APAC recapitalisation & co-investment: A growing opportunity

The opportunity set for investors to increase their exposure to Asia Pacific real estate has evolved over the past decade, becoming more diverse and sophisticated. In our view, the combination of several thematic drivers is behind the maturing market and will ensure broader and increased investor interest in the sector over the coming decade.

Firstly, the investible stock, via develop-to-core, has grown massively over the last two decades. Due to its scale, more unique, diverse opportunities are now being presented to investors.

Secondly, investors actively deploying capital into Asia Pacific real estate have become more sophisticated and will only mature. They have been demanding more creative ways to get exposure to real estate and will increasingly look for a wider catchment of solutions.

Thirdly, in aggregate the amount of capital flowing into the region by global investors has risen dramatically. The capital pool has grown with the ‘early’ investors investing even more in addition to many first-time investors. More recently, we’ve seen evidence of new types of capital entering the fray including more Asia capital. To deploy capital efficiently and seamlessly amid increased competition, all these investors are compelled to seek unconventional venues to gain access to the region’s real estate.

Fourthly, the risk/return opportunity set has undergone a notable change at not only individual market level but also sector level. A secular growth in more operation-intensive sectors has scaled up Opco/Propco deals where investors gain exposure to the Opco either to enhance control (and learn) or get exposure to the fee stream.

If we had to generalise, most global investors ‘new’ to the region a decade or two ago did find exposure via direct assets, private or publicly listed vehicles. Fast-forward, the market has evolved and partnerships, joint ventures (JV), club deals, recapitalisation and co-investment have become more prominent. The way the corporate governance works for these ventures is often different versus private funds. Also, the offering in the private fund market has changed. As an example, about 10 years ago there was effectively no pan-Asia open-end core funds; currently there are about a dozen offerings and their aggregate market cap has grown to over US$25 billion. Also, we have seen an emergence of funds focused on secondaries and recapitalisations both regionally and globally.

The public markets have also tremendously grown in size — the overall market capitalisation of the Asia Pacific REIT market has risen to US$355 billion from US$205 billion over the last decade. The debuts of the pioneering REITs in the region — CapitaMall Trust in Singapore in 2002 and Link REIT in Hong Kong in 2005 — have inspired many to follow suit, helping revolutionise the regional REIT landscape. Now, REIT markets in Japan, Singapore, and Australia have become markets on their own. In Korea, China and India counterparts are still in their early stages but are growing at a brisk pace. This growth of the REIT market will further increase transparency in the sector as well as diversify a path to exit for private funds and other ventures.

Now, these aforementioned drivers and the revolution in the industry regionally are leading to the emergence of recapitalisation and co-investment as the two distinguished trends in the market. In our observations and investor interactions, first of all, this recapitalisation wave is taking many forms while fundamentally drawing its definition as any material change in equity ownership to the underlying real estate investment.

Broadly speaking, real estate recapitalisation is split into two categories — asset level and portfolio/entity level. Over the last decade, each segment has gained traction rapidly among investors, evolving into a more common way for investors to get exposure to the real estate they are targeting. More recently, investors are also using it to rebalance their real estate portfolio.

In Asia Pacific, the recapitalisation market is at varying stages of development and acceptance. Typically, the simplest form of the recapitalisation transpires at asset level. Over the past decade, larger investors have become keener to join forces with like-minded investors and teaming up with the right manager to acquire prime assets across the region. The joint venture arrangement allows investors to gain more manageable exposure, sidestepping over-concentration risk. Also, co-investors gain marked benefits from sharing pre- and post-acquisition costs and risks including due-diligence and asset management.

The joint venture market now accounts for 16% of the Asia Pacific investment market, and 32% of the market if large size transactions with more than US$500 million or above are only considered. Intriguingly, the joint venture space in Singapore and Australia, arguably the more advanced part of the region, represents 23% and 24% of the overall investment market respectively (these shares surged to 61% and 62% respectively if including only US$500 million or above deals).

Asia Pacific JV share as % of total transaction (>US$500 million) 2011-2022

Source: RCA

Australia JV share as % of total transaction (>US$500 million) 2013-2022

Source: RCA

We expect many of these ventures to be recapitalised over the next several years with many investors engaging in a partnership — particularly pension funds, insurance companies, and sovereign wealth funds — now increasingly turning to the recapitalisation market to facilitate earlier exits. Conversely, this is also being driven by the opposite needs of long-term and strategic investors who desire to hold assets longer, leading other parties to resort to recapitalisation.

Another catalyst for recapitalisation at the asset level is a notable uptick in partial stake sales. In its early days, partial stake opportunities had been frowned upon as investors favoured taking a 100% ownership to manage an asset at their discretion. Furthermore, attractive partial stake investments remained scarce as they were tightly held by real estate operating companies and large-sized corporates.

