[K-INVESTORS]⑨Why Only the Korean Office Market Remains Strong

Mastern Investment Management's Executive Director Kyungbae Park
Background Includes Low Remote Work, Concentrated Demand in Prime Office Market, and Supply Restrictions
Plans to Seize New Opportunities in Over 30-Year-Old Aging Office Remodeling Market

Editor's NoteThe Korean capital market is more turbulent than ever due to greed and selfishness. Market manipulation and unfair practices are rampant. However, many investors have carved out their own investment worlds and emerged as role models for individual investors, having endured various crises from the foreign exchange crisis, dot-com bubble, global financial crisis, to COVID-19. Through meetings with these investors, we aim to convey the value of money through their war-like stories of the capital market, their philosophies, failures, and successes. Starting now, we bring you stories from experts across various fields, including chief investment officers of domestic pension funds who have become global 'big players' in value investing and activism, leaders of private equity and asset management firms, and CEOs of financial companies.

Park Kyung-bae, Executive Director of Maston Investment Management, is explaining the Korean commercial real estate market.
[Photo by Maston Investment Management]

Although concerns about a global real estate market downturn are significant, the Korean office market is different. Especially in prime office markets such as downtown Seoul, Yeouido, Gangnam, and Pangyo, vacancy rates are falling and rents are rising. Why is the Korean office market uniquely resilient compared to major commercial real estate markets in the US, Europe, China, and Japan? We met with Park Kyung-bae, Executive Director of Maston Investment Management, a leading domestic real estate asset management firm, to discuss the background and outlook. Executive Director Park is a prominent real estate fund manager who has successfully closed major deals since Maston’s inception, including D Tower Donuimun, Pangyo Alpharium Tower, and Musinsa Campus N1 in Seongsu-dong.

Low Remote Work, No Supply in Gwanghwamun, Yeouido, Gangnam, and Pangyo for 4-5 Years

Park, a former accountant known for his meticulous work style, analyzed the Korean office market by four factors: demand, supply, work style, and investor sentiment.

"Korea has been relatively less affected by remote work. Major office locations and business districts in Seoul are concentrated. There are four main districts: the Central Business District (CBD), Yeouido Business District (YBD), Gangnam Business District (GBD), and Bundang-Pangyo Business District (BBD). Yeouido has nearly completed large-scale new developments. Development along Teheran-ro from Gangnam Station to Samseong Station is also finished. In fact, Gangnam has had virtually no vacancies for 4-5 years. That’s why expansion is happening toward Jamsil and Seongsu. Looking at downtown, expansion is occurring eastward from Gwanghwamun and Jongno to Euljiro, and southward to Yongsan. However, there will be no supply in these four districts for the next 4-5 years. From the supply side, this explains why Korea’s office vacancy rate remains low."

Conservative Investors and Companies Seeking 'Qualitative Improvement' of Offices

Institutional investors are the 'big players' in Korea’s commercial real estate investment. They are conservative and prefer stable, easily explainable investments.

"Institutional investors mainly invest in the four major office districts. They rarely invest outside Seoul and Bundang-Pangyo. Companies also cluster in the metropolitan area to maintain good human resources. Because they do not invest in other districts, available properties are limited and prices remain firm. Foreign investors also prefer downtown areas, as many foreign company headquarters are near Gwanghwamun. They first look at Gwanghwamun, then Gangnam, and Yeouido."

On the demand side, not only traditional large corporations but also IT and biotech companies from new industries have emerged. Their characteristic is a strong emphasis on office building quality.

"Seven to eight years ago, tenants were mostly large corporations. Since the buildings we handle are large-scale, worth over 100 billion KRW, mainly large corporations occupied them. Recently, however, many companies from IT and biotech sectors have grown, increasing new tenant demand. To attract excellent human resources, they ultimately need good buildings, good locations, and good working environments. The industry calls this 'Flight to quality.' There is a growing demand for welfare facilities and common spaces for employees. Office space per person, which used to be around 2 pyeong (approx. 6.6 sqm), is now increasing to over 3 and even 4 pyeong. This means a 25% increase in space, not just a simple increase of one pyeong. This is one of the main factors stabilizing market vacancy rates."

