ESR's new axis of growth

Goola Warden
Goola Warden10/21/2021 03:40 PM GMT+08  • 12 min read
ESR's new axis of growth
The ESR Cayman-ARA Asset Management amalgamation is poised to benefit from the New Economy and increasing financialisation
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Founded in 2016 and listed in Hong Kong on Nov 1, 2019, ESR Cayman, whose business involves the development and management of logistics property portfolios, has taken the market by storm. On Nov 3, 2021, ESR Cayman will hold an EGM to obtain permission from its shareholders to acquire real estate fund manager ARA Asset Management, issue new shares as part of the acquisition, and vote in new directors of ESR Cayman. They are John Lim, ARA’s founder; Justin Chiu, a director of property developer CK Asset Holdings; and Rajeev Kannan, a representative from SMBC.

From an AUM of just US$12 billion in 2017 to US$22.1 billion in FY2019 just after the IPO, ESR Cayman will have assets under management (AUM) of US$131 billion ($175.95 billion) following the completion of its acquisition of ARA.

With almost US$53 billion in “New Economy” assets, ESR Cayman is set to become the largest “New Economy” real estate investment manager by the end of this year. Of course, “New Economy” is the buzzword for new, high-growth industries that are on the cutting edge of technology and are believed to be the driving force of economic growth and productivity.

The jewel in ARA’s crown is LOGOS, the developer of property solutions for customers in the logistics sector. ARA holds 52% of LOGOS but will raise this stake to 86.4% ahead of the completion of the transaction, according to a circular issued on Oct 17. On Oct 15, LOGOS announced it had entered into binding arrangements to acquire a 100% freehold interest in 13.8ha of land belonging to Qantas Airways near Sydney Airport for A$802 million ($809.51 million). The acquisition will increase AUM by LOGOS in Australia and New Zealand to A$13 billion and the property could have an end value of A$2 billion.

“Every major developer was looking at that property. It’s the single best last-mile logistics development site in Australia given it’s literally adjacent to the Sydney airport. It’s really a credit to the LOGOS folks for putting together a very good plan for Qantas,” says Jeffrey Perl­man, chairman of ESR Cayman. “Sometimes, when you lose, you really win,” he remarks, as LOGOS will become a member of the enlarged ESR Group post completion of the ARA transaction.

Perhaps, Perlman relishes the thought of ESR Cayman’s Australian AUM overtaking that of logistic player Goodman Group’s home market. With the Sydney Airport transaction, the enlarged ESR’s AUM is likely to match Goodman’s AUM in Australia/New Zealand of US$18 billion.

In April this year, ESR Cayman announced the acquisition from Blackstone of a US$3 billion logistics portfolio in Australia. No surprise then that Perlman likens the ESR-LOGOS amalgamation as a dual-growth engine. It is like having two horses in the land grab phase of the logistics sector and incredibly valuable, Perlman reckons. “We’re going through this once-in-a-generation change in real estate, driven by technology,” he says.

In the New Economy, the “location, location, location” mantra has taken on new meaning for logistics and so has the definition of the so-called “last mile” delivery. “[For logistics], it’s about proximity to end consumers, to your online customers. In the case of data centres, it is their proximity to power and to end-users while in the case of Life Science real estate, it is their proximity to higher education and research,” he elaborates.

“Most global real estate investors are just heavily under-allocated to New Economy real estate today. Most global real estate investors on average had about 20%–25% of their portfolios historically in retail and less than 10% of logistics. Most now want to flip that exposure. That change alone is US$200 billion of capital flows,” Perlman estimates.

Financialisation of real estate
Perlman, who co-founded ESR Cayman, has coined the phrase “the financialisation of real estate”. He sees similarities in Asia today to the US market of decades ago. “The total cumulative market capitalisation of the REIT space in the US was only about US$100 billion. Fast forward to today 20 years later and it’s up by 10 times to more than US$1.3 trillion,” Perlman recounts.

REITs, which unitise multi-million and often billions of dollars of real estate, have become an essential investment vehicle and tool for institutional and retail investors. This is because real estate is capital-intensive and it is difficult for individuals to own a whole building.

