ESR Kendall Square REIT Eyes Disposals as Korea Logistics Market Matures

Korean real estate investment trust ESR Kendall Square REIT has identified up to five assets for potential sale this year as Korea’s industrial property market begins to normalise following a surge in supply during the pandemic, according to EKSR chief executive Sanghwoi Bae.

The trust, which listed in December 2020 as Korea’s first pure-play logistics REIT, expects its capital recycling strategy to benefit from profitable disposals amidst strong demand for high quality logistics assets from core and value-add investors.

“We have a large pool of potentially lucrative dispositions for our capital recycling objective — roughly four to five candidates — that would create a very strong appetite from potential buyers and would hand us an even better profit margin than the 25 percent we generated from our disposal last year, especially given the market expectation on the normalizing rates,” Bae told Mingtiandi. “Once the market normalises in 2024, because our fundamentals have remained so strong, we do expect core and value-add investors to seek opportunities again in Korea’s logistics sector.”

Backed by Hong Kong-listed industrial heavyweight ESR and Canadian pension giant CPPIB, EKSR expects e-commerce and third party logistics (3PL) growth in Korea to continue driving leasing demand for sheds despite market concerns of slowing e-commerce growth coming out of the pandemic.

E-Commerce and 3PL

The trust has boosted leasing to e-commerce and 3PL providers, with the two categories respectively accounting for 60 and 28 percent of its tenant portfolio as of November 2023. Among its tenants is Korea’s largest e-commerce platform Coupang, which Bae noted had overtaken offline retail giant Shinsegae last year as the second largest retailer in Korea.

“What we are seeing today is, even within Coupang, their specific services have been relegated to more of a B2B platform serving mid-sized 3PLs, who need to cater to giants like Coupang and Naver. These are the new players occupying new spaces in our portfolio,” said Bae. “This is a critical point because the more specified and sub-divided each value chain gets within the e-commerce universe, you simply need more space to process and less space to store.”

EKSR, which currently has 18 assets spanning 1.2 million square metres of gross floor area, has maintained 100 percent occupancy across its facilities since its IPO. The trust secured a 100 percent renewal rate for its lease agreements expiring in 2023 with an 18 percent average rent increase, which the company attributed to growing demand from mid-sized 3PL providers.

The trust’s portfolio had a weighted average lease expiry of 3.7 years as of November 2023, with 78 percent of leases expiring in 2 to 5 years, according to company disclosures.

Market Normalisation

The expansion of Korean e-commerce through the pandemic has turbocharged investment in warehouse projects, with investors growing increasingly concerned with oversupply. During 2023, the number of new warehouses of more than 10,000 square metres registered reached an all-time annual high of 114, according to a December report by consultancy Colliers citing data from Korea’s National Logistics Information Integration Centre.

EKSR sees that figure providing a high-water mark, with the market set to level off in 2024 as speculative capital leaves the field.

“We are seeing the exiting of opportunistic capital from the market, along with the volume of non-materialised projects in 2023. There is a great discrepancy between planned supply and the actual materialised, completed assets that will be available in 2024. This means that we can expect 2024 will mark the beginning of the market normalisation for the logistics market,” said Bae.

Bae’s assessment is echoed by Colliers, which observed that recent interest rates for asset-backed securities used as project financing for logistics centres have increased to 8 to 9 percent, making it more challenging for developers to raise capital and complete logistics projects.

Share Price Skid

Despite growing its assets under management by 67 percent and boosting its operating revenue by 89 percent since 2021, EKSR has seen its share price decline since May 2022, with the stock now trading at 27 percent below its IPO price.

The trust attributed the underperformance to macro factors including elevated interest rates and high-yielding US Treasurys, as well as a lack of understanding of Korea’s REIT market among investors which would allow for recognition of trusts which are outperforming the market or which have more attractive fundamentals.

“The K-REIT universe is still at a very nascent stage. Investors look at it against US Treasurys and the Korean policy rate, but they have yet to realise that it is also important to compare a single product against other products in the K-REIT universe,” said Bae.

Bae noted that the company’s December refinancing of roughly $373 million in senior bank loans was achieved at 4.7 percent, the lowest possible rate for Korean commercial real estate borrowers, which compares to 5 to 8 percent rates for typical mezzanine financing in the sector. The company also highlighted that the quality of EKSR’s offering is reflected by the fact that it is the only K-REIT with double digit foreign shareholding, with more than 50 percent of its equity held by international investors.

According to Bae, macro factors including interest rate hikes have curbed expansion of the K-REIT sector, with boosting the asset class’s scale and liquidity a key to generating more investor interest.

“In order for larger masses of capital and investors to come into the Korean market, creating more liquidity for everyone is extremely important. Right now, ESR Kendall Square REIT and possibly one or two other competitor REITs are the only options for international investors. Once the sector has a more attractive scale, we will have more buffer in terms of price volatility,” said Bae.