A case has emerged confirming that even if domestic investors who invested in foreign real estate funds have decided to wait until the real estate market recovers, they will have to accept losses without recourse if local financial institutions decide to dispose of their assets.
Real estate funds are broadly classified into senior, mezzanine, and junior categories, with the latter two being 'high-risk, high-return' products. Most domestic investors are now positioned in mezzanine and junior categories. When a senior investor decides to sell their assets, junior investors typically have no choice but to follow suit, resulting in them experiencing losses since the proceeds from asset sales go to senior investors first.
According to the Financial Supervisory Service, as of the 27th, many domestic financial institutions have reported that a significant portion of their investments in foreign real estate is in the mezzanine and junior categories. However, they did not disclose precise figures. They are publicly sharing statistics on which sectors invested how much and which regions they focused on quarterly, but the scale of senior and junior investments is only shared internally.
This is a measure taken in light of growing market concerns. Even with the spread of COVID-19 leading to a normalization of remote work and a decline in the value of foreign real estate, there are fears that the significance of the larger share of mezzanine and junior categories—which carries a higher risk of loss—will be revealed. An FSS official noted, “Yes, it is relatively more dangerous, but not all junior investors incur losses,” adding that “it varies among junior investors.”
However, the structure does not allow for complete reassurance. If senior investors withdraw their funds, junior investors cannot take any action, and losses are confirmed. Most foreign real estate funds involve asset management companies pooling funds from domestic investors and then securing loans from local financial institutions to purchase buildings and other properties. In this process, local financial institutions invest in real estate in the form of loans, taking the respective buildings as collateral. Such local financial institutions are senior investors.
For instance, let’s say an investment is made in a $100 million building in the U.S. Asset Management Company A collects $50 million from domestic investors and secures a $50 million loan from a U.S. bank. This is done to maximize revenue through leverage. When the building’s price rises, it’s all good, but the problem arises when the price falls.
As the building’s value starts to decline, if the loan-to-value ratio (LTV) exceeds a certain level, even before the loan maturity, the U.S. bank will initiate a capital recovery process. This means that the asset management company must sell the depreciated building to repay the loan. Senior investors exit, leaving junior investors to bear all the losses.
The fund Korean Investment Real Asset Management’s 'Korean Investment Belgium Core Office Real Estate Investment Trust No. 2 (Derivative Type)' has informed junior investors of the forced disposal of assets by senior investors, resulting in a high likelihood of a complete loss of 9 billion won for the junior investors. Some funds are holding beneficiary meetings to extend the fund's duration, waiting for assets to be sold at favorable prices, but if the senior investors declare their withdrawal, it becomes meaningless.
Funds like the Belgian real estate fund, where losses are nearly confirmed, amount to trillions. According to statistics released by the FSS this month, as of the end of June this year, the total amount invested by financial firms in single real estate funds was 34.7 trillion won, of which 2.61 trillion won has faced an event of default (EOD). This implies that senior investors, the local financial institutions, have the capability to recuperate their loans before the maturity date.
A senior official in the securities industry stated, “In the pinnacle of capitalism, America has no blood or tears,” adding, “When an EOD occurs, senior investors take recoveries without a second thought, leaving mezzanine and junior investors with total losses.”
To make matters worse, even interest rates are not aiding the foreign real estate market. Lower interest rates typically stimulate real estate investments, and rapid rate cuts would be necessary to sell assets at good prices, but that has not been the case. Just last September, the U.S. Federal Reserve (Fed) projected four rate cuts for next year but revised it to two this month, indicating a slower approach to rate reductions than initially anticipated.
However, the assessment by financial authorities is that the massive losses incurred from foreign real estate funds do not significantly impact the soundness of financial firms. This is because the proportion of foreign real estate investments within the total assets of financial firms is at most 3%. The FSS stated, “We will closely monitor establishments with unusual trends, such as EOD,” and announced plans to enhance the risk response system.