be much more impactful,” Hannam posits. He cites companies in a range of fields that Taronga Ventures has reviewed for potential investment: improving property listings by boosting results with machine-learning capability; generating images or copy for marketing purposes based on existing models; lease management by using machine learning to review and “manage” large numbers of leases; mortgage and insurance provision through personalised underwriting and claims management; construction bidding by using AI models to generate costings and even base-level designs; boosting buildings management by making it more efficient; improving energy use and sustainability with predictive office-use modelling; and customer service, by improving the tenant experience, which could potentially lead to higher rents. Healthcare aid Specific property sectors may benefit from purpose-built tech. For instance, the use of AI in hospitals and the health-related aspects of aged care will likely improve care and boost both the health and experience of residents and patients. Taronga Ventures has invested in two companies in that field. Xandar Kardian uses radar technology to detect vibrations from human bodies. This can already deliver the breathing rate and resting heart rate of a person, in real time. The company’s medical device has been approved by the US Federal Drug Administration, and it will be using both AI and machine-learning algorithms to detect patterns not only alerting staff to current health issues but also learning about human conditions to, ultimately, deliver predictive diagnoses that could stave off health problems before symptoms become apparent. The Xandar Kardian sensor can also be used to analyse sleep patterns. Participants must, of course, agree to the monitoring, which is privacy-protected. Calumino has created a smart thermal sensor that can be scaled up to care for large-scale facilities. Its AI analytics study movement patterns that can be used to detect incidents such as falls in real time that is particularly valuable for aged-care facilities. The reason AI is taking hold in the property sector and for other applications is that the user experience has dramatically improved. “In all these cases, the creation of an application interface or dashboard that effectively allows users to engage with these new models and formats has been a key turning point for adoption,” says Hannam. Creating full-service “solutions” that improve the user experience for the staff operating the systems and for the customers or patients “is likely to be a part of the next horizon for the industry,” he concludes. The resistance to overcome What are the challenges or problems to overcome, as AI embeds itself into the property industry? Perhaps the first to note is that the real estate industry can be rather hidebound, and resist change. There’s a temptation to stick with existing methods of operating a business — “if it ain’t broke, don’t fix it”. The most immediate effect from AI may therefore come in more “revolutionary” uses, particularly if they perform a task from start to finish. It will be harder for property companies to adopt AI if it is offering incremental improvements on an existing process or system. What is more, it will take time and effort, not to mention cost, to implement new models or systems in house. “On the flip side, property professionals and businesses need to be open to change,” suggests Hannam. “Professionals, both new and particularly older, will need to be open to experimenting with new tooling to enable their jobs.” Bent seconds the notion that the resistance to overcome will be human, not technological. “I don’t think [the issue] is so much where AI still needs to deliver but whether the real estate industry is willing to collaborate on research and data across large portfolios to come to effective conclusions,” he states. To look at the issue in a positive light, the built environment has both a great responsibility, as an industry that is one of the largest greenhouse-gas emitters, to address the issue, as well as great potential to succeed. “This is only realistic if real estate firms, construction companies and regulatory bodies come together around problem statements and data to help solve for these issues,” continues Bent. “Once that accurate data is available, AI can be very effective in making sense of these gigantic problems, and coming to conclusions around new building materials, effective heating and cooling, energy systems, building facades, and insulation, and so on.” When does AI cross the line? Are the machines taking over the world or, at a more-pragmatic level, taking our jobs? There is plenty of high-level anxiety over how AI will be used and how it will be regulated, as well as concerns about plagiarism and intellectual-property theft, if an AI system is used to draft an architecture plan “in the style of” a certain starchitect. “Data ethics and data privacy are undoubtedly two of the most important concerns,” says Crowley. “Being accountable and transparent about the data collected is crucial here. Further, once a set of data has been processed, the AI is unable to ‘unlearn’ it or not be biased by it, much like humans,” she says. “As such, it is imperative for businesses to develop guidelines and policies that ensure their organisations are using AI responsibly and keeping private internal data out of publicly accessible AI platforms.” Surveillance technology raises a separate set of issues. Video analytics and facial recognition present potential conflict between public safety and privacy rights. Cybersecurity risks necessitate air-tight data systems. Only as good as the data In fact, of course, AI already exists in our pocket with Apple’s virtual assistant Siri, in our workplace, in our car and our home. The means of communication are already being enhanced even in simple ways, such as with predictive word choice and spellcheck. Property professionals will certainly need to adopt AI-augmented tech to improve property management, customer service and building design. “The challenge really is that AI is only as good as the data it is being given,” says Kehr. Equally, the AI system is only as strong as its computer coders and creators, embedding any biases they may not consider. “AI is still in its infancy. And like any infant, that means that it’s really about helping AI learn and understand the environment it is exposed to,” he adds. “Once AI has been taught — and that only works through copious amounts of data and iterative refinement of its algorithm — AI will be able to contribute materially.” The process, he feels, will likely take years. Bent raises the issue of the data “moat”. Big Tech has already demonstrated how valuable relatively simple information tracking consumers can be. The creation of data banks and the ease of access to data “will become more valuable and important,” he says. Then again, many property companies already generate reams of data, in building management on the operations side and in portfolio management on the investment side. This represents the largest opportunity for big developers, asset managers and funds to “make sense of the vast amounts of data that their portfolio is generating, and come to conclusions around what they need to do from a sustainability and climate perspective to future-proof those portfolios,” says Bent. In practical terms, one sliver of the property market that will see large-scale demand due to the use of AI is the data centre specialty segment. Huge amounts of data will need to be sorted and stored across the world, and particularly in decentralised locations, nearer to users of the information. “The emergence of AI goes hand-in-hand with the infrastructure needed to support this intelligence,” states Hannam. Data-capacity demand will spike, and data centres will need to adapt quickly to new uses. “Just as technology such as graphic processors and hardware chips have had to evolve for the AI revolution, so too will the data centre need to be able to support the extent and use cases that emerge from the widespread adoption of AI.” The AI promise There’s no doubt the adoption moves far beyond tinkering with ChatGPT to see if it churns out a few funny answers. AI is not coming for you specifically, or your job, but it is coming, and we in the property world would do well to offer a welcome mat more than a cold shoulder. When asked what changes he anticipates near term, Kehr expects generative AI to take some time to develop, and above all to consume the copious amounts of data necessary to posit what solutions are possible and feasible. Looking further beyond, though, Kehr envisions a world where AI will not only be a co-pilot but may assume much day-to-day management of the planet: addressing issues such as overcrowding, affordability and environmental decay. Kehr also recalls a comment from Microsoft pioneer Bill Gates, “We always overestimate the change that will occur in the next two years, and underestimate the change that will occur in the next 10. Don’t let yourself be lulled into inaction.” It’s a fitting final word to a story written not yet by AI but a breathing human tapping a keyboard. Content is easy to create, but insight is hard to attain. Alex Frew McMillan is a freelance writer based in Hong Kong.

