As the havoc wreaked by the COVID-19 pandemic continues to weigh on the global economy, Hong Kong-based private equity major Gaw Capital Partners is poised to capture turnaround deals in real estate, including in the hospitality sector, that could start hitting the market in the first half of 2021.
Distressed opportunities may come about when governments’ monetary support expires, and lenders face downgrades on risk profiles approaching their year-end valuations, said Kenneth Gaw, president and managing principal of Gaw Capital, during an opening keynote chat at DealStreetAsia’s Asia PE-VC Summit 2020.
“Obviously, the biggest impact of the COVID is on hospitality. There is no real escape from that for whoever in the hospitality industry and pretty much wherever they operate from,” he said.
Real estate-focused PE powerhouse Gaw Capital was co-founded by Gaw and his elder brother Goodwin in 2005. The firm mainly invests in under-utilised real estate projects worldwide, spanning the residential, commercial, hospitality, and industrial sectors.
Gaw Capital has two vehicles dedicated to investments in the hospitality sector, including a pan-Asia Hospitality Fund, which was fully committed; and a European Hospitality Fund that already deployed about 40 per cent of its capital pool. The firm also invests in hotel properties through its flagship Gateway Real Estate Fund series.
Since its inception 15 years ago, Gaw Capital has raised six commingled funds targeting the Greater China and Asia-Pacific regions. Apart from the two hospitality funds, it also manages value-add/opportunistic funds in Vietnam and the US and provides services for separate account direct investments globally.
As of Q2 2020, the firm has garnered equity of $15.6 billion with assets of $26.7 billion under management. Its latest flagship fund, Gateway Real Estate Fund VI, the firm’s largest vehicle to date, was closed at a hard-cap of $2.2 billion in December 2019.
Edited excerpts of the interview with Kenneth Gaw:
Does a Biden presidency change anything for Gaw Capital?
Under a Biden administration, there will be less sensational headlines and more normal US diplomacy for both China and the rest of the world. But we think a strategic rivalry with China will continue. As long as Democrats don’t win over control of the Senate, a lot of those more socialist type of promises [that Biden has made] during the campaign are unlikely to be passed. Most importantly – for real estate – interest rates will remain low since the Fed has already said that they will remain close to zero until the end of 2023. More than anything else, that is probably the best support for real estate.
In Hong Kong, where you are based, Gaw Capital this November announced the acquisition of CityPlaza One office building at about HK$9.8 billion ($1.3 billion). Could you walk us through the deal? How do you see the real estate scene playing out in Hong Kong?
Since Hong Kong dollars are pegged to US dollars, the city will also follow the US interest rates. That would be very supportive for the Hong Kong real estate market. With a Biden presidency, there’ll be a lot less kind of headline-grabbing type of policies. Some of these measures that Trump and Republicans were trying to pass this summer, especially those against Hong Kong (which include moves to sanction Hong Kong officials and end the city’s special trade status), may not get passed at all.
Most importantly, we think that Hong Kong will remain the main international financial centre for China. Fundamental things like “One Country, Two Systems,” which ensures a legal system based on a combination of English common law [and local legislation codified in the Laws of Hong Kong], as well as English remaining as the principal business language, and Hong Kong being the lowest tax regime in China will still be in place until 2047. All these factors ensure Hong Kong’s position as the main financial centre for China.
People in China are making a lot of money. The latest Forbes China Rich List, published earlier this month, shows that the total wealth of the top 400 richest in China is now at $2.1 trillion, compared to just $1.3 trillion in 2019. It is an increase of about $800 billion, compared to the total wealth of the US richest that increased by only $240 billion. (America’s 400 richest are worth a record $3.2 trillion in 2020). And the number of new billionaires in China also increased by 64 people, compared to an addition of only 18 people on the US list.
A lot of this wealth will flow to Hong Kong. While many concerned multinational companies and their expatriates may leave the city following the National Security Law and China’s tightening control, I think the most important thing for Hong Kong is its relationship with mainland China. As long as Hong Kong continues to be the freest place in China for both people and money, it will continue to be an international financial centre. We remain optimistic about Hong Kong’s development. Our latest acquisition in Hong Kong also showcased our confidence.
