Practice Area Articles

Asian Capital Investment

December 13, 2020

By Paul Hastings Professional

Market Insights: Asian Capital Investment

In today’s complex environment, our clients require a clear understanding of critical developments taking place in markets around the world to help them move their businesses forward. In our Q&A, London Real Estate partner Jeffrey Diener and Shanghai Corporate partner David Wang share their perspectives on current trends in Asian capital investment in international real estate – and what these developments mean for local market participants.

Is Asian capital investing directly or indirectly?

The short answer to this question is “both,” with indirect investment being the more widespread model for now (more on timing to come). That said, this hinges on how you define “indirectly.”

In today’s European market, the most common model is the Asian capital investor joint venturing with a local operator. The Asian investor brings the bulk of the capital, and the local partner brings the local expertise and some capital, to the deal. The local partner is able to source the transaction and then manage the asset through disposition.

What roles do the capital investor and local partner typically play in these joint ventures?

In days past, the capital investor was typically expected to sit back and let the local partner manage the asset. In a typical transaction, the joint venture vehicle enters into asset management and property management agreements with affiliates of the operating partner. The capital partner then usually only gets involved in major decisions such as approval of the business plan and annual budget, asset sales and refinancings, major leases, major contracts, and changes to the joint venture structure.

This brings us to the above point regarding how you define “indirectly.” Asian investors may enter into transactions which are based on the above JV model, but they now often expect such a high degree of control over day-to-day operational matters and long-term strategic matters that such control no longer fits within the definition of “indirect” investment from a western perspective.

Among other things, Asian investors in recent deals generally negotiate for expanded lists of “major decisions” (also referred to as “reserved matters” or “major matters”) and expect to be consulted on what a western operator may deem the minutiae of the operations (i.e., architect selection and invoice review processes).

Why the atypically high level of involvement in the asset and property management?

One reason is that the investment teams face significant pressure from within their organizations to obtain a certain degree of control over their investments. The investor partner’s viewpoint is “If we’re putting in the majority of the capital, then we should have the majority of the control,” whereas the operator partner’s viewpoint is “You want to work with us because we know how to manage these types of assets, so let us do our part.” This is often the most difficult issue to bridge in these joint ventures.

On a related note, certain Asian investors’ inexperience with investments outside of their home countries and new and untested relationships breed distrust, which can be assuaged through greater control. It should also be noted that some of these savvy investors have a lot of experience with western investors in their home countries and have seen the western investors make spectacular returns on Asian assets for decades.

The Asian investors have learned from those decades and want to replicate the model now that they are on the buy-side. Further, some Chinese investors believe that the “China element” is what will make a project successful and if the Chinese party is bringing the China element to the table, then it should have control both as compensation for that value and to control the way that the China element is implemented.

Finally, and this brings us back to our first point that the “indirect” model is more popular for now, these investors do not plan on sitting in the backseat for long. In many cases, these are very sophisticated real estate managers, but sophisticated in operating assets in their home countries. Many of the Asian investors are arguably teaming up with local operators to learn the lay of the land and gain experience with managing European assets.

Also, although many of these investors have substantial operations in their home countries, they do not have much, if any, local presence. This makes it very difficult for Asian investors to gain access to deals in a very competitive market. However, considering their very deep pockets, long-term perspective, investment know-how, and a cost of capital that differs from U.S. and European private equity funds, we would not expect the Asian investors’ dependence on local partners to last for very long.

This article first appeared, in a different format, in Property Investor Europe.