Asia Pacific

A generational opportunity: Investing in real estate secondaries in Asia

The recent volatility in global stock and bond portfolios has fundamentally reinforced the need for the secondaries market. Elevated public-market valuations in 2021, superseded by a stark correction in 2022, have driven the denominator effect — the relative weight of private holdings now represents an enlarged slice of limited partners’ (LPs) overall portfolio. A perfect storm of rising rates, intensifying inflationary pressures and the precipitous cliff of unrealised value across mature private market fund vintages has exacerbated this effect, amplifying investors’ need for strategic portfolio rebalancing. In Asia, this has triggered a trend of “West selling East”. Amidst such heightened market uncertainty, North American and European investors have been actively seeking near-term liquidity for their noncore Asian private market exposure to pivot back to their home markets. As a result, many of these LPs have turned towards the secondaries market to obtain liquidity for a traditionally illiquid asset class. In addition, a challenging exit environment has also pushed general partners (GPs) to utilise secondaries solutions as an alternative way to generate portfolio liquidity for their investors, mainly in the form of GP-led transactions such as continuation funds, strip sales and tender offers. Despite the evident demand for secondaries liquidity and unprecedented growth in Asia’s private capital markets assets under management, the region’s complex and disintermediated operating environment has proven a formidable barrier to entry for the fresh supply of secondaries liquidity, resulting in a fundamental lack of dedicated secondaries capital in Asia. In consequence, the region’s growing imbalance in demand and supply for secondaries liquidity presents an exceptional opportunity for secondaries investors with strong on-the-ground coverage, dedicated capital and local expertise to benefit from. Superior risk-adjusted returns of secondaries Secondaries have historically delivered superior risk-adjusted returns to investors relative to other private-market strategies. The secondaries market offers buyers the opportunity to access diversified pools of real estate assets later in a fund’s lifecycle at an illiquidity discount, which creates the basis for secondaries to deliver strong returns at reduced risk. Preqin data for private market fund vintages between 2000 to 2020 indicate that secondaries outperformed other asset classes, achieving the highest median internal rate of return of 17.8 percent while maintaining the lowest level of volatility (see chart, page 6). The defensiveness of secondaries is evident in their very low loss rates. According to Preqin, less than 1.5 percent of secondaries funds had a net return of capital below 1.0x, which compares favourably with buyout funds that had a distinctly higher net loss rate of 10.6 percent. This is a testament to the highly diversified nature of secondaries, in terms of assets, strategies, managers and vintages. Furthermore, because secondaries investments generally involve acquiring fund positions at a mature stage of their fund lives, this enables investors to avoid the dreaded J-curve effect experienced in primary investments. These fully prespecified portfolios are often comprised of mature assets with high cashflow and exit visibility, rationalising the underwriting process. Given these funds are usually nearing full liquidation or significantly past their investment periods at the time of a secondaries acquisition, the portfolios should generate a robust cash yield as well as an accelerated return of capital driven by the shorter hold periods. Capitalising on Asia’s disintermediation and market complexity The North American and European secondaries markets have evolved considerably during the past decade to become highly sophisticated and competitive, with typically intermediated processes and large, heavily-standardised transactions where pricing oftentimes serves as the only differentiator. The characteristics of Asia’s secondaries market, however, are fundamentally different. Unlike the more mature markets in the West, the relatively nascent secondaries market in Asia lacks well-established sourcing channels and experiences a significant level of disintermediation. As a result, the majority of secondaries deal flow in Asia is transacted on a proprietary basis not captured by the broader transaction