Dr Jane Murray, Asia Pacific Head of Research, Jones Lang LaSalle
Pádraig Brown, International Capital Group, Jones Lang LaSalle
Increased attention from international players has made local markets increasingly competitive and liquid, with strong unsatisfied demand chasing increasingly scarce assets and resulting in significant yield compression. Improving transparency levels and the lowering of foreign investment barriers are facilitating the movement of real estate towards a truly global asset class.
Jones Lang LaSalle’s annual Global Capital Flows study has been tracking the relentless globalisation of real estate investment markets since 2003. This 2005 3rd edition leverages the firm’s Capital Markets and Research capabilities in over 100 markets worldwide to capture and analyse over 5,000 individual transactions recorded in Europe, North America and Asia Pacific. It provides the definitive guide to global commercial real estate investment activity and cross-border capital flows.
Record Investment – Record Cross-border Activity
Direct commercial real estate investment jumped to an all time record of US$475bn1 in 2005, a 21% increase over 2004 levels. Cross-border investment flows increased to US$164bn (up 43%) and now account for 35% of total transactions. Inter-regional2 investment flows soared to US$114bn (up 40%), and now comprise almost a quarter of total transactions.
On a regional level, total transaction and cross-border activity increased strongly in Europe, Asia Pacific and North America. However, these regions demonstrate distinct variations:
European real estate investment increased 20% to US$191bn, of which 59% was cross-border (up from 48% in 2004). Inter-regional investment represented 37% of total volumes, marking Europe as the most “globalised” real estate market. Global3 and US sources of funds accounted for approximately two thirds of cross-border investment in Europe, while dominant intra-regional investors included German, Irish and UK sources of funds.
Asia Pacific was the fastest-growing market, with investment growing 46% to US$68bn. Cross-border investment increased to 29% of total investment, with inter-regional investment comprising 17%. Global and US sources of funds provided the bulk of inter-regional capital. Dominant intra-regional purchasers were Australian and Singaporean sources of funds.
North America remained the largest investment destination, with investment rising 17% to US$216bn – nearly half of total global transaction volumes. Cross-border investment rose strongly to 16% of total investment and was almost entirely represented by inter-regional investment. Significant inter-regional purchases were made by Australian, German, global, Hong Kong and Middle Eastern sources of funds.
The record investment volumes have resulted in unprecedented liquidity in real estate markets. In the established markets of Europe and North America, we estimate over 10%4 of investor-owned real estate (both public and private) was transacted in 2005. Despite these record investment levels, a huge weight of investment demand remains unsatisfied. Jones Lang LaSalle estimates that over 50% of investors cannot locate suitable assets. For every $1 of real estate investment product, there is $2 seeking to purchase that investment. This demand-supply imbalance is intensifying competition in local markets, forcing down yields, and driving the globalisation of the asset class as investors search distant horizons for enhanced investment opportunities and returns.
Inter-regional investment flows comprise almost a quarter of direct commercial real estate investment. Furthermore, this phenomenon is accelerating. While total investment grew by 21% in 2005, inter-regional flows grew by 40%, reaching US$114bn.
As figure 3 shows, the dominant inter-regional activity was by global sources of funds investing into Europe. These funds, which are predominantly unlisted vehicles, made significant investments in the UK, Germany, France and Sweden, and were also active in Mexico, China and the US.
Trans-Atlantic real estate investment is the longest established inter-regional investment market. North American investors remained strong net purchasers of European real estate, making significant investments in Germany, the UK and France. German investors, in particular the open-ended funds which are re-weighting their portfolios in favour of international assets, invested heavily in the US and Canadian markets. German investors were also active in European countries, namely the UK, France, the Netherlands, Poland and Sweden.
A notable feature of the 2005 study was the emergence of significant capital exports from the Asia Pacific region to North American markets. The majority of this investment came from Australian Listed Property Trusts (LPTs) and was invested in US retail assets. These investment flows were significant as they were negligible in 2004 and as they represented strong net purchase activity (accompanied by very low corresponding sales activity). These investors have started to target Europe in 2006. Reciprocally, North American investors demonstrated renewed interest in Japan and increased interest in China.
