Global market cycle pushing Asian real estate investors abroad

It is a period of great change in commercial real estate investments, change that impacts all segments of the industry, and key among these changes is the growing presence of outbound Asian capital in the global marketplace.

With a record $46 billion hitting the real estate market in 2014, Asian capital in all forms — private and public funds, and both indirect and direct placements — has started on the path to becoming what we believe will be the dominant factor in global investments.

As the pace of this investment picks up, by some counts as much as a 61% increase in 2015 alone, Asian players, much like U.S. investors, will be moving further out on the risk spectrum and exploring more alternatives in their search for yield. Also similar to U.S. institutional investors, Asian investors have already looked beyond the traditional gateway cities of New York, San Francisco, Seattle, and Washington D.C. in the U.S. to other major metropolitan areas, such as Houston and Chicago that have long-term, sustainable demographic growth and a strong business base to drive economic expansion. (According to the Association of Foreign Investors in Real Estate, the top five global cities for investment in recent years are, in descending order: New York, London, San Francisco, Tokyo and Madrid.)

But now, as competition in the traditional gateway cities and major metropolitan markets grows more intense and current yields are compressed across all markets and asset types, stateside and foreign investors alike, Asia included, are turning increasingly to less-crowded secondary markets that provide the amenities and growth of the primary metropolitan statistical areas and opportunities for core-plus or value-added investments. Secondary cities such as Austin, Nashville, Raleigh and San Diego are a few of the markets with demographic and commercial characteristics capturing the attention of institutional capital.

What types of assets are most sought after by Asian investors? Sectors and specific assets that can provide stable cash flow and a shortened J-curve are particularly attractive. Multifamily and office properties are favored in locations that are suitable for long-term holds and most able to endure volatility through market cycles. Investors have also been focused on demographically driven sectors, including health-care-related facilities such as medical office and senior housing (more on this later). Opportunities to invest in these sectors will continue to be attractive strategies for investors.

Asian investors are even looking beyond the traditional targets that provide current yield and have generally become more comfortable with moving up the risk curve. As a result, they are also likely to consider assets that have potential for projected current yield, growth in revenue streams or capital appreciation.

Assets that benefit from a stable and growing economy, such as hotels, industrial and retail, are attractive and can be a successful strategy in all metropolitan statistical areas — top-tier and secondary markets alike. However, as investors look toward more complex properties globally — particularly senior housing, hotels and retail assets — partnership with an experienced investor and operator is critical as these property types require extensive hands-on asset management and oversight. Investment and operating experience in these asset types is critical to a successful investment outcome.

In the past few years, Asian investors have also been attracted to debt investments that provide stable cash flow and strong relative returns, which were bolstered in part by reduced sources of financing, and therefore alternative sources of debt came at a premium. However, as more traditional lenders come back to the market and values rise such that the debt-to-equity gap is reduced within the total capitalization, returns to investors in debt strategies will likely normalize.

A major part of the Asian investment expansion will be to other countries within the Asian market itself, and it is anticipated that players in North Asia will seek to make more investments in Southeast Asian countries. This diversification from their domestic markets comes despite likely additional market volatility.

Within China, domestic and foreign investors are expected to continue their focus on both debt and equity distressed investments, as the lack of access to debt financing, overbuilding and the general economic slowdown has led to increased levels of distress across most property types.

In terms of specific assets types, we expect increased investor focus in Asian industrial and logistics-related properties as well as infrastructure. These sectors remain attractive due to massive demand and inadequate supply. That supply/demand imbalance in industrial and distribution space, office parks and warehouse facilities is expected to continue for some time. There is a similar supply/demand imbalance among quality office properties in emerging Asian countries, such as the Philippines, Indonesia and Malaysia, especially as their economies expand, and we anticipate an increase of activity in those countries in an attempt to capture additional growth.

Another trend within Asia that is comparable to shifts taking place in the U.S. are product types formerly considered niche markets emerging as prime investment targets, specifically senior and student housing. Of particular importance are the drivers behind the growth in the first of these — senior housing.

There is a massive shift taking place in the centuries-old culture of senior care. The tradition of caring for the elderly in the family home is being challenged by the urbanization trends in China, Japan and Singapore. As the younger generations move to larger metropolitan areas for education and job opportunities, they are returning home less frequently to care for their elderly relations. Their urban dwellings are, in addition, smaller and not suited to accommodate other family members. As cultural changes lead to more independence and economic constraints drive demand for smaller housing units, an asset class that was culturally unacceptable for generations is now a necessity and will be an attractive target for investors across Asia.

It is important to note that this overall trend toward diversification will also take in a number of new areas that are still considered niche areas offering attractive yield, such as infrastructure credit, particularly for middle-market businesses, and aircraft leasing.

As mentioned previously, investment within Asia does carry unique risk. Investors face a variety of regulatory and economic uncertainties within each of their markets, including political tensions across the China Sea; various economic disincentives and taxes in Hong Kong, China and Singapore to stem development; overheated residential markets; the ultimate impact of the economic stimulus program (“Abe-nomics”) in Japan; and the potential for a hard economic landing in China.

Turning once again to the global stage, Asian investors face currency risk in Europe and a competitive environment both there and in the U.S., driving prices up and yields down. Both Europe and the U.S. also face interest-rate risk as stimulus programs tail off.

When we speak of risk, we also have to consider the fact that direct investing in any market or over any point in a market cycle comes with significant risks to the investor. That risk, of course, can be minimized if they have a substantial and experienced staff and local operating partners whom they can trust. There is a premium paid to a fund manager to act as a fiduciary on behalf of an investor. But they have the expertise within their markets, flexibility to shift between markets and sectors and the property and capital market experience to source differentiated transactions and manage the myriad complexities of an investment throughout its hold period.

There will continue to be an interest in direct investments, but only the largest investors with in-house capabilities to invest and manage will be able to execute a direct investment strategy on their own. Other investors will continue to benefit from relationships with fund managers to either execute a direct investment program through a separate account or an indirect investment program through a commingled fund that provides a strategy suited to the investor's return objectives and risk tolerance.

Many Asian investors have a longer-term plan to increase indirect real estate investment, but currently many are in the process of shifting from direct domestic to direct international investments, often again with trusted managers. Finally, many institutional investors have and are expected to continue to invest outside of their domestic markets with other like-minded Asian investors in club or joint venture structures with trusted managers to provide exposure to and diversification within a larger portfolio of investments.

Lori Campana is managing director and partner at Monument Group.