data recorded by brokers, reflecting a tremendous off-market opportunity. From an underwriting perspective, readily available access to information is rare, and therefore unlocking value by leveraging an information advantage becomes a daunting undertaking. Secondaries investors in Asia cannot solely rely on desktop analysis but are required to utilise on-the-ground local coverage and personal relationships with market participants to disentangle the intricacies of the largely unbrokered market to bridge the information gap between buyers and sellers. Given this highly complex and resource-intensive operating environment, most large international secondaries players have yet to build a presence in the region and are instead focused on scaling up the deployment of capital in their domestic markets, where they can benefit from both their local expertise as well as economies of scale. This has resulted in a scarcity of institutional secondaries capital in the region and limited avenues of liquidity for investors in Asian real estate funds. A confluence of disintermediation and market complexity in Asia has resulted in a lack of dedicated institutional secondaries capital relative to more traditional direct strategies. Based on data from Preqin, Asia represented less than 4 percent of the US$265 billion of secondaries capital raised globally during the past five years. This has led to pricing inefficiencies being more profound than global levels, providing further headroom for an increased risk-return profile. Sellers and managers in Asia undertake bilateral negotiations more frequently and require custom-tailored solutions for their complex liquidity needs. Based on research by Greenhill, the average discount to net asset value for global secondaries funds between 2013 to 2022 was 11 percent, while it was considerably higher for Asian secondaries funds, at 20 percent. The opportunity The current timing is unique for the deployment of secondaries capital in Asia. Despite its latent potential, the market remains highly underpenetrated, where numerous sellers with increasing liquidity needs are serviced by a relatively limited pool of institutional buyers. At present, investors’ overallocation to private markets from the denominator effect is a key driver of vast pent-up demand for liquidity solutions. Coupled with the turbulence in the global economy and geopolitical pressures, many institutional investors based in the West have been further compelled to tactically rebalance their portfolios by trimming noncore Asian exposure and pivoting back to more familiar domestic markets. This trend of “West selling East” has aggravated the near-term demand-supply imbalance and serves as a potent catalyst for further liquidity needs with LP portfolios. Meanwhile, a wall of impending real estate fund maturities across Asia is incentivising fund managers to tap the secondaries market for portfolio liquidity. Based on data from Preqin, there is currently US$124 billion of unrealised value outstanding for pre-2013 vintage Asian funds. The disruption created by the global pandemic has further challenged the original exit plans of many Asian GPs, necessitating fund managers to seek alternative sources of exit liquidity. Tapping the secondaries market for such liquidity through GP-led offerings not only satisfies the existing LP base but also allows these GPs to hold winners longer and maximise value creation. Working through this immense cliff of unrealised private market value will fuel the Asian secondaries market for the foreseeable future. Asia’s favourable secondaries market dynamics present a generational opportunity for investors with deep-rooted local relationships, dedicated capital and on-the-ground coverage to capitalise on the urgent, unmet demand for secondaries liquidity in the region. In exchange for solving the illiquidity challenges of Asia’s complex secondaries ecosystem, investors gain access to diversified pools of quality real estate at higher cashflow visibility and lower risk. The positive structural forces that have emerged in the Asian secondaries landscape are likely to persist into the long term, enabling transaction volumes to remain robust and sustaining it as a buyer’s market for institutional secondaries capital for many years to come. Bastian Wolff is a founding partner at Aquilius Investment Partners, an Asia-focused secondaries fund manager, based in Singapore. Shawn Chow is a senior associate in the firm’s investment division.

