High transaction costs are affecting foreign investors’ interest in Taiwanese real estate, while Taiwan’s institutional investors are looking abroad.
As compared with some major Asian markets, Taiwan’s real estate market has been dominated by domestic investors. While freehold ownership is attractive to foreign investors, the low yield levels and a dearth of investment-grade properties are among the reasons deterring the entry of foreign capital. According to CBRE Research, prime office yields in Taipei City averaged 2.4% in Q2 2016, the lowest level in the Asia Pacific. It is therefore not a surprise that properties purchased by foreign investors usually account for less than 4% of total investment turnover in Taiwan after the global financial crisis.
By asset class, there are two major segments – land and commercial property – in the Taiwan real estate market in addition to the residential sector. The land sector, contributing to average annual transaction sales of NT$130 billion (about US$4.2 billion) over the past 10 years, has seen local developers actively purchase sites to expand their land banks for future development.
The commercial real estate sector, on the other hand, has been mainly the focus of insurance companies looking to diversify their investment portfolios. Prior to the tightening of rules concerning insurance companies’ real estate investment in 2012, commercial property transactions involving insurers as buyers constituted about 40% of the total investment turnover, which reached a historic high of NT$144 billion in 2011.
As for the residential sector, the overall housing market experienced an unprecedented upturn between 2004 and 2014, with average unit prices nationwide surging 144%. In Taipei, the price growth was even more significant – 195% over 11 years. To curb speculative activity and tame prices, the government since 2010 has implemented a series of cooling measures, including selective credit controls and property tax revision.
However, housing prices did not start to fall until 2014, even though the total transaction volume for residential properties began to drop in 2011. As a result, developers turned more cautious regarding land acquisition, causing total investment turnover to decline 50% year-on-year in 2015 and 72% year-on-year over the first half of 2016.
Developers focused on residential developments are not the only stakeholders affected by the tax reform. The most recent such reform, effective from January 2016, concerns a capital gains tax levied on profits earned by owners selling their properties. Under the new tax rules, foreigners will be subject to a 45% tax rate if they sell real estate within one year of purchase and a 35% tax rate if they sell properties with a holding period longer than one year.
The high transaction costs will inevitably affect foreign investors’ interest in the Taiwan real estate market. The only exception will be for foreign companies setting up subsidiaries in Taiwan, since they – along with other local companies – will be subject to corporate income tax for capital gains from real estate transactions. The rate of corporate income tax is a flat 17%.
While cooling measures adopted by the government also apply to commercial real estate players, they have been the least affected by the policy changes. One reason is that most of them are institutional investors, who rarely purchase and sell assets within a short period of time. Insurance companies, for example, tend to hold real estate for a long term. Under existing rules, moreover, insurance companies are only allowed to acquire properties without financing. The cash-rich nature of insurance companies’ real estate investment structure has enabled them to chase prices higher regardless of the low yield levels.
Role of insurance companies
In the aftermath of the global financial crisis, the robust demand for commercial real estate in Taiwan, arising from insurance companies’ needs to park capital in a relatively safe haven, pushed property prices to new highs and resulted in highly compressed yields. Against this backdrop, the Financial Supervisory Commission (FSC) imposed a new rule in November 2012, requiring insurance companies to meet a minimum annualized yield of 2.875% when making commercial real estate investments.
Compared to the average office yield of 2.2% at the time, the minimum yield requirement of 2.875% made it nearly impossible for insurance companies to continue purchasing commercial assets in Taipei City. As a result, Taiwanese insurers no longer sought investment opportunities in the commercial real estate market. Instead, they shifted their focus to sectors not subject to the minimum yield requirement, such as office buildings for self-use, development projects initiated by the government, and superficies land rights.
With insurance companies remaining inactive in the commercial real estate market, since 2013 owner-occupiers have become the largest type of buyer in terms of investment turnover. Compared to insurance companies’ preference for income-producing office assets, owner-occupiers mainly obtain industrial properties for business operation and future expansion.
The minimum yield requirement remained unchanged until September 2015 when the Central Bank cut benchmark interest rates for the first time in 6.5 years. As the Bank lowered its policy rates for four consecutive quarters amid lackluster economic fundamentals, the minimum yield requirement fell to 2.345% in July 2016, finally meeting the market rate of around 2.4%. Nevertheless, insurance companies largely stayed cautious due to the economic downturn.
