- Oct 28, 2013
As the world’s economies emerge from the Great Recession, investors are becoming more interested in revisiting crossborder real estate opportunities. With the possibilities varying by market, impacted in the short term by financial and political volatility and in the long term by demographic and economic trends, three experts on global real estate spoke with editorial director Suzann D. Silverman about what to expect. They include Peter Hobbs, managing director & head of research for IPD; Ray Torto, global chairman of research for CBRE Group Inc.; and Stephen Collins, international director with Jones Lang LaSalle Inc.
CPE: How does the U.S. real estate investment market compare to other markets around the world right now?
HOBBS: I think we need to look at both where they are in the cycle but also structurally. On both counts, the U.S. is very well placed. Structurally, it’s one of the most sophisticated, liquid, mature, transparent markets in the world, which reduces risks for investors … whereas in other markets, there’s a lot of corruption, lack of transparency. … In terms of its cycle, it’s also quite well placed because it bounced back quite well from the financial crisis. … The fundamentals are better placed than in many other parts of the world. … For Asia, there are huge differences across the markets, but many markets there are quite aggressively priced and there’s quite a lot of supply coming on stream, whereas in Europe, there’s a real weakness in the economy. … Over the medium term, you’ll see markets cycling. … Some cities are starting to slip now. Washington, D.C., is a clear example. Hong Kong is another, where growth has been very good but it’s weakening. …
Most U.S. plan sponsors have 80 percent plus of their real estate in the domestic market, maybe 85, 90 percent, some of them 100 percent. But that’s starting to change. … We’re starting to see increased appetite now for global real estate exposure. Over the next five years, I’m sure we’ll see more capital becoming global in real estate to (capitalize on) markets at different stages of the cycle.
TORTO: One of the important things with commercial real estate is to have the availability of debt. That is one thing that’s different in the U.S.: There is availability of debt at a relatively reasonable historic price. You see that both in the CMBS market and with insurance companies. Even the banks are starting to step up and make some loans. All of that is not true in a great way in Europe. In between Europe and the U.S. is Asia and Asia-Pac. … There’s availability of debt in Asia-Pacific, but not as much and as cheap as in the U.S. And then … if you look at the regions of the world, the U.S. real estate market is doing better than most other places in terms of the expected returns and also in terms of yields.
CPE: What kinds of opportunities are there now overseas that are not available in the U.S.?
HOBBS: You’ve got other markets that are very similar to the U.S. in terms of their maturities—say, Australia or the U.K., (which are) very sophisticated, transparent (markets)—but you’ve got other markets where a lot of the real estate is unoccupied still. And so, there’s a wave of sale-leasebacks, and Continental Europe is a particular area where this is happening because of the distress that they’re under. (While) in the U.S. or U.K. it might be 60, 70 percent is rented and 30, 40 percent is unoccupied, it’s the other way around in France or Germany. There is a move to bring that unoccupied space into the institutional market, and that’s ideal for a lot of investors because you tend to get very good credit, a long lease and good-quality real estate.
So I think you’ve got your cyclical opportunities, but also some structural changes going on, particularly related to owner occupation reducing. But also, student housing, self storage, medical offices. These are tiny in most non-U.S. markets. Logistics is starting to grow very significantly in Asia and Europe, but it’s still way behind the sophistication and size of the U.S. I think these are very powerful opportunities. They reflect the demand in the economy, but they haven’t yet matured as real estate asset classes in Europe or Asia. The strategy is often to build or develop to core, so they won’t develop and then plan to sell.
TORTO: When you think about Asia, the real opportunity there … (is) development. Whether it’s retail or office or even industrial space, there’s not a lot of that kind of space, and there is a tremendous demand by global occupiers. But your issues are dealing with the permitting and the land and the construction risks and all that sort of stuff. If you get it built, you’re probably OK; you’ll probably get it leased. …
Distress is still an opportunity in Europe because there’s not the capital there. The banks really haven’t dealt with getting rid of their distressed properties. And this is going on five, six years now. They’re in a situation where they really do need to get rid of those properties, and there’s not a lot of institutional existing capital in those banks. So I think the opportunity is there for American capital to go over there and to pick up those properties. That’s what you’re starting to see. You’re starting to see a lot of the Blackstones of the world who are capitalizing on that. Carlyle (Group is also) starting to go there.