As virus-induced lockdowns and social distancing measures impact sectors such as travel, hospitality, offline retail, and office buildings, how are the assets in your portfolio performing? How are you protecting them from the downside?
Obviously, the biggest impact of the COVID is on hospitality. There is no real escape from that for whoever in the hospitality industry and pretty much wherever they operate from. At the worst time of pandemic lockdowns, 30 out of our 33 hotels worldwide were shut down. Till now, we have reopened many of them and some are doing better than others. Our hotels in Singapore are paying for Malaysian employees to stay in the city-state, so they don’t have to travel back and forth and be subject to quarantines or other restrictions. Some of our hotels in the US are doing well due to their proximity to popular tourist attractions, as well as our hotels in Pattaya, which enjoys strong weekend traffic from Bangkok. But in general, I think hospitality has taken the biggest hit.
So far, we haven’t seen a lot of distress in this sector, probably because central banks worldwide have been giving monetary support to the market and banks haven’t been pushing debtors too much yet. However, I think many loans might be breached as we approach year-end valuations. With persistent negative cash flows, we may see some distress in the sector in H1 2021.
We have two hospitality funds, one in Asia and one in Europe. The one in Asia is fully committed, while the one in Europe is about 40 per cent committed. We’re not looking to immediately launch a follow-on Asia Hospitality Fund. When opportunities come in H1 2021, we could do some separate accounts’ type of investment, or use capital from our Fund VI, or use our own capital to invest along with some of our co-investors.
Another sector that has been facing pressure is retail, especially retail that is tied to the tourism trade. Fortunately, the anchor tenants of most of our assets in Hong Kong are community shopping malls, supermarkets, and fresh produce & wet markets serving local communities, rather than tourists. They are actually doing pretty well during the COVID, as people stay back and purchase more food and household products. We are fairly insulated on the retail side.
In China, interestingly, our main retail exposure is outlet malls targeting a combination of domestic tourism and local consumption. All these malls are European-style villages that host discount outlets of luxury brands like Gucci, Prada, and Burberry. With many mainland citizens unable to travel overseas to shop, the turnover of our six (or so) malls in the mainland has upped 30-50 per cent in the past three months, compared to the same period in 2019.
What will be the overall impact of the COVID-19 pandemic on your investment returns or exit strategies?
In the hospitality sector, a few hotels that we bought a few years back and did value-added upgrading work have been growing well. We have initially planned to exit from a couple of them this year, but obviously, we’re going to postpone it because it’s not a good time to sell. We are still making money, but I think [the COVID] will certainly influence our returns.
In 2015, you took over a Vietnamese real estate fund at a discount believed to be over 50 per cent due to Vietnam’s market downturn at that time. Are you expecting to do similar deals in Vietnam after its central bank stimulus eventually eases off?
On that particular fund, we bought a portfolio of four assets. We already sold three of them with the investment returns doubling what we had originally invested. The fourth asset is actually one of the hotels that we have planned to sell this year. But we have to delay it until the market normalises. But yes, it was a good deal that had taken us roughly nine months to almost a year to fulfill all condition precedents before we could close it in 2015 – when the market was already on its way out of the downturn.
Vietnam is still a hot market even with the COVID. It is a market currently with the fastest economic growth in Asia and an indirect beneficiary of the US-China trade war. Many manufacturers are moving from China to Vietnam, including Samsung Electronics (which planned to shift much of its display production from China to a plant in southern Vietnam in 2020). But I don’t really see the same kind of opportunities in Vietnam as what we saw in 2014 when the market was just coming out of the previous major crisis in 2011.
As many remain bullish on Vietnam, there are also regulatory, currency, and exit challenges in the market. For your Vietnam-specific fund, what sort of investment returns are you expecting?
