Members of ULI’s Global Exchange Council discuss the opportunities and challenges for real estate investment across the globe this year.
Which parts of the world offer some of the best opportunities for real estate investment?
Philip Fitzgerald, founder and chief executive
officer of Seven Bridges Capital Partners
in Santa Monica, California; member,
Global Exchange Council.
Stephen Furnary: The common wisdom is that the best investment opportunities today are in the United States. While high returns have been available in China and Brazil, growth in those countries has recently slowed somewhat, although both are still strong investment markets. As a result, real estate investors who were looking for high opportunistic returns there are turning back to the United States, where values are increasing, though somewhat more slowly and steadily than many people expected. The U.S. didn’t produce, at least in volume, the opportunistic investment opportunities from distressed assets that we saw in the days of the Resolution Trust Corporation. Because growth in the U.S. is steady, it’s likely to be sustainable for a fairly long time. Investors are starting to accept slightly lower returns than they have looked for in the past. Asset prices feel high in certain markets, so there aren’t a lot of get-rich-quick schemes, and that leads more to core, core-plus, and value-add investing.
Kurt Roeloffs: In 2013, we are going to see a lot of the same. Investors will be conservative, focusing on very high-quality opportunities in the best markets. We will see a preference for the U.S. over many destinations in Europe, and investors who do focus on Europe are going to choose countries with the stronger economies, like the U.K., France, and Germany. But there are also some new bright spots [in the world], like Japan. The decline in rents, occupancy, and capital values there is largely already accounted for in the pricing, and the yields are high compared to the financing rates, so there is good leveraged investing. Because people think China has managed a soft landing, some investors will go back [there]. Others will play China indirectly, through commodity demand, which is why Australia is starting to look interesting to investors again.
Stephen Furnary, chairman and chief executive
officer of Clarion Partners in New York City;
member, Global Exchange Council.
Paige Mueller: Opportunities vary by region and by country. In Europe, there are definitely opportunities on the debt side due to the crisis in the capital markets. Leverage spreads for good properties are not as wide as they are in other markets. So many of the European economies are in slow-growth mode, and banks are more focused on sovereign lending than on real estate lending, which creates an opportunity to do some lending at nice spreads in those markets. In some of the emerging markets, we are still seeing some construction, even though that is slowing in comparison to a couple of years ago and is occurring more in the secondary cities now. We are still seeing niche opportunities in many of those emerging markets. There are also opportunities to provide debt or equity financing in emerging countries that don’t have well-developed capital markets, especially in Asia and Latin America.
Philip Fitzgerald: In Latin America, the biggest opportunities are in Brazil, Peru, and Colombia. Brazil is Latin America’s biggest market because of its demographics and huge population. The challenge is that it’s pretty expensive in every respect—the cost of assets, the cost of living, the cost of operations. Everyone focuses on São Paulo and Rio de Janeiro, but there are more than 20 Brazilian cities with greater metropolitan areas of more than 1 million people. Colombia and Peru are very strong economic performers, and they are both coming off a fairly low basis. Colombia is probably Latin America’s most diversified economy, with a well-educated professional population and good banking system. Mexico is Latin America’s second-largest market, enjoys a privileged location next to the United States, and is outperforming Brazil economically, but the headline and event risk is so great that it is nearly impossible to get investors to consider it. I believe that will change in a couple of years, but we have to see how the new government addresses security concerns.
Paige Mueller, managing director,
RCLCO in Santa Monica, California;
vice chair, Global Exchange Council.
What property types hold potential?
Roeloffs: Office, multifamily, and industrial investment all require economic growth, but people need to shop where they live—it doesn’t matter as much how vibrant the economy is. Many retail properties can simply offer attractive yields. This is true everywhere in the world—beyond the obvious destinations in cities that people talk about. Investors can be more adventurous in their city selection, but they must remain rigorous in their asset selection.
Furnary: The pricing for multifamily housing is characterized by lower cap rates than those of all other property types. That’s principally driven by Fannie Mae and Freddie Mac, because they supply debt more inexpensively than the other readily available sources of debt in the market for other property types. But Clarion Partners is still investing substantial capital in multifamily housing. There is always a good property or location available that will support development and that we feel offers adequate returns for the risk.
