Sovereign Wealth Funds

Given their relatively unrestricted investment parameters, sovereign wealth funds are expected to become an increasingly important source of capital for real estate—particularly in the United States.

When asked why he robbed banks, William “Slick Willie” Sutton was reported to have responded: “Because that’s where the money is.” A similar line of reasoning can explain why sovereign wealth funds (SWFs) could become a more commonly sought-after source of capital in the United States and throughout the world. Such funds are estimated to have close to $4 trillion under management worldwide, up from about $1 trillion a decade ago, and the total is expected to balloon to $6 trillion within a few years. The real amount, however, is difficult to pinpoint, since many funds are secretive and definitions of SWFs differ.

Sovereign wealth funds are entities owned by national governments for the purpose of investing a country’s surplus wealth. Many were formed in the wake of the 1997 Asian financial crisis as nations began to build up their foreign exchange reserves. In fact, more than half of existing SWFs were created since 2000.

Where does the surplus wealth originate? The largest group of SWFs comprises those funded by hydrocarbon export revenues. This group, according to New York City–based research organization Preqin Ltd., accounts for 60 percent of the total number of funds and 56 percent of all SWFs’ aggregate assets under management. The second-largest group includes those SWFs not funded by exports. Sovereign wealth funds that are funded by revenues from the export of commodities other than hydrocarbons account for only 1 percent of SWFs’ aggregate value.

About a quarter of all SWFs have $50 billion or more in assets under management; 18 percent have $100 billion or more. Although it does not release information on its assets publicly, the 34-year-old Abu Dhabi Investment Authority (ADIA) is widely believed to be the world’s largest sovereign wealth fund, with an estimated $625 billion under management. It is followed by Norway’s Government Pension Fund-Global with over $450 billion under management, and China’s SAFE Investment Company with approximately $350 billion.

Although there is some crossover, experts usually distinguish between sovereign pension funds (SPFs) and SWFs. SPFs generally take a conservative, close-to-home investment approach, investing primarily in domestic assets (86 percent, according to a recent study) and in bonds (88 percent). SWFs, on the other hand, represent a source of permanent capital and thus can afford to implement long-term investment strategies focusing on investments with higher risk and less liquidity. They face relatively few restrictions on investment, do not have liabilities, and are not subject to withdrawals by investors like private equity and pension funds. However, some SWFs have been used to fund government spending and offset budget deficits. Russia’s Reserve Fund, for example, is being depleted rapidly and may not survive the rest of the year.

Given their relatively unrestricted investment parameters, SWFs are expected to become an increasingly important source of capital for real estate—particularly in the United States. This is especially true in a market that has seen a marked decrease in capital available from other institutional investors. Analysts at Bethesda, Maryland–based CoStar Group Inc. predict that as the U.S. economy recovers, SWFs—along with pension funds and real estate investment trusts (REITs)—are likely to be very active in U.S. real estate investment. SWFs have been looking closely at the U.S. market in the wake of the Greek financial crisis, which has them giving a thumbs-down to the euro. Many SWF managers view U.S. commercial real estate, in part, as a hedge against currency depreciation, but they also like what they are seeing in terms of projected economic growth.

At present, just a handful of SWFs have real estate portfolios, CoStar notes, and real estate represents only about 5 percent of SWFs’ total asset allocation. These small percentages can translate to big numbers, however, with SWFs’ annual investment in real estate totaling several hundred billion dollars or more going forward.

Many SWF managers view U.S. commercial real estate, in part, as a hedge against currency depreciation, but they also like what they are seeing in terms of projected economic growth.

What type of real estate investments are SWFs looking for? Sovereign wealth fund managers “don’t take connecting flights,” notes Hans Nordby, CoStar Group’s director of advisory services. “They like big shiny buildings that will impress their brothers-in-law.”

One does not have to look far to find examples of successful SWF investment in “big shiny buildings” in major Western cities. In 2008, the aforementioned ADIA acquired a 75 percent stake in New York City’s landmark Chrysler Building for $800 million. Across the pond, ADIA was among the investors in London-based Grosvenor’s $2 billion Liverpool One project, which delivered in 2008 with over 1.6 million square feet (148,800 sq m) of retail space along with office, residential, hotel, entertainment, and open-space development.

Also in 2008, the General Motors Building and three other properties sold for nearly $4 billion to a group of investors that included the SWFs of Qatar and Kuwait along with Boston Properties and Goldman Sachs. Dubai Investment Group, in a joint venture with Beverly Hills, California–based Kennedy-Wilson, has invested more than $80 million in Avalon Bay’s apartment portfolio. In a joint venture with Boston Properties, Kuwait Investment Authority invested in excess of $1 billion in three Manhattan office towers. Dubai World has a 20 percent stake in the recently opened MGM Mirage hotel in Las Vegas and has invested $2.7 billion in the surrounding 67-acre (27-ha) City Center development.

To offset some of the risk, many are co-investing with joint venture partners such as commercial real estate owners or private equity investors. Their methods of involvement include provision of bridge equity, bridge financing, convertible debt securities, co-investments, and funds, among others. Some SWFs are partnering with and/or investing in U.S. real estate firms for future development. Abu Dhabi’s Mubadela Development Company, for instance, acquired a stake in Chicago-based John Buck Company for the purpose of jointly developing real estate within Abu Dhabi and in other Middle Eastern countries. The Government of Singapore Investment Corporation has partnered with Bethesda, Maryland– based Host Hotels & Resorts Inc., with plans of leveraging $600 million in equity to develop a $2 billion hospitality property portfolio in Asia and Australia.

While the world’s sovereign wealth funds may hold trillions of dollars’ worth of capital and assets, gaining access to their funds is not as simple as walking in the door of a bank. SWFs’ threshold for participation is high; many invest in megafunds of $1 billion or more. To access capital from SWFs, real estate owners and developers would be well advised to work with experienced investment advisory firms.

Like other investors in the current economy, SWFs have reduced their leverage. While they might have been 75 to 80 percent leveraged before the recession, they are now only 50 to 60 percent leveraged. The upside of this situation is that the SWFs are focusing on value-add and opportunistic investing based on underlying property value rather than leveraging.

While their desire for anonymity usually allows SWFs to choose their investments freely, this is not always the case. Many Americans recall the scandal that erupted in 2005 when government-owned Dubai Ports World announced its intention to acquire U.K.-based P&O, which in turn held contracts to operate six U.S. ports including those in Los Angeles, California, and Newark, New Jersey. While the deal had been championed by President George W. Bush, intense media and congressional scrutiny resulted in the Dubai entity agreeing to divest P&O’s U.S. interests, including the port operations.

Although the Congressional Committee on Foreign Investment in the United States has been in place since 1975, post-9/11 security concerns have heightened oversight of foreign investments. Yet many other countries, particularly China, have far more onerous restrictions on SWF investment. SWF countries and those receiving significant SWF investments are cooperating on the development and implementation of voluntary guidelines and principles to facilitate the unhindered flow of capital from SWFs.