Morgan Stanley's (MS) bid to buy a Seoul office tower for some $1 billion underscores global investors' voracious appetite for Asian real estate assets. It also reflects fierce competition, led by investment bankers and fund management companies, for office space in the South Korean capital, which, until last decade, was shunned by foreign property investors.
The 1997 Asian financial crisis and subsequent deregulation opened Korea's real estate markets. But not to the extent that anyone ever paid as much as $1 billion to buy a Korean office building—especially one that's 30 years old. "Prices (for Korea's commercial buildings) have really launched ahead in the last three to six months," says Seoul associate director Steven Craig at Jones Lang LaSalle (JLL), a Chicago real estate consulting and brokerage firm. "We have a situation now where there are 10 buyers for every seller."
Morgan Stanley, the largest property investor among U.S. banks, won exclusive rights to buy the 23-story headquarters of Daewoo Engineering & Construction in late June, according to bankers familiar with the deal. Although the building is a landmark overlooking Seoul's main railway station, its drab boxy appearance would need remodeling if it were to be offered as a modern office tower. New York-based Morgan outbid Australia's Macquarie Bank, Korea's Kookmin Bank, and Koramco Reits Management & Trust. Morgan Stanley and Daewoo Engineering declined to comment (see BusinessWeek.com, 12/26/06, "Biggest Real Estate Deals of 2006").
To be sure, Asia isn't the only place on the planet where commercial real estate is hot. On June 30, a Park Avenue office building in Manhattan sold for $1,589 per square foot—a new record price in the U.S. on a per-square-foot basis. And Europe is undergoing a major boom of its own (see BusinessWeek.com, 5/29/07, "Europe's Commercial Real Estate Boom").

Commercial Boom Arrives

Now Asia has joined the boom. If the Korean transaction comes through, it will be one of the first from Morgan Stanley's $8 billion property fund—the world's largest—recently built to capitalize on surging demand for real estate in Asia and emerging markets. Major investment destinations include Japan, China, and India. In the Asia Pacific region, investment in commercial real estate by global players reached $94 billion in 2006, up 42% from 2005, according to Jones Lang LaSalle. In Seoul, Singapore's Government Investment Corp. (GIC) has been a major property investor, buying the 30-story Seoul Finance Center in central Seoul for about $460 million in 2000 and a 45-story building, Star Tower, in a trendy district in southern Seoul for more than $900 million in 2004.
The $1 billion deal, however, isn't the U.S. investment bank's biggest property foray into Asia. In April, it concluded Japan's largest real estate deal by a foreign investor by paying $2.4 billion for 13 luxury hotels, including the flagship ANA InterContinental Tokyo and the Manza Beach Hotel & Resort in Okinawa, from All Nippon Airways.

Global Property Investors Target Asia

Morgan Stanley is among a host of overseas investors seeking to profit from Seoul's tight leasing market. Others include Merrill Lynch (MER), Macquarie, GE Real Estate, Deutsche Bank (DB), Germany's DIFA, or Deutsche Immobilien Fonds, and Singapore's GIC and Ascendas.

Demand for Space

It's easy to see why foreign investors are flocking to Seoul. Real estate researchers forecast demand for quality office space will continue to outstrip supply for years to come. Jones Lang LaSalle's Craig says Tokyo and Seoul are the top two Asian cities suffering from an acute shortage of good-quality office space. Seoul's vacancy rate for "Grade A" office buildings was 1.3% in the second quarter of this year following a brief technical uptick to 3.4% in the first quarter—when five new buildings opened in preferred areas—from 1.4% in the fourth quarter of 2006. The vacancy rate was 6.3% five years ago.
One strong driver of growth in demand for prime office space is the financial sector. Major global investment banks, including Merrill Lynch, Morgan Stanley, JPMorgan Chase (JPM), and Lehman Brothers (LEH), all doubled their presence in Korea in the past two to three years. "We managed to find one more floor for our office space recently, but we'll soon have to add more," says one U.S. investment banker in Seoul who asked not to be identified. "Our real estate team is very actively tapping into Korea's tight leasing market."
Few new buildings are being developed in Seoul's central business district because of the difficulty of consolidating existing land parcels, although ultra-high towers are being built on the outskirts of the capital (see BusinessWeek.com, 5/29/07, "Europe: Commercial Real Estate Sizzles").

Investment Opportunity

Both foreign and local asset managers are also expanding their offices to cater to a growing number of rich individuals. A Merrill Lynch report in June said the number of Koreans with net assets of at least $1 million, excluding their primary residence and consumables, jumped 14.1% last year to 98,925. U.S. fund manager Franklin Templeton (BEN) said in June that assets it raised from Korea grew to $6 billion in June from $4.2 billion eight months ago, and could rise to $10 billion in the next three to five years.
The country's rapidly aging population is also creating a rising pool of pension funds. "We believe asset management and investment banking will play an ever bigger role as pension funds and wealthy individuals seek better returns than stocks and bonds offer," says Ahn Young Hoe, chief investment officer at fund manager KTB Asset Management in Seoul. The services sector, which generally requires better-quality offices, now accounts for only about half the country's GDP but will likely spearhead future economic growth.
Perhaps more important, local companies have joined the race to find higher-quality office space. "With Korean companies competing with multinational firms for the same talent pool, we do expect in coming years that Korean firms will increasingly try to upgrade the standard of offices they operate in," says Jones Lang LaSalle's Craig. Korean companies are also placing more emphasis on improving their working environments as they seek to start new trends or create new products through innovation rather than catching up with industry leaders as they have in the past.
It all adds up to accelerating rental growth in Seoul. Jones Lang LaSalle expects average rents in central Seoul to rise by about 6% annually over the next three years, about double the growth in the past year. Local vendors are well aware of the trend, and that's why sales transactions subsided in the past 18 months. Sure, $1 billion is a huge sum, but a remodeled Daewoo building is going to be worth its weight in gold.