Asia Pacific

Opportunity in volatility: Asia Pacific remains strategically positioned to weather global market conditions

The current macroeconomic climate is uncertain, but a closer look at the Asia Pacific region reveals numerous opportunities for investors with varying risk appetites and investment horizons. Amidst market risks and the consequences of the denominator effect, now is an opportune time for investors to review and diversify their real assets portfolios strategically. This article explores how investors can benefit from ongoing cyclical and secular trends in Asia Pacific, highlighting potential investment strategies (see chart, page 23) and the region’s appeal in a cross-regional investment approach. As long as interest rates are high and return enhancers are low, investors should take a renewed focus on market fundamentals and assess prospective investments through a clear lens of opportunity:

  1. Core/core-plus: Incremental access to prime-grade commercial assets with solid attributes in strategic locations, and asset classes that thrive given current demographic trends and that are well-positioned to deliver stable and risk-adjusted returns.
  2. Value-added/tactical: The evolution of workspace strategies has paved the way for lower-grade assets that are ripe for repurposing or upgrade as part of a lease-up strategy; incorporating energy efficiency and sustainability practices presents another layer of opportunity within data centre developments and enhancements.
  3. Opportunistic/contrarian: Elevated repricing and refinancing risks are creating more viable opportunities for distressed investments, credit strategies, and potentially attractive entry points for core office and retail assets.
Asia Pacific’s appeal in a cross-regional strategy The global market slowdown has spurred investors to explore growth markets in a bid to supplement and diversify their real estate portfolios, which typically have a domestic bias in terms of economic and property market exposure. Asia Pacific is rich with growth markets, with several cities well supported by secular tailwinds and robust economic growth potential. We expect the ongoing institutionalisation of Asia Pacific markets to deepen the pool of investment products and accelerate their pace of maturity. Incorporating Asia Pacific real estate into a US or European domestic portfolio can meaningfully lower overall volatility and enhance risk-adjusted returns (i.e. gross return per unit of volatility), as indicated by analysis from CLI Group Research. For instance, adding a 30 percent Asia Pacific allocation to a US-only portfolio would improve the gross return per unit of volatility from 0.84 to 1.04 and a Europe-only portfolio would see a similar uptick from 0.59 to 0.85. In addition, Asia Pacific currencies, spurred in part by interest rate differentials, have steadily depreciated against the US dollar since 2021. This could be an added sweetener for investors looking to increase their exposure to the region. Fundamentals are fundamental in challenging times Central banks, led by the US Federal Reserve, are facing extraordinary volatility as interest rates surge. Signs of disinflation in developed markets provide some comfort, but structural inflation levels may necessitate an increase in long-term inflation targets by governments, leading to tighter monetary policies. Despite this, the Asia Pacific region’s place in the global economy has not wavered and is unlikely to do so in the future. Asia Pacific sets the scene for the global growth picture: its economy is forecast to almost double in size by 2030 to contribute close to 40 percent of global GDP in nominal US dollar terms, based on Oxford Economics’ projections. A closer look shows that China, India and Southeast Asia alone will account for half of the global growth within this period (see chart, page 23). The transition from globalisation to regionalisation is evident as supply-chain strategies undergo fundamental transformations. Further, the region’s focus on data protection and tightening regulations are influencing inwards foreign direct investment, positioning the region for significant growth during the next decade. Real estate in Asia Pacific strategically better positioned than its global counterparts A comparison of Asia Pacific and the United States reveals Asia Pacific’s resilience in the commercial real estate asset class. The high office occupancy rate in Asia Pacific gateway cities stands in stark contrast to major US metro cities. The dynamics of the office occupier demand pool are driven by infrastructure modernisation, financial market institutionalisation, and a shift towards higher value-added manufacturing and a growing consumer class. Despite commercial real estate’s relative resilience, alternative investment options in the debt and mezzanine space are emerging due to steep interest-rate hikes in select developed economies. The developed markets of South Korea and Australia, for example, as well as emerging markets such as China and India, present diverse investment opportunities in the absence of well-established core debt instruments. In some developed markets such as South Korea and Australia, the ripple effect of elevated interest-rate levels is clear, as costs escalate and market liquidity plummets. We expect that steadfastly negative real consumption growth and unwinding debt levels will suppress consumer and corporate sentiment, which could curtail any meaningful expansionary demand for commercial real estate in the next couple of years. Financial leverage is no longer the name of the game. Operational capability, which expands across an on-ground presence and more active asset management approaches, is critical to truly sustain net operating income growth to compensate for diminishing capital returns, and potentially deliver alpha returns over the medium term. Deploying capital with vertically-integrated investment managers with extensive experience and operational capabilities in these areas will be key. Structural demand drivers stand strong Asia Pacific has been at the forefront of growth for the past decade, and this is not expected to change, thanks to deep and healthy labour pools, favourable demographics, and a rapidly growing middle-class population. The region will also see the strongest shift in urbanisation worldwide. According to Oxford Economics, China, India and Southeast Asia are set to lead the charge globally, further compounding the potential demand for real estate and infrastructure investment in the process. This presents a window of opportunity for long-term investors with dry powder ready to acquire quality defensive assets in Asia Pacific that are underpinned by these megatrends. In addition, sustainability has become imperative in real estate. Governments, corporates, investors and financiers emphasise sustainable practices and green technologies, driving the development of sustainable financing instruments and green-rated assets. Notably, the reality that will unfold after the COVID-19 pandemic is still being played out. Much like a testbed of ideas, certain “new normals” have had more permanence than others. The “death of the office”, for example, has not materialised, as employers and employees embrace working in the office to varying degrees. Conversely, other trends — such as heightened hygiene and wellness factors in the hospitality sector — have enabled operators with the highest standards to differentiate themselves and gain a competitive edge. Operators with a strong track record and differentiated strategies withstood COVID-19 and emerged as industry leaders. Having shored up reserves as their peers rebuilt post-pandemic, they will be instrumental in driving underlying income streams in the future. A measured approach to finding opportunity in volatility The real assets investment landscape is riding a wave of unprecedented volatility, which coupled with heightened interest rates and inflation has led to a perfect storm of uncertainty. Asia Pacific may have much in its favour, but it is vital investors consider the unique risks and challenges of the region, such as political and economic instability, regulatory uncertainty, and cultural differences. Present market dynamics may represent unchartered waters for even the most seasoned of investors, but Asia Pacific has proven time and again its flair for reinvention and presenting opportunities in the most challenging of markets. Yu Jin Ow is head of research and Tara Wong is manager, research at CapitaLand Investment. They are based in Singapore.

Asia Pacific

Ch-ch-ch-changes: Adaptations emerge in the marketplace for real estate joint ventures

