Cross-Border Investors Are Back Firing On All Cylinders — But What They Want From CRE Has Changed

It intuitively feels right that cross-border investment into real estate must have dropped during the coronavirus pandemic. No one could get on a plane to travel, making it less likely investors would buy a unique asset like a piece of commercial real estate halfway around the world sight unseen.

Now, with vaccination rates on the rise in the U.S., the UK and Europe, it stands to reason real estate should see a fresh surge of cross-border investment, driving those volumes higher. 

Right?

Well, yes and no. Reality is rarely that black and white, and the truth is cross-border investment never really went away during the pandemic. Global investors simply did what everyone did, hunkering down until the world seemed less chaotic. That said, easing travel bans will make it easier for international investors, who as a group want to put more into commercial real estate than ever before.

And strange as it might seem, 2021, a year that started with the world still unable to access huge swathes of the real estate sector, could come close to a record year for investment. 

“Capital can move across borders even if people can’t,” Real Capital Analytics Senior Vice President Jim Costello said. The firm’s data highlights that any perceived demise in cross-border real estate capital was greatly exaggerated. 

As of Q1 2020, prior to the pandemic, cross-border investment into U.S. real estate was 8.5%, whereas in the year to Q3 2021, that figure was 8.3%, almost identical. In Europe, where cross-border investment makes up a bigger portion of the market, there was a bigger but still not dramatic drop from 16% to 12%. 

“That capital just didn’t see the opportunity set, the same as domestic investors,” Costello said. “They just didn’t see deals they liked.”

What cross-border investors want to buy has shifted — not completely, but enough to exacerbate existing trends about where capital is flowing. For one thing, it was obviously more difficult for overseas investors to transact during the pandemic.

“Liquidity in real estate is correlated with the movement of people,” Valesco Chief Executive Shiraz Jiwa said. “So absolutely liquidity was reduced. Transactions with cross-border investors were not happening as frequently because of travel bans.” 

Valesco invests for clients, many of them from Korea, looking to put money into Europe, and Jiwa pointed out many institutional investors from Asia and the Middle East have a regulatory structure requiring a chief risk officer to physically inspect a property. No amount of drone tours is getting around that. 

Those deals that were transacted by global firms during the period of lockdowns tended to be at the "core" end of the scale, simple transactions in which complexity was at a minimum.

“We were in talks to buy a portfolio on behalf of a Korean investor, who was happy to do the deal remotely,” Avison Young European Capital Markets principal Penny Hacking said. “Then the credit rating of the deal changed and they were no longer willing to transact.”

Of course cross-border investors are not a homogenous group, and for some, it was easier to keep buying than others. RCA data showed that Singaporean firms climbed to become the second-largest exporters of capital globally in the first three quarters of 2021.

“Singaporean investors have always had a global outlook, but traditionally not invested as much abroad as investors from places like Canada,” RCA Head of Analytics for Asia Benjamin Chow said. “But firms like GIC already have teams on the ground in major markets around the world, and the Singaporean corporate real estate firms, which might traditionally have invested cross-border in Asia, now have ambitions to become global firms.”

In some cases, markets opened up in just a matter of weeks.

“We didn’t send a team to Mipim [the property conference that took place in Cannes at the beginning of September], and the feedback we got was that it was a bit too early,” Hacking said. “But at Exporeal [in Munich] four weeks later, our Korean colleagues were over with clients, travelling around looking at deals.”

All the data points to global investors still really hearting real estate, and the sector has rebounded strongly this year. Global real estate investment was $293B in the third quarter, RCA data said, up 92% on the same period in 2020. The figure for the first three quarters of 2021 was just shy of $800B, ahead of where the sector was in 2019. That means a final quarter that is anything other than a disaster will see 2021 investment break the 2020 record despite lockdowns only beginning to ease in the summer. 

And there is more to come. A survey of global institutional investors from Hodes Weill and Cornell University that collectively manage $13.4 trillion in assets suggested those investors have increased their target allocation to the sector by 10 basis points to 10.7% — a small increase, but one that would mean an extra $80B to $120B of investment in the sector, if those investors can find the deals. 

Yet the way cross-border investors splash the cash is changing.

Foreign capital used to be focused on really shiny, high-profile assets, particularly on offices in gateway cities, Costello said, but now were increasingly looking to sectors like industrial and multifamily — less sexy, but providing better returns. He pointed out this brings cross-border investors in line with the preferences exhibited by domestic investors, particularly in the U.S., for some time. 

Manhattan has dropped from its perennial spot as the most liquid real estate market in the world to the 10th spot, according to RCA’s measure of liquidity. Boston, driven by the indomitable life sciences sector, is No. 1. Investors are just not sure about the prospects for traditional offices in the central business district of big cities.

“Domestic investors have been looking to smaller markets for some time, because of the stronger returns available there,” Costello said. “International investors have like gateway offices because it’s a good way to put out a lot of money in one go, which is the most efficient way to do it if you’re flying halfway around the world.”

Avison Young’s Hacking has worked with Korean investors on large-scale industrial deals, and said global investors are increasingly comfortable buying industrial assets rather than offices. Residential is trickier, Hacking pointed out because it is a much more heavily regulated and politicised asset class, though the imbalance between supply and demand is often too pronounced to ignore. 

Not all cross-border investors are shying away from offices.

“If you look at private investors based overseas, people that don’t have to report to a central investment committee, then they are looking at London offices,” Savills Head of Global Cross-Border Investment Rasheed Hassan said. “They are not trying to time the market right to buy and sell for a closed-end fund with a short-term value-add strategy. They are typically buying to diversify their wealth and are choosing London because it has been a major global centre of business for centuries. The question of whether people are coming into the office three days a week or five days in the short term doesn’t matter to them as much.”

A major question being asked by investors both international and domestic regards the impact of the sharp rise in inflation seen in both the U.S. and UK recently. Understandably, given inflation is something investors have not had to factor in for a generation, there is a broad spectrum of views. 

Hard assets like real estate are generally thought to perform well in a period of inflation, real estate investors argued. But not all real estate will perform well in a period of inflation.

“There are certain sectors that will perform well, particularly those sectors with secular tailwinds, especially those with shorter duration leases," Blackstone Head of Real Estate Americas Nadeem Meghji said "Rental housing and industrial would be good examples.”

In periods of inflation, theoretically rents should go up, so assets with short leases in growing sectors should see that inflation feed through to rising rents. The flip side is longer leased assets, which would likely underperform. Assets with long leases and fixed uplifts are often compared to bonds, and bonds underperform in times of inflation. 

For Costello, periods of inflation can cause people to make mistakes that they ordinarily wouldn’t: “People factor in rent increases to their development appraisal or investment underwriting that only make sense because of those inflation assumptions.”

Then there is the question of interest rate rises. For at least a decade, low interest rates have boosted real estate values — because interest rates are lower than real estate yields, it is accretive to buy commercial property using debt, which produces free cashflow from day one, boosting returns. 

And while there is no expectation of dramatic rate rises, inflation does pose a challenge to one investment thesis: Rate rises are the primary tool for central banks to lower inflation. Indeed, in a note last month, Knight Frank pointed out that in the UK, for the first time in more than five years, interest swap rates were indicating borrowing costs were going to start rising in the near future. 

Cross-border investors are fully liberated to invest in real estate as 2021 draws to a close. But they have a lot to think about as they do.