More recently, however, investors have started to adopt more open attitudes towards these schemes, especially into core asset opportunities. Simultaneously, many real estate operating companies (REOC) and corporates have been refocusing their real estate portfolio, recycling capital from selling some stakes in some of their trophy assets. These recapitalisation opportunities have become more prevalent over the years particularly in Australia but also more so these days in Singapore and Japan. We expect this trend to spread to other geographical markets in Asia as well, in particular to South Korea and Hong Kong.

APAC partial stake sales 2013-2022

Source: RCA

Similarly, entity-level recapitalisations are increasingly coming into view across the region. In Asia Pacific, at the centre of a rise in entity-level recap is a two-decade long boom of ‘build to core’ strategies, not driven by market downturns or poor fund performance. In fact, over the last 20 years, the Asia Pacific investible stock has grown tremendously on the back of ‘build to core’ investment strategies.

Funded by larger global investors, many of these ventures via joint ventures, club deals and/or separate managed accounts have now become old vintages with their fund life drawing to a close. Additionally, we believe over half of the assets in these ventures have already stabilised, transforming into income-producing core assets spanning from office, retail to logistics markets (to a certain extent residential as well). Examples include those large-sized European and Canadian pension funds, who started relatively early in forming joint ventures and partnerships in retail and logistics sectors.

Some of these institutional investors may now aspire to exit their positions — either fully or partially — to realise returns and re-deploy into other fast-growing sectors, including but not limited to living, data centres, life sciences, and cold storage. Some are even attempting to re-allocate the redeemed capital into a maturing tourism/lodging industry or value-added opportunities at office from tactical allocation perspective.

In return, those exits will present attractive entry points for new investors as they are allowed to 1) mitigate J-curve and blind pool risks, 2) gain a direct exposure to income-producing real estate in conjunction with an access to development pipeline, and 3) pour money into an outstanding fund manager with proven track records.

Another driver behind entity recapitalisation is portfolio rebalancing needs arising from numerous elements such as the denominator effect, portfolio reweighting, mismatches between capital calls and distributions, all of which could abruptly force investors to unwind their stake ahead of other co-investors. Furthermore, regardless of fund vintage or investors’ needs, entities are constantly undergoing various types of corporate restructuring activities including leverage adjustments, spin offs, divestments, and IPOs. Most of the time, these activities involve recapitalisation plays spurred by a re-adjusted capital mix between equity and debt.

With these drivers in mind, we estimate roughly 25% of the prospective entity/fund level sales could tap into recapitalisation market over the next five years, translating into a US$5-7 billion entity-level recap market per annum for the region.

Another salient trend we foresee in Asia Pacific real estate is an increased activity in co-investment deals. Co-investment has over the years become a popular feature in private equity real estate funds as GPs increasingly attempt to add this particular right to woo prospective and existing LPs, basically granting them an additional investment opportunity to get exposure to assets alongside a fund. This offering mutually benefits GPs and LPs. From the GP perspective, co-investment, first and foremost, allows GPs to further cement their relationship with LPs. This also helps GPs scale up their AUM. Equally, LPs are rewarded with better perks. Some frequently cited benefits are a closer relationship with manager, diversification, control and visibility, accelerated capital deployment, fee advantage, and improved returns.

More Asia Pacific real estate funds starting to offer co-investments

Source: Preqin, only included funds showing this optionality 

More fundamentally, the emergence of co-investment deals is closely linked with the highly concentrated fund-raising landscape as well as the launches of second-generation real estate funds. As repercussions of the pandemic and historically aggressive monetary tightening, the number of funds that raised capital has plummeted to 56 in 2022 from 131 in 2019 even though the total raised capital jumped to US$29.1 billion from US$23.7 billion over this period.

APAC real estate fund raising – average fund size and the number of funds that raised capital

Source: Preqin

The dominance of large-scale managers in the industry underlies an increasingly competitive fund raising environment for many small and mid-sized managers. On a similar note, of late, many individuals armed with relevant track records have successfully spun out of large managers, building out their own platforms and brands especially in living, data centres, logistics, and self-storage sectors.

In this backdrop, co-investment would play a pivotal role, aiding these lesser-known fund managers to plug their financing gap, quickly pooling the required capital from their LPs. We believe numerous co-investment opportunities anywhere between US$25-100 million are likely to come to the fore across the region over the next several years, offering a unique set of opportunities — higher return but reduced risk and costs compared to traditional commingled funds — for global and regional institutional investors.

On a separate note, several managers in Asia are seeking equity growth capital at GP level and will offer the opportunity for strategic capital to take an equity stake in the platform whilst providing funding/co-investment at asset level at the same time. Examples are Canadian insurer Manulife and Korean insurer Samsung Life taking a minority stake in Arch Capital and Savills IM respectively. This trend as a drive to scale is expected to give rise to more M&A activities whilst further diversifying the investment landscape in Asia Pacific.

We expect the recapitalisation and co-investment trend to continue because it will offer interesting investment opportunities with a different risk/return profile especially where it requires a more specialist skill and expertise to underwrite and investors have to become more creative to find good products and the right partners to work with.