Mega-deals helped spur foreign investment in U.S. commercial real estate to a near record level in 2018, and many are watching to see if that momentum can carry over into 2019.
According to research firm Real Capital Analytics (RCA), cross-border acquisitions of U.S. commercial real estate surged to $94.9 billion last year, jumping 73percent over the $55.3 billion reported in 2017 and nearly on par with the $100 billion recorded in 2015. That spike in volume shows continued confidence in the U.S. real estate market.
Investors are attracted to the stability and growth factors surrounding the U.S. economy, the ability for predictable cash flow and the strength of property fundamentals, notes Chris Ludeman, global president of capital markets at real estate services firm CBRE. “It also underscores the belief that the U.S. is not expected to experience any sort of economic downturn in the next 12 to 24 months, whereas the flow of capital in other parts of the world [is] a little more tenuous in terms of economic output,” he says.
Several sizable entity-level transactions provided a strong lift for that cross-border sales volume, including Brookfield’s nearly $15 billion acquisition of GGP and a second purchase of Forest City for $11.4 billion. Unibail-Rodamco also purchased mall operatorWestfield with U.S. assets that were valued at about $8 billion. “Those entity-level deals were really the headline behind that extremely strong volume,” says Maggie Coleman, managing director in the international capital markets group of real estate services firm JLL.
Platform level deals tilted the scales pretty significantly last year, notes Alex Foshay, vice chairman and divisional head of international capital markets at real estate services firm Newmark Knight Frank. “We don’t see any reason why that trend shouldn’t continue, and I think it will make up a very significant part of activity in 2019” he says. One potential target for international capital in the coming year could be REITs that are trading below net asset values, which could allow major overseas investors to come in and take significant positions in REITs at a discounted cost, he adds.
Capital expands outside of core markets
There has been a noticeable drop-off in volume coming from Chinese investors due to the tighter monetary policies in that country, but other investor groups are stepping into that gap. Canadians are typically one of the most active investors in the U.S. real estate market, and thanks in large part to Brookfield, the Canadians took credit for about half of all foreign-led acquisitions last year, according to RCA.
Singapore was also a major player in 2018, with $4.2 billion in acquisitions, which put it third behind Canada and France for cross-border acquisitions, notes Coleman. “There were some large-scale deals that Singapore entities purchased, and we certainly expect them to remain active in the U.S. going forward,” she says. Singaporean investors are looking to the U.S. for diversification, as well as the ability to capture higher yields in a relatively stable environment.
Foreign capital continues to move beyond core gateway markets and into other property types aside from office and hotels, such as industrial, multifamily and alternatives that include medical office, healthcare and data centers among others. “The story that has been most interesting in the last few years that seems to be gaining momentum is the flow of capital into strong growth cities other than gateways,” says Ludeman. That doesn’t mean that foreign capital sources are not interested in gateways, but foreign investors are recognizing that there are more attractive cities around the U.S. outside of those select markets, he adds.
In addition, more capital is targeting multifamily assets. Last year, there was an estimated $15 billion in foreign capital acquisitions in the multifamily sector, which represents about a 30 percent increase compared to the prior year, according to JLL.
Canadian investors were the dominant buyers in the multifamily space last year, and overseas investor pool for that asset class is expected to broaden significantly. “We are seeing the demand for multifamily rising in Japan, Singapore, Hong Kong and from certain investors in Europe,” notes Foshay. International investors are attracted to the strong performance metrics, and they also see it as a good inflationary hedge given the shorter term leases, he adds.
Hedging costs shift strategies
One of the biggest factors impacting international capital flows over the last 18 months is the increase in hedging costs for investors that seek to guard against fluctuations in the value of the dollar. Some major investors around the world, notably South Korean institutions and German pension funds, are required to hedge on currency values based on their own domestic laws.
Hedging costs spiked about 18 months ago due the Fed’s increase in interest rates, while other central banks around the world have yet to follow suit. “Those investors have seen the returns generated on their investments severely impacted by, at times, up to 250 basis points,” says Foshay. Hedging costs have retreated in recent months to about 150 basis points, but it is still causing those groups to look to higher yielding, emerging markets versus gateway cities.
For example, Samsung SRA Asset Management recently acquired the US Bank Tower in Denver and Commerz Real from Germany bought the National office building in Chicago. NKF is in the process of executing the sale of Micron’s headquarters in San Jose to Maury Trust of Japan for $430 million. Eighteen months ago, all of those groups were focused on gateway CBD office markets, and now they are looking at markets where they can make higher returns to compensate for the cost of hedging their investment, notes Foshay.
One of the biggest potential challenges ahead for international investment activity are rising interest rates that would increase hedging costs. However, interest rates have moderated in 2019. The 10-year Treasury, which was up well over 3 percent in 2018, has settled back around 2.7percent in recent weeks. In addition, the relatively flat yield curve between the 2-year and 10-year Treasury has widened slightly, easing concerns about a potential inverted yield curve.
“We have yet to see any caution exhibited by global capital coming into the U.S. for reasons other than hedging costs,” says Ludeman. “The sound economic footing that the U.S. is in relative to other economies around the world continues to be a positive. So, I think we’re in good shape for 2019.”