1 International Capital Sources - U.S. Inflows United States. Winter 2014 U.S. maintained as dominant destination for the placement of global real estate capital Real estate investment options are growing more limited in some foreign domestic markets, and more players continue to look to the U.S. for further opportunities for capital appreciation and income yield associated with the asset class. Across all property types in aggregate, investors from Canada, China and Australia comprised the top three foreign sources of capital for U.S. real estate investment over the past year. The Canadians have teamed up with REITs and have grown their focus on residential units in Sunbelt markets, while the Chinese are leveraging more relaxed domestic rules and are investing strongly in Trophy and Class A office assets in gateways such as Manhattan and San Francisco. Priced out of these markets, we note increased focus of income-driven South Korean pension funds on office and industrial assets in Chicago, Washington, DC, and rising secondary markets such as Houston, Seattle and Denver. Australia continues to utilize partnerships, with a focus on retail. New sources of foreign capital into the U.S. are constantly emerging. If FIRPTA rules change, we could see increased real estate allocations from pension and sovereign wealth funds, as more capital finds a new home within the prominent U.S.
2 2 Jones Lang LaSalle International Capital Sources - U.S. Inflows Global commercial real estate markets overall continued to show signs of strength in 2013, particularly in the second half of the year. For the U.S., the country maintained its dominance as the top destination for direct real estate investment and continues to be the world s largest and most liquid real estate market. For the fourth quarter of 2013, the U.S. posted the highest amount of direct real estate investment of $80.2 billion, compared to $66.7 billion in the fourth quarter of last year for a 20.0 percent gain. For the full year, the U.S. finished 2013 at $214.6 billion, up 21.0 percent from last year s $177.5 billion level. Direct commercial real estate investment, largest markets; U.S. is the world s largest and most liquid $US billions Q3 13 Q4 13 % change Q3 13-Q4 13 Q4 12 % change Q4 12-Q % change USA % % % UK % % % Germany % % % Japan % % % China % % % France % % % Australia % % % Canada % % % Sweden % % % Singapore % % % Italy % % % Russia % % % South Korea % % % Norway % % % Hong Kong % % % Denmark % % % Switzerland % % % Netherlands % % % Poland % % % Mexico % % % Taiwan % 1.3-1% % Spain % 1.2 9% % Finland % % % Ireland % % % Source: Jones Lang LaSalle, January 2014 Aside from being the world s largest and most liquid real estate market, with ample debt and equity capital to fund investment activity, investors remain drawn to the steadily improving healthy growth prospects in the U.S. as compared to other developed countries, some which have exhibited recent signs of slowing during Q The risk premium for U.S. real estate investment, although tightened given an increase in long-term risk-free rates over the course of 2013, remains quite attractive. By the end of Q4 2013, spreads between the 10-year Treasury yield and cap rates of top core properties of typical interest to foreign investors ended in the basis point range, compared to the average basis point range a year ago. So far for 2014, despite some initial volatility associated with Federal Reserve tapering that began in January, overall interest rates and government yields in the U.S. are currently down by basis points and remain low from a historical perspective. Throughout any fluctuations, the favorable lending environment continues to provide competitive financing product to still make all-in loan pricing for real estate very attractive for borrowers of all types. yield premium over risk-free rate has tightened given rise in Treasury yields, more so by quarter-end; but still attractive in a basis point range Spread of office over 10 year treasury yield (basis pts) Q4 2003Q2 2003Q4 2004Q2 2004Q4 2005Q2 International capital sources of direct investment into the U.S. and their targets As the search for yield continues, investors around the world are taking note of the growth prospects in the U.S. and continue to place capital into the real estate asset class. Across all property types in aggregate, investors from Canada, China and Australia comprised the top three foreign countries of origin for investment funds into the U.S. real estate market in In total, over $38.7 billion of foreign capital has flowed into the U.S. during the past year, up over 40.0 percent compared to the $26.8 billion in Foreign capital into the U.S. 2005Q4 2006Q2 2006Q4 2007Q2 Avg. cap rates used in spread calculation are dollar-weighted, includes property sales of at least $5 