A trip to the restaurant that sits atop the No. 1 Poultry office block in London's financial district is a chance to experience firsthand the "Tale of Two Cities" that's upending the commercial real-estate market.
From the vantage point of the Coq d'Argent you can gaze out at a forest of new skyscrapers that developers hope will bring in big rents and even bigger prices. For the South Korean owners of the older WeWork-occupied building down below, the future looks far bleaker.
Taking in the view, Kaela Fenn Smith - ex-executive at property giant Land Securities, and now managing director of CBRE Group's ESG consultancy - speaks of the "huge flight to quality" transforming the office market where only "the truly grade-A space" will do. Her comments come as flawless environmental credentials become a must for corporate renters, many of whom are thinking about downsizing because of the WFH revolution.
This "super-prime" stampede might be a boon to owners of those gleaming modern towers, but it's bad news for older places like No. 1 Poultry. In big cities everywhere, owners of these B-list office blocks face the prospect of wildly expensive refurbs - or depressed sales.
South Korean investors, who've been on a five-year binge on this second tier of commercial buildings, look particularly exposed. Seoul's Hana Alternative Asset Management is preparing to put the Poultry site back up for sale, people with knowledge of the process say. Its estimated worth is £125 million ($164 million), according to the same people - about a third less than Hana paid.
"The asset has never been" for sale and the firm is in the refinancing process, Hana said in an emailed statement on Wednesday, adding that the valuation "isn't correct" and has "never been quoted," without elaborating further.
Its unhappy experience is far from unique. Prices for this type of property are plummeting around the world, from midtown Manhattan to Hong Kong and Paris. With real estate already reeling from the end of rock-bottom interest rates, a reckoning is coming for many landlords and debtholders.
But Hana's plight does also highlight something more specific: the common involvement of Korean money in buildings of this profile. The country's asset managers splurged tens of billions of dollars on overseas offices and risky property loans in recent years - right before Covid and rate-hiking central bankers drove a bulldozer through the market.
In London alone at least half a dozen large blocks owned by Korean firms are available to buy, people familiar with the sales processes say. Most are struggling with depressed valuations.
South Korea joins a line of nations whose funds made bad real-estate bets, from the Japanese in the early '90s to the Irish just before the financial crisis. "The City of London's history is of investors arriving and then leaving," says Michael Marx, ex-boss of landlord Development Securities. "Some with fingers burnt and some to replace losses in their home market."
Korea's Bad Bet
The genesis of the country's overseas punt is fairly recent. At the end of the last decade, drawn by favorable exchange rates and higher yields than they could get at home, funds from Seoul piled into what they hoped was a treasure trove of hot buildings. In 2019 they were the biggest external investors after the U.S. in Europe's commercial real estate, doing €13 billion ($14.6 billion) of deals in just that year, according to data from MSCI Real Assets.
Between 2017 and 2022, the investors snapped up more than 90 European properties for prices above €200 million each. Many were large blocks in the City of London and Paris's La Defense. Values in both financial hubs have fallen more than 20% in the past year, according to broker Savills.
Koreans were fond of buildings with long leases to well-known tenants, like Amazon, so they focused less on perfect locations or green ratings and worried more about the perceived quality of who was paying the rent. They also liked big sites, which are more expensive to fix up when they become outdated.
Rising construction costs for bringing buildings up to environmental scratch will leave behind ghost and zombie office properties and "be severely value-destructive" for older commercial real estate, Fitch Ratings warned recently, without specifying Korean-owned assets.
"There will need to be a lot of capex" because people are looking at whether older offices might become stranded assets, says Fenn Smith, also speaking generally. "When is your building going to start losing value because it's coming off the net zero pathway to 2050?"
Unfortunate Timing
Financially, the timing of the market shakeout couldn't be much worse for Korean investors. About 30 trillion won ($24 billion) of their property funds mature through 2025, according to data provided by national watchdog the Financial Supervisory Service to opposition party lawmaker Oh Gi-hyoung. That's almost 40% of the total, meaning a flood of commercial buildings could be about to hit the market at a time when demand has cratered.
