Founded in 1988, AFIRE has, as its mission, "provided an opportunity for the foreign investor in the US to become as knowledgeable as US domestic investors". James Fetgatter became the organisation's CEO in 1992, and since then has grown the association from a small group of Dutch pension funds to an organisation of over 180 investors from 20 countries. He sets out the key trends and the challenges ahead both for AFIRE and the wider US real estate industry to Martin Hurst
What do you see as the key trends in foreign investment in US real estate?
The overriding trend in 2007 seems to be that acquisitions by foreign investors of US real estate companies are running ahead of the figure for last year. In fact by July, foreign investors had acquired more real estate in the US than the entire year of 2006 or any of the previous five years.
Another significant development is that the more experienced investors like the Dutch and Germans, seem to be going further up the risk curve because of the competition for assets. As is the case elsewhere, yield spreads are narrowing so the benefits of risk taking in this market are not as clear as they were. As a result investors are going into some other cities which they would have considered secondary cities in the past such as Phoenix and Seattle, as identified in our most recent survey. They are also expanding out of core properties and redefining what is investable real estate.
We expect further growth in foreign investment once the new German-US tax treaty is approved. The provisions will grant German pension funds tax exemption on dividends from US real estate securities. This will be similar to the Dutch-US treaty.
There is also a significant amount of money coming from Australia through listed property trusts, typically in retail. This money is being generated by the enormous amount of capital held in retirement accounts in Australia seeking yield and diversification. A lot of capital also continues to flow in from the Middle East. In 2006, Middle East capital accounted for 27% of all foreign acquisitions and Australia accounted for 19%.
Furthermore, investors are also adopting more innovative strategies - by far the most popular one is joint ventures with local partners to increase the yield or increase their access to deal flow.
In spite of the competition for assets, a significant number of foreign investors are still paying market prices for core properties including downtown, CBD and hotels, and they all have different motivations for doing this, diversification among them. They offset the low yield by the rationale that they are diversifying into another country and another currency. The perception of the US as a stable economy and a stable market went up significantly in our last survey, and this is another factor behind the continued growing interest in investment in US real estate. Additionally the euro's strength against the US dollar offers some psychological advantage to European investors looking for opportunities here. Typically, however, large institutional investors hedge against currency fluctuations, so the exchange rate is less of a factor.
How do you think the sub-prime crisis will impact the attractiveness of the
I think the concern over the sub-prime crisis is generally overblown and the turmoil in the credit markets is emotional. As far as our investors are concerned I think the impact will be minimal. Some of our members are reporting active interest in construction lending at more favourable rates than before. The debt that is affected the most has been high-risk debt and there has been a flight to quality. Institutional real estate investors are generally not dealing in the more risky sub-prime loans unless they are in a CMBS pool, which does have a sub-prime element. There may be some knock-on effect for the better grade debt but I don't see this as being a major factor. The economy is still strong, and as long as investors have a significant amount of equity in the deal they shouldn't have a problem.
The sub-prime issue affects the residential market and a small segment of that market; this is a segment of the market which five years ago would not even have received a loan. It was created because Wall Street and the financial institutions have been looking for more ways to generate yield. They began lowering their standards and loaned money to people who were at a greater risk of not being able to afford it. I think we are gradually getting back to a more normal way to do business in the residential market. The danger is the emotional reaction to it: if people think it will be bad, it ends up becoming bad - a self-fulfilling prophecy, in other words. As far as the impact on our industry is concerned, unless the banks cut back on all lending then this will not be a problem. There has been a hysterical reaction on Wall Street, but that's Wall Street - it always reacts to rumours and emotions.
How do you think the US could make itself (even) more attractive as a destination for real estate investment?
We have always been a user-friendly market. There are some vehicles which we could adapt which would make things better still - our real estate derivatives market is not as advanced as that in Europe that needs some work to make it more accessible. We also need to develop more tax efficient funds that will allow investors to invest and disinvest without paying excessive taxes on their gains.