Like any business, a successful real estate enterprise requires marrying strategic vision, operational skill and capital. For a long time, one of the dominant paradigms for bringing these ingredients together has been joint ventures, which marry an operating partner’s vision and operational expertise with an institutional investor’s capital. But as the investment climate has evolved, a growing number of alternative structures have emerged. The basic theme is a push by institutional investors towards vertical integration. This trend is fuelled by both (i) institutional investors’ desire to improve alignment with their operating partners, which is in turn driven in part by nascent judicial and regulatory hostility towards traditional restrictive covenants, and (ii) institutional investors’ efforts to capture a greater share of overall deal economics and deal flow. While most institutional investor experiments with alternative investment structures are driven by the same fundamental incentives, a broad variety of deal structures have emerged to account for the idiosyncratic motivations of individual capital partners and operating partners. From a capital partner’s perspective, traditional joint ventures have two big flaws: (i) successful operating partners receive a disproportionate share of deal economics (as compared to their invested capital) and (ii) established operating partners can market their team and deal pipeline to multiple capital providers — creating an insecure deal pipeline for capital partners and forcing capital partners to pay more for access to the best operators. This is especially painful for capital partners who back emerging operating partners, only to see the operating partners leverage the track record created by the capital partner’s initial investment to seek better economics from new capital sources. While traditional joint ventures can be highly lucrative for operating partners, there are downsides for operating partners as well, especially emerging managers. Operating partners need to source capital to start and run their businesses and face a similar insecurity to those faced by capital partners; while they can have some comfort that there is always a market for skilled operators, there is no guarantee that a given capital partner will want to continue a relationship after a given joint venture’s investment period expires. To ameliorate these perceived deficiencies in the traditional joint venture model, operating and capital partners have implemented several strategies for expanding the traditional joint venture relationship:

  1. Expansion of existing working relationship. On one end of the spectrum, capital partners continue to pursue traditional joint ventures while seeking to develop a spirit of goodwill with their operating partners by offering additional support and services to operating partners without tying such services to specific investments. This soft-power approach can include, for example, seconding employees with an operating partner to help build out the operating partner’s capabilities at relatively low cost to the capital partner.
  2. Granting of participation rights. Focusing more on economics and providing capital partners with a path beyond traditional joint ventures to participate in the growth of an operating partner’s business, capital partners are negotiating for preferential rights to invest in an operating partner’s co-investment vehicles or in future funds that may be sponsored by the operating partner. The terms of these preferential participation rights vary, but may include, for example, the right to participate in the operating partner’s GP co-investments (and receive promote) in joint ventures or funds between the operating partner, as sponsor, and other institutional investors. In addition, for future LP investments in operating partner–sponsored funds, capital partners may negotiate for preferential terms as compared with other fund investors, such as lower fees or promote discounts.
These types of preferential rights to participate in operating partner co-investments or operating partner–sponsored funds are typically granted when a capital partner is backing an emerging operating partner with a limited track record, and thus may have more leverage to lock in preferred terms for future investments. These types of arrangements also arise when operating partners are seeking to syndicate their co-investments, whether because they are capital constrained or because they are seeking less personal exposure to the underlying investments. Depending on the structure, these preferential rights arrangements may give capital partners a larger portion of the overall deal economics from day one (because they are sharing in the promote by participating in the operating partner GP co-investment vehicles) or afford the capital partner comfort that it has a path, should it choose, to benefit in any enterprise value created by backing an emerging manager.
  1. Investments in management/development companies. Focusing more on control and alignment, some capital partners are investing (or securing warrants to invest in the future) directly in their operating partners’ operating businesses. Such investments are often highly customised, but typically range from purely passive minority investments to more substantial investments that include reporting and control rights.
These investments in operating companies are often paired with a traditional real estate joint venture between the capital partner and the operating partner, or the capital partner’s participation in the operating partner’s GP co-investment in one or more joint ventures or funds with third-party LP capital. When a capital partner’s investment in an operating business is paired with a traditional joint venture or participation in a GP co-investment, the capital partner is often able to negotiate for a share of the promote paid by the underlying joint venture or fund. Direct investments by capital partners in the operating businesses of their operating partners expands the scope of the traditional joint venture partnership and creates a deeper alignment between capital and operating partners because both partners are truly sharing in all of the upsides — and downsides — of their joint enterprise. This both makes it harder for the operating partners to seek alternative capital sources (against the wishes of the capital partner) and allows for capital partners to participate in the upside from any additional capital relationships the operating partner has or may develop. In addition, such direct investments may afford capital partners greater visibility into an operating partner’s operations (e.g. relationships with other institutional investors) and deal pipelines. Operating partners are often open to a capital partner’s direct investment because operating partners appreciate the value created by the capital partners’ early-stage investment or are at a stage where they are seeking to monetise some of the enterprise value in their business. In addition, the improved alignment benefits the operating partner by deepening the relationship with their capital provider for future investments, whether traditional joint ventures or additional investments in the operating business, and incentivising commercial resolutions of any disputes that emerge in the overall relationship between the operating and capital partners.
  1. Creation of new management companies. At the more extreme end, some capital partners are taking a leading role in standing up their operating partners, whether by partnering with an existing or emerging manager to form a new operating joint venture to service traditional real estate joint ventures or funds, or by forming a wholly captive operating company and directly hiring senior executives to run the new business. This approach is typically seen when a capital partner has a specific investment strategy it wants to undertake but either cannot identify an existing operating partner for a traditional joint venture or wants control rights over the operating partner and deal pipeline that can’t be achieved through a traditional joint venture. While the strategy of creating a new operating business affords capital partners significant control (including over how overall deal economics are allocated), it requires a significant commitment of resources, both time and equity, by capital partners to fund the startup expenses of the operating business.
Final thoughts As in any case where an established order is challenged, it is unclear whether any of the models described above will become dominant, or if this moment of experimentation will only serve to underscore the strengths of the traditional joint venture model. But during this period of market evolution, market participants would be wise to carefully consider the benefits and burdens of moving away from traditional structures. When two roads diverge, choosing the one more or less travelled may make all the difference, but the prudent choice may ultimately be clear only in hindsight. Peter Scherer serves as real estate counsel at global law firm Ropes & Gray LLP. Joseph Nania and Joseph Theall are associates at the firm.