Middle Eastern investors retained their position as major exporters of inter-regional capital. Investments were predominantly in transparent and liquid markets. The UK and the US were prime targets followed by France and Germany.
Liquid, Transparent and High Growth Markets are Attractive
Inter-regional capital continues to target the most liquid and transparent real estate markets. The US and UK together attracted over half of total inter-regional investment followed by Germany, France and Sweden. These five markets accounted for 80% of total inter-regional investment. High growth economies in Asia and Latin America and the recovering Japanese market were also favoured.
Inter-regional investors purchased US$21.8bn and sold US$14.0bn of US commercial real estate. The market attracts significant capital due to its size, strong economy and established strength in occupier markets. Inter-regional investment was dominated by Australian LPTs, which invested over US$8bn in joint ventures with established domestic property companies. German (US$3.9bn), Hong Kong (US$2.4bn) and Middle Eastern sources of funds (US$2.4bn) were active purchasers.
Inter-regional investors found the UK an attractive market due to its liquid and transparent market, long term leases and relatively attractive tax treaties. These funds purchased US$19.8bn and sold US$13.6bn of UK commercial real estate. Inter-regional investment was dominated by global (US$9.9bn), Middle Eastern (US$5.9bn) and US sources of funds (US$2.4bn). Intra-regional capital was also significant, namely Irish (US$7.6bn) and German sources of funds (US$4.3bn).
Inter-regional investors showed strong interest in the recovering German market, purchasing US$10.8bn of commercial real estate, while selling US$6.1bn. Germany offers cross-border investors a significant stock of investment opportunities due to its relative size and increasingly frequent sale and leaseback opportunities. Additionally, German Open Ended Funds have come under pressure to re-balance their heavily domestic-weighted portfolios in favour of international assets. The withdrawal of many German funds from the domestic market has been replaced by strong investment by global (US$5.8bn) and US sources of funds (US$2.9bn). UK funds (US$5.6bn) dominated intra-regional investment.
The availability of very large residential portfolios attracted substantial investment from cross-border investors traditionally focussed on commercial investments. For reasons of consistency, these flows do not appear in our analysis5.
France’s high transparency, large office market and good rental growth prospects attracted inter-regional investors who purchased US$7.2bn and sold US$5.0bn. Global (US$4.2bn) and US investors (US$2.3bn) dominated inter-regional purchase activity. German and UK investors were also active.
Sweden’s commercial property market offers international investors a highly sophisticated economy with attractive demand dynamics in addition to a good source of investment grade assets. Global sources of funds were the most active investors, purchasing US$1.5bn of assets.
China’s economic success and improving transparency is creating huge demand from investors keen to benefit from the scale of real estate opportunity available. Inter-regional capital purchased US$2.3bn of assets and made negligible sales. Global sources of funds were particularly active in retail and office markets, purchasing over US$1.6bn of assets. Significant investments were also made by US, Australian and Singaporean sources of funds.
Retail and office buildings in Shanghai are the main focus for cross-border investors. However as competition for investment intensifies, we are seeing a number of investors beginning to target secondary cities.
Although inter-regional transaction volumes are currently insignificant relative to the larger markets of UK, US, Germany and France, the proportion of investible stock is continuing to grow with rapid economic expansion, relaxation of foreign investment laws and improving transparency.
2005 was a strong year for cross-border flows into Latin America. Mexican real estate was an attractive target with global sources of funds purchasing over US$1.7bn of assets, and US sources of funds purchasing US$0.8bn. Purchasers from Asia Pacific emerged, led by Singaporean funds, and European sources of funds were involved in sale and leaseback transactions and office purchases.
