The U.S. market remains the top destination for foreign real estate investment. Capital flows in 2014 surpassed 2013 levels and investment activity continues to increase. According to the Association of Foreign Investors in Real Estate, a recent survey indicated that 81 percent of respondents “intend to increase their portfolio of assets in the U.S. [as it] is perceived to provide a stable environment in which to invest and is the best market for capital appreciation.”
While sovereign funds from countries such as Singapore, China and Norway are well known investors, many newer entrants are making significant inroads into the U.S. real estate market, or have announced plans to do so, including investors from South Korea, Malaysia and the Middle East, among others.
These institutions are fluent in the U.S. market, are comfortable with the economic recovery and continue to see the United States as a large, liquid and stable “safe haven” for investing. As large scale “trophy” assets become more difficult to source and as property prices continue to climb, foreign investors are increasingly looking to debt markets as a means of fulfilling their U.S. real estate allocations.
Interest rates are at historically low levels on a global basis. Low interest rates, particularly in Asia and Europe, have led to increased allocations by sovereigns to U.S. real estate as a greater “total return” investment and as a portfolio diversifier.
As larger equity investments from hotels to office buildings have become increasingly challenging to source, and increasingly expensive, seasoned and newer entrants alike have uncovered real estate debt as a compelling alternative, or as a complementary asset class, to their equity investment strategies that provides diversity, liquidity and current income. Also, notably, U.S. CMBS remains cheap relative to other U.S. indices as it has yet to fully recover from the global financial crisis, hence making investment in the asset class opportune.
An analysis of the current investment landscape reveals five primary attributes that make U.S. commercial real estate debt and CMBS in particular a compelling investment for foreign investors:
1. Favorable Tax Treatment
While the Foreign Investment in Real Property Tax Act (FIRPTA) subjects non-U.S. investors to a 10% withholding tax on the sale of U.S. property investments, CRE debt in most forms is exempt from such adverse taxation. With some caveats, CMBS is exempt from other U.S. taxation as well.
2. Logical First Step Providing Visibility and Exposure to U.S. Property Markets
Through CMBS, off-shore investors are able to achieve broad exposure to a wide assortment of sponsors, asset classes and geographic regions that are more senior to, and more conservative than, the corresponding equity.
3. CMBS Allows Investors to Pinpoint Risk and Reward Along the Capital Structure
Through tranching CMBS from AAA to unrated mezzanine level, investors are able to select the level of risk and reward with which they are comfortable.
4. CMBS Provides Liquidity and Discretion
CMBS are liquid securities that can easily be divided to customize and manage portfolio risk. In addition, because there is no “deed-of-record,” investing in CMBS is confidential.
5. CMBS Provides Current Income and is Easily Hedged
CMBS generates monthly income and investors can choose between floating or fixed-rate assets in addition to customizing by vintage, sponsor and geographic region.
Foreign investors seeking exposure to the U.S. property market should consider CMBS as an essential component of their U.S. real estate investment strategy. For a newer entrant, CMBS, as compared to direct property investing, provides a tax-efficient means of participating in the market at attractive valuation points while also providing current income, liquidity, confidentiality and market access and visibility. Compared to traditional direct property investing, CMBS offers numerous competitive advantages.
For the foreign investor that may already have U.S. property exposure, CMBS provides current income to off-set their “J-Curve” equity investments. CMBS also provides an efficient means for an investor in a private equity fund to effectively “co-invest” (through CMBS) in assets where the investor seeks increased exposure. Additionally, existing investors benefit from CMBS by gaining valuable exposure and insight into markets that may lead to follow-on investments via direct equity.
Ed Shugrue, III, is CEO of Talmage LLC.