Increasing M&A deals in real estate despite risks

Keppel Land is one such foreign developer with a big Vietnamese presence (Photo: Le Toan)

During the last two years, the Vietnamese real estate market has witnessed some huge deals. Among those, Vingroup retained its top position in large-scale transactions, with moves such as selling stakes equivalent to $1.3 billion to Singaporean GIC and $1billion to SK of South Korea.

SonKim Land also carried out a major transaction with EXS Capital, ACA Investments, and Credit Suisse AG valued at $121 million.

The Singapore developer Keppel Land, meanwhile, has divested 70 per cent interest in Dong Nai Waterfront City to Nam Long Group at VND2.3 trillion ($100 million).

Keppel Land, through its wholly-owned subsidiary, Monestine Pte. Ltd., has also recently entered into a conditional sale and purchase agreement with Phu Long Real Estate Corporation to acquire 60 per cent interest in the three sites with the aggregate consideration of VND1.3 trillion ($56.5 million).

Lotte FLC JSC, a joint venture between FLC Group and Lotte Land, has been formed with a charter capital of VND556.5 billion ($24.2 million) to operate in the field of real estate, according to the National Agency for Business Registration. Lotte Land owns 60 per cent of Lotte FLC and the remaining stake is held by FLC and its affiliates.

Risk rises after M&A deals

While there are many successful cases, some others do find themselves with hurdles to overcome. Some potential deals occur in which the two sides fail to have the same voice, mainly caused by the differing mindsets on evaluation and post-M&A strategies.

Although some companies have achieved successes and created synergy values thanks to M&A, others do not anticipate the real effectiveness of the deals, nor been able to manage the target companies correctly.

The risk in implementing deals with regards to M&A strategy, valuation, legal compliance, and human resources are also lessons that can still be learned from such deals.

According to Remco van der Mije, head of strategic consulting of JLL Netherlands, while real estate can be a highly efficient way to maximise value from M&A, all too often property is assessed in the latter stages of negotiation and this can present multiple problems when the problems emerge.

“One-in-five fail to take property into consideration until the agreement is signed which can lead to additional risk, unforeseen cost, and strategic misalignment,” said van der Mije. “The market value of an acquired real estate portfolio can differ wildly from the value on which the deal price was fixed, exposing the acquiring company to significant financial risk.”

He analysed that in the early stage of a merger or acquisition, companies need to be looking at expiring leases and rent reviews because they need to know the financial implications. Exit penalties are another cost that can remain hidden unless the property team has time to do in-depth research.

Moreover, property portfolios can be complex, containing all sorts of risks ranging from security problems to environmental issues.

Van der Mije analysed that in a volatile country, the exact location can affect value hugely. “You can adjust a deal to prevent losing value, perhaps taking the riskier property assets out of the deal, but only if you assess security risks well in advance of the deal closure,” he said.

Meanwhile, Tom Carroll, head of EMEA Corporate Research, added that a contaminated site has a direct impact on purchase price and may even break the deal if significant enough.

“For example, an insurance indemnification may be needed to protect you from future litigation, so that any claims rest with the previous owner. Assessing risk early on in the M&A process gives you time to work out what action to take,” Carroll added.

Apart from these, poor alignment with the overall deal and rocking the business boat also produce high risk.

“Any newly acquired property must support the broader deal strategy. For instance, if the objective of a merger or acquisition rests on consolidating or streamlining real estate, a property portfolio must allow this,” said Carroll.

In addition, M&A also brings the risk of dismissing employees. “If a company has a highly-skilled workforce, whose expertise is central to business continuity and the value of the organisation, a property strategy should allow them to stay in the same location. If relocation is involved, create a property strategy that relocates those whose replacement would be detrimental to productivity,” he added.

According to Masahiro Kotaka, managing director of KPMG Japan, only the “integration level after M&A” of that company will decide the success of that deal.

“Do not think simply that M&A is just an evaluation assessment and a purchase. The real challenge for M&A deals are how the involved partners cope with issues arising after the signing,” Kotaka said. “Two sides must have a clear investment strategy, vision, and targets in the next three to five years after the M&A.”

Moreover, both sides must understand the culture of the other. Only then can they have a familiar voice in developing their project, he added.

According to experts, failed projects after M&A mostly occur in developers who have lacked experiences or who are burdened with limitations in the financial source from banks.

Companies who do not boast real estate development in their core business will also see a high risk of failure.

Real estate M&A still high

According to the Vietnam M&A Forum Research Group and the Merger and Acquisition Research Centre, M&A in the real estate sector remains high, focusing on large-scale projects, newly-developed urban areas, resort projects, and hotels in central areas of the country.

Real estate M&A is attracting both domestic and foreign investors. International groups typically from Japan, South Korea, and Singapore are in the race to seek the best investment opportunities with the expectation of cash flow with stable profitability and high interest rates.

The form of acquisition to form a joint venture, meanwhile, is mainly being carried out among foreign investors with strong and experienced financial capabilities that will partner with local corporations – investors who are holding land in the market as well as having a close relationship with the local government.

Domestic investors, though not participating in the deals with the greatest value, are gradually transforming themselves to master large M&A deals thanks to the advantage of accessing land funds, understanding the market, and improving competitiveness.

Apart from residential and commercial properties, there is continued strong interest in industrial and logistics assets, with both incumbent and new investors actively looking for joint ventures with local industrial developers and/or the acquisition of land and operating assets.