The country's funds usually invest for five years, less than the international average, making it harder to hunker down and ride out a downturn, says Yoon Jaewon, head of international investment advisory at Savills Korea.
Adding to the stress, many loans used to buy the properties are coming due just as lenders pull back and borrowing costs spiral. Banks are also demanding additional equity from landlords before providing loans.
The FSS is closely monitoring the situation, talking with firms and will discuss the problem at a meeting this Thursday, according to two officials who asked not to be identified as they're not authorized to speak publicly.
While the watchdog is worried about potential losses for domestic investors, a third official says there won't be a rush to withdraw cash because Koreans typically have to wait until a fund winds down. Most are backed by institutional money, which is less likely to panic, the person adds.
The lawmaker Oh says this is too complacent: "Financial authorities should thoroughly inspect the situation and prepare for it, not keep saying there's not much risk."
There's another reason for Korean vulnerability: Europeans were hesitant at times to sell to the country's investors because buyers usually included multiple institutions in a syndicate, people with knowledge of the matter say, making negotiations protracted and at risk of falling apart. That prompted buyers to offer more, sometimes paying premiums of 10% or higher.
There was almost a herd mentality among asset managers eager for yield, says a banker who worked with borrowers on a few of these deals.
Mezzanine Misery
In the U.S. and elsewhere, Korean investors pushed hard into risky mezzanine lending against real estate, providing junior loans that would take the first hit when valuations plunge. Appetite was so high that they'd sometimes accept a lower return than the market, in a few cases doing deals at 6% rather than the 8% or so that others demanded, the banker says.
Some of the loan bets are turning sour.
Payments to mezzanine lenders at a troubled project at New York's 20 Times Square, which includes a hotel and an NFL Experience store, ceased 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 is cutting by 80-100% the value of a fund that provided more than $240m of mezzanine finance to the Goldin Financial Global Centre, according to local media. A Mirae spokesperson says it's focused on recovering money.
Receivers Appointed
Back in London, receivers have been appointed to the former home of BP's oil trading unit at 20 Canada Square in Canary Wharf. It was acquired by China's Cheung Kei in 2017 and financed in part by a mezzanine facility from Seoul's Hanwha Asset Management. Hanwha declined to comment.
A presentation prepared by broker Jones Lang LaSalle, which was attempting to sell the property for Cheung Kei, advised approaching an initial shortlist of potential buyers offering the building for £250 million, well below the value of even the senior debt.
In fairness, Korean funds aren't the only ones to suffer overseas. Several Chinese ventures have struggled too, including another Canary Wharf failure. Some Seoul investors have done well on international property bets: The National Pension Service of Korea has been discerning and been rewarded for it, says the banker who's worked on Korean deals.
Investors have also been shielded slightly by Europe's approach to real-estate valuations, which doesn't take market sentiment into account. With sales largely frozen, there have been few deals to measure the true decline in values. Inflation-linked rent increases have helped as well.
Nonetheless, opportunists are circling, ready to offer expensive new debt to refinance buildings whose owners can't inject capital. Oaktree and other alternative-finance providers have held talks with Korean asset managers about large loan facilities to let landlords restructure investments, according to a person familiar with the discussions. Oaktree declined to comment.
Funds under pressure to extend the maturity of their borrowings are looking to inject more capital or inviting mezzanine investment rather than dumping assets on the cheap, says Yoon at Savills, who adds that a few have pulled sales. Increasingly, however, owners are following No. 1 Poultry's path and having another crack at selling after several failed attempts last year - as seen with the rush for the exit in London.
In Seoul, meanwhile, there's deepening unease about how the endgame will play out for domestic investors. "With overseas commercial real-estate assets declining, there are significant concerns about distress," says Oh.
WASHINGTON POST