Sovereign Wealth Funds Go After Western Property

In many United States gateway cities, London and Paris, among others, it's likely that a growing number of the skyscrapers are actually owned by a foreign government through sovereign wealth fund.

So much money is pouring into large office buildings and shopping malls in major US cities including New York, Washington DC and San Francisco that they are driving leasing demand in those cities, according to several reports on the industry.

It isn't just real property. They are buying up schools, sports domes and forestlands. The Government of Singapore Investment Corporation bought the Fukuoka Yahoo Japan Dome from Colony Capital in 2007 for ¥50 billion, then spun it last year to Softbank for ¥87 billion. China Investment Corporation, in order to respond to rising lumber demand, purchased 254,000 hectares of forest in Vancouver Island, Canada, from Brookfield Asset Management in 2012.

Asian and developing world sovereign wealth funds, awash in money from oil revenues or swollen foreign exchange reserves, in fact are playing a major role in propping up faltering property markets in the recession-bitten west, discouraged as the funds are by faltering yields their own markets, according a report by the Seoul-based Samsung Economic Research Institute, written by Research Fellow Kim Han-Kyul.

There has been rising concern in the west since the onset of the 2008 global financial crisis as the funds have invested in the west, critics say, because of a worry that foreign nations that control them are gaining too much control over western financial and other institutions and that these nations could use that control for political reasons. US and European lawmakers also assert that the funds pose a threat to national security because of their lack of transparency. Their advocates point out, however, that the deep pocketed funds played a major role in rescuing rescue struggling Western banks including CitiGroup, Merrill Lynch, UBS and Morgan Stanley.

The US has been the leading destination for direct investments by SWFs since 2005, accounting for around a fifth of the total during the period. The UK followed with about a sixth. Other important destinations include China, France, Switzerland, Germany and Qatar. Emerging market countries have accounted for a growing share of investments over the past two years, a trend that is likely to continue, SERI says.

Some of the biggest and most active are the Brunei Investment Agency, the Temasek/General Investment Corporation of Singapore, Korea's National Pension Services and others. Assets managed by sovereign wealth funds have increased by three to five times over the past 10 years, totaling at least US$5 trillion in 2012, according to the SERI report.

The International Forum of Sovereign Wealth Funds, a group of 24 funds led by China, Russia and the Gulf States that have combined assets of around $4 trillion, is establishing a London secretariat to facilitate their operations.

Until fairly recently the financial service sector has drawn most of the funds, according to a report by The CityUK, a London-based NGO, with about a third invested. The funds, seeking a safe haven, have favored the United States, with about 20 percent of the total invested since 2005, followed by the UK at 16 percent. Other important destinations include China, France, Switzerland, Germany and Qatar.

"With their deep pockets, sovereign wealth funds (SWFs) have become influential players in international financial markets," SERI said. "Their investments in stocks and currencies of emerging market economies have boosted asset prices while their declining purchases of eurozone government bonds have driven down bond prices in southern European countries."

"Over the next 10 years, the real estate allocation is expected to double," the SERI report notes. "Norway's sovereign fund in particular, plans up to a 5 percent position in real estate by 2020, a commitment of US$30 billion. In addition to SWFs, pension funds, private equity funds and asset management companies are also increasingly being drawn to property investments."

The catalysts for the move to the property market include declining returns and confidence in stocks and bonds at a time when prime property has remained depressed due to the global financial crisis which began in 2008 and the popping of a massive property bubble. The funds' ability to take a long view means they can buy and hold property for the long view. Their positions rose 36 percent in 2012 to about US$10 billion.

Second, as the report notes, property investments are a way to spread risk and hedge against inflation. Returns on real estate have low correlations with those of financial assets, and thus mitigation of risk is possible. Third, real estate fits the long-term investment horizons of SWFs, which normally are not forced to unload assets to raise cash like ordinary financial institutions.

The funds have been shifting from large European cities, where prices already have risen, to the US, which is just emerging from the devastating effects of the 2008 meltdown. At the same time, SERI says, the SWFs have also gravitated to southern Europe, where property carries a higher risk but at deep discounts. They are diversifying risk by going beyond offices and residential housing to industrial buildings and even schools, while investing in large-scale development projects that are in their initial stages.

The attention to the US's gateway cities is built on the US economic recovery. Direct investment in US real estate rebounded after the global financial crisis to top US$2.5 billion in 2009. For example, South Korea's National Pension Service bailed out of the 18-storey commercial building it owned at 88 Wood Street in the heart of London's financial district and increased its investments in the US. Norway's SWF already has purchased 49.9 percent of five office buildings in New York, Washington and Boston for US$600 million from TIAA-CREF.

As competition has intensified for prime office space in London, Paris and other European cities, the funds have turned to bargain hunting for distressed assets in southern European countries whose banks are cleaning up their balance sheets and unloading non-performing properties at bargain rates.

"Their efforts to dispose of bad debt have bloated the property market in beleaguered European countries, creating deep discounts. In 2012, Deutsche Bank acquired distressed property loans in Ireland from the UK-based Lloyd Banking Group at an 83 percent discount of €360 million. SWFs are also seeking investment in European distressed assets whose price merit has increased. Korea Investment Corporation has announced plans to invest in European distressed assets. Also, in 2012, Korea's national pension fund invested W74.9 billion in Spanish property and W141 billion in Italian real estate.

In addition to conventional real estate like office buildings, SWFs are increasingly diversifying into industrial complexes and school buildings. In 2012, the Norwegian wealth fund through a joint venture with US logistics firm ProLogis bought 50 percent of a portfolio of logistics facilities for €1.2 billion. The portfolio consists of 195 logistics facilities in 11 European countries.

Sovereign wealth funds have traditionally preferred investing in already developed real estate, but there are a growing number of funds (centering on Middle Eastern sovereign wealth funds that have a proactive investment strategy) that are investing at the initial stages of projects. Since Middle Eastern sovereign wealth funds are derived from oil experts, they are less burdened than SWFs that depend on foreign exchange reserves.

Consequently, they can engage in more aggressive investments. These Middle Eastern SWFs are investing in infrastructure projects at the planning stage, which is necessary in a national perspective, even if they have low business value. During the process, they are inducing participation from private developers.

Recently, for instance, Qatar's SWF established a US$26 billion joint venture with Deutsche Bahn, a German railroad company, and began building the Qatar railway. Middle Eastern SWFs are also establishing joint ventures with local developers in their overseas real estate investments to directly pursue development projects, rather than making direct purchases.

That is because they can reduce risk through a joint investment with local developers and increase returns through investment in the initial stages of development projects. In 2012, Qatar's sovereign wealth fund established a plan to develop an ultra high-rise building in Jakarta through a joint investment with KLCC Property Holdings Bhd, a state-funded development firm in Malaysia.