Seoul advised to prepare exit plans for real estate funds

Global real estate investment funds managed by South Korean financial services firms have swelled by more than 14 times to 72 trillion won ($5.4 billion) in value over the past decade, according to the Korea Financial Investment Association.

The surge in overseas real estate investments now leaves them with greater exposure to fallout from declining property values in Europe and the US, a business lobby group said on Wednesday.

To address such risk, South Korea needs to take preemptive measures to minimize potential losses from loans backed by commercial properties, Kim Hyun-soo, chief of the Korea Chamber of Commerce and Industry’s (KCCI) economic policy team, told a seminar KCCI hosted.

Korean investors have invested heavily in senior secured loans, which carry the lowest default risk compared to other debt tranches.

If a drop in rental incomes or in asset value leads to a contract breach for the investors, however, Korean financial services firms will likely be under pressure to inject additional money into the overseas real estate funds before their expiration, Park Young-Joon, a partner of law firm Shin & Kim LLC. warned.

“In this case, they may need to make capital calls to domestic investors, borrow money from a third party, set up a new vehicle at home, or raise money in the country (where their real estate assets are located),” he added.

Under the worst-case scenario, fund managers may fail to refinance their real estate-backed loans or find a new investor until the maturity of the funds.

Park noted that they need to draw up exit plans such as selling underlying assets or offering them at a discount to retrieve some of the investments and minimize losses at their earliest.

Joel Rothstein, Asia real estate head of the law firm Greenberg Traurig, advised that South Korean financial institutions bolster equity capital and set aside reserves to guard against potential losses, based on the result of their financial stress test.

For financial authorities, he suggests liquidity support measures be prepared to help financial services firms in a temporary capital crunch to ensure that the South Korean financial market remains resilient even in a crisis.

Rising interest rates, fears of an economic downturn and banking turmoil in the US have taken a toll on commercial real estate markets in the US and Europe.

Write to Ye-Rin Choi at rambutan@hankyung.com

Yeonhee Kim edited this article.