million. Treasury yield used in spread calculation is quarterly avg. *Dollar-weighted average of lowest quartile of cap rates *Cap rate data used to calculate spreads preliminary as of early January 2014 Source: Jones Lang LaSalle Research, Bloomberg, Real Capital Analytics Source of Capital Volume in $US Billions # of Properties Canada $ China $ Australia $ Germany $ Singapore $ Israel $ Norway $ Switzerland $ South Korea $ Other $ Total $ * Properties and portfolios of $2.5 million and greater; includes $2.25 billion for development sites, February 3, Q4 For 2013, much of this international capital has flowed collectively into the primary markets of Manhattan, Los Angeles and Chicago, as well as into select secondary markets with the continued rising appeal of Houston, Dallas and Seattle. As with last year, the office property type was the most targeted by foreign investors. However, a change from 2008Q2 2008Q4 2009Q2 -High Quality 2009Q4 2010Q2 2010Q4 Q Q Q % cap rate Q Q Q4 2013*
3 3 Jones Lang LaSalle International Capital Sources - U.S. Inflows last year, San Francisco did not register as a top market destination among the gateways. We attribute this to lack of available product, and also partly to yield compression and the increase in prime office capital values over the past 12 months, which have risen the greatest for that market, in excess of 25.0 percent year-over-year. For growth in the secondary markets shown, this trend mainly reflects the continued impact of the employment growth drivers of energy and technology within these markets. Market destination of foreign capital Market Destination Volume in $US Billions # of Properties Manhattan $ Los Angeles $ Chicago $ Houston $ Dallas $ Boston $ Seattle $ DC $ Inland Empire $ Other $ Total $ * Properties and portfolios of $2.5 million and greater; includes $2.25 billion for development sites, February 3, 2014 The U.S. remains viewed as a safe haven further into the broadening recovery A weak first half of 2013, followed by a strong back half with GDP growth of 3.2 percent in Q4 2013, led the U.S. to post total growth for its economy at an annual rate of 1.9 percent for the full year. With this growth, and now five years post the 2008 Financial Crisis comes an improved housing market, greater lending capacity by vendors and the broadening of more local market economies. Absent headwinds of last year related to budgetary policy and other gridlock in Washington, global markets continue to support an environment in the U.S. for relatively stable and secure investment, as well as further opportunities for capital appreciation and income yield associated with real estate across more property types and geographies within the country. As a result of more desired stability, off-shore capital is expected to remain active, and emerging market capital sources are also likely to become increasingly active in U.S. properties. As of late, emerging market economies are being impacted by our own Fed QE tapering currently implemented, bringing into question global growth prospects and uncertainty as emerging market currencies are finding it difficult to adjust to a new environment of restrictive monetary policy. In essence, we could see a protracted capital flight out of emerging markets including China, which is experiencing its own slowdown in growth, toward safety and quality sought in U.S. assets. In particular, the flows of capital into emerging markets caused by QE are now reversing as the Fed tapers (hopefully not drastically). Some of this capital could potentially find a home in U.S. real estate across a growing number of markets. The bigger picture is that foreign capital as a whole is expected to remain a growing part of the U.S. real estate market. Currently comprising about 10.0 percent of all capital for the investment of commercial real estate in the country, this trend could accelerate if foreign investors expand further beyond absolute core assets and consider more opportunities that require a greater risk appetite and could potentially deliver higher returns on the expanding pools of their own domestic savings. We are starting to see these trends emerge, as some foreign investors choose to expand into value-add and development opportunities. Pricing and competition intensifies greatly with influx of international capital flows The abundance of international capital flowing into the country continues to intensify competition for the limited supply of the most sought after quality assets. Accordingly, asset values continue to increase. Apartment property values are now 3.0 percent above their peak level reached the beginning of January 2008, with the greatest recent increases coming in during 2H For commercial property values, overall pricing remains 15.0 percent below their November 2007 peak. Macro pricing