Park Kyung-bae, Executive Director of Maston Investment Management, is explaining the Korean commercial real estate market.
[Photo by Maston Investment Management]

Seongsu-dong Gains Attention for 'Fun and Accessibility'

Park’s recent focus is on Seongsu-dong. He is the key figure who established Musinsa’s headquarters there.

The investment management division he leads first invested in Seongsu-dong in 2021 by pre-purchasing Musinsa Campus N1. Until then, there were hardly any decent rental offices near Seongsu Station.

"We observed that many large knowledge industry centers were being supplied, increasing the working population, and at the same time, the Gangnam area was saturated with rentals up to Jamsil, so we judged that Seongsu-dong had potential as an alternative district. We were able to acquire Musinsa Campus N1 at a relatively low price. We invested believing that even receiving rents comparable to nearby knowledge industry centers would yield stable returns. The pre-purchase was made about a year before completion, and from then on, there were many rental inquiries. The completion of Musinsa Campus N1 coincided with the opening of Dior’s Seongsu pop-up store. Seeing Dior Seongsu’s construction progress, we anticipated a ripple effect throughout Seongsu-dong."

This year, two large office investments were made solely in Seongsu-dong, both scheduled for completion in 2-3 years. They are expected to become landmark assets in Seongsu-dong.

"There are clear reasons to focus on Seongsu-dong. It is only about 10 minutes from Samseong Station by distance. Because Gangnam rents are high, companies are moving to Seongsu, which is relatively more price competitive. Seongsu offers fun that cannot be found in Gangnam, downtown, or Yeouido. Public transportation is good, with Line 2 providing excellent access to downtown and Gangnam. It’s just one bridge away from Cheongdam-dong. Musinsa and SM have established offices there. Gentle Monster and Krafton are building headquarters. I believe Seongsu will become a main office district within 3-4 years."

Designing Investments to Absorb Market When It’s Not on Your Side

This year’s market environment was unfavorable. The main focus during difficult times was designing investment structures that could be absorbed by the market.

"The Seongsu-dong office development project required project financing (PF) to pay the land balance and start construction. Although we secured several large investments totaling about 800 billion KRW, we were short by about 20 billion KRW. I reviewed a list of savings banks and contacted them via cold calls (calls to parties without prior relationship). The construction company had to gather only savings banks. Through these calls, we raised 500 million, 1 billion, and 2 billion KRW increments, eventually raising the missing 20 billion KRW to reach 80 billion KRW. The fund managers endured a lot of stress and hardship this year. It seems this will continue until next year."

Another pre-purchase in Seongsu-dong was also created through investment design and persuasion.

"Originally, the landowner planned to build a knowledge industry center and sell units. This year, knowledge industry center sales were sluggish. The owner, who was in logistics and facing poor business conditions, contacted us via cold call out of frustration. After meeting, we restructured the deal. We persuaded the owner to pre-sell to Maston before construction. Although the sale price was initially unsatisfactory, we convinced them that reinvesting in our fund was beneficial. We persuaded them that converting from a knowledge industry center to office use, building a better building, leasing it, and then selling it later for additional profit was the best structure. It took about half a year and was finalized in October."

With ideas suited to market conditions and swift investment decisions, two exits (investment recoveries) were successfully completed this year.

"The Donghwa Building is nearly 50 years old. The most difficult aspects of development projects are eviction and permits, which are core risks. We resolved these and sold the development rights, i.e., the opportunity to build a quality new office, to JB Financial Group. We achieved an internal rate of return (IRR) of 29%. This strategy is somewhat unconventional but ended with good profits."

This unique approach of resolving core risks and selling new construction opportunities to financially capable financial groups proved effective in a tough market.

"When creating a fund, predictability is most important, but permits can be delayed and evictions may fail. Office tenants generally cooperate well with eviction. If you support moving and interior costs and persuade them, most office tenants agree. The problem is retail tenants, who are tied to their livelihoods and have business rights at their locations, making negotiations difficult. Active persuasion including eviction costs is necessary. For Donghwa Building, negotiations with merchants went well, partly due to the COVID-19 situation."

