Foreign investment in U.S. real estate has surged in recent years, and is likely to continue. In a recent survey of its members, the Association of Foreign Investors in Real Estate found that foreign equity investors plan to increase their investment activity in the U.S. by 73% in 2009 compared with the prior year. But many of these investors overlook the apartment sector and its superior returns because they are unfamiliar with how the market operates.
In the U.S., apartments account for the second-largest share of institutional investors' real estate holdings, lagging only the office sector. But allocations by foreign investors to the apartment sector lag behind other property types. Over the past few years foreign buyers accounted for about 10% of all acquisitions, but just 2% to 3% of multifamily.
The National Multi Housing Council (NMHC) has commissioned research examining this disparity. “A Case for Investing in U.S. Apartments”, produced for NMHC by Torto Wheaton Research, helps foreign investors understand the benefits of investing in U.S. apartments. The report highlights factors that make apartments a highly liquid asset class with stable cash flows, abundant debt financing and unique diversification benefits.
Where are the opportunities?
Since 2001, the list of major foreign investors in apartments differs considerably from foreign investors in all real estate. This suggests the apartment sector has an opportunity to attract new capital, if it can educate would-be foreign sources.
Apartments have received only 8% of total foreign investment since 2001. That lags far behind the office sector, the preferred property type, which has captured 56% of total foreign investment during the period. Although year-to-year changes in investment by country are fairly volatile, an analysis of the largest share of foreign investment in U.S. apartments since 2001 shows Canada atop the list at 34%, followed by Australia (18.8%), Israel (12%), the United Arab Emirates (9.1%) and the United Kingdom (8%).
Those investment figures stand in contrast with foreign investors in total U.S. commercial real estate. This list is dominated by Australia (25.6%), Germany (19.7%), Canada (16.8%), the United Arab Emirates (7.7%) and the United Kingdom (7.1%).
Making the case
The biggest obstacle apartment owners face in attracting foreign capital is that many foreign investors assume our apartment market is like theirs. Many investors come from countries where apartment returns are inferior because the sector is highly regulated and where a greater share of the inventory consists of subsidized and lower-income housing.
In reality, of all the property types, U.S. apartments have provided the highest return over the past 30 years and the second highest return over the past 20 and 25 years. Also, U.S. apartments have displayed higher returns during periods when other property sectors have underperformed, thus bringing diversification benefits to real estate portfolios.
In general, U.S. apartments have less volatile demand than other property types and shorter leasing cycles, which average one year. The buildings have a shorter development cycle than other asset sectors, averaging 12 to 14 months. This makes them more able to change prices as market conditions improve and less susceptible to overbuilding due to falling demand during a long building cycle.
U.S. apartments have the most efficient cash distribution, translating 83% of net operating income into cash flow compared with 64% to 74% for other property types. They also have a lower cost of capital and wider availability of debt capital than other property types because of Fannie Mae and Freddie Mac.
U.S. apartments operate in a favorable, transparent and market-driven regulatory and taxation environment. While 15% to 25% of apartments in many European markets are heavily regulated, only 5% to 10% of the U.S. apartment inventory is subsidized or regulated.
There are 23,000 investment-grade apartment properties in the U.S. and they vary by age, size, quality and location, creating a broad playing field and liquidity. Demographics also are favorable across the 60 or so major metropolitan areas in the U.S., where institutional investors focus the majority of their capital.
Demand for rental housing in the U.S. is expanding at the strongest pace since the mid-1980s. More than 3 million new renter households were created in the four-year period ending in 2008.
The NMHC report is available at www.nmhc.org/goto/investment for firms seeking to educate foreign investors on the benefits of investing in U.S. apartments.
Doug Bibby is president of the National Multi Housing Council based in Washington, D.C.