Latin American markets beginning to emerge as popular destinations for inter-regional capital include Sao Paulo, Rio de Janeiro and Buenos Aires. With stable economic growth, declining unemployment, improving sovereign risk and increased access to credit, capital flows into Latin America are predicted to accelerate in 2006.
With improved economic performance and an end to deflation in Japan, real estate investors are returning to the Japanese market, driving down yields. Investment volumes were up 28% on 2004 levels, with the majority of investments made by local listed, unlisted and institutional funds. Hungry domestic investors crowded out inter-regional investment with only US sources of funds investing in significant volume. Inter-regional purchase activity totalled US$1.6bn in 2005 whilst US$0.9bn was recorded in sales. A shortage of quality investment opportunities led a number of investors to seek arbitrage opportunities through purchases of real estate-rich corporations.
Japanese investors – dominant inter-regional players in the 1980’s – have recently re-emerged and we are noting very early signs of a revival of Japanese private and institutional investment into the US and European markets.
With Japanese corporate earnings rebounding, unemployment and office vacancy rates declining, the scene is set for a strong recovery in the occupier market – Japan is a market to watch in 2006.
Who is Investing Inter-regionally?
Unlisted funds were the dominant inter-regional purchasers in 2005, purchasing US$35bn of commercial real estate outside of their “home” region – an increase of 73% over 2004 levels. Many of these funds took advantage of low-interest rate environments to pursue arbitrage opportunities and heavily leverage returns. A number of large US REITS were privatised in 2005, further swelling the volumes of unlisted funds. Unlisted funds were most active in the UK, German, US, French and Swedish markets.
Institutions were significantly more active in 2005, increasing by 55% their inter-regional purchases over 2004 levels. However they were still overall net sellers. Institutions were significantly more aggressive on price in the US and some European markets in 2005, crowding out other investors and contributing to the search for cross-border opportunities. Institutions were most active in the UK, US, Mexico, France and South Korea.
Listed funds and developers/property companies were also significantly more active in inter-regional markets than in 2004. Both were significant capital exporters to the US market.
Which Sectors were Attractive?
During 2005, there was little change to the sectoral type bought by inter-regional investors. Office transactions remained dominant, accounting for over half of inter-regional transactions.
Will Real Estate Globalisation Continue?
We are witnessing an unprecedented weight of capital seeking real estate opportunities and expect this to continue in 2006 due to a number of factors.
Debt environments are expected to remain favourable, enabling arbitrage opportunities in markets with a positive yield spread over swap rates.
Improving market transparency and practice presents investors with opportunities to search for assets, transfer best practice, build scale and benefit from real estate cycles on a global level.
The ‘baby-boom’ generation is rapidly approaching retirement age in most developed economies, putting fund managers under pressure to both maximise returns and diversify their portfolios outside of their domestic markets. A large portion of these investments are made through unlisted funds, and we have seen that these funds have a high propensity to invest inter-regionally.
While the majority of real-estate investment capital continues to flow into established markets in the US and Western Europe, yield compression in these markets is leading to an increasingly global search for return. Markets in Asia, Eastern Europe and Latin America are rapidly developing and offer exciting opportunities for investors to compete for growth and diversification. This will help drive the continued globalisation of real estate investment.
This article first appeared in the July issue of PricewaterhouseCoopers Global Real Estate Now publication.
1 This study focuses on the commercial real estate sectors popular with inter-regional investors, and excludes multi-family residential real estate.The multi-family residential real estate market is a growing sector with approximately US$120bn invested in the US, Germany, Sweden, Japan, Hong Kong, Singapore and Mexico in 2005. With few exceptions (notably Germany), these markets are dominated by domestic investors and cross-border investment activity is low.
2 Cross-border investment is classified as “intra-regional” investment (both purchaser and vendor originate from the region where the transaction occurs) and “inter-regional” investment (purchaser, vendor or both originate from outside the region where the transaction occurs).
3 A “global source of funds” is an investment fund that raises capital from multiple countries, i.e. the source of capital is not identifiable to a single country or region.