trends: apartment and overall core commercial property values* Index Dec. 00 = Dec-00 Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-09 Dec-09 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Moody's/REAL Commercial Property Price Index - Core Commercial* Apartment *Moody s repeat sales indices representative of total core commercial property sector with data thru Nov 2013 updated Jan 2014 Source: Bloomberg, Real Capital Analytics, NAREIT, Jones Lang LaSalle Research With further room to rise, in 2014 we can expect new foreign players into the U.S. real estate market to target more top quality well-leased office and industrial properties that are expected to gain further pricing ground in select markets. These property types are more desirable to pension funds, as seen with the South Korean investors, as assets within these sectors (particularly office) are a closer match to their
4 4 Jones Lang LaSalle International Capital Sources - U.S. Inflows long-term liabilities. In addition, as pricing per square foot has reached a new peak for apartments on average, we can expect to see more site development for this property type, as demand in various metros increases and is ready to absorb any new supply. China has taken note of this growing demand in and around primary markets and has added residential development to its focus. During 2013, Canadian investors have allocated $11.86 billion (up from $9.12 billion for all of 2012) to U.S. real estate across over 458 properties (compared to 337 last year). Canada s $11.68 billion allocation to U.S. real estate and the number of properties in 2013 Hotel $0.25, 51 Development Site $0.46, 14 Transaction prices per square foot As of Q office and industrial values have the greatest room to climb, retail is flat relative to 2012, while apartments are at a new peak Retail $0.96B, 58 Apartment $3.54B, 173 Transaction price index, 2001 = 100 Property sales of at least $5 million, apartment price index based on price per unit *Preliminary data as of early January 2014 Source: Bloomberg, Real Capital Analytics, NAREIT, Jones Lang LaSalle Research Key players driving the flow of foreign capital into the U.S. Canada has been a dominant foreign investor in U.S. real estate over the past four years, post the 2008 Financial Crisis, after emerging in better financial shape from the mortgage meltdown due to the ability of the country s banks to issue recourse loans and not take as big of a hit as other countries. The deeper pockets of the Canadians have allowed the country the ability to invest in U.S. real estate when values were most suppressed. For 2013, Canadian investment represents almost one-third of all foreign activity coming into the U.S., and we expect activity to remain strong over Canadian investment as a percentage of total foreign investment in U.S. real estate; dominant in past four years 45% 40% 35% 30% 25% 20% 15% 10% 5% % % 13% 13% Apartment Industrial Retail 7% 15% 12% 6% 20% 37% 39% 38% 39% 11% $5.04B, 48 Industrial $1.60B, 114 Canada dominates the Americas in foreign capital flows into the U.S. through public REOCs and REITs A year ago, a lot of the buying activity in Canada was done by the pension funds, mainly due to the prior elimination of a rule imposed in accordance with the Foreign Property Rule (FPR), which placed a ceiling on the share of assets such funds could invest in outside of Canada. During 2013, however, the majority of the Canadian capital into the U.S. was generated by public real estate operating companies (REOCs) and real estate investment trusts (REITs). Much of this has to do with the average percent decline in value the Canadian REITs faced last year, as it become more difficult to find accretive deals, as well as the lack of product in Canada to make such deals happen. Accordingly, these buyers turned to the U.S. to take advantage of improving market conditions here, and searched for opportunities where yields in most cases were above their own record low sub-4.0 percent level seen in parts of the Canadian region. Marking the top Canadian investor in 2013, Toronto-based Brookfield Asset Management is a public REOC that invested over $4 billion across an average percent occupied suburban and CBD office properties, garden style apartments and industrial warehouses located mostly across Dallas, Houston, Los Angeles and Washington, DC. 0% YTD 2014 Note: Excludes transactions without country data. Only includes transactions with a grossed up value of $5 MM and greater. Data through February 3, 2014 Source: Real Capital Analytics, Jones Lang LaSalle
