Foreign capital is flooding into U.S. real estate despite lower return expectations.
Money managers are taking advantage of this source of cash — expected to surpass $39 billion by year-end — by partnering with foreign investors on direct deals and collecting capital for separate accounts.
But the capital tsunami has a dark side: It is pushing prices skyward for all real estate investors.
U.S. real estate is attracting massive foreign investment, said Stephen Collins, president of Jones Lang LaSalle Inc.'s capital markets group-Americas, Washington.
“There's $10 looking for every $1” of property, said Scott Latham, vice chairman in Jones Lang LaSalle's capital markets group in New York. It will grow to $12 for every dollar's worth, he said.
“Demand so greatly outweighs supply,” Mr. Latham added.
Jones Lang LaSalle estimates foreign investment in the Americas will grow 25% in 2014, far exceeding the combined 15% rise in Europe, the Middle East and Africa and the 10% increase in the Asia-Pacific region. And the firm predicts foreign investors will invest nearly $50 billion in the U.S. alone this year, 29% more than 2013's record $38.7 billion.
Pensions & Investments' annual survey of the largest institutional real estate money managers (P&I, Oct. 27), showed that managers' investment in U.S. real estate for foreign clients jumped 33% to $62.1 billion as of June 30, almost double the 18% growth of the year-previous survey.
Among recent deals:
- Norges Bank Investment Management, investing for Norway's 5.53 trillion kroner ($830 billion) Government Pension Fund Global, Oslo, this month announced it acquired 49.9% of an office/retail building in Washington as part of a joint venture with TIAA-CREF. In September, NBIM bought a 45% interest in three buildings — one in New York and two in Boston — for $1.5 billion from real estate investment trust Boston Properties Inc.
- In October, Kensington Realty Advisors Inc. and SEDCO Capital, a Jiddah, Saudi Arabia-based firm, purchased a 97-unit assisted-living and memory-care facility in McKinney, Texas.
- In August, the Canada Pension Plan Investment Board committed US$500 million to a joint venture with real estate investment manager Goodman Group that invests in U.S. warehouses. That commitment brought the fund's total allocation to the Goodman North American Partnership joint venture, launched in 2012, to US$900 million.
Foreign investors' interest in U.S. real estate is because the U.S. “is perceived to provide a stable environment in which to invest and is the best market for capital,” a recent survey of foreign investors by the Association of Foreign Investors in Real Estate, a Washington-based trade group, said.
On a relative value basis, the U.S. market is cheap and is the most liquid, said Peter S. Nicoletti, New York-based executive managing director of Jones Lang LaSalle's capital markets group.
But this wave of foreign capital has a downside.
“Foreign capital is driving the wave of price escalation and speculation,” said Ronald M. Dickerman, president and founder of New York real estate money management firm Madison International Realty.
Foreign capital has been boosting prices in the 25 biggest U.S. office markets since the fourth quarter of 2012 — a low point in the cycle — with prices growing 8.8% in the second quarter of 2014 up from 3.2% growth in the fourth quarter of 2012, according to data from Jones Lang LaSalle.
And it's not just flowing to the hottest markets. In the first nine months of this year, Hawaii attracted $1.98 billion of foreign capital; Northern New Jersey, $1.11 billion; and San Francisco's East Bay, $89 million. None was on the list of top U.S. markets for foreign investment in 2013.
Indeed, 71% of respondents to the foreign investors' survey indicated interest in buying properties in the so-called secondary cities in the U.S. because of an increase in economic fundamentals, such as rent and occupancy.
“The markets are getting frothy,” Mr. Dickerman said. Prices are getting ahead of real estate fundamentals, he said.
For example, Washington continues to be a hot real estate market despite sluggish expected rental growth, limited occupancy rates and tepid demand for space.
Foreign investors have invested $2.29 billion in Washington this year as of Sept. 30, compared to $1.15 billion in the nation's capital in all of 2013, said the Jones Lang LaSalle report shows, using Real Capital Analytics Inc. data.
Canadian institutions have been a leading investor in U.S. real estate.
In the three years ended July 31, more capital was invested in the United States by Canadian investors than investors from any other foreign country, said the Urban Land Institute and PricewaterhouseCoopers' Emerging Trends in Real Estate 2015 survey.
In the 12 months ended July 31 alone, foreign investors scooped up 12.7%, or $50.15 billion, of the $394.9 billion in total sales in the U.S., with Canadian investors accounting for close to $15 billion of the 12-month total, the report said. Indeed, 47% of Canadian investors' investment in U.S. real estate in the three years ended July 31 happened in the past 12 months.
U.S. office and apartment sectors were top on the Canadian's shopping lists, the Jones Lang LaSalle cross-border study shows. Canadian investors were the top foreign capital source investing in the office and apartment sectors with $3.72 billion invested in U.S. office and $1.28 billion in U.S. apartments in 2014 through Sept. 30. Japanese investors, including institutions, were the top foreign investors in U.S. hotels, investing $1.94 billion in the first nine months of 2014, while Chinese investors were the top foreign capital source for development sites at $1.34 billion.
And Canadian institutions have large allocations, giving them more money to invest in real estate.
Canada's largest pension funds have target real estate allocations of between 12% and 14%, among the largest in any major pension market, Jones Lang LaSalle data show.
The Canada Pension Plan Investment Board, Toronto, which oversees C$234.4 billion (US$206.9 billion) in pension assets, has a 12% real estate allocation, for example. By comparison, the $296 billion California Public Employees' Retirement System, Sacramento, has a 7% allocation.
As of March 31, 35.1% of the CPPIB's C$24.6 billion real estate portfolio was invested in U.S. properties, the board's largest exposure to a single country or region.
“CPPIB has been an active investor in the U.S., with assets of C$10.5 billion as of Sept. 30,” said Peter Ballon, CPPIB's managing director and head of real estate investments–Americas. “The U.S. economic environment is showing positive momentum, and we continue to find attractive investment opportunities. However we continue to approach the market with discipline as competition for real estate assets grows.”
The gush of money from outside the U.S. shows no sign of slowing down.
Respondents to the ULI/PwC trend survey released last month expect equity capital in 2015 will increase more from foreign investors than any other capital source. And 81% of respondents to the survey by the Association of Foreign Investors in Real Estate indicated they intend to increase their portfolio of assets in the U.S.