The other opportunity that’s a big opportunity that people are looking toward is Africa. I think Carlyle is the only big private equity fund that’s gone to Africa and put together a fund around real estate. …
In other parts of the world—you’re talking Asia; you’re talking Africa—the demand for real estate is just population growth, population density in the sense that they’re creating cities, and then of course the middle-class development as their economies grow and that middle class wants to buy things through retail outlets and so on. …
Overseas, it’s generally the traditional food groups, except for seniors housing. With particular issues in Europe, where you already have a population that’s aging, like we have here. It’s also an issue that’s starting to develop in China.
COLLINS: What is very attractive and very lucrative for U.S. investors specifically in Europe right now is the distressed loan and note sale business. Heretofore, the European banks have not been as willing to admit that they had a problem and they’re going to have a problem. There are some who believe that the distressed notes that are coming back in Europe are more plentiful than they were in the U.S. Therefore, a lot of U.S. investors, private equity firms, are looking at Europe to buy portfolios of loans at a discount. But it all depends on which countries. To get a property back in France is practically impossible. But in Germany, the U.K., it’s much more prevalent. … The second opportunity, I’d say, is the multi-family business. It hasn’t been as robust as it always is here in the U.S., and it’s getting stronger and stronger over there. …
The U.S. investors that are able to invest in Asia right now run from the big U.S. institutions who have established offices and been over there for years to the regional sponsors from the U.S. who have been over there for years and years and have met a couple of sources who they can then develop a small project with. Access right now to note sales is not—it’s coming. It’ll hit the Asia-Pacific region, if not this year, a couple years from now. In three years, there will be some distressed notes coming back. But it hasn’t hit there yet to any degree.
CPE: Are there opportunities in Latin America?
COLLINS: Some people are likening it to the Wild, Wild West. You have specific markets in Chile—really questionable markets—but aggressive pricing in Argentina. But the bulk of the money is going to Brazil and to Mexico. Brazil—I say Wild, Wild West—is not for the faint of heart. They’ve developed a lot of product down there, but right now the market is extremely soft. It’s like when they said the BRIC countries—you know, Brazil, Russia, India, China—well, now there’s a glut of office space in China. Now there’s a glut of office space in Brazil. There really haven’t been a lot of governors on the markets in either place, to govern themselves about, “OK, you can’t build this much here.” They were looking for the income from the developers to buy the sites.
You see a lot of U.S. developers—the Hineses and the Tishman Speyers and others—build down there, and build very well and very successfully. But now you see a lot more development down there coming out of the ground, and so the market is soft. We advise our clients, in almost all cases, when you go down into especially Brazil, you need some sort of local partner. And do your due diligence on your local partner very well, because there’s a lot of opportunities for failure if you don’t pick the right partner. Mexico is the same. It’s come back strong. Some areas are still kind of soft because of the drug cartel issues, but they’re still going strong. Mexico City, Juarez—they’re all still benefiting from the U.S. assembly, light manufacturing groups. You’re selling stuff at 8, 9, 10, 11 cap rates, as opposed to big cities in the U.S. where—in New York, D.C., it’s 4.5, 5.5. But again, it’s difficult to get financing down there.
TORTO: Brazil is a good 50 percent of all of the GDP in Latin America, 200 million-plus people. After that, there’s Mexico, and that’s certainly a strong market. And then there’s a little market called Panama that’s just been booming because of the Panama Canal. They really are growing. They’re doubling, tripling their existing stock. But again, it seems to be much more of a domestic market, not really an international market.
CPE: How has the recession impacted returns globally?
COLLINS: The range has spread. For instance, if you were buying anything with a London address three or four years ago, before the market tanked, (it) was painted with the same brush—a 4.5, 5.5 percent return. And then the recession hit, and all of a sudden it was only City or West End. West End was getting 6 percent. So some foreigners came in and bought at 6 percent right away. And literally within six months after the recession hit, they got, like, 6.5, 6.75 percent, and then they turned around and sold it two years later for 4 percent.
So now, if you look at London, it’s not painted with the same brush. City and West End get the low cap rates and high prices, whereas in MidCity and other places—Canary Wharf—returns are a little higher. So it’s affected it that way. With the flow of information being so readily available via the Internet and people willing to give it away, (it) has made it so much easier for people to make decisions. It’s caused the markets that they’re looking at to be more focused, as well.
HOBBS: Calgary, because of the oil, Perth, because of the mining, Oslo, because of the oil, Houston, because of the oil, (were) performing particularly well. You also have another set of cities, the financial capital cities—London, Paris, New York, Hong Kong—that have done well. And then you have some tech cities—San Diego, Munich, Seoul, Stockholm. This has been the case the last two, three years. With commodities doing less well now, there’s got to be concerns over the likes of Perth, Calgary and Oslo, where they’ve had fantastic performances the last two, three years but now they’ve become quite pricy and there’s less of a commodity growth spurt than we’ve seen over the last two or three years. And supply has increased dramatically in those cities.