Fitzgerald: The for-sale middle-income residential opportunities are generally good across the countries I’ve mentioned. Fifty million people in the region have entered the middle class and another 50 million should do so in the next 20 years. The housing supply is not keeping up with population growth. Brazil needs 2 million new housing units per year, and the formal housing sector is supplying only half that. With the office market, I would be hesitant to look at an office deal today in São Paulo or Lima—they are going to have an oversupply for a couple of years. [The Mexican cities of] Guadalajara, Monterrey, and Mexico City, and all the major cities in Colombia, have no office oversupply. For retail, although there are plenty of large Class A shopping malls, the story for neighborhood shopping centers and power centers throughout the region is pretty compelling. The formal retail sector has a fairly low penetration of the overall market. As for the warehouse/industrial sector, the continued expansion of consumer demand in Brazil and Colombia is going to be very compelling for the logistics industry.
Kurt Roeloffs, former
global chief investment officer,
RREEF Real Estate in New York City;
member, Global Exchange Council.
What are the challenges, now or on the horizon, for real estate investors?
Mueller: Investors remain risk-averse because of the uncertainty in the global capital markets. Thus, pricing is quite steep for prime properties in markets such as New York City, London, Beijing, and Sydney. There is a lot of money chasing those prime markets. In contrast to the United States, construction continues in some high-growth countries. While some of these are maintaining occupancies, we are starting to see some pressure on rents in others. The other big challenge for U.S. investors is how to access these other markets. It is so important to have a local presence in those markets, which means finding and underwriting a local partner.
Furnary: If you pick up a newspaper, the headlines are about Greece’s economic problems and the contagion effect on Italy and Portugal. Europe in general has a lot of volatility right now, and the recovery there is lagging behind that of the United States. European real estate values have not yet been marked down to reflect current pricing, and investors don’t like investing when they think that values will be lower the next day. And it’s hard to get access to debt in Europe, because the banking system is still being sorted out there. Elsewhere, there is unrest in the Middle East, and China’s economy is slowing down. In the U.S., we are facing the fiscal cliff. There are unknowns everywhere, although a lot of these factors have already been priced into the market. I don’t see Armageddon anywhere today, and real estate yields are very favorable compared with [those offered by] other asset classes.
Roeloffs: People are very mindful now of the multiple levels of risk that fiscal contraction in the public sector is creating, both in the United States and in Europe. At first, investors were worried about the effect of the fiscal cliff on the market in Washington, D.C., but now they understand the potential implications that reduced federal funds and greater regulatory constraints may have at the state level. Certain submarkets are particularly susceptible to that. In southern Europe, fiscal contraction is an issue [in countries] such as Spain and Italy. Spain, in particular, and some cities are more affected than others.
What other trends or forces will be shaping the global real estate market?
Fitzgerald: A lot of the large pension funds and endowments want to invest in real estate in Latin America, but many say they only want to consider specific projects for coinvestment, not funds. That means they have to commit themselves to investing with a fund manager big enough to carry one of those projects on its balance sheet or tie up the balance sheet long enough to execute a deal. With a plan sponsor whose minimum commitment is $50 million at 50 percent of a deal, that’s a $100 million equity commitment. Those deals are few and far between, and by making that your business model, you have relegated yourself to only doing things with companies that have a multibillion-dollar balance sheet. That’s a challenge for the marketplace in general, but it also means these investors could miss out on higher-yielding small- and mid-sized deals.
Mueller: The developed markets have unusually high debt burdens and aging populations, and some also have lower levels of immigration. These factors are slowing economic growth and creating uncertainty. At the same time, Asia has a growing middle class and strong economic growth, but also fairly full construction pipelines. Although there is still a lot of unmet new demand for real estate, in markets that have significant construction pipelines, investors need to be careful about which locations they choose to invest in. The growing middle class in Asia and Latin America is creating demand for institutional-quality buildings and creating a more formal retail market that will require modern buildings. In emerging markets, buildings may be held by several owners, in a more condominium-type ownership. So there is not only a net new demand for buildings but also a need for new ownership structures. That will create a lot of opportunity for institutional investors.
Roeloffs: Investors are more willing to take on an additional degree of risk, looking beyond the obvious markets to the second or third submarket in a city that has great dynamics. This is a big phenomenon in the United States, and it will be true in Europe’s safer markets. So, with New York City, instead of focusing on midtown, investors are considering midtown south or Greenwich, Connecticut. It means taking a little bit more incremental risk in terms of the submarket. Investors are not going beyond the top 20 or 25 metropolitan areas to the secondary or tertiary markets yet. But it’s still a big step forward compared to where we were a year ago.