Another investment recovery was through fund-of-funds investment and exit. A minority stake in the Jamsil Samsung SDS Tower fund was offered at a good price, nearly at cost, presenting a good opportunity.

"In early 2020, we created a fund to acquire the stake and completed the acquisition immediately. We exited in October this year. Although sudden at the time, we had extensively studied the Jamsil area. Investors understood Maston’s growth expectations and direction for the area well, enabling quick investment execution, closing the fund in a month, and acquisition."

Although major hurdles were overcome, this year prompted deep reflection on the essence of asset management.

"There was a time when just buying was good. I think that lasted about 10 years. Now, not only Maston but the entire industry faces many fund issues. Some problems can be solved, but many assets are realistically difficult. Fund managers must minimize investor losses and show their efforts. After difficult times, an upcycle market will come again. Even if a fund is losing money now, showing how problems are being solved and efforts made is necessary for future understanding."

The Secret to Investment Success Lies in the Details

Real estate fund managers have a very demanding job. They must persuade both sellers and investors, raise funds, and negotiate.

"Fund managers must have pride to do this work. Investment inherently involves risk. One must identify risk factors and controllable risks well and seize opportunities. That is the role of the manager. Each investment has a tolerable level of risk. Downside stability in returns means judging how much the product can deteriorate if things go wrong. We gather various opinions on risk for every deal. Ultimately, all investments involve understanding risks and obtaining commensurate returns."

Preparing risk response measures is both the first and last step in investment. Differentiating types of risks is key. Everything hinges on detailed contract wording.

"For example, negotiations with sellers or tenants do not happen immediately based on contract wording. Usually, negotiations take over a month. The contract is not a one-page real estate agreement but 30-40 pages. If you insist only on your demands, negotiations fail. Fund managers must understand the meaning of contract clauses. They must judge whether a risk is tolerable or must be avoided. If acceptable, they use it as a negotiation card: 'I will accept A if you accept B.' To make such judgments, deep knowledge is essential. That’s why I tell staff to focus on details. Real estate investment is, in a way, simple: buy, earn rental income, increase value, and sell. To differentiate and win against competitors, details matter. Differentiation comes from data analysis skills and future outlook based on market trends."

Liquidity Recovery Will Take Time... Opportunities in Remodeling Aging Offices

He expects the real estate market to stabilize more next year than this year.

"I definitely think it will be more stable than now. Ultimately, liquidity must return to the market, but it will take some time for liquidity to come back and transactions to activate. There were transactions this year, mainly in prime assets. However, the gap between sellers’ and buyers’ expectations was large. Once interest rates stabilize and uncertainty subsides, the gap will narrow. Selective transactions of prime assets will occur, with prices gradually rising."

He plans to seek investment opportunities in remodeling aging buildings, as major office districts have been established for over 30 years, increasing the number of aging office buildings.

"I plan to focus on discovering undervalued offices. It’s not always best to demolish and rebuild old buildings. Construction costs must be manageable. We must consider ways to increase value within the existing structure. Some buildings improve with renovation, while others remain problematic due to hardware limitations. Buildings with many columns and low ceilings have many constraints. If the parking entrance is inherently narrow, it’s difficult to resolve."

He suggested that many challenges remain for future real estate market growth, including deregulation and enhancing investment transparency.

"Senior housing, expected to see increased demand, cannot be sold but only leased. Ultimately, it involves paying deposits and renting, with no change in ownership. Upon completion, residents pay monthly rents of 2 to 3 million KRW. Such monthly rent models are unlikely to become widespread in Korea. For the domestic real estate market to become more popular and active, systems and cultures that provide easy and transparent investment information to general investors must be established."

◇About Park Kyung-bae, Executive Director of Maston Investment Management=He graduated from Daewon Foreign Language High School and Korea University’s Business Administration Department. After working at Samil Accounting Corporation (2003?2010) and Koramco Asset Trust (2010?2011), he has been managing real estate fund investments at Maston Investment Management since 2011. A former certified public accountant, he has managed 19 real estate funds at Maston and exited 10 of them, achieving an average internal rate of return (IRR) of 21%.