While recent market conditions have necessitated a few changes to strategy, international investors' interest in most sectors of the U.S. commercial real estate (CRE) remains strong, thus maintaining a crucial market driver by helping keep the dollars (or their equivalents) flowing.
The opportunities for becoming involved from overseas these days remain numerous and highly attractive, according to Scott Sweeney, executive vice president at Falcon Real Estate Investment Co. LP, a provider of advisory services for international investors in U.S. real estate.
‘Today, just like with the domestic players, there are a lot of foreign investors looking to take advantage of the difficulties caused by the strained capital markets today, whether it's an outright acquisition of a property or by providing subordinated debt to an owner or structuring some sort of JV with an owner,’ he remarks.
Like their U.S.-based counterparts, the more risk-averse players and those who require a great deal of leverage for completing deals may find investment activity particularly challenging these days, in the midst of the credit crunch and an environment of generally lowered leverage. Sweeney notes that the many non-U.S. investors that do tend to use leverage in their acquisitions may now be in a difficult position.
Fundamentally unwavering interest with a few needed pauses remains the dominant trend right now in foreign CRE investment, concurs Gerald Monash, executive director of investment services at NAI Global.
‘There is a tremendous amount of capital outside the U.S. looking at acquiring assets within the U.S. Some of it is on hold,’ he says, emphasizing that the delay is likely to be short-term. Although many of the investors are waiting to gauge the immediate direction of the U.S. economy, their long-term commitments to investing in the U.S. CRE market ensure that ultimately, these transactions will move forward.
The exact timelines for jumping back in are likely to be extremely individualized, dependent on both the investor and the market.
Monash says that many pension fund clients are currently waiting for the market to settle down rather than make a large investment on the brink of a recession. On the other hand, individual high net-worth investors, who tend to be more ‘entrepreneurial-minded,’ are likely to be fully committed to buying right now.
For both major groups, ‘Once the U.S. economy has stabilized and the issues are fully identified and plans in place, the spigot will turn on, producing tremendous inflows of capital,’ he predicts.
The debt search
Overseas investors who are currently active must find appropriate financing sources in a market that now lacks its formerly sparkling superstar: commercial mortgage-backed securities (CMBS).
Consequently, some foreign investors are now seeking financing in their home countries much more aggressively than in the past, Sweeney says. Others are following domestic investors to U.S.-based regional banks and life companies. Access to cash to complete a transaction remains the crucial factor for domestic and international investors alike.
On the other hand, many international investors were not, as a rule, dependent on conduit debt in the first place and have not been significantly affected by the collapse of the CMBS market, according to Monash.
‘If anything, it makes opportunities more available to them: Some are buying discounted debt – discounted paper – rather than the actual equity instruments,’ he points out.
Monash anticipates that the debt markets crisis may inflict more severe damage on borrowers – both domestic and international – with existing loans that will soon be due for refinancings. ‘I think there will be readily available money to [refinance], but the problem will be that the cashflow might not service the debt of the necessary funds. With those loans that were highly leveraged, you might not be able to meet the total amount of leverage that was originally in place,’ he warns.
Although other avenues, such as joint venture or mezzanine, may help bridge the gap between the senior debt and total purchase price, some existing loans in these challenging refinance situations will ultimately be written down by lenders, he adds.
Defaults have not popped up in significant numbers, but many lenders have begun to gear up for a wave of workouts. Accordingly, a great deal of capital – also on both the foreign and domestic sides – awaits the widespread opportunities to purchase the masses of nonperforming loans that have not yet materialized.
Among his clients, Sweeney reports very little workout activity thus far. ‘I think it's still a little early, and a lot of investors today have been able to find an alternative capital source to take them out of the deal,’ he says.
Failed condominium conversions and borrowers' subsequent struggles, on the other hand, have provided substantial opportunities for international investors of late. ‘We see that as an opportunity for a new client coming in to solicit a potential acquisition for one of those types of properties,’ he explains.
Looking for patterns
Many sizeable foreign investments lately have come from sovereign wealth funds based in countries in the Middle East. ‘I think that's another trend that we're going to continue to see because they're really looking at the high-profile trophy assets, and there are very few groups today willing to put the big dollars into those types of investments,’ mnotes Sweeney.
Profits from the oil industry are expected to allow this investment to continue, while the long-term rewards from investing in commercial real estate are likely to continue to outweigh the concerns of risk for this group.
Japanese investors, on the other hand, are exhibiting some caution in the U.S. CRE market at the moment. Despite active expressions of interest and ample questioning from this investor base, including a noticeable ramp-up over the past several months, ‘We haven't seen anyone want to pull the trigger on anything yet,’ he reports.
Overall, because of emergent problems among different commercial property types, identifying country-specific or even region-specific investment trends has proven difficult in recent months, says Monash.
Although multifamily, along with grocery-anchored retail, remains highly favored by international investors in general, such old generalizations as ‘Australian investors like opportunistic deals’ no longer apply with the same degree of dependability. Neither attitude toward risk nor preferred asset type can be consistently categorized by country anymore, he says.
At the same time, according to Sweeney, some reliable trends can be derived from overall foreign-investor behavior.
Most of these participants tend to focus on the top 10 real estate markets in the U.S. and are unlikely to venture into the secondary markets. ‘They're really looking for stable properties today where the real estate risk has been minimized, because there's so much other risk involved,’ he explains.
World view
The question of risk in the U.S. market has naturally taken on new urgency during a time when talk of the national economy is essentially talk of recession. Opinions vary regarding the severity of such a downturn and what effect it would have on overseas' investors attitudes, as well as commercial real estate investment as a whole.
‘If we do see a recession, I think many economists predict it will be a shallow and short-lived one, and the bigger issues is the lack of liquidity in the credit markets,’ states Sweeney. ‘That's really affected a lot of players, both U.S.-based and offshore."
Monash foresees a more protracted, trough-like recession. Nevertheless, he reiterates that even if the national economy does not immediately correct itself, hardy participants who remain in the market may find themselves in an even stronger position than they may encounter in a more broadly favorable climate.
‘Because a lot of the opportunistic players have been thrown out of the business due to a lack of highly leveraged debt, the foreign investors that are buying with a lower cost of capital are more competitive,’ he notes. Moreover, ‘They can buy at lower yields and still achieve a higher yield as a result of positive arbitrage.’
In particular, investors dealing with the euro and buying in U.S. dollars can achieve significant boosts on return as a result of the week dollar.
Strong property fundamentals and a general sense of trust in the country's market remain the dominant reasons for foreign investors' entrance, Sweeney says. The currency play is usually merely ‘icing on the cake,’ he stresses, and it does not drive anyone's investment decisions at either the overall market level or the property level.
Recession or not, the U.S. commercial real estate market is an obvious enduring choice for foreign investment, confirms Dr. Peter Linneman, chief economist at NAI Global and principal at Linneman Asssociates, in the spring 2008 issue of NAI Global's Property Advisor.
‘The reasons are simple: solid long term macro-economic growth; political stability; an entrepreneurial and dynamic private sector; growth demographics; a massively undervalued currency; risk mitigation through diversification across a broad array of large metropolitan areas; and a variety of proven investment vehicles,’ the report explains. ‘Few, if any, other markets provide this compelling combination of benefits.’
