Two years ago Chinese regulators restricted capital from leaving its shores, driving down foreign investment in U.S. commercial real estate to well below the record of nearly $100 billion set in 2015. But cross-border inflows in 2018 were on pace to exceed 2017’s total of roughly $52 billion, according to commercial property research firm Real Capital Analytics (RCA).
Hurdles threaten to trip up the momentum, however. The Federal Reserve Board’s tightening monetary policy, which has set it apart from most other developed countries in the world, has increased the risk that future currency fluctuations could eat away at returns when foreign investors sell a property and convert the proceeds back into their country’s currency.
As a result, the cost to insure, or “hedge,” against adverse currency moves has increased over the last several months. Those factors are also making other global markets like Europe and Asia more attractive.
Additionally, trade disagreements and shifting regulations, including heightened efforts to thwart money laundering and to prevent foreign acquisitions of sensitive U.S. assets or properties near them, also are making it harder for some offshore buyers to deploy money in the United States (see sidebar).
“Offshore investment is muted at the moment,” says Woody Heller, vice chairman and co-head of the capital markets group for Savills Studley in New York. By way of example, he notes that most European investors attending the recent EXPO REAL conference, an international trade fair for real estate and investment held in Munich, indicated that they were staying on the sidelines in the United States. “Deals are getting done,” he adds, “but there’s a different feeling than in the past.”
Despite those headwinds, foreign investors still consider the United States a safe haven for the long term, especially the gateway markets of New York and Boston in the Northeast. And some real estate experts expect that longstanding appeal to translate into steadier if not more robust investment sales activity as some buyers continue to search for steadfast countries to shelter their capital while others become more strategic.
“It’s not necessarily that there’s less demand as much as it is that there are economic and political roadblocks preventing capital from coming in,” says Edward Mermelstein, an attorney specializing in foreign investment in New York. “As long as there are no capital controls in place preventing investment from coming out of a country, foreign investors continue to show significant interest in the U.S.”
Big Deal Momentum
Foreign investment in the United States increased to $33 billion during the first half of 2018 from $25 billion a year earlier, according to RCA, which tracks property and portfolio sales $2.5 million and above in the commercial and multifamily real estate space.
While observers predict 2018 volume will surpass 2017’s $52 billion, they point out that a number of large portfolio deals and mergers have accounted for much of the investment growth, none more so than the $16 billion acquisition in June of Westfield by Paris-based commercial real estate firm Unibail-Rodamco (now Unibail-Rodamco-Westfield).
Large platform transactions continued during the second half of 2018, largely driven by Singaporean real estate investment and development companies. For example, Mapletree Investments paid Prologis $1.1 billion for a 16.5 million-square-foot industrial portfolio. Meanwhile, CapitalLand paid Starwood Capital $835 million for 16 apartment properties. Starwood Capital also sold 33 office properties to Ascendas-Singbridge.
In the Northeast, foreign investment in the first half of 2018 totaled roughly $7.2 billion, which was about the same amount invested in the region during the first half of 2017 despite a year-over-year decline of roughly $1.1 billion in Manhattan and $1.4 billion in Boston, according to RCA. Increased foreign investment in Philadelphia, Northern New Jersey, Long Island and tertiary Northeast markets made up the difference.
In Boston, foreign property investment totaled only $244 million in the first half of 2018, although Norwegian government pension asset manager Norges Bank Real Estate has inked significant deals since then.
Norges acquired a 49.9 percent stake in a 610,000-square-foot office and retail building at 501 Boylston for $291 million in August, and a month later it partnered with American Realty Advisors to put 400,342 square feet of office space at 121 Seaport Boulevard under contract for $455 million. Norges Bank is paying about $205 million for a 45 percent interest in the deal.
Riaz Cassum, a senior managing director and co-head of the global capital team for HFF in Boston, says that a lack of product is to blame for the sluggish foreign activity in the market in addition to China’s retreat.
Cross-border investors appear to be broadening their horizons by studying up on life science properties predominant in the Cambridge submarket, he says. Yet Cassum is quick to add that the relatively concentrated ownership of the assets will likely limit investment opportunities in that niche property type, too.
Meanwhile, New York has fallen out of the top five international markets targeted by foreign capital for the first time on record, according to Winning in Growth Cities, a Cushman & Wakefield report on global real estate capital trends for the year ended June 30, 2018.
Still, during the first half of 2018, foreign investors plowed nearly $3.7 billion into Manhattan commercial properties, the most of any metro in the U.S., according to RCA. Notable transactions included Columbia Property Trust’s $332 million sale of a 25-story Midtown office building to German investment manager Commerz Real.
