New opportunities in U.S. real estate
Andres Szita explains how global economic conditions create unique buying opportunities for Middle Eastern investors in the U.S. real estate market.
The dramatic upswing seen across many sectors of the real estate market over the past several years appears to be abating, with a new emerging sense that the market has hit pause. Deal pace has slowed in the United States as buyers and sellers assess the changing market environment, taking into account how political instability caused by Brexit, more rigid lending practices caused by the 2008 Global Financial Crisis and the upcoming changes in the U.S. Administration will affect their portfolios moving forward. Funds and investment managers are taking their time, carefully combing for smart deals, and adopting a wait-and-see approach as the market transitions.
Brexit underscores uncertainty
While the recent Brexit outcome has destabilised financial markets in the United Kingdom, the uncertainty in that part of the globe underscores a unique opportunity for United States-focused funds and investors. As with most volatile global market situations, we find investors are more apt to protect their capital by investing in hard assets, prompting an interest in U.S. projects as a means to safeguard their portfolios.
With the U.S. continuing to exhibit growth fundamentals that are currently outpacing the UK, Eurozone, Japan and other major industrialised nations, interest from Middle East investors is expected to remain strong. The diversity of the U.S.’ major markets enables investors to gain exposure to the continued growth of sectors including financial services, technology, healthcare and education which are leading the way in employment growth. It’s likely that Brexit could also potentially extend the current cycle in the United States, as the Federal Government continues to keep interest rates low.
Conservative lending nearly a decade later
It’s no surprise the real estate debt capital markets have been completely transformed as a result of the 2008 Global Financial Crisis. Since then, financing has become much more conservative, with many banks reluctant to lend anywhere near pre-crises levels. As heavier banking regulations emerge requiring banks to hold more of their secured product on their balance sheet, the door has opened for private lenders. In many instances, private equity real estate fund and debt fund capital has been able to step in and take the place of banks, with the opportunity to earn attractive yields for overseas investors, particularly on a net after-tax basis.
American political landscape
Back in December 2015, sitting American President Barack Obama signed into law an easement on the Foreign Investment in Real Property Tax Act of 1980, which waived the tax on foreign pension funds. This opened the door for a significant uptick in interest from overseas institutional investors. With the upcoming November 2016 election, many are curious to see what the new administration’s attitudes will be toward foreign investment and taxation.
Regardless of upcoming changes, a private equity fund can also set up an offshore feeder entity known as a blocker. Subject to certain regulations, foreign investors can invest through the blocker corporation, and then they are no longer personally considered to be partners in the eyes of the Internal Revenue Service (IRS), as it is the foreign corporation that is the owner of equity in the fund. If structured properly, this may help to significantly improve the tax efficiency of their investments.
An experienced fund manager like Ethika Investments relishes this period in the market cycle, because it creates various pockets of opportunity for us and our investors that may not be immediately obvious.
There is certainly a healthy mix of interest from overseas buyers in both new construction and existing assets. While new-build luxury residential in gateway markets has been a favored asset class for foreign investors for the past few years, pricing and absorption have decelerated, especially with exchange rates impacting many buyers.
With respect to commercial real estate, construction financing has remained conservative which has kept the delivery of new supply in check. This phenomenon has helped to keep real estate fundamentals in balance, although there have been limited opportunities to acquire new Class A office buildings, hotels or retail centers.
With existing assets, there is still plenty of opportunity to consider. Absent the execution risk that corresponds with greenfield development, and typically with some measure of in-place cash flow, existing assets continue to demonstrate favorable risk-adjusted returns. First and foremost, it’s incredibly important to acknowledge the vast discrepancies across asset types and markets and the importance of a diversified portfolio. Though there is turbulence in the hospitality sector as the gap widens between buyers and sellers, office and retail are offering solid investment opportunities with a substantial upside if you know where to look.
For the office sector, positive projections for the next three years anticipate absorption of existing office space to total 175 million square feet, which is more than the past eight years combined. Retail is undergoing a major paradigm shift as the continued growth of online retail revolutionises the brick and mortar store front and the spending habits of millennials lead to changing configurations of shopping centers. As a result, retail destinations that in many cases have had low single digit vacancies for a generation are experiencing volatility and a needed capital infusion to stay relevant. For investors with the capability to execute on value-add strategies, these temporary displacements create unique buying opportunities in the sector.
Marching ahead toward the second half of 2016, we are observing a very interesting real estate market in the United States – one that’s propelled in part by the economic conditions globally but is just as susceptible to domestic uncertainties. The reality is that while growth rates in the commercial markets have begun to decelerate, moderate growth is still progress.
With that said, additional interest in U.S. real estate means increased competition, hence it is important to understand the nuances affecting regional deals, and to dig deeper into to secondary markets and moving beyond U.S. gateways like New York and Washington DC.
About the author
Andres Szita is the Co-founder and Chairman of U.S.-based Ethika Investments, a real estate private equity firm that has relationships with various types of investors, including many from the Middle East.
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