Fuelled by e-commerce and foreign investment, Asia seems set to become the world’s growth
engine, as US investors sound a clarion call for a chance to proft from high internal rates of return
US opportunity funds and investment banks are leading a charge into Asian property markets in the dash for internal rates of return of up to 40%. And European funds should pile in too, according to managing director Jack Rodman at Ernst & Young’s Asia Pacific Financial Solutions.
E&Y thinks that if Asian governments, asset management corporations, and banks succeed in moving almost $1.5trn of non-performing loans (NPLs) off their books and into the private sector, Asia will emerge as the world’s growth engine, fuelled by e-commerce and foreign investment.
In the meantime, US investors will continue to acquire portfolios of distressed corporate assets and non-performing real estate loans. Over the last 18 months they pumped $20bn into Asian markets.
They splashed around $11bn on non-performing loans secured on real estate, bad corporate loans from banks, or whole companies and banks.
New Bridge Capital, a Hong Kong-based bank financed by the US’s Texas Pacific Group and Richard Blom Associates, bought Korea First Bank, paying between $500m and $600m for a 51% stake. In another deal, US group Ripplewood Holdings paid $1bn for Long Term Credit Bank in Japan; the Ripplewood investors include General Electric Co and Citigroup as well as Deutsche Bank.
Direct property was another target with investors spending around $3bn of the $20bn chiefly on major office buildings and hotels.
According to Rodman: “The big boys active in the region are Goldman Sachs through its Whitehall Fund, Cargill, Cerberus, Colony Capital, DLJ Realty Capital, Lehman Brothers, Lonestar, Merrill Lynch, Morgan Stanley Dean Witter, Secured Capital Corporation and Starwood Capital.
“And there are a few European investors already in there too, like Credit Suisse First Boston, Deutsche Bank and LF Rothschild,” he adds.
Most of the money is from opportunity funds chasing an internal rate of return of 20% to 30%. “If these guys do a good job they can often get double or triple that as these are unleveraged returns. Now you can actually borrow debt against these purchases in Japan and Korea.
“This increases the equity return substantially since, if you were buying something to earn 20% and now you can borrow half the money at 10%, the half that you have in the deal is earning a lot more for you when you leverage it,” explains Rodman.
Peter Churchouse, managing director and co-head of research at Morgan Stanley Dean Witter Asia, says: “In Thailand, billions of dollars of non-performing real estate loans have been sold at 20 cents on the dollar. Most of what Morgan Stanley Real Estate Funds wants for this sort of property risk is an IRR of at least 25%, and we would probably want to get a lot more – up to 40%.”
But he is keen to point out that a lot of real estate funds that have targeted the domestic US market have achieved up to 35%. “Why go off-shore into more risky markets for lower returns?”
Richard Georgi, managing partner of Soros Real Estate Partners, compares Japan with Europe in the mid 1990s, a period which saw vast restructuring and reorganisation of markets concurrent with cyclical upturn.
“That process gave tremendous opportunities for real estate. That kind of restructuring process is what I see about to occur in Japan, whose economy is in many ways similar to that of France,” says Georgi.
“Japan has no alternative but to embrace shareholder value, which will put renewed vigour into private enterprise, and this will ultimately lead to renewed economic growth,” he adds.
Rodman is a keen advocate of European opportunity funds going into Asia: “I think they can raise money at a lower yield than US opportunity funds, and can compete effectively against the US funds. Europeans can be pretty ecstatic with a 15% return as opposed to 20% or 30% which US ones favour – therefore they can be more competitive in bidding for these portfolios.”
He says that occasionally UK investors like Grosvenor scout around, but they have yet to buy anything.
As more foreign players enter the market and Japanese opportunity funds start to enter, higher competition has pushed up prices of NPL portfolios by 10% to 15% in the past 12 months.
Depending on the loan, investors could originally sell loans for as low as five or 10 cents on the dollar; now the range is 15 to 20 cents. The loans are generally backed by traditional office and residential properties, but also include parking lots and golf courses.
When buying these loans at deep discounts from face value, US investors can collect only a part of the loan and still realise substantial profits. Alternatively, investors can negotiate debt-restructuring plans with borrowers that give them full or partial ownership of the underlying assets. Or they can foreclose and take control of the assets and hold for future sale.
E&Y’s US Investment in Asia report says that some Asian banks have been slow to sell NPL portfolios. They expect that the economy will recover, property markets rebound, and the value of the assets underlying the loans will improve so they will not suffer additional significant losses from loan sales.
A variety of foreign investors including insurance giant AIG, as well as Colony Capital, CSFB, DLJ, Goldman Sachs, Morgan Stanley Dean Witter, and Westbrook have made direct investments in Japanese real estate. But many others have been frustrated by the difficulty in acquiring properties.
Japanese owners traditionally have been reluctant to sell real estate as they perceive it a sign of weakness. They have also been reluctant to adopt the discounted cash flow method of valuing properties used in the US, and a big gap exists between official land values and the lower discounted values.
However, Japanese companies that were aggressive buyers of US real estate at the height of the Japanese investment boom in the late 1980s are now liquidating some or all of their US holdings.
These include Shuwa Investment Corporation which originally invested $3bn in office properties in Los Angeles, New York and Orange County; and Daiichi Real Estate Co, which acquired Tiffany & Co’s flagship New York building in 1984 and late last year sold it back to Tiffany.
If Japanese owners are selling major US investments, E&Y thinks sales of some of their major property assets in Japan could follow.
Meanwhile, foreign investors are creating special purpose corporations (SPCs) to service NPLs, and as the Japanese economy improves, the SPCs are expected to originate loans. An SPC of General Motors Acceptance Corporation acquired Nippon Asset Management Inc (formerly Japan Leasing Corporation) to create the largest foreign-owned service company in Japan.
Salomon Smith Barney and JP Morgan have also created SPCs. The entry of such major players into the NPL market could create a higher comfort level among foreign investors about acquiring such loans.
A real estate capital market is developing in Japan, which should help to create more liquidity in the country’s property markets. Last year, Morgan Stanley Dean Witter sold the first securities backed by Japanese NPLs on an office, retail, and residential mix.
Additionally, a market for securitisation of performing commercial real estate loans is starting in the country and international rating agencies are starting to rate portfolios of such loans.
Asia’s markets are in various stages of recovery. The one that everybody likes is Japan, says Rodman: “They see a very strong future for Japan and Korea, followed by Thailand, Malaysia, Indonesia and then China.”
China and Indonesia, he points out with relish, have not really started yet. “China just transferred $120bn of NPLs into four bad banks and has not moved any of it yet. And Indonesia is sitting on $80bn through its debt reconstruction agency,” adds Rodman.
“Clients complain that it’s getting too competitive and people are paying too much, but that’s because they have had it too good for the last two years,” he says.
