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Oil profits plummet, U.S. real estate profits

Austin Khan, Chief Investment Officer of Ethika Investments,* shares his insight into how Middle Eastern investors are changing their global investment strategies and are now targeting U.S. commercial real estate with big money.

November 2015

As global oil prices continue to slip in an environment of oversupply, investors hailing from oil and energy dependent regions of the world – including the Middle East – are refocusing their attention outward and seeking opportunities to buy stable assets that can provide dependable yields and consistent growth levels. We are witnessing these savvy investors continuing to grow their overall real estate holdings as a way to insulate themselves from market fluctuations, with commercial real estate investments providing greater geographic and sector diversification for portfolios.

The Middle East has grown its influence in the global real estate markets significantly, drawing attention from market participants, analysts and investors alike. The Middle East ranks as the third largest source of cross-regional capital globally and estimates also suggest that investors from the region will allocate an average of USD 15 billion annually in international real estate opportunities moving forward, with plans to target the United States in a big way.

Historically, much of the real estate investment originating in the Middle East has been driven by some of the world’s largest sovereign wealth funds, many of which found equity markets to be too volatile and the bond markets too low yielding. Weakening oil prices may lead to sovereign wealth funds to reduce their total spend over the long run, but we are predicting continued strong growth in capital from family offices and other institutions. Direct real estate investments present a significant opportunity for these groups and many faced little competition in grabbing up well-placed assets within Europe’s historic trophy cities including London, Paris and Madrid during the global financial crisis.

However, as competition from Chinese investors and other global capital sources increased, prices in those cities soared and Middle Eastern investors turned their sights to the United States and to our gateway cities: New York, Washington D.C. and Miami. These types of high-profile purchases have captured plenty of attention, including Abu Dhabi Investment Authority’s acquisition of the Miami Beach EDITION hotel for USD 230 million earlier this year.

The shift to secondary U.S. markets

More recently, we are seeing investors look beyond those primary U.S. markets and the trophy hotels and office buildings they acquired in those locations to seek higher-yielding investments.

Focus is gradually shifting to secondary markets that provide more growth opportunities, comparable interest rates and more balance between pricing and fundamentals. These lesser known areas throughout the Southeast, Midwest and American West have an unbelievable amount of depth and potential, housing the headquarters of many Fortune 500 companies and strong regional firms. Minneapolis, for example, is known as a prominent centre for medical technology and research, and as home to 17 Fortune 500 companies, is currently undergoing very strong leasing momentum given the breadth and diversity of its economy.

Office: The new target sector

Priorities are shifting among these private investors who once preferred assets with long leases that provided a consistent level of annuity income. The standard request for an office building with a 20-year lease agreement to the U.S. government is finally being re-evaluated. Now, more than ever before, foreign investors are seeking office space investment opportunities in resource driven industries such as healthcare, education and financial services.

The office market is a prime industry for both foreign and domestic investment, because as the job market strengthens and corporate confidence improves, businesses are expected to continue growing physically. The national office vacancy rate is also likely to continue decreasing below its current six-year low, creating attractive acquisition and new construction opportunities in the office market across the board.

Recent data gathered by CBRE suggests that while demand for office space is strong across the country, office construction activity is particularly robust in key markets that led the nation out of recession including; Houston, Manhattan, Seattle, San Jose and San Francisco.  At mid-year 2015, the ten most active markets for new single-and multi-tenant office construction accounted for 71 million sq. ft., or about three quarters of the U.S.’ total new construction.

West Coast boom & the incubation of tech companies

Further data reveals that the West Coast has significantly jumped ahead of other markets in terms of office demand. Silicon Valley and San Francisco are experiencing some of the highest office absorption rates in the country, fuelled almost single-handedly by the eruption in the tech industry and the expansion of notable mass employers like Apple and Intel. Interestingly enough, the market is so robust in Silicon Valley that the rent variance between Class-A and Class-B buildings is now extremely slim.

As a result, investors are faced with several viable strategies that range from the highly sought-after existing traditional office space assets to the development of new creative offices spaces with open layouts and outdoor access most commonly associated with the incubation of tech companies.

A perfect example of the renewed appetite for office space of all types is clearly visible in an area  of Los Angeles known as Playa Vista, a growing technology and entertainment hub referred to as “Silicon Beach” that is now home to many prominent companies including Facebook, YouTube, Electronic Arts and IMAX. An abundance of pre-existing traditional and creative office spaces, much of which sat vacant through the global recession of 2008, are finally being absorbed.

This local technology boom is concurrently driving incredible global investment in other property types, including nearby residential and retail developments. Earlier this summer, Ethika Investments allocated capital to acquire and reposition the Promenade at Howard Hughes, an approximately 250,000 square-foot office/mixed use centre just a few miles from the heart of Playa Vista. The 1.3 million square feet of office space in the Howard Hughes community is feeding off of the success of the Silicon Beach movement, which has already spurred the addition of nearly 3,200 new multifamily units.

Future of Middle Eastern Capital

While not at its peak pre-recession level, we expect Middle Eastern capital to continue flowing to the United States over the next two years as big sovereigns continue to seek safe havens and long-term growth potential.

Ethika is an opportunistic real estate fund manager that serves as an ally for Middle Eastern banks, family offices and other financial institutions, including those looking for a Sharia-compliant investment management firm.  

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