Two events have coalesced to catalyse the financialisation trend. First off, regulatory frameworks for REITs have been introduced in several Asian jurisdictions, the most recent being China with C-REITs, Korea with K-REITs, and the Philippines. India’s REIT regulation had already produced infrastructure trusts (InVITs) and commercial REITs.

“The securitisation of real estate through the launch of REITs in China and India is in a relatively nascent stage. In China, the first nine REITs were listed on the Shanghai and Shenzhen Stock Exchanges in June. REITs in China are currently limited to infrastructure projects and some real estate assets including business parks and logistics,” observes Jonathan Yap, CEO, fund management at CapitaLand Investment (CLI). India’s first REIT was launched in 2019 with a third REIT listed in February but they are focused mainly on the office sector.

Elsewhere, Indonesia has introduced Dana Investasi Real Estat (DIRE). Lippo Karawaci, whose related company OUE is a sponsor to three S-REITs, was quick off the ground with DIRE Bowsprit Commercial & Infrastructure, a commercial and infrastructure DIRE.

“There is potential for more REIT listings with improved market liquidity, tax transparency and corporate governance, and as the governments seek to make the local REITs more attractive to global and domestic investors to spur economic growth,” Yap concurs. CLI itself is planning to raise more funds.

In China, CLI was registered as a private equity fund manager in June this year. “It allows us to forge more capital partnerships with China’s domestic institutional investors. It also facilitates access to the abundant liquidity in China’s financial markets to partner with and grow CapitaLand’s funds under management [FUM] and fee-related earnings,” Yap says.

The second major catalyst, which is an emerging trend, is the need for institutional ownership and professional management of real estate. Historically, real estate in Asia has largely been owned by families and conglomerates and maybe even end-users in some cases.

In mature markets like the US and Europe, most owners prefer to sell their property and then lease it back, to get a better return on equity. To facilitate sale-and-leaseback transactions, sophisticated counterparties in real estate are required and putting it in a REIT is one way to monetise the asset.

“The third trend — and we’re seeing it in ESR — is the hyper growth of New Economy logistics assets and data centres. There isn’t enough. The only way the average investor can access New Economy assets is through a REIT. There’s going to be tremendous demand,” Perlman says. In a way, REITs democratise the ownership of real estate and it was able to do that at scale in the US.

The other consideration in Asia is that many of these countries — China included — have closed capital markets. While China is opening up with Stock Connect and more recently Wealth Connect, investors in general have access only to A Shares and financial products, some of which were questionable.

“People in Asia naturally lean towards real estate, it’s tangible, they understand it and it’s a part of the culture. If you can institutionalise and professionalise the ownership of real estate through REITs and in a tax-efficient manner, there is tremendous demand from retail investors,” Perlman figures.

Moreover, in the US, the market capitalisation of REITs represents 6% of GDP while in Asia, REITs market cap only represents 1% of GDP. “We’ve got a real gap that I think will close over the next decade or so and it’s these three catalysts that I think will propel it in an accelerated direction,” Perlman says.

With the acquisition of ARA, ESR is likely to be developing over US$5 billion of projects and development starts per year. Multiple pockets of capital will be needed to absorb those developments.

A place for carbon-neutral data centre REITs
Data centres are a little more complicated than warehouses but not in terms of construction. A data centre shell takes about the same time to build at around 20 months. It is the power load that makes the difference because that is why tenants rent space in data centres.

The enlarged ESR is planning a US$2 billion to US$3 billion data centre fund and is developing a 40MW project in Hong Kong and an 80MW multi-phase development in Osaka, Japan.

The group is planning for data centres to be carbon neutral. In July, LOGOS and French utility company Engie established a partnership to build a regional renewable energy platform to provide solar generation and renewable energy options for the Asia Pacific portfolio under LOGOS. Engie and LOGOS will jointly look to deliver options for the development and financing of renewable energy generation and storage assets throughout Asia Pacific, with an initial focus on rooftop solar photovoltaics in Singapore, Australia and New Zealand.

