[Why&Next] Overseas Real Estate Public Offering Funds, Will Waiting Reduce Losses?

Due to the prolonged high interest rates and a sharp increase in vacancy rates, the value of commercial real estate in the United States and Europe has declined, raising concerns about losses among overseas real estate fund investors. Some funds have faced situations where they have no choice but to sell their properties at prices lower than the purchase price. Investors are reluctantly agreeing to extend the fund maturities, but there is no guarantee of recovering the principal. Some are optimistic, expecting commercial real estate prices to rebound from next year, when interest rates may be lowered and vacancy rates recover.

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According to financial information provider FnGuide on the 20th, the net assets of overseas real estate public funds amounted to 2.4971 trillion KRW, down 8.7% from the end of last year. The net assets of overseas real estate public funds grew from 888 billion KRW in January 2016 to 4.3011 trillion KRW in January 2022, but have since decreased by more than 40% in two and a half years due to the sharp rise in benchmark interest rates in major countries including the U.S.

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The maturity period for overseas real estate public funds is typically 5 to 7 years. The maturity of overseas real estate fund investments set up in 2018-2019 is now approaching. The 'Aegis Global Real Estate Investment Trust No. 229 (Derivative Type)', which has recently raised concerns about losses, was also established in October 2018. In 2018, before the global outbreak of COVID-19, European commercial real estate was regarded as an investment asset that could expect capital gains from asset value appreciation based on stable rental income.

However, with the rise of remote work during the COVID-19 pandemic, preference for commercial real estate declined. From 2022, as inflation concerns grew, central banks in major countries rapidly raised benchmark interest rates. With rising interest rates and the outbreak of the Russia-Ukraine war, commercial real estate transactions in Europe decreased. Only properties priced below appraisal values are occasionally traded.

According to Kiwoom Securities, as of February this year, office transaction volumes among commercial real estate worldwide decreased by 16% compared to the same period last year. Retail and industrial building transactions also fell by 25% and 26%, respectively. Choi Jaewon, a researcher at Kiwoom Securities, explained, "Since the second quarter of 2022, commercial real estate prices have continued to decline," adding, "Overall commercial real estate prices have dropped 12% from their peak." He further noted, "The spread between the capitalization rate (Cap. rate), which gauges commercial real estate yields, and market interest rates has significantly narrowed," adding, "This is a factor that makes improvement in investor sentiment difficult."

As losses in funds invested in European real estate increase, fund managers are taking measures such as extending maturities. An asset management industry official explained, "Due to the decline in asset valuation, the loan-to-value ratio (LTV) has increased, causing cash trap or event of default (EOD) situations in loan contracts," adding, "With interest rate hikes, refinancing leads to higher interest rates and reduced yields, creating unfavorable conditions." He continued, "Project funds with maturities have limited solutions compared to perpetual large funds," adding, "Properties with heavy loans are facing difficulties in extending or refinancing loan maturities."

In some funds invested in European real estate, the loss rate exceeds 50% compared to the initial benchmark price at the time of establishment. Although the exact loss amount cannot be confirmed until the properties are sold and the funds are liquidated, the real estate market conditions are not favorable for recovering the principal. Amid expectations that the special purpose company (SPC) related to Aegis Global Real Estate Investment Trust No. 229 will enter bankruptcy proceedings, Aegis Asset Management is preparing countermeasures with local law firms. It is expected to take about 1 to 2 years if a bankruptcy trustee appointed by the local court leads the asset sales. Aegis Global Real Estate Investment Trust No. 229 is a real estate fund that purchased the office building 'Trianon' in the central business district (CBD) of Frankfurt, Germany, aiming for operating income and asset value appreciation. Considering the current German real estate market situation and loan interest rates, it is highly likely that the property will be sold at a price lower than the purchase price. The evaluation loss rate compared to the initial benchmark price is about 80%.

‘Korea Investment Belgium Core Office Real Estate Investment Trust No. 2’, established by Korea Investment Real Asset Management in 2019, is also among the funds with large losses. The loss rate reaches 68%. Attempts to sell the held properties failed to find potential buyers, and the maturity date was extended to May 2029. With inevitable loan interest rate increases, neither a market recovery nor a sale at a low price seems favorable.

Investors in overseas real estate funds are hoping only for an improvement in the real estate market and a reduction in principal loss. Most experts agree that the overseas real estate market has approached the bottom. However, opinions differ on the timing of the rebound. Vacancy rates are expected to decrease next year. Although vacancy rates vary depending on the real estate consulting firm reporting the results, the prevailing view is that this year will mark the peak. Global companies such as Microsoft, Amazon, Google, and Apple prefer office work over remote work, which is expected to lower vacancy rates. As of March, the office return rate in the U.S. is 61% compared to January 2020.

Han Sewon, a researcher at Shinhan Financial Investment, analyzed, "It is highly likely that the U.S. office vacancy rate peak will be confirmed after the second half of this year," adding, "New office supply is decreasing due to issues such as construction costs and financial burdens."

According to global real estate services firm CBRE, the average office vacancy rate in the U.S. market is expected to reach 19.8% by the end of this year, up about 1.6 percentage points from last year. Real estate consulting firm Cushman & Wakefield reported that the national average office vacancy rate in the U.S. is 20.2%, up 2.1 percentage points from the previous year and 7.7 percentage points higher than before the COVID-19 pandemic. Some regions in the U.S. have already seen vacancy rates fall below 15%. The North American real estate market, including the U.S., accounts for 74% of the total private real estate deal volume, making it the largest market.

Kim Misook, a researcher at KB Securities, analyzed, "With the U.S. benchmark interest rate held steady at 5.5% early last month, the commercial real estate market situation is developing differently by region and asset type," adding, "Overseas investors are proceeding with investments, viewing this as a buying opportunity at low prices."

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