Despite Shaky Market, Savills Studley Optimistic About US CRE

Savills Studley's latest report analyzes the effects of global market volatility on U.S. commercial real estate.
Heidi Learner of Savills Studley

Heidi Learner of Savills Studley

New York—Fears of an oil oversupply, concerns about the ability of monetary policy to boost inflation and worries about China’s slowing economy are all stoking instability in financial markets. Though global financial markets have shown substantial volatility for these and other causes, it’s nonetheless rational to believe that U.S. commercial real estate will hold up well, according to a brand-new report from Savills Studley.

In the report, the company’s chief economist, Heidi Learner, focuses on four reasons for optimism:

  • Further appreciation of the U.S. dollar hikes returns for overseas investors.
  • In troubled times, CRE’s very illiquidity can be an advantage.
  • Recent changes in the Foreign Investment in Real Property Tax Act of 1980 are favorable for foreign investors.
  • U.S. index investors might need to rebalance by adding CRE to their portfolios.

Let’s look at each of these four factors more closely.

Appreciation of the U.S. dollar

The report notes that, as of December, the U.S. is one of few countries that has begun monetary policy normalization. It continues: “To the extent that higher government yields in the U.S. support further U.S. dollar strength—particularly relative to currencies at risk of further devaluations, such as the Chinese yuan—the currency impact of an investment in the U.S. can provide an added source of return for overseas investors.”

Further, strength in the dollar has been associated with an increase in foreign investment in U.S. CRE. As the dollar rose nearly 20 percent (adjusted for inflation) versus its major trading partners since 2009, foreign investors “have gone from being net sellers of commercial real estate to accounting for more than 11 percent of all U.S. real estate activity” last year.

CRE’s illiquidity

When “the sky is falling,” Learner wrote, the very illiquidity of CRE investments means that they tend not to be traded quickly. During periods from 1972 through 2015 when the S&P 500 monthly total returns were negative (38 percent of the time), the FTSE NAREIT U.S. Real Estate Index Series (Equity REITs) performed worse than the S&P 500 just 31 percent of the time.

This suggests, according to the report, that “equity REITs outperformed the S&P 500 more than two-thirds of the times during those months when overall equity performance was down.”

Favorable tax changes

Under FIRPTA changes signed into law by President Obama in mid-December, qualified foreign pension funds can now invest in CRE without facing a tax on gains upon sale, and foreign entities will be able to increase their holdings in publicly traded REITs from 5 percent to 10 percent before triggering tax upon sale of these interests.

Rebalancing by U.S. index investors

Equity index funds could find a need to increase their REIT investments, following the first-ever creation of a new sector (for real estate, which is being moved out of the Financials industry group), in the GICS. In addition, non-mortgage REITs will be classified in a new sub-category.

Learner cautions that all of this doesn’t necessarily add up to an ongoing increase in sale prices per square foot. “But even if U.S. commercial real estate were to weaken from current levels, chances are the sector will still outperform most long-only investment alternatives in the coming months,” she concludes.