Are We At Risk Of A Foreign Capital Bubble?

Includes: REM, REZ, RTL-OLD
by: Llenrock Group

The United States is by far the most popular destination for foreign commercial real estate capital. According to a report published by Jones Lang LaSalle (NYSE: JLL) earlier this year, the top five destinations for foreign capital are China (5), Japan (4), Germany (3), UK (2), and the US (1). There are many other real estate markets, both emerging and developed, to which family offices, private equity firms, REITs, and various institutional investors deploy capital, but the U.S. is generally seen as the strongest destination for core (read: stable) investment opportunities, particularly in office, industrial, hospitality, and multifamily.

Foreign investment in U.S. real estate, particularly in gateway markets like Manhattan, is only increasing. Why? For one thing, risk-averse investors from around the globe see the U.S. as quite simply a strong investment, with less risk than other markets. Further, many nations that are home to wealthy investors or real estate funds are experiencing – or may soon experience – economic challenges or political turmoil in one form or another. But this isn’t always the case, as this list of the top five foreign nations investing in U.S. CRE in early 2014 demonstrates: Singapore (5), Germany (4), Australia (3), China (2), Canada (1). All of these nations are economic power houses, to be sure, but this doesn’t necessarily invalidate my argument that foreign investment in U.S. real estate opportunities can be a strategy to ensure the safety of foreign investors’ capital. I’m thinking particularly about China, which in the early part of 2014 had already deployed over $3B (NYSEARCA:USD) into markets like Manhattan, Los Angeles, and Chicago.

Good news? Yes and no. If you’re selling a property in one of the United States’ tier-one markets, the odds are high that you are enjoying the interest and great amount of capital that is coming from markets outside the country. If you’re a domestic buyer, big REIT or small office, you’re in a bit of a predicament, facing some of the stiffest competition out there for the top choices in office, shopping mall, condos, luxury hotels, and so on. Further, investment by some foreign countries – I’m thinking particularly of China in this instance – is driving up pricing considerably. Again, this is great news for sellers, but not less-capitalized buyers.

CoStar Group recently ran an article on the subject: “World Class Properties Plus World Buyers Equals Prices Out of this World”:

The news… that Beijing-based Anbang Insurance Group agreed to buy the storied Waldorf Astoria New York for $1.95 billion reveals a lot about the current flow of international capital to U.S.commercial real estate.

Foreign buyers are showing an insatiable appetite for world-class core real estate investments and dropping bags of money on some of the biggest properties in the U.S.

The 1,413-room, 1.68 million square-foot Waldorf Astoria price comes to a stunning $1.38 million per room, the equivalent of $3,780 per night per room for one year. The sale is believed to qualify as the highest price ever paid for a single hotel and is the largest U.S. property purchase by a Chinese firm ever.

$1.38 million per key. Is the hotel worth this much?

As someone wise once said, "it’s worth whatever someone is willing to pay."

But we need to think about how big-ticket acquisitions like this affect the market. Will Anbang, however many years from now they choose to sell the Waldorf Astoria, be able to see a respectable yield from their investment? And how will this affect future luxury hospitality deals in Manhattan or other top-tier markets? It seems Anbang and Hilton (NYSE:HLT) (the seller) have set the bar wildly high in terms of deal value – an indication of a possible pricing bubble in major markets like New York City. Even if flooding the market with foreign capital, a market can only withstand so much upward pricing pressure. Ironically, considering Manhattan is viewed as a safe haven for foreign capital, there seems to be a great deal of risk involved in this deal. Likely we’ll see further risk in future deals of this kind.