CorporateInsight December 2003.

Foreign Investors Rise to the Challenge
in Pursuit of U.S. Property

As 2003 comes to a close, the U.S. commercial real estate landscape has experienced a familiar trend: an influx of foreign investors. Unlike the Japanese during the 1980s, the new face of foreign capital has been a bit more cautious and methodical in its approach. With the majority of these large investors coming out of Germany in the way of open and closed-ended funds, we have also seen new capital sources from Australia, the United Kingdom, and numerous private high net-worth individuals.

According to Real Capital Analytics, a national research and consulting firm based in New York, foreign investors through the first three quarters of 2003 accounted for the acquisition of $5.24 billion nationwide in office, retail, and industrial properties. These figures are already comparable to full-year 2002 levels. Depending on fourth quarter results, it would seem that foreign investors have not gone away but have increased their activity and investment power. Even considering numerous distractions, concerns over the U.S. economy, weak market fundamentals, the dollars' rapid decline and the varying opinions concerning the U.S. military involvement in Iraq, to name a few, foreign investors have stuck to their game plan of building a U.S. portfolio and will continue to be a force that will not be leaving our shores anytime soon.

Several important factors have contributed to the inflow of capital from overseas, including the recent Fourth Promotion Act from Germany, which in 2002 increased the amount of capital German funds could invest outside of the E.U. Other factors include the issue of superannuation in Australia, which is the deployment of private and corporate capital in pursuance on long-term, annuity style returns which are oriented to providing stable income in retirement, and the abundance of private capital that has been seeking safer investment havens in U.S. real estate.

In Australia, compulsory superannuation has led to a very dramatic inflow of capital into pension funds and managed financial vehicles. The volume of capital is greater than the domestic market's ability to provide opportunities and place this investment. This, together with the need to diversify risk, is driving increasing volumes of capital offshore. From a real estate perspective, the U.S. and U.K. represent mature, English-speaking markets and are therefore logical targets. Several billion dollars will be spent in the direct and indirect real estate sectors in the U.S. over the next decade. The superannuation profile of this capital emphasizes stable, annuity returns over time. Core product with credit tenants is highly favored in major metro markets.

Although a shortage of capital does not seem to be an issue, it has not been an easy ride in attempting to build up a U.S. portfolio. U.S. investors have fared much better due to their ability to quickly respond to opportunities, knowledge of the real estate markets, and a willingness to accept more risk. Making it even more difficult are the swelling ranks of U.S. investors able to compete for the coveted trophy properties, with continued low interest rates leveling the playing field for any number of private equity investors who have found it easy to raise large amounts of capital.

Office properties were the product of choice for foreign investors in 2003 and should remain for the upcoming year. At the same time, more and more foreign investors are getting comfortable with retail and industrial investments and should make more of a wave in 2004 with these product types. New York City, Washington D.C., Los Angeles, San Francisco, and Chicago have historically been the cities where foreign activity has been high. These markets are well-known and are often perceived as "comfort" markets. As we have seen tremendous activity and competition in the top five U.S. markets, foreign investors have had their hands full competing against the U.S. giants targeting the same product. If markets such as Washington and New York continue to experience pricing run-ups, foreign investors in 2004 may consider exploring other markets that might not be on the radar screen of the larger domestic national players.

One trend that will be more common in 2004 should be the inclination of foreign investors to be a bit more creative in how they pursue investments. Forming U.S. joint ventures to compete for properties, quietly pursuing property recapitalizations, and a willingness to consider secondary markets, effectively addressing and overcoming the obstacles they faced in the past, may prove to create the momentum of investment they have been seeking in U.S. markets.

Based in London, Bill Bannon serves as the global investment liaison between Grubb & Ellis and Knight Frank. References to market data included in this article are obtained from Grubb & Ellis' and Knight Frank research analysts who routinely track local, national and global trends. Click here to find out more about Grubb & Ellis's research .