Why foreign CRE investors aren’t deterred by US economic concerns
Despite high inflation in the United States and growing worries about a recession, much of the world still sees the United States as a safe haven for investment.
Foreign investment in US properties saw a sharp decline in 2020, when many countries were virtually immobile. But it rebounded last year and continues to gain momentum amid rising global tensions and a bleaker outlook for US GDP growth.
“We’ve seen a massive recovery in 2021,” said Aaron Jodka, director of US capital markets research at Necklaces. “Foreign investment has returned to the United States”
Overall, foreign investment in CRE jumped to $72.6 billion in 2021, nearly doubling the previous year’s figure. Foreign investment as a percentage of total U.S. sales volume, however, Jodka noted, is around 8%, well below the 2014-2018 rate, when it averaged nearly 14%. .
The second half of last year was particularly strong, with near-record investment volumes seen in the fourth quarter, according to Riaz Cassum, executive managing director and global head of international capital for JLL. And while the fundamentals remained strong at the start of the year, there was a noticeable shift.
“The rising interest rate environment has placed near-term upward pressure on initial yields,” Cassum said.
Will CRE decrease significantly?
After the high volume of the previous quarter, foreign investment in the US CRE moderated in the first quarter of this year, according to Darin Mellott, CBRESenior Director of Capital Markets Research at .
From a historical perspective, he continued, the first quarter of 2022 was 38.1% lower than the first quarter average of the five years before the pandemic. So, if volumes in 2021 were driven by strong economic growth which translated into attractive CRE fundamentals for investors, what has changed?
“To understand foreign investment flows into the United States right now, you have to look at the value of the US dollar and hedging costs, which have skyrocketed since the start of the year,” Mellott explained. “As a result, it is more difficult for foreign investors to deploy capital in the United States”
Even given this, the United States is increasingly seen as a safe haven.
“Dry powder from cross-border investors for US commercial real estate remains historically high,” Cassum commented.
So, as market volatility wanes and investors get a clearer picture of inflation and Fed policy, foreign investment in US properties should pick up again. “We expect cross-border investors to continue to be active in the US market,” he said.
The results of the annual survey of the Association of Foreign Investors in Real Estate confirm this. Three-quarters of AFIRE members (175 organizations in 23 countries) expect to increase their volume of investment activity this year. Most also plan to increase their real estate investments in the United States over the next three to five years.
AFIRE CEO Gunnar Branson, however, warned that the responses to the survey were given before Russia invaded Ukraine. Investor concerns about geopolitical volatility are undoubtedly higher now.
CRE markets attracting foreign investors
The AFIRE survey – and the industry experts interviewed here – provide substantial insight into the places, properties and players at the heart of the next wave of foreign investment.
Atlanta, Austin and Boston are the top three cities cited for 2022 by investors, the majority of whom are also moving beyond traditional metros and showing more interest in secondary markets (like Dallas, Denver and Seattle) and tertiary locations (like Charlotte and Raleigh).
The flow of capital to non-gateway markets is expected to continue, with investors targeting markets with the best prospects for revenue growth. “Secondary growth markets, particularly in the Sun Belt, captured an increasing share of cross-border investment in 2020 and 2021,” Cassum said.
The report also adds that hub cities are likely to maintain their preferred status over the next decade, even though “investors widely agree that the pandemic has permanently altered cultural attitudes towards work preferences.”
Properties of interest
While there’s a reason for the stereotype of a foreign investor taking a 49% stake in a downtown office building in a hub city — and it’s not entirely invalid now — the types of properties of interest are also changing.
Respondents to the AFIRE survey overwhelmingly place multifamily at the top of the list of preferred property types over the next three to five years (90% plan to increase their investment), followed by life sciences (77% plan buying more) and industrial (75% planned to develop their properties).
These changes, Cassim said, are a result of “cross-border investors becoming more knowledgeable about property types outside of the office sector” and being drawn to age-old drivers of multi-family and industrial demand.
In the office sector, Jodka noted, while the typical choice for foreign investors was CBD office assets, it is now closer to 50/50 CBD versus suburban. This is partly for better diversification, he said, but it’s also because suburban properties are seeing a stronger tendency to return to the office, as the offices themselves are seen as safer and more spacious and often involve what office workers consider to be safer travel.
But, even if there will be some changes in appetite, the strategy will generally be the same. “Even though preferred property types change from year to year, a focus on core business remains the primary investment strategy for half of all investment strategies, while value-added activity could see a 62% increase over the next five years,” the report states.
CRE’s most active foreign investor
Who, exactly, will do all that investing is largely unchanged from the recent past. Canada remains the largest investor in U.S. CRE, accounting for 37% of total foreign investment activity in the 12 months to Q1, slightly more than Asian sources of capital in the same period, according to Jodka. It was followed by Singapore, South Korea, Germany and Bahrain.
Mellott, however, calls a somewhat different top five: Canada, followed by Germany, Switzerland, Australia and Singapore.
While there has been little change in country composition, Cassum notes increasing activity by private investors deploying capital in the United States. These include wealthy family offices, as well as syndicators, including German open funds like Union Investment, Deka and Commerz Real.
Will the United States always be a safe haven?
One of the reasons the United States is still considered a safe haven is its growing population, Jodka noted. “We have stronger demographics than many countries in the world,” he said. “Ultimately, real estate is driven by people.”
Yet risks remain, perhaps in part because of this growth. Jodka referred to a presentation on “Climate Migration and Future Population Centers” at the Urban Land Institute conference last April. Author and futurist Dr Parag Khanna has warned that, given its latitude and therefore vulnerability to climate change, the United States is doing very little to mitigate that vulnerability.
So, especially for investors who measure their timelines in decades, or even generations, America’s response to climate change may well be the next factor that attracts foreign capital here — or scares it away.
Read the August 2022 issue of CPE.