Another important change is to make our benchmarking indices more acceptable. Most investors here are using the NCREIF index; if we had one that looked more like IPD, investors, certainly those from Europe, would feel more comfortable. That is what they are used to and that is what our members prefer. Such a change is difficult because NCREIF has been the accepted index among US investors for a long time and there are most likely some political reasons why it would be difficult to switch over to an IPD-type index. Many investors question the accuracy of the NCREIF index because of how the real estate is valued and how often it is valued.
What are the key challenges facing investors in US real estate?
Private equity firms represent the biggest competition for real estate investors because they are willing to pay significant money for assets and they seem to be in on every deal. The public-to-private deals that we have seen over the past year have had the effect of putting more real estate on the market since the acquirers typically strip off some of the real estate to other buyers.
In addition to this, there are two key forces in the market: first, the price of debt appears to be increasing, partly because of the sub-prime mortgage scare. Easy access to credit made most real estate deals simple, but now that access to debt may not be so straightforward, the deals may become more challenging. At the same time the prices of real estate investment trusts (REITs) have been falling so there appears to be less speculation among investors. Investors in REITs will need to rely more on dividends as a larger component of their yield rather than capital gains. So while REIT prices are coming down, access to easy debt is getting more difficult, making public-to-private deals less predictable. I have a feeling that overall, these two factors will result in a slowdown in speculative investment.
What could other markets learn from the US experience?
The US is one of the most transparent markets in the world. Increasing transparency is always a goal for any market, but it is easier said than done. It is a long-term process that sometimes requires cultural changes. The legislation that the US has enacted to bolster the REIT market may serve as a guide to other markets. Any legislation that is passed which makes markets more accessible is an advantage to that market. A country that enacts REIT legislation of some kind will open the door to foreign investment which will have knock-on effects for other types of investment as well: a foreign investor may make a small investment in a REIT and see how that goes and then may be ready to make direct investments later on.
Which US cities do you rate as the top investment opportunities?
In our most recent survey New York City (NYC) came out as the number one choice for foreign investors. Until then Washington, DC had been the favourite because of government spending in areas such as defence and homeland security. Washington, DC has been ranked either number one or number two for the entire 15 years we have conducted our survey. DC was one of the few major cities that did not have some significant vacancy after 9/11. After 9/11 investors were concerned about NYC because some of the larger corporations decided they needed to disperse their leased premises and real estate holdings because of the fear of another attack. All this has now worked itself out and NYC is again extremely popular.
Foreign investors seem to have a bi-coastal strategy when it comes to investing in the US. In addition to the east coast cities of NYC and Washington, Los Angeles, San Francisco and Seattle on the west coast are in the top five most popular cities.
What are the key challenges facing AFIRE?
When we were formed 18 years ago it was fairly easy to make the distinction between agent and investor, especially coming as we did out of the Dutch industry where it was very easy to distinguish pension funds from agents. It is not so easy now because there are a wide variety of organisations with multi-disciplinary functions. They may be both investing for their own account and managing investments for third parties. So the line between who is an investor and who is an asset or fund manager has become blurred.
There are also new investors coming into the market all the time and we want to make sure that we have an adequate representation from all of them, wherever they come from. We do not provide a special organisation within AFIRE for pension funds because we believe that most investors allowed into our organisation generally have the same investment parameters that a pension fund has - long-term goals and a disciplined approach to investing, rather than speculative hot money. We generally do not approve applications for membership from investors who don't have that mentality.
With the exception of mammoth trade fairs such as MIPIM and EXPO REAL, a further challenge - for all non profit associations in the industry - is the proliferation of private conference organisers. The primary concern is that they siphon off investor time and money; people often forget that the not-for-profit organisations are there to benefit the members - all the time and money they put into the organisation comes back to them. It belongs to them. The private organisers keep all the marbles, so to speak.
Throughout AFIRE's history we have tried to keep our organisation an exclusive association of international investors and to provide conference programmes without equal. These goals require the constant attention of our association's volunteer leadership.