Here's Why Real Estate Funds Are Sitting On Billions Of Dollars

Institutional investors both foreign and domestic are flocking to America’s commercial property market for safe investments and strong yields, causing somewhat of a dilemma — there is an abundance of available capital to deploy but a lack of attractive real estate to buy.

This is one instance where the saying “you can never have too much of a good thing” does not apply. Last year, real estate investment funds had a whopping $237B available in dry powder (cash reserves set aside for investment purposes) according to Preqin, a jump from the $229B that was on reserve in 2015.

“In a nutshell, cap rates are going down. There’s more money searching for the same deals essentially, and there’s a lot of money [coming] from overseas,” McDermott, Will and Emery partner Daniel Martin said. “For example, the flight to [quality] of the U.S. dollar is driving a lot of investment dollars [to the U.S.] from sovereign wealth funds and pension funds abroad. Then you have traditional real estate developers who are also still looking for deals, but as cap rates go down, those deals become less attractive.”

It should come as no surprise that the top three markets in the world foreign investors flocked to last year were New York City, Los Angeles and San Francisco, according to this year’s AFIRE rankings of investor sentiment.

And there is no reason to think foreigners' appetite for U.S. property will slow. Last year, foreign investors acquired $48.5B worth of U.S. property, up 7.8% compared to 2007’s peak, though slightly down from the record in 2015, according to JLL. Offshore investors stormed the hotel and office industry in particular: 48.4% of the year’s deals involved hotel, and more than $20B of foreign real estate capital was spent on offices.

The problem, Martin said, is institutional investors in the U.S. expect a certain return on their properties but are competing for the same assets that offshore investors are throwing money into, and are often willing to accept lower yields on.

“I think it’s very frustrating," Martin said. "There’s a lot of demand in the U.S. from investors that did not have a big presence here before, [including] Middle Eastern sovereign funds and Chinese and Russian money in particular. As that new money comes in, I know it’s frustrating for investors in traditional funds to see cap rates go down and prices go up.”

Alternative Lenders

This tug of war has forced money managers to look for alternative investment opportunities.

As banks tighten their lending standards as a result of post-recession financial restrictions in hopes of preventing another financial crisis — particularly where commercial lending is concerned — institutional investors have increasingly stepped up to fill the gap for construction loans, putting added pressure on banks. The firms typically receive large cash flows from clients that allow them to make these loans available.

Policies pushed by President Donald Trump would deregulate banks in an effort to make lending more widely available, particularly for small businesses. These deregulation efforts have translated mostly into a revamp of the 2010 Dodd-Frank Act. Today’s Republican-dominated Congress is advocating for multiple amendments to Dodd-Frank, criticizing the law and claiming it unnecessarily burdens lenders, limits consumers’ options for funding, and hurts business and economic growth.

One positive in the midst of this fierce competition for attractive real estate is how the commercial property market ebbs and flows. Properties are constantly changing hands, new developments will always be on the horizon and opportunities to grab stakes in value-add properties are always available, Martin said.

“The thing with real estate is there’s no bad asset, there’s only bad prices,” Martin said. “So I think the investors are looking at different assets and ways to invest; but there’s always real estate and ways to invest in it.”