So in terms of where they’re placed, I think we’ve got to think about the fundamentals but also the capital. Two areas I worry about always is, if the supply gets too far ahead of itself and if the capital markets get too far ahead of themselves. I think that’s the danger, really, happening in those commodity cities. But in terms of supply across Europe, there isn’t a real problem except for maybe parts of the city of London, where there’s a lot of supply coming on stream.
CPE: Peter, you mentioned some sectors that are considered economic drivers in the U.S.: technology and energy. Are these the main drivers globally or are there other factors defining the best cities for investment outside the U.S.?
HOBBS: There’s another group that really isn’t there, which is the capital cities, the administrative cities, which often tend to have a financial or a technical or a commodity strength. But we’re seeing big cutbacks in public-sector spending. …
In the States, the big focus is, where are the drivers of employment growth—look at where the employment growth is and demand will follow and then returns will follow. There’s less of a clear-cut relationship in many other parts of the world—certainly in Europe, because there’s such a lot of poor-quality real estate that a lot of it becomes redundant. And so, although employment growth—and Japan is actually a case of this—might not be very strong, there’s huge demand for good quality, whether it’s office or retail, because the redundant spaces get taken out of the supply. … There’s been a feeling, an understanding that if you build better-quality office and retail space, then it will tend to perform well, whereas in the U.S. there’s been much more interest in fundamentals. Asia is different, where it’s much more about the fundamentals. There is, also, as in the States, a big awareness of supply because there’s much more supply being built as these economies become developed.
But (the drivers) are the same: It’s technical, financial capital cities, I think, although manufacturing is another group. One other group is transportation, and that relates to logistics. As in the States, you don’t tend to get cities; it’s more hubs. It’s distribution hubs that tend to be wider, very strong ports, very strong airports that generate that demand, not just for logistics but also for office and retail.
There’s a lot of debate in Europe about migration and immigration. There’s out-migration from the weaker parts of Greece or Spain to the stronger growing parts of Europe—Germany and the U.K. And I think it’s important to drill down. A lot of people are aware of the shrinking population in Japan, but Tokyo continues to grow. … Germany is shrinking, but the German cities are growing. People are concentrating more and more on the cities. And we need to drill down not just to the city but also, within the city, where do people want to live?
COLLINS: Technology is definitely one of them. And still the banking sector. (That is driving growth in) London. Frankfurt. Paris. And I think that’s it for Europe right now. Asia would be Singapore and Hong Kong. And Shanghai—definitely Shanghai. And the folks in Europe have had to deal with the environmental and the energy issue for a lot longer than the U.S. has, so they’ve kind of got it down. Especially the Nordic states have that down. In any markets, as you get a highly educated workforce with disposable income, like the U.S.—I call it the re-urbanization of major cities. It’s happening in the U.S.; it’s happening in Europe, as well.
CPE: In the U.S., there is a lot of talk about investing in secondary cities. Do those opportunities exist elsewhere?
HOBBS: We are starting to see appetite now for maybe not so much secondary cities but not prime, prime, prime parts of the city. So not the best-quality assets but the ones where there’s leasing potential, leasing risk. I think we’re starting to see a ripple out from the core cities, but it’s not as widespread as we’re seeing in the U.S. People are starting to look at Italy, starting to look at Spain, but it’s still very tentative.
What we’re seeing now is less American but Asian capital going to the U.K.—to, say, Manchester, rather than going to, say, Spain. Because there’s still concern over the political outlook and economic outlook for those countries. But I think that’s a big change, because a lot of new investors were saying, “Oh, it’s gotta be London.” But London is one of the most volatile markets in the world, so it’s not a good place for long-term capital. The weight of capital is very much in London, but there is more appetite for some of the provincial, secondary cities.
TORTO: If you’re willing to take a little bit more risk and go to the secondary assets, you’ve got the U.S., which is starting to show some economic velocity, and you’ve got the U.K., which is starting to do a little bit better. … We did have interest in looking at secondary cities in China four or five months ago. It’s sort of tapered away with the current slowdown and the concern that they might have a hard landing.
