Market volatility is holding back cross-border investment in U.S. CREs

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Earlier this year, South Korean firm Mirae Asset Global Investments lost $520 million on 1.16 million square feet of land. industrial portfolio in the context of an off-market transaction. Located throughout California and Utah, the eight buildings are 100% triple-net leased to Amazon, which uses the facilities for last-mile distribution.

A few weeks later, the company invested an additional $190 million in a 1.5 million square foot. distribution center in suburban Houston. The industrial property is 100% leased to Academy Sports + Outdoors on a long-term absolute triple net lease basis.

The deals, brokered by Newmark’s capital markets team, illustrate several cross-border investment themes, according to Alex Foshay, vice president and division head of international capital markets for Newmark. “The weight of international capital looking to invest in the United States is enormous, and international investors remain in an aggressive posture, particularly when it comes to industrial assets in non-gateway markets,” he said. he declares.

However, the Fed’s decision to raise interest rates has increased both the price of debt and the costs of currency hedging, making it not only difficult for international investors to capture the leverage they seek, but also puts them in a position of not having the visibility into valuation and pricing they need to make commitments, Foshay notes.

“These are the main reasons why we are seeing a decline in international capital flows,” he said. “But once investors gain some level of certainty about costs and valuations, we expect to see a robust return to international capital executed in the United States.”

Cross-border capital flows are declining

In the first quarter of 2022, inbound cross-border investment fell 19% year-on-year to $6 billion, largely due to the strength of the U.S. dollar, according to a recent U.S. Capital Markets report from the firm. of commercial real estate services CBRE. International investors were net sellers with a sale/acquisition ratio of 1.6 (the only exception was the industrial sector, where foreign investors were net buyers). To this end, the market share of cross-border capital investments in the first quarter of 2022 was 4.3% compared to 7.6% in the first quarter of 2021.

Last year, 30% of international investors were unable to place up to half of their U.S. real estate allocations, according to the 2022 International Investor Survey Report from AFIRE, the association of international real estate investors focused on commercial real estate in the United States.

Only 30% of non-US respondents participating in the AFIRE survey indicated that their US investment volume would likely remain the same in 2022. The majority of these respondents plan to allocate up to $5 billion each to the next year.

“Most investors I speak with are optimistic, but also understand that the next few quarters could be challenging,” says Gunnar Branson, CEO of AFIRE.

The AFIRE survey suggests that 77% of non-US respondents plan to increase their investments in the US over the next three to five years. Similarly, 82% expect to increase their investments in the United States over the next decade.

Last year, survey respondents identified tax rates, prospects for US economic growth and fluctuating interest rates as top concerns for them. This year, inflation took first place, followed by the fluctuation of interest rates.

“As market volatility wanes and investors have a clearer picture of Fed policy and inflation, we expect cross-border investors to continue to be active in the U.S. market,” he said. Branson said. “Amid heightened geopolitical volatility and the war in Ukraine, the United States is increasingly likely to benefit from its ‘safe haven’ status. These factors, coupled with increased allocations to real estate, should spur continued robust investment in US commercial real estate among cross-border investors.

Hedging impacts US investments

In recent months, the dollar has appreciated significantly against other currencies as the Federal Reserve has tightened monetary policy and raised interest rates. The WSJ Dollar Index, which measures the performance of the U.S. currency against 16 others, is up more than 12% from the same time last year and more than 8% from the start of 2022.

These currency fluctuations have an impact on investors’ hedging costs. Depending on an investor’s country of origin, hedging costs can make any new investment less attractive.

“The last time the dollar peaked was in the early 2000s, and inflation is now at a 40-year high,” notes Darin Mellott, senior director of equity market research. capital at CBRE. “For most real estate investors, they have never had to face in their career the circumstances that we know today. They have to navigate very difficult conditions and try to make deals in a dynamic environment.

European and Asian investors are particularly vulnerable to currency fluctuations favoring the dollar, especially since many of these investors are legally required by their own countries to hedge against currency risk. For example, German open funds and South Korean institutional investors must hedge the equity portion of their investments.

“For cross-border investors, the strengthening US dollar has increased hedging costs, acting as a potential dampener on investment returns for investors from certain countries,” said Riaz Cassum, Executive Managing Director and Global Head. international capital for JLL Capital. Markets. “That said, Canadian and Australian investors are currently seeing a rally when hedging US assets.”

Canada continues to be a major player

Canada has historically been the most active foreign investor in US commercial real estate. Historically, our northern neighbor has accounted for 30-40% of incoming capital, and it led the rebound in international investment activity last year, along with Asian investors.

Today, Canada remains the most important source of cross-border capital. For the four rolling quarters ending in the first quarter of 2022, it accounted for 37% of total inbound cross-border investment, or $23 billion. However, the year-over-year investment volume in Canada fell 24%, according to CBRE.

Similarly, Asian investors were also down, but not as much – year-over-year volume was down just 8%. Singapore was the second most active international investor in US real estate, accounting for 23% of the overall investment volume at $14 billion, while South Korea ranked third with $5 billion in investment. For example, Singaporean sovereign wealth fund GIC has made several large portfolio acquisitions in recent quarters in the industrials sector, as well as in other asset classes.

“As you would expect, given the incredible growth of Asian economies over the past decades, we continue to see growth in investment from South Korea, Japan, Hong Kong and Singapore,” notes Branson, adding that the South Korean and Japanese pension plans have allocated a significant amount of capital that has not yet been placed in the United States.

Bahrain and Germany round out the top five foreign investors, according to CBRE. Syndicates such as traditional German open-end funds Union Investments, Deka and Commerz Real continue to be active, Cassum notes.

And while Canada will likely continue to lead cross-border investment in the United States, experts are also noting new institutional interest in U.S. real estate markets from Latin America and the Middle East. Capital flows from these parts of the world tend to increase during political and economic “stress,” says Jonathan Woods, chief operating officer of Excelsa, a Lebanon-based investment firm that raises funds. to Middle Eastern investors through fund vehicles.

“Our investors want exposure to the United States because it offers yield and growth,” Woods notes. “The United States, with its strong demographics, transparency, liquidity and abundant debt, offers an attractive risk-adjusted return compared to other countries and especially its home country.”

Love affair with industrial and multi-family

Foreign investors are largely ignoring office buildings and hotels, while continuing their love affair with industrial and multi-family assets.

Cross-border investors were net sellers of office and hotel assets in the first quarter of 2022, according to data from MSCI Real Assets. During this period, cross-border acquisitions of CBD office assets were 79% lower than the pre-pandemic average (2015 to 2019), while cross-border disposals of these assets were 86% higher than the pre-pandemic average. pandemic.

Meanwhile, investors sold $1.9 billion in hotel assets in the first quarter of 2022, the fourth quarter in which they were net sellers. Hotel purchases by cross-border investors totaled $1.7 billion in the first quarter.

“In previous cycles, cross-border investors often favored the office sector, with an emphasis on gateway markets,” notes Cassum. “In recent years, however, we have seen these investors allocate significantly more capital to the industrial, multi-residential and alternative sectors.”

During the first quarter, the industrial sector garnered 35% of cross-border investment volume, the highest share ever for this type of property, according to MSCI. Even so, the quarterly net acquisition volume of $1.6 billion was low compared to the 2021 total, when foreign investors added $15.3 billion in industrial assets.

Cassum attributes these changes to cross-border investors who are more familiar with property types beyond the office sector. In addition, they target sectors supported by strong supply-demand dynamics.

“Institutional investors continue to hold large office portfolios, but their new investments are increasingly in residential products,” Branson notes. “Given the ongoing housing shortage, they will likely be a favorite for some time.”

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