Tapping overseas markets
In May 2013, the FSC relaxed restrictions to allow local insurance companies to invest in overseas real estate markets, a move anticipated by insurers after their domestic investment was constrained by the yield requirement. Before the relaxation of the rules, insurance companies were only allowed to buy overseas properties for self-use. To date, Taiwanese insurers have closed seven real estate transactions abroad with investment turnover totaling NT$86.4 billion (see the following article for more details).
Taiwan was not the only Asian market that saw its insurance regulator gradually liberalize regulations governing insurance companies’ ability to invest in overseas real estate. Insurance firms in China and South Korea also benefited from similar regulatory changes in recent years. In addition to permitting investment overseas, the authorities in Taiwan, China, and South Korea also increased insurance companies’ maximum investment allocation to real estate and streamlined the approval processes.
In Taiwan, insurance companies’ maximum allocation to overseas real estate is set at 1-3% of total capital or 10-40% of owner’s equity, dependent on the insurer’s risk-based capital (RBC) ratio. In contrast, insurances companies from China and South Korea are both allowed to invest up to 15% of total assets. It is apparent that Taiwan’s FSC, in putting in place the RBC ratio criteria, still holds a relatively conservative attitude towards insurance firms’ overseas real estate investment. Such rules could exclude smaller-sized insurance companies from investing in global real estate markets.
Analyzing the investment activities by Taiwanese, South Korean, and Chinese insurers, it can be seen that Taiwan’s insurance companies have focused predominantly on office properties in London. Meanwhile, South Korean insurers are more flexible in terms of investment strategy and destinations. Samsung Life, for instance, bought an office asset in Chicago, while Hyundai Marine & Fire Insurance partnered with other Korean institutional investors to engage in a club deal in London.
On the other hand, some Chinese insurers have moved up the risk curve as they gained overseas experience. In one notable transaction, China Life Insurance and Ping An Insurance jointly invested in a large-scale development project in Boston. For their part, Taiwanese insurers have adopted a comparatively conservative investment strategy to meet the authorities’ preference for core assets to be located in gateway cities.
The way ahead
In Asia, the low yield levels and a shortage of investable stock are prompting Asian institutional investors to seek opportunities in overseas real estate markets. Chinese insurers have been particularly active given their sheer size. Taiwanese insurance companies looking to invest in real estate abroad are therefore facing increased competition, especially in gateway cities. CBRE Research expects that an increasing number of Taiwanese insurers are poised to search for better returns, at home or abroad, amid a slow economic recovery. They are advised to review their current investment strategy and to adopt a more flexible approach to real estate investment.
CBRE Research estimates that around NT$244 billion of Taiwanese insurance funds could be channeled to global real estate investment markets. However, under the new rules, the maximum allocation to overseas real estate is determined by the insurer’s financial capability, making it difficult for small and medium-sized insurances firms to tap into markets abroad. In addition, Taiwanese insurers are restricted from co-investment and stake acquisitions when purchasing overseas assets, although these have been a norm in many mature markets, especially the United States. To enable smaller-sized firms to gain exposure to overseas real estate and help large ones to achieve economies of scale, the government is urged to ease restrictions on partnership formation. Meanwhile, insurers are recommended to consider participating in club deals, which would allow smaller-sized firms to access overseas markets and also enable larger players to partner with like-minded investors and leverage investment managers’ expertise.
As stipulated in the new rules, insurance companies are now unable to apply for an additional quota should their total investment exceed the ceiling amount. Large insurance companies that have purchased property overseas may become inactive due to their total investment amount being capped at a certain level. Under these circumstances, CBRE Research suggests that Taiwanese insurers change their mindsets to consider the option of disposing of property if good returns are available. Doing so will not only free up capital for future investment but will also allow insurers to realize capital gains as an alternative to holding income-producing properties for a long time.
Domestic insurance companies have preferred holding office assets, whether onshore or offshore. In Taiwan, they mainly invest in office properties located in Taipei City, while in overseas markets they have a tendency to look for office investment opportunities in the central business district (CBD) areas of gateway cities.
Although office properties generally provide stable income, CBRE Research expects that an increasing number of insurers will expand their interest in allocating capital into alternative sectors such as retail and hotels in order to ride the uptrends. In addition, insurers are advised to consider office properties in secondary locations to capture increasing demand for cost-saving leasing opportunities.
CBRE Research anticipates that the authorities will continue to relax regulations relating to real estate investment by insurance companies as they gain more confidence about overseeing such activity. The adoption of a positive attitude by regulators will further encourage Taiwanese insurers to achieve greater diversification of their portfolios by geography and by asset type, thus attaining higher returns.