COLLINS: It’s hard for a U.S. investor. … I love Dusseldorf. It’s a cool city. But it’s hard to get invested there, because the local players know it; the European players know it. You would have to find a local partner to do it. So the investments are there, but the question is whether these guys are willing to take the risk. And then U.S. investors typically say, “I know what’s going on over in Chattanooga or Nashville or Memphis. I know those markets because I live there. I don’t need to go over to Dusseldorf and find a deal when I can find one right here.”
CPE: Ray, according to a recent CBRE Research report, crossborder investment decreased during the recession. Do you anticipate this turning around soon?
TORTO: That was surprising. … When we looked at the total flow of volume, I was somewhat shocked to see what a large share of it was domestic, particularly for Asia-Pac and for the Americas. Europe is a generally smaller set of countries; there’s much more of a tradition of crossborder, intra-regional investments there. There’s just an enormous amount of capital and an enormous amount of competition when you go to places like Asia-Pacific. And we expect that to continue.
I do think U.S. investors will try to reach out. … The institutional investors will go overseas and they’ll find enormous competition for existing product. The developers who want to go overseas, and the people who want to take more risk, I think they’ll have more opportunities.
HOBBS: I think that’s been driven by risk aversion. In the financial crisis, there was a return to the bricks-and-mortar real estate, which tended to be domestic. A number of investor groups didn’t follow that trend: The Canadians, actually, have increased, over the last three years, their global investing. Foreign wealth funds—in Asia, the Middle East—are increasing their crossborder investing. And a number of the German institutional investors increased. But the big investors in the U.S. have tended to be more domestic.
One of the other reasons for this is that in the past, when U.S. planned sponsors went overseas, they tended to do it just about always through opportunistic funds. As you know, there was a big reaction against opportunistic funds because they’re the ones who suffered the most in the crisis because of the leverage. So they pulled back from opportunistic, and then, as a consequence, they reduced their overseas exposure. And it was the U.S. who were the big sponsors of the opportunistic model, so the retreat was most significant from the U.S. … There’s also now better awareness, better platforms to invest globally. There’s more transparency. People are being more transparent about the strengths and weaknesses of their platforms; there’s more sophistication. So the supply side, if you like, of the investment vehicles has improved.
Many Asian markets are aggressively priced, so it’s very hard to acquire core real estate in these markets at this point in the cycle. But that will change. What we’ve seen in the last 18 months is 10 or so new core funds, pan-Asian core funds, being developed to appeal to this demand.
COLLINS: I think there are a variety of reasons (why crossborder investment will increase), but the main one is, as I mentioned earlier, they made some money; they’re trying to preserve it. It’s all risk-adjusted. They’ll buy an asset for a 4 percent yield in Manhattan and then buy a 7 percent yield in Chicago and buy a 9 percent yield in La Defense in Paris. So they’re spreading the risk, but they’re averaging their returns. I think you’re going to continue to see that.
CPE: Are there emerging markets that you see as big growing targets for investment?
HOBBS: People are hot or cold on Turkey. Some people are really positive on Turkey because of the demographics and so on. And others … are in a similar way very polarized on Russia. … There are always points in time when these emerging markets look exciting, cyclically. But the bigger question is, structurally, how deep is the capital, how transparent are they? I think it’s more incremental. Central Europe—Poland and the Czech Republic—they really benefited over the last 15 years from gradual emergence. I think we’re seeing more of that emergence moving farther east and farther southeast across Europe. There was talk before the crisis of North Africa, the Morocco area, being a sort of Mexico of Europe, sort of industrial. But the political problems there have caused—wherever you’ve seen a setback, it’s often politically or institutionally related. I think we’re seeing in Asia a similar thing. It’s more the steadily improving markets like Malaysia, like Taiwan—and China, as well—rather than Indonesia or India, which are further back. There always will be excitement. Someone will say, “Oh yeah, Vietnam now looks really attractive.” Yes, but I still worry about institutional risks in those markets.
CPE: Steve, what are your views on the MIST countries: Mexico, Indonesia, South Korea and Turkey?
COLLINS: Turkey was a darling of everybody for the last year, especially for retail. The amount of highly educated, young, smart population in Turkey, especially in Istanbul, was incredible. … India, as part of the BRICs before, was up and down and up and down, and it’s kind of quasi-down again. It’s still a hugely populated country with an educated workforce, but there are still too many highs and lows with respect to the haves and the have-nots. That’s always going to affect investment there. … Indonesia is interesting in that there’s a ton of wealth coming out of there. … As these markets get better, pull themselves up in the transparency craft from a higher score to a lower score, they become more attractive for institutions.
Read this article in its original format in the October 2013 issue of CPE