“To say that international demand is gone in the U.S. is incorrect and overstates the situation,” says Alex Foshay, vice chairman and divisional head of international capital markets for Newmark Knight Frank in New York. “But certainly a few factors have come together to reduce the amount of capital coming into the U.S.”
Pricey Protection
While Foshay and other observers point to China’s clampdown on money flowing into the United States as a big reason for the decline in foreign investment, a recent increase in the cost to hedge acquisitions has also dampened activity.
Some 70 percent of foreign real estate investors, including German retail pension funds and Korean asset managers, are required to hedge against a declining dollar, Foshay points out.
To insure against currency swings, the funds typically buy a hedging contract based on expected cash flow or residual value over relatively short-term hold periods of less than a decade. That allows them to exit an investment on par with where they entered it.
But hedging costs have surged from a fraction of 1 percent to a whopping 2 percent or more over the last several months, thanks to rising interest rates in the United States and a strengthening dollar. That extra cost is coming straight out of the bottom line, Foshay explains. In some cases, a foreign buyer targeting a cash-on-cash return of 6.5 percent today must decide whether it will accept 4.5 percent instead.
“The main reason for the big increase is that our interest rates have been rising and they’re expected to keep going up,” while interest rates in Europe and Asia are expected to remain low, adds Cassum. “It’s all about what’s going to happen with interest rates in the future, which will ultimately affect the relationship between the dollar and currencies like the Euro.”
Given the divergence of U.S. interest rate policies compared with other countries, the focus of some foreign buyers has shifted, says Thomas Toomey, CEO of UDR, a Denver-based apartment real estate investment trust. “The world is looking at the strength of the U.S. economy and is finding better risk-adjusted returns in other places,” adds Toomey, who is also global chairman of the Urban Land Institute. “Some parts of Asia and Europe are much more attractive.”
No Hedge Needed
Not all foreign buyers are subject to hedging requirements, particularly sovereign wealth and national pension funds that tend to hold assets for the long term, or that hold substantial dollar-denominated investments, observers say.
High-net-worth individuals or families located in politically unstable countries that are looking for safe havens also are less concerned with currency fluctuations. Observers expect such buyers from Canada, Japan, Hong Kong, Korea, Germany and the Middle East to remain active or become more prolific in the United States going forward.
“Sovereign wealth funds are all increasing their allocations to real estate, so gateway cities will continue to play a large role in their strategies,” says Revathi Greenwood, head of research for the Americas in Cushman & Wakefield’s Washington, D.C., office. “Even China has not completely taken all foreign investment off the table, but it is being more strategic in its investment decisions.”
Indeed, Chinese investment in the United States from July 1, 2017 to June 30, 2018 was 70 percent lower than the preceding 12 months. Even so, Chinese investors plowed $5.4 billion into the United States, according to RCA. That ranked China fourth behind Canada, Singapore and France based on the amount of foreign capital placed in the United States during that period.
Among other deals in 2018, a group of Chinese private equity investors completed the $11.6 billion purchase of Global Logistics Properties, a Singapore-based warehouse landlord that had amassed some 175 million square feet in the United States alone. The Bank of China also paid $200 million for the land under the building it occupies at 7 Bryant Park in New York, where it also owned the leasehold.
China-based companies that have operations outside of the country continue to deploy capital, too. DMG Investments, a New York-based subsidiary of Chinese real estate developer DoThink Holding Group, is one such entity.
When it entered the states about five years ago, DMG Investments initially focused on building condominiums and multifamily projects in New Jersey, Houston and Milwaukee, but more recently it expanded into student housing.
Among other projects, the company this year opened One Park, a 14-story, 204-unit luxury condo development atop the Palisades Cliffs in Cliffside, New Jersey and Auden Albany, a $30.5 million, 322-bed student housing project at the State University of New York at Albany.
Student housing investments tend to provide downside protection during recessions and higher yields than conventional apartments, says Jacky He, executive vice president of the firm.
Additionally, some 500,000 Chinese students are studying in the United States, a trend that the firm intends to leverage for leasing purposes as it pursues student housing projects in Houston, Sacramento, Calif., Chicago and other markets.
Because DMG Investments came to the United States when the Chinese government was encouraging investment America, capital controls have had minimal affect on the company as it recycles capital from projects for further investment, explains He. What’s more, certain Chinese investors desire overseas markets.
“We think that there is still strong demand from companies and high-net-worth families in China to invest here,” emphasizes He. “But they would rather go through a smaller fund than go through a big institution because there is more flexibility.”
— Joe Gose