Risk warning

The value of investments, and the income from them, can go down as well as up and an investor may get back less than the amount invested. Past performance is not a guide to future results.

In a world of Teams calls and working from home, it can be hard to find an office market with a good story. Well, look no further. To say that the Seoul office market has had a good run in the last five years is an understatement. The average effective rent was up 42.1% and the average gain in capital values was 44.6% over the period. This compares with -14.1% and -4.8%, respectively, across Asia-Pacific (APAC).[1] Seoul was easily the best-performing office market in APAC and one of the best in the world.

This robust performance occurred despite a global pandemic, a 20% increase in the overall office stock and a 200 basis-point increase in interest rates.

Considering an overall vacancy rate of just 2% (see chart), limited near-term new supply, the high return-to-office rate among Korean workers, and the vibrant domestic tech sector that underpins occupier demand, we believe the fundamentals for the Seoul office market remain solid. While sentiment towards offices globally is at an all-time low, is now the best time to get into a market that is towering over the competition?

Chart: Seoul prime grade-A office vacancy rate (%)

Source: Jones Lang LaSalle REIS; September 2023

Timing the market

The spike in interest rates has been challenging and investors are cautious. It is hard to say if the performance in recent years can be repeated. But when it comes to value-add strategies, our experience has taught us that some of the best opportunities tend to emerge when there’s doubt.

In 2017, for instance, there were concerns over high vacancies and weak rental growth prospects, investors were able to capitalise on the poor sentiment and make tactical purchases with higher conviction strategies. abrdn pounced on this gap in the market, with both a forward commitment on a new office scheme and a full-scale office refurbishment project. Both investments benefited from an appealing entry point and the timing meant the market had a chance to recover through the project lead-times.

In the case of the forward commitment, there were concerns at the time about competition from high supply levels. But there had been no new office developments in the project’s vicinity in over 20 years and that gave us the confidence that it would be the stand-out option in an otherwise tired market. It was clear to us that the building offered a different proposition to prospective tenants. We were closely involved in the development process to make sure the project had the look and feel of a premium product. When investors deliver exceptional products like this, the door is open to a wider range of potential buyers with different motivations. Towards the project’s completion, we received an offer to purchase the building for owner-occupation, which suited the investment business plan perfectly.

In the case of the refurbishment project, the asset was in a prime location but poorly managed when we took over. The building was under-rented, the tenants had poor credit ratings, and it had a vacancy rate above 20%. Once it became clear to the market what our plans were, we were approached by an international co-working operator, which was aggressively acquiring space, to lease the entire building once our work was complete. With the asset renovated and fully leased, it was unsurprising that we were able to find a long-term investor interested in an income-producing prime office.

Location, location, location

These two examples were achieved through strong business plans and conviction in the stories we were selling to our investors. From this experience, we learned that value-add work begins before the acquisition.

When taking a risk-on approach, the first rule must be to create a product where companies absolutely want to be – most often supply constrained central business districts.

Secondly, when the buyer already has capital in place, the seller is reassured that the deal will close smoothly. This gives the project the best chance of a good start.

Lastly, having a high-conviction business plan for each asset ensures quicker and more efficient project management. It also provides the earliest sign that the project needs amended.

Conviction calls, not video calls

Investors are understandably cautious given the macroeconomic uncertainties and the bad reputation that global offices have earned themselves. But we see a lot of potential for value-add strategies to work in the Seoul office market. With restricted access to project financing for many borrowers, prospective buyers with ready capital to deploy are in a good position to maximise their bargaining power. They can target special situations or sellers who might be in distress.

Importantly, there is also less competition from domestic institutions, given they typically dominate the market with competitive pricing when market sentiment is more bullish. This is especially the case for value-add properties, since these investors tend to focus on stabilised assets to minimise risk during times when the market outlook is less certain.

We believe office sector sentiment is close to rock bottom. We are likely at the tail-end of the monetary policy tightening cycle and we expect interest rates to trend lower over the next three-to-five years. As such, we believe this is an opportune time for investors to target troubled office assets in prime parts of Seoul, which could benefit when the market recovers.

Paul Lee, Head of Direct Real Estate – APAC & Korea

  1. Jones Lang LaSalle REIS data