“LOGOS has a strategic partnership with Engie. No one has more rooftop space in Asia Pacific logistics than the enlarged ESR post the ARA acquisition. We’re rolling out a very major solar programme across Asia Pacific,” Perlman says.

“We think we will have a unique competitive advantage versus our peers as LOGOS spent a lot of time on looking to solve and enhance the sustainability element of data centres.”

Over time, ESR is looking to offer a net neutral carbon solution for its data centres. “It’s not going to happen fully overnight because we’ve got to finish putting the solar panels across the rooftops. It’s now become essential to customers, capital partners and local governments. If you want to build a data centre in Singapore, you’re going to have to demonstrate that it’s net neutral from a carbon perspective as opposed to trying to use carbon offsets,” he says.

As Perlman sees it, ESR’s existing REITs have the ability to take in data centres. And if there is sufficient scale over time, there could be standalone data centre REITs in ESR’s stable.

What about Singapore REITs?
ESR Cayman first came to the attention of Singapore investors in 2017 with its acquisition of ESR-REIT’s manager and units in what was then Cambridge Industrial Trust.

ESR itself was an amalgamation of e-Shang, co-founded by Perlman and Jeffrey Shen in 2010 and Redwood co-founded by Stuart Gibson and Charles De Portes in 2006. Loosely translated, e-Shang means “e-commerce” in Mandarin. Perlman represented Warburg Pincus, where he is managing director and head of Asia-Pacific real estate. e-Shang and Redwood Group merged in 2016 to form ESR.

“When we started e-Shang, it wasn’t so obvious that e-commerce was going to take off in the way it has. That’s always been a guiding principle. Today, two-thirds of our customers are either e-commerce companies or 3PL providers who largely service e-commerce companies,” Perlman says.

Listing in 2019 achieved three key goals for ESR, Perlman indicates: The ability to access lower cost of capital, capital partners have the benefit of studying ESR’s financials, and thirdly, equity is a form of currency that helps in M&A and growth.

For the ARA transaction, Perlman said there was always admiration for the business John Lim had created. LOGOS acted as a further catalyst. In addition to LOGOS, ARA has discretionary funds, where investors hand over discretion to manage the fund to the manager. These funds attract different types of capital partners than the usual pension and sovereign wealth funds.

REITs have proven to be valuable offtake vehicles for stabilised assets for real estate investment managers (REIMs) and developers. In ESR’s ecosystem, divesting a warehouse to a REIT keeps the property and its tenants within the ecosystem. “If you sell an asset, you sell the tenant relationship. We do so much repeat business with all the largest e-commerce companies and 3PLs. We would never want to lose those pieces because once you lose or sell them, you’re not going to be able to replicate the same kind of network further down the road,” Perlman says. Investors can trade in and out of the REIT but the REIT itself can continue to own those assets, keeping the tenant relationship within the group.

“Singapore is an important market from a REIT perspective. By bringing ESR-REIT and ARA LOGOS Logistics Trust together to create that flagship New Economy REIT, we think will engender a very significant following as it continues to grow and to scale up,” Perlman says.

He says there is a possibility to add other REITs to ESR’s current REITs. “There are opportunities for the group to list other REITs in the future. In South Korea, we listed a very successful logistics REIT. We don’t have a New Economy REIT in Japan but we will have a strategic stake in Kenedix post the ARA acquisition, the largest manager of REITs in Japan. We’d love to build on that with more REITs in Japan as well as other key strategic markets,” Perlman says. ARA holds a 30% stake in Kenedix.

According to JLL, investment by institutions in income-producing real estate is expected to increase from approximately US$3.3 trillion in 2020 to US$5.2 trillion in 2025. Given the favourable economic and demographic factors, JLL expects Asia Pacific’s income-producing real estate to expand at a faster pace than other major regions globally. The rising popularity of REITs in Asia Pacific also signals additional headroom for institutional investors to grow their real estate portfolio. JLL is forecasting that between now and 2030, the market capitalisation of REITs in Asia is likely to rise to US$1 trillion. “As the largest sponsor of REITs in Asia with 14 REITs, that’s a great opportunity for ESR,” says Perlman.

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