In our first Vietnam portfolio I just mentioned, we already exited from three out of the four investments by selling these assets to both domestic and foreign buyers, with an average of high 20 per cent IRR. The number will be higher after we sell the fourth asset, so I think it’s possible to exit [in Vietnam] as well, not just investing. Our remaining asset in Vietnam is a mixture of hotels, residential properties, office buildings, and lands for industrial development.
Vietnam’s residential market is very hot. We currently have a major residential development project in Ho Chi Minh City in its fourth phase. As we launch one phase every year in the past four years, the market price has gone from the first phase of $2,600 per square metre, to the second phase of $3,300, and then to the third phase of $5,800. The latest phase is selling at over $6,000. This kind of pick-up in Vietnam in the recent 4-5 years is the same growth speed that we saw in Shanghai, Beijing, and Shenzhen in the last 10 years.
How does PE competition in Vietnam influence the way you seek out quality assets?
So far, the competition has mainly come from local PE players. There are some foreign investors, but not nearly as keen as what we’re seeing in markets like China and Japan. It’s probably because many foreign investors think the size of deals in Vietnam are too small for the efforts they need to make. It’s a good market with strong macro-economic growth, but it’s not an easy market to navigate. If the market grows big enough that is worthwhile for people to pursue, there will be more competition, but also more exit opportunities for our assets in hand.
Are you looking to do more VC deals in Vietnam, after co-leading the Series A round in the country’s proptech startup Propzy this June?
In addition to our regular real estate funds, we’ve also raised a few vehicles to participate in PE type of opportunities, especially opportunities related to real estate. We became interested in Propzy, a leading O2O residential brokerage platform because we backed China’s Beike Zhaofang. Beike is a similar type of business of a much larger size. Amongst our various funds, we have about $300 million invested in PE deals, most of which are in the real estate and proptech fields.
In this sense, when do you expect to further up your stakes in proptech and other businesses, such as healthcare, where you’ve invested in Tencent Trusted Doctor?
In fact, we also have about $200-300 million invested in other types of PE deals that are not closely real estate-related, including our investment in Tencent Trusted Doctor. Because the vehicles that we have raised for such deals are mostly committed, we are actually raising a new similar vehicle upon the requests from some of our investors.
What are the other focus areas of the fund that also invests in non-real estate businesses? What is the fund size and the size of deployed capital?
The fund invested about $100 million in Beike’s Series D round two years ago, and the firm just went public this August. It has been a very good investment for us.
Apart from those, we invested in co-working operator naked Hub, which was sold to WeWork (in 2018) and became part of WeWork China. We partnered with Tencent to invest in Tencent Trusted Doctors (in April 2019), which actually started as a real estate-related deal. We help the firm build physical clinics and Tencent contributes its online customer base for patient [acquisition] and bringing in doctors and physicians to give online consultation. Most of our deals are somehow related to real estate.
The fund is separated into three accounts that collectively have a capital pool of $300 million, and 80 per cent of the fund was invested.
How does the Asia-focused education fund, which you’ve closed this August, fit into your larger portfolio strategy?
As we continue our focus on property while looking for opportunities in education businesses, we’ve budgeted about three-quarters of a $500 million capital pool for property-related deals in the education sector. The first investment of that fund was Stellart International School of Arts, a Guangzhou-based art school developed by us and located right next to one of our Florentia outlet villages. The art school, which specialises in students in Grade 10-12, was just opened this September.
We have identified a few pipeline deals to expand this concept within China, where we are working with some well-known English boarding schools. We’ve also invested in a school project in Vietnam. The focus so far has been on China and Vietnam, but we’re also looking at other Southeast Asian and North Asian markets.
We have a dedicated team for education-related investments. Although they mainly look into property-related education deals, we still get exposure to companies on the operation side [who are tenants or owners of these properties], including edtech. The COVID has accelerated the adoption of working and studying remotely. Edtech is a future trend that we are interested to invest in.
You just closed an Internet Data Centre (IDC) fund at $1.3 billion in October to focus on the Chinese market. Are you looking at any similar opportunities in Southeast Asia?