The lack of high specification, modern logistics warehouse space, and strong demand from regional occupiers are supporting the potential growth of this industry. The quality of the assets, rental growth, deal size, and remaining land tenure are crucial factors in investment decisions.

Figures released from Ben Gray, director of capital markets at Cushman & Wakefield Vietnam note that M&A for the next year will be huge and can only get bigger.

“In the year to date we have consulted with many investors on their pipeline of deals and targets for Vietnam. As an estimate, I would say that the total value for these deals – that is total asset value, not investment value – would be over $2 billion. That includes both officially and unofficially consulted deals, but not deals that have yet moved forward or closed,” Gray said.

Crinkles must be ironed out for overseas groups in real estate Vietnam has continuously been considered a potential destination for mergers and acquisitions with its increasing urbanisation, stable political system and fast growing economy. However, lawyer Nguyen Thanh Ha, chairman of SBLaw, cites that the country still needs more efforts in improving its legal framework to make it become more competitive and encourage foreign investment. Recent figures show that the ratio of capital pouring into the real estate market has been slowing down. Do you have a reason as to why? Vietnam has been considered a promising market for international investors, especially in recent years after a new legal framework was introduced on a range of laws such as the Law on Real Estate Business, Law on Housing, and the amended Law on Investment. This attraction is reasonable based on the case that Vietnam has provided more favourable conditions for foreign investors. The Vietnamese market meanwhile has only just reached the mature period of the development cycle. We can see the presence of many new investors from the United States and Japan, besides traditional investors coming from South Korea, Hong Kong, and Singapore. However, many such investors are still wait and observing even though their level of disbursement has increased slightly. Many international investors are still exploring Vietnam. Although the legal framework has been more open for them, the specific regulations and guidelines have not really been implemented accordingly. When participating in the Vietnamese market, overseas parties are very interested in the access to information. This issue, however, has been not very transparent in Vietnam, although the country has made great progress in improving its transparency index. A recent report made by real estate consultant JLL indicated that Vietnam was listed at the top of the less transparent group and is moving to the semi-transparent group. In addition, there are a number of other factors that are blocking the flow of foreign capital into Vietnam regarding the investment efficiency, market, listed assets, the legal environment and trading methods, private ownership, and rights. These factors have not been well implemented and not good enough to encourage overseas investors. What are the barriers for them in taking up M&A in real estate in Vietnam? Having been involved in many consultations, we recognise that the interest from foreign investors into this market is huge. However, when it comes to the real implementation, there are still many obstacles and bottlenecks and eventually many have to withdraw from targeted projects. For example, Article 49 of the Law on Real Estate Business 2014 stipulates that real estate projects which are proposed to be transferred to a new investor must have conditions such as the current investor fully clearing the ground, and having a certificate of land use rights. There are many projects which have not been fully cleared or do not have the required certificates due to the weak capacity of the previous investor. In the Vietnamese market now that the valuation of the asset, land area, and brand name of the sellers are not transparent and those cause the failure of many M&A deals. The demand for finding foreign partners to contribute capital investment and co-develop projects is very large, especially in resorts, high-end apartment, and office rental projects because domestic partners want to utilise global brand names and the marketing ability of foreign partners. The inaccurate information provided by sellers brings to light that many foreign investors get inaccurate evaluation of proposed assets. In addition, the financial figures made by sellers and auditors are also inaccurate, leading to inaccurate asset and brand valuation, as well as many other aspects such as revenue and profits. This leads to hesitance from foreign buyers. The current legal framework has been not open enough to foreign investors and still has discriminations between foreign and domestic investors. For example, many overseas parties are interested in land plots in Hanoi, Ho Chi Minh City, and in some other cities and provinces which are mortgaged at banks and are going into auction, but they are facing difficulties in approaching relevant information. Meanwhile, domestic investors have many ways to grasp the status of this collateral, based on their long-term relationship with the involved bank. In many cases, Vietnamese investors will find foreign buyers after they have acquired good projects for a higher price, and can get profit from this transaction. Such a method is popular and foreign investors meanwhile will have to buy the project at very high prices, especially in the golden land located in the CBDs. Therefore, the sale will be conducted through the purchase of shares held by the holding company. Then, they will increase the investment capital of the project to legalise the money which they paid to buy shares. How can the upcoming legal solutions and amendments to the legal framework be improved in order to alter the situation? In general, the major issue still is the development and improvement of legal standards, towards transparency of market information. This is a long story and must be improved not only in Vietnam but in all other markets. In order to make the market become more transparent, competent authorities need to build a legal corridor for services of the real estate market, including consultancy on planning, land and asset valuation, cadastral measurement, information providing, real estate trading floor set up, and mortgage activities. Another issue that needs special attention is the co-ordination mechanism among local management authorities to avoid overlapping. There is still overlapping management in mortgage of asset rights between local Department for Natural Resources and ­Environment with other departments in construction and justice. Hence, we need a closer and more efficient co-ordination among related ­authorities to have an exact view on the investors’ ­capacity. Last but not least, after ­taking an M&A, international investors need to adjust their projects in order to be suitable to the new investment strategy. However, it takes much time for them to do this. As far as we understand, a new investor would need around one year with more than 120 signatures for ­finishing all related ­procedures. This is really a ­barrier to many ­investors and needs to be ­improved in the coming time.