5 5 Jones Lang LaSalle International Capital Sources - U.S. Inflows Canada s most active buyers Two other Canadian actives are the Milestone Apartments and Morguard N.A. Residential REITs. As their name suggests, both have a focus on the U.S. apartment sector, particularly of the garden style. Acquisitions throughout 2013 include residential units located across Dallas, Tampa, Raleigh, and Atlanta, as well as in Pensacola, Florida, and Mobile, Alabama, in an effort to take advantage of improved apartment fundamentals in these Sunbelt markets. Lastly, Triple Five Group is an Alberta-based private developer, which executed a deal for the future development of retail property in northern, New Jersey. During 2013, Chinese investors have allocated $3.12 billion to U.S. real estate across 31 properties. China s $3.12 billion allocation to U.S. real estate and the number of properties in 2013 Retail $0.06B, 2 Location Development Site $0.28B, 7 Hotel $0.24B, 7 Type Apartment $0.31B, 6 $2.23B, 6 Acquisition Price (US $ in billions) China s sizeable deals by its high net worth players, state-owned Number of Properties Brookfield Asset Management Toronto Public REOC $ Caisse de Depot Quebec City Investment Manager $ Milestone Apartments REIT Toronto REIT $ Morguard N.A. Residential REIT Ontario REIT $ Triple Five Group Alberta Private Developer $ enterprises and developers set it apart in North Asia The U.S. has seen a great deal of influx of Asian capital for varying reasons, including the need for diversification. However, a main impetus for the boom of China capital coming into the U.S. has been a slowdown at home, in addition to the opening opportunity of nondomestic real estate investment for the first time which began at the end of As a result, Chinese liquidity has directly targeted real estate opportunities located mainly in the core Manhattan, Los Angeles and San Francisco gateway markets where these investors believe they can become more knowledgeable. A fairly large deal in the office sector during 2013 was the private HNW investment by Zhang Xin out of China (along with the Safra family out of Brazil), which involved the purchase of a 40.0 percent stake in the General Motors Building located in Manhattan for a total cost in excess of $1.3 billion by the investors. Another sizeable Manhattan office-cbd deal involved the acquisition of the initial percent occupied One Chase Manhattan Plaza for $725 million by public REOC Fosun International. Shifting the focus outside of Manhattan office, Chinese state owned enterprises and development firms have been seizing development sites in primary markets and their surrounding areas mostly for residential opportunities. In primary markets for example, residential development transactions include a $620 million joint venture between China Vanke and New York-based Tishman Speyer in San Francisco for a luxury condo project. As an example of the latter, we have seen activity taking place in the NYC boroughs of Brooklyn, NY with state owned enterprise Greenland Group for the planned development of 6,400 apartment units, as well as additional activity by other Chinese developers in Queens, NY. The trend here has been for the Chinese to seek out either new development opportunities or existing underperforming large assets, where they can come in and potentially make higher value-add returns. For 2014, Greenland Group has publicly stated its goal to generate up to 25.0 percent of its revenue from overseas, as it seeks to diversify away from its volatile home market. Investment in the U.S. remains a big part of this strategy. Varying laws such as the China Insurance Regulatory Commission (CIRC) and the National Development and Reform Commission (NDRC) on China outbound investments are aimed at increased overseas investment of insurance funds and businesses, respectively. If laws become more liberal to allow individuals to invest outside of China, we could see more HNW deals as well as the increased pooling of funds going after more U.S. real estate investments. China s most active buyers Location Type Acquisition Price (US $ in billions) Number of Properties Zhang Xin Beijing Private HNW $ Fosun Int'l Ltd Shanghai Public REOC $ Grand China Fund Beijing Equity Fund $ Greenland Group Shanghai State Owned Enterprise $0.20 1
6 6 Jones Lang LaSalle International Capital Sources - U.S. Inflows Pension fund activity also propels South Korea as a top Northeast Asian source of capital There has been a surge in South Korean pension fund activity, due in part to a tight domestic market, an overall aging population and the need to expand and accumulate more diversified funds in preparation for this retiring cohort. During 2013, South Korean investors have allocated $1.38 billion to U.S. real estate across 27 properties. This compares to $1.01 billion across 18 properties for all of Not uncommon for the South Koreans to form partnerships and utilize asset managers, the majority of the 2013 activity was transacted by Seoul-based National Pension Service across 22 properties via a