We’re looking at raising an IDC platform outside of China, but not just for Southeast Asia. In fact, I would say that the bigger part of the fund would be more likely to focus on North Asia, such as South Korea, Japan, Hong Kong, and Taiwan, which are larger markets than Southeast Asia. But in Southeast Asia, we certainly look at Singapore, Indonesia, and some of the other jurisdictions.
Generally, we like the data centre industry. The industry is a clear beneficiary of the COVID, which has forced people to work from home. Even before the COVID, we saw a secular growth of demand for data centres amid technology advancements in 5G, AI, cross-border e-commerce, online learning, and gaming.
Broadly, how has the pandemic influenced your investment process, the fundamentals of the real estate industry, such as the utilisation of buildings?
Travel restrictions obviously make us unable to travel freely, so I can’t make site visits to meet potential investees. During COVID, we bought two Grade A commercial office buildings in Japan because I’ve seen them before the pandemic. We actually had lost in the first bidding round. But the winners of the bids failed to close the deals due to COVID, so the sellers came back to us and we were able to acquire them at a lower price than before. It makes sense to us because we knew the assets already. We also did a bunch of deals in logistics real estate and data centres in China through our Fund VI. Since we have a China team on the ground, our team is able to visit sites and send us site information using drone videos, Google maps, and more.
However, there are deals that I wanted to do in countries like Australia and Singapore, deals that we think are good. But we have to be more conservative and thus less competitive than investors on the ground because we can’t visit the sites. COVID definitely affects our investment.
My team and I think that things will revert to normal in the long term. People have been talking about remote working for a long time. Twenty years ago, amid the last dot-com boom, experts predicted to see the peak of office demand in the world because technology enabled people to work from wherever they want. But demand for office has been stronger than ever in the past 20 years. In the short term, companies will certainly experiment with flexible working arrangements, including allowing part of their employees or departments to shift to work remotely. But I think the best employees would prefer to work in the office, where they can share ideas with others and show their dedication to career.
What about the valuation metrics you employed before the pandemic? Are they still applicable to the current market downturn?
I think the cap rate will certainly go up for sectors like hospitality because the whole industry has been exposed to the riskiness of its short-term tenancy nature. While people may think differently about the office sector, I think there’ll be some adjustments to a higher cap rate because there will be less demand for offices in the short term. But the sector is cushioned by its longer-term tenancy nature and low-interest rates ensured by central banks worldwide.
Are there any bright spots in the overall real estate business that excites you at this point?
The clear winners are data centres and logistics warehouses as people spend a lot more time at home to work, study, entertain, and shop online. Another sector that I’ve seen to be resilient is self-storage since more people stay back and probably want to create more space for themselves. E-commerce and last-mile logistics services have also driven the development of the self-storage sector.
Last time we spoke, you said two of the hot areas back then were student housing and co-working, and they would remain hot going forward. What’s your broad view on the development of the two sectors after the pandemic?
The student housing market is obviously taking a hit. In countries like Australia, where foreign students contribute to the majority of student housing demand, the sector is as much impacted as hospitality.
As a service, I think co-working is here to stay. But I think it is probably a misjudge from the private market on the type of valuation that WeWork has been commanding. Fundamentally, it is still a real estate service company, rather than a technology company. So, it should not be getting that kind of valuation. I think WeWork’s mistake was – for the valuation matrix that it employs – the only way for the firm to meet the valuation is to sustain the kind of growth in the top line. In order to sustain the growth in the top line, they have to enter into a lot of leases themselves and take the risk of the [profit and loss] on each of those co-working centres.
A more sustainable model is probably to operate more like a hotel management company, where WeWork, which has built a good brand, could have the landlord to do the fit-out and they do the management. In this way, they don’t need all these short-term rental leases, nor do they need all this capital for build-up. Of course, they will be only earning the management fee, rather than the sales income from their co-working centres. But it will be a totally different risk profile, and certainly, a different valuation matrix. But it will be more sustainable.