A sweltering hot Germany was the setting for AFIRE's European conference this week. Much of the discussion was about overheating of another kind, Richard Lowe reports.
Cologne was forecast to hit 37 degrees centigrade on Wednesday. It was uncomfortable, but the unusual humidity for Germany provided a somewhat fitting atmosphere for AFIRE's annual European conference. The event, run by an organisation that represents the interests of foreign real estate investors in the US, was very much concerned with the question of whether core markets in America were overheating. (Much of the conference chatter was also about an address from the 42nd US president Bill Clinton, although due to this topic being strictly off-limits nothing more can be revealed).
Strong yield compression has been sweeping the prime US property markets, driven largely by heightened investor demand – both domestic and foreign – spurred by the low-interest-rate environment. In the same week, PwC published its latest investor survey, highlighting concerns about the US property recovery being driven too much by a capital markets and becoming detached from its underlying fundamentals.
Two domestic investment groups, USAA Real Estate and the Lionstone Group, were revealed to be 'net-sellers' when it came to core real estate. The former acquired more than $2bn (€1.5bn) of "predominantly core" assets in 2011, but chief executive Leonard O'Donnell expected transactions to total less than $500m this year. "We are considerably less active in core than we were," he said. "The core market is pretty fully priced right now, so we're being pretty cautious in that area." The focus had instead shifted to value-add opportunities and development in multi-family and industrial, he said.
Glenn Lowenstein, founding partner and CIO of Lionstone, added: "Right now we are a net-seller." Lowenstein said his company focused on the ability of markets to generate income growth, invariably through capitalising on positive employment trends, rather than just concentrating on those cities most widely considered 'core'. He cited Austin, the capital of Texas, as an example: a city benefiting from a burgeoning university population, technology and energy industries. Lionstone had recently bought in Dallas as well, he said.
Texas was to crop up again in the form of the state's largest city, Houston. Due to the strength of the local economy, the market has recently experienced an increase in activity from real estate investors. As a result, cap rates for core assets – or yields – have become comparable with those in Washington, DC, an entirely different market in terms of size and maturity.
Frank Lively, executive vice-president at Wafra Investment Advisory Group, asked: "Is there no risk premium associated with Houston versus Washington today?"
Scott Galloway, executive managing director at HFF, said: "The investors that are investing in Houston would not tell you there's a 'risk premium'." He added: "People have done their homework that it is a 'core market' in their mind."
Audience members questioned Houston's lack of a zoning code or public transport system, perhaps implying the comparison with DC was flawed. Speaking privately afterwards, one consultant voiced concerns about the heightened investment activity in Houston, saying fund managers were being compelled into these less mature markets to deliver the returns they had promised to investors.
Of course, real estate investors have much to be concerned about when it comes to a market like Washington, DC, not least the implications of government spending cuts and the spectre of BRAC (Base Realignment and Closure Commission, a US agency set up to dispose of unnecessary real estate used by the Department of Defence). "That is creating some unusual situations in some sub-markets," said Michael Darby, principal and co-founder of Monument Realty.
Seattle, meanwhile, was favoured by both Mark Wilsmann, managing director at Met Life Real Estate Investors, and Mark Preston, group chief executive of Grosvenor. "The downtown core and the South Lake Union area are two of the most exciting sub-markets in the country right now," Wilsmann said.