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MIDDLE EASTERN INVESTORS TARGET U.S. REAL ESTATE

Austin Khan, Chief Investment Officer of Laurus Corporation, shares an insight into the growing attraction of U.S. real estate to international investors. Laurus Corporation is a private real estate investment and development firm that has relationships with various types of investors, including many from the Middle East.

May 2015

In the last year alone, increasing numbers of Middle Eastern investors have sought out properties in the American real estate market. Accelerated by a sharp drop in energy prices in 2014, many groups have begun to review their investment strategies and allocations. This has shifted their focus to the United States.

A new wave of diversification is one of the most important business strategies for these investors, who are exercising caution in the wake of the Gulf’s largest asset class taking a hit, the energy sector.

This shift towards the United States happened more quickly than anticipated. At this point, there are groups of investors who are looking to either enter the American real estate market as first timers, or ones who are historically invested in the major European markets for proximity’s sake, but have begun to look at the U.S. because they see more value in terms of a general macroeconomic picture of all the industrialised western nations. From an investment standpoint, the United States has the strongest underpinning in economic fundamentals.

Capitalising on U.S. recovery

Middle Eastern investors have been on edge regarding interest rate policies. First, it was the question of how quickly the reduction of quantitative easing would happen. Second, it was the question of how quickly the transition from elimination of qualitative easing into actual increases into the fed funds rate and short-term interest rates. Even if quantitative easing has been entirely dissolved, the current strength of the U.S. dollar has prevented any sort of inflation to take hold. In terms of a short-medium range interest forecast, it seems that the interest rates will continue to be monitored and kept steady, with the Fed’s policy leaning more towards a focus on economic growth.

The global real estate markets still have elements of volatility; however, to mitigate this issue, investors can take a top-down approach, distilling a broad macroeconomic picture into regional, market specific tracts and then drilling into those markets to find the best balance between property valuations and economic growth trajectory. The markets that are seeing more sustained growth are those exposed to the energy, financial services, technology, healthcare and education sectors.

The U.S. is a great example of how global demand for new energy resources and technology have worked in parallel to create new employment demand. In the last several years, the U.S. has gone from generally being the world’s largest importer of energy to trending towards a net exporter of energy. The emergence of new hydraulic fracturing technologies have also made the U.S. a leading player in shale oil and gas exploration and extraction, creating hundreds of thousands of new jobs in the process.

The importance of looking at these particular markets with economic diversification and sufficient size to attract institutional capital cannot be overstated, however. Take for example the city of Williston, North Dakota, a shining example of what explosive growth in an industry sector can create. Both the city and the state are awash in capital and discretionary income, with the city’s unemployment rate below 1 percent and the state at 3.1 percent, the second lowest in the U.S. However, should a significant retrenchment in energy demand occur, the market has little support for sustained real estate investment.

Solid growth for hospitality and office industries

Other exciting areas for Middle Eastern investors in the near future lie in the hospitality and office industries. In 2016, there is an expected 6 percent growth in hotel industry revenue, with group segment revenues finally beginning to gain traction. Generally speaking, most markets are seeing limited new supply, particularly in the upper-upscale chain scales. With corporate earnings at an all time high, firms are expanding travel budgets and investing more in training and incentive trips as they aim to hire and retain the best talent. Non-corporate, convention-based leisure travel is also starting to make a comeback as well as increasing home values and stock portfolios driving the discretionary purchasing power of consumers higher.

In terms of the U.S. office sector, the single most important corollary to declining vacancy and increasing rental rates is total employment growth, which is currently at an above-population growth pace of three million jobs annually.

Opportunities lie ahead

When approaching the U.S. real estate market in general, it is important to be cautious of the macroeconomic variables that come with the territory. Namely, there is some risk to looking at core real estate as a replacement for certain types of fixed income investments. The more consistent opportunities at this moment lie in value-add real estate.

In an environment of rising interest rates, investors need to be mindful of the erosion of stabilised yield and cap rate spreads. Currently, the real estate sector is trading quite close to the long-run cap rate spread over interest rates. As rates rise, being invested in real estate, which is building to higher stabilised yields on income, is where a significant payoff can be reached.

Value-added real estate that involves repositioning and underperforming assets through renovation are best suited to those types of opportunities, taking underperforming assets with impaired cash flow, but attractive purchase base and implementing strategic renovation and operational changes to expand gross revenue and profitability. Historically, capital has always looked towards the U.S., particularly New York, Washington D.C., San Francisco and Boston. However, investors should be aware that the U.S. has thirty markets with more than two million in population which are significant in the size and breadth of their economies, and looking beyond the coastlines can yield fantastic opportunities to buy in institutionally-favored markets as attractive prices relative to fundamentals.

 The author can be reached at akhan@lauruscorporation.com

 

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