Asia Pacific

Scraping the toast: Has today’s environment become riskier than it was a few years ago?

Everyone talked about how much riskier the investment climate was immediately following the global financial crisis. But was it really? I’d argue the period of time leading up to the global financial crisis was a lot riskier than the period following it. Going into the global financial crisis, there were a lot more things that could go wrong and almost no one was paying any serious attention to them. Oh, there were plenty of voices crying out in the wilderness warning about the impending financial market meltdown. But most of these were treated as Cassandras, alarmists, party spoilers. Everyone was making too much money to attempt to pull in their oars and hunker down the ship until the storm blew over. Once the markets collapsed, however, investors suddenly had much fewer options. That means there were far fewer things that could go wrong, and most of the things that could go wrong were now known. So, while everyone’s awareness of risk was elevated, the actual risks were fewer than prior to the collapse of the markets. This is the way risk recognition and markets always tend to operate. Everyone starts to worry about securing the barn door only after the cows have vacated the barn. The fact is most reactions to risk involve scraping the toast after the risks have turned into adverse events. A more productive approach to risk management would be to identify in advance all the things that might burn the toast in the first place. And then taking preventative actions in advance to ensure those things don’t happen (it is always less time consuming and less wasteful to not burn the toast in the first place than it is to have to scrape the toast afterwards). Risk will always be with us, of course. Risk has been defined as the fact that more things can happen than will happen. Recognising this fact forces us to start thinking about impact and probabilities. Which things that could happen would have the most adverse impacts on our short- and long-term investment success? And, of those, which ones are most probable, i.e. most likely to occur? And, of those that are most likely to occur, what if anything can be done to prevent them from occurring (or insulate our portfolio from those occurrences should they in fact occur)? And — especially for those highly impactful, highly improbable events that still could happen — what steps can we take to minimise the negative impacts, should those events in fact occur? The Kepner-Tregoe organisation of Princeton, New Jersey, in the United States, has been training managers and decision-makers at Fortune 500 companies to ask these kinds of questions (what they call “Rational Processes”) for more than 60 years now. Hundreds of thousands of professionals have gone through these programmes. While universally effective when applied, very few of their graduates actually end up continuing to practice the use of these processes after several months have passed from their graduating from these courses. Why? Human nature, plain and simple. As noted in a prior editorial, thinking about risk is not an intuitive process. Our normal heuristics aren’t very helpful, as we’re hardwired whenever we take shortcuts in thinking to make conceptual errors when thinking about risk. Most people simply aren’t willing to put in the hard sustained effort it takes to replace old heuristic habits (thinking fast) with new, more systematic approaches that take more time and feel more like hard work (thinking slow). So, most of us continue to stumble around blind to the true realities of risks that surround us and continue to make poorly informed knee-jerk decisions that too often turn out to be disasters. Now, in a prolonged bull market, most of these poor decisions are hidden by rising tides. It’s only when the party ends, when the tide rolls out, that we find ourselves standing naked on slippery ground. The most important thing this industry can do is devote itself to mastering the art of risk assessment. Mind you, I am talking about mastering that art, not assuming you already have, when the record clearly shows you haven’t — at least, not as an industry. The people who depend upon you for the investment results you produce deserve nothing less. Accomplishing this will not be easy. The work you are going to need to do to discipline your brain and build more productive thinking habits is going to be hard; it literally is going to be a painful process as the two hemispheres of your brain struggle for control. But the end product will be worth it. Where do you start? The best place to start is at the top. The leaders of your firm need to prioritise becoming wiser about assessing risks and about taking risks. They need to invest in the training necessary to make good risk assessment skills and appropriate risk-taking behaviour an integral part of your company’s culture. And they need to encourage you and your co-workers to develop better risk assessment and decision-making frameworks and tools. But, even if they don’t, that doesn’t mean you personally cannot get better at dealing with risk. Doing so can only boost your career prospects. So, what are you waiting for? Of course, it is important in doing all this for you to be careful. Be very, very careful. It’s a wacky world out there. Geoffrey Dohrmann Pompano Beach, Florida, USA 22 August 2023

Asia Pacific

Growing interest in real estate among Asian family offices

Institutional Real Estate, Inc held an inaugural Asia Pacific private wealth real estate symposium on 2 August in Singapore in partnership with Raffles Family Office, which invests on behalf of family offices in the Asia Pacific region, with a focus on family offices based in greater China and Southeast Asia. More than 100 family office practitioners from 70 single-family offices participated in the event, with a 5:1 ratio of investors to investment managers. “Private wealth is increasingly making its mark in the real estate investment landscape,” said Joe Kwan, managing director of real estate at Raffles Family Office. “Therefore, bridging the gap between private wealth in Asia and institutional-grade real estate investment strategies is a crucial objective of this symposium.” The event’s “Think Different” theme involved speaker interviews and panel discussions with institutional real estate investment managers on where they see alpha despite market gyrations. According to one speaker, the next decade will be a tension-filled rollercoaster ride where we should fasten our seat belts but also count ourselves lucky to have a front-row seat to history unfolding. This will include opportunities and risks across China+AI, meaning ASEAN and India. Key highlights include:

  • Real estate is a capital-intensive asset class. There is an increasing allocation towards real estate as an alternative asset class because of its role as a medium- to long-term inflation hedge compared with other asset classes. Even if a building turns to ashes, the land value appreciates over time, which is why it aligns with a family office legacy.
  • There are risks not only across countries, but within cities, markets and property types. Real estate investors want a stable, predictable environment in which to transact and grow their businesses and investments. China, however, has become the largest real estate market because of geopolitical change, and economic progression could propel China to overtake the United States as the world’s largest economy by 2035 or earlier, with India following closely behind.
  • Are Chinese government policies favourable to foreign investors? China will remain open to foreign direct investment and will work to maintain diplomatic ties with the United States and many other countries. China will engage ASEAN for strategic friendship reasons. Global real estate investors normally allocate a third of their investments each to North America, Europe and Asia Pacific. While US investor allocations to China have slowed in the past two to three years given divergent investment interest, Asian, European and Middle Eastern investors are more willing to allocate to China.
  • Investor capital to Asia always flows to perceived safe havens such as Singapore, Australia, Hong Kong and Japan, which receive the most institutional and private money. Countries that will remain relevant to investors have the highest probability of being places where people want to study, stay, work, travel and retire. One may find value in the United States, where public markets have fallen well below intrinsic value, and in Europe, where there is still price discovery. We may be two quarters away from either an economic rebound or a recession.
  • Real estate subsectors with continued strong tailwinds include living, ageing, offices, modern logistics, hospitality, grocery or mixed-use retail malls, life sciences, media and entertainment, and data centres. Infrastructure and farmland/agricultural assets are alternatives for consideration, as well as digital assets.
  • Not all real estate sectors are created equal, with nuances in each country and across regions. Diversification across the four quadrants, regions, countries, strategies, property types, vehicles and capital structures are key in building a resilient portfolio that can withstand economic pressure and sustainability challenges.

Asia Pacific

Investor views on obsolescence risk

From office to logistics assets and everything in between, obsolescence is a foe of long-term institutional investors. What are the most significant risks to investors, what steps can they take to minimise these risks when acquiring assets, and how can they best modernise properties already in their portfolios to combat these risks? These and other questions were addressed in a recent virtual roundtable on obsolescence risk with institutional investors, consultants and investment managers. The in-depth strategy session, hosted by Institutional Real Estate, Inc, was moderated by Reno Sio, managing director, Asia Pacific, at IREI. Key takeaways include:

  • The need to reposition assets in order to avoid obsolescence risk is top of mind for a lot of investors.
  • The ability to do so can be challenging, though, depending on the type of conversion. For example, there has been talk in the United States of converting office assets to multifamily properties, but most construction on multifamily is carefully choreographed in a structured sequence, typically from the ground up. So, attempting to re-engineer office space into multifamily is difficult, and an example is the need for enough natural light. The United States and Asia have seen some success, however, converting existing dry industrial into cold-storage assets.
  • Retrofitting projects and redevelopment take time, such as with the Solar City Seoul project in the South Korean capital’s CBD.
  • The pandemic’s effect on the office and retail sectors cannot be understated. It created a technical shift in the supply/demand balance, accelerating making buildings out-of-date. As a financial matter, changes to the discount rate mean a building that might have been optimal under the old regime is now suboptimal, particularly given rising interest rates. In the Australian residential sector, for example, many apartments are undergoing alterations and being repositioned into individual residences because of the sudden change in the cost of capital.
  • The best thing investors can do is anticipate the potential obsolescence risk. The nature of the real estate business is that buildings get old and technology causes disruption. Asset selection and location are very important. Is the district likely to become better or worse? Investors should anticipate which assets are going to be more “curable” down the road.
  • Investment managers can help investors identify and evaluate opportunities for when an asset becomes outdated, such as to operating, repositioning or renovating it. Having a business plan of continued upgrades and upkeep also helps when refinancing.
  • Less discussed is how capex-intensive obsolescence risk is given market bifurcation. Especially in Europe, capex provisions must be constantly revisited to make sure ESG regulations are followed to keep properties leasable. But with high inflation, putting so much money back into a building often does not make a tenable investment case for investors given conversion costs and attainable rents.
  • The more existential question for the real estate industry: What about sector obsolescence? While the retail sector is not obsolete, it is being resized into a less significant piece of the overall real estate landscape. A similar phenomenon is occurring in the office sector, particularly in the United States. The natural next question for investors is: What is going to happen to the space being vacated by these major traditional real estate sectors?
For information on how to take part in IREI virtual roundtables on topics of importance to institutional investors, please contact Reno Sio at

Asia Pacific

Fundraising picks up in second quarter

Real estate fundraising in the second quarter totalled US$53.2 billion, according to the latest results from Institutional Real Estate, Inc’s IREI.Q database — a dramatic bounce back from the US$20.2 billion that was raised by funds that held a final close in the first quarter of 2023, with much of the credit for the reversal due to a single, massive fund. Blackstone Real Estate Partners X, the 10th fund in Blackstone’s opportunistic real estate fund series, held its final close with a total haul of US$30.4 billion — the largest closed-end real estate private equity fund ever. The investment manager shattered its own record, which was established in 2019 when it raised US$20.5 billion for Blackstone Real Estate Partners IX. In line with recent performances by the various property types and current investment trends, BREP X will target logistics, rental housing, lab offices and data centre properties, as it shuns many office and retail assets. But even without that 800-pound gorilla, the second quarter saw more funds hold a final closing than in the previous quarter (20 versus 17), raising more capital — US$22.8 billion versus US$20.2 billion. The second quarter saw the continued trend of sector-specific real estate funds, with four funds focused on logistics investments raising US$8.8 billion. In addition, four funds focused on residential investments collected US$2.4 billion, and one fund focused on residential and logistics investments raised more than US$4.0 billion. In addition, one fund each was focused on retail properties and life sciences assets, for a total of US$240 million and US$80 million, respectively. Excluding the Blackstone fund, the average fund size in the second quarter was US$1.1 billion, and seven of the funds were megafunds (raising US$1 billion or more). Other significant fund closes were EQT Exeter’s EQT Exeter U.S. Industrial Value-Add Fund VI, which raised US$4.8 billion to invest in US industrial and logistics properties; Nordic Real Estate Partners’ NREP Nordic Strategies Fund V, which raised €3.65 billion (US$4.06 billion) to invest in senior housing, student housing and logistics assets in the Nordic region; and Gaw Capital Partners’ Gateway Real Estate Fund VII, which raised US$3.0 billion to invest in data centres and logistics assets in Asia, focusing on China, Japan, Singapore, South Korea and Vietnam. On a geographic breakdown, funds targeting global investments attracted the lion’s share of capital, at US$30.8 billion. US-focused funds raised US$14.3 billion, 27 percent of the quarterly total, followed by US$4.8 billion focused on Europe and US$3.4 billion focused on Asia Pacific. Closed-end funds tend to focus on higher-return strategies, and that trend held up in the second quarter. Some US$31.3 billion, or 59 percent of the total fundraising, is targeted for opportunistic strategies, while one-quarter of the capital, or US$13.2 billion, was raised by funds with a value-added strategy. Another US$5.4 billion, or 10 percent of the capital, was raised by funds targeting value-add and opportunistic investments.

Asia Pacific

Global real estate capital flows continue decline in H1 2023

Global cross-regional capital flows totalled US$30.5 billion in the first half of 2023, down by 52 percent from the first half of 2022 and the second consecutive half-year period with an approximate 50 percent decrease in volume, according to CBRE’s Global Real Estate Capital Flows H1 2023. Much of this decline in cross-regional activity was from a decrease in North American capital flows to Europe amid high interest rates, constrained debt markets and economic uncertainty. Europe saw inflows decline by two-thirds year-over-year, which is notable because the region is the largest recipient of cross-regional investment by a wide margin. Key findings include:

  • Elevated interest rates, softer real estate fundamentals, and a mismatch in pricing expectations of buyers and sellers limited global investment.
  • Cross-regional capital flow to Europe from the United States fell substantially in the first half of 2023, causing Europe’s total global cross-regional capital inflow to fall by 68 percent from the first half of 2022.
  • Cross-regional investment in North America increased by 5 percent year-over-year, primarily driven by two large acquisitions by Asian investors.
  • Cross-regional capital inflows to Asia Pacific decreased by approximately one-third year-over-year. Investment was evenly distributed among industrial and logistics, multifamily, and office assets. However, cross-regional investment in office assets fell by two-thirds year-over-year. Japan received relatively strong volume from North America because of favourable exchange rates, lower cost of finance and positive carry.
  • Industrial and logistics were the most sought-after assets globally given their strong supply-and-demand dynamics. They accounted for 37 percent of all global cross-regional investment in the first half of 2023, the highest half-year share of any asset type on record.
  • The retail sector accounted for approximately one-fifth of all cross-regional investment volume amid strong consumer fundamentals and limited new supply. Cross-regional investment in the office sector hit its lowest half-year amount since 2011, while inflows to the multifamily sector decreased substantially year-over-year to just under US$4.8 billion, although its share of total volume remained the same.

Asia Pacific

The enhanced benefit of diversification

An allocation into Asia Pacific allows investors to add value to their global portfolio through intra-regional growth diversification and also benefit from the variances across economies within the region, states Nuveen Real Estate’s Asia Pacific cities in tomorrow’s world report. A top-down macro perspective of real GDP growth since 1990 suggests the enhanced diversification benefit of adding Asia Pacific into a portfolio that includes the United States and Europe is highly pronounced given growth across Asia Pacific historically being driven by the United States and to a lesser extent Europe. The overriding macro dynamics, however, have evolved substantially during the past three decades. Asia Pacific is now driving and outpacing world growth. The more attractive secular growth prospect for the region vis-a-vis many Organisation for Economic Co-operation and Development countries — lower structural unemployment rate, well-buffered fiscal and foreign exchange reserve position, better infrastructure and transportation networks, among others — suggests Asia Pacific can better stand alone and act as a strong diversifier to growth in the United States and Europe. Choosing a balanced and diverse portfolio, backed by economic growth cycles across Asia Pacific is vital, as strong and resilient growth pulls income and capital value higher over the long term. Equally important are the more varied differences across global and regional markets — such as investable size, transparency, liquidity, tax and currency — that can further help mitigate overall portfolio risk and enhance total returns. Broadly speaking, scaling up a diversified portfolio of office assets can be achieved through:

  1. Avoiding overconcentration in purely Australian and/or Japanese cities, given that cities within the same economies tend to trend in the same direction (by varying magnitude and with lags) due to similar economic or capital market conditions.
  2. Limit exposure to both Hong Kong and Singapore, for similar reasons, given the high market correlation.
  3. Include Seoul and Singapore office markets, the former being a localised market, while the limited size, scale and depth of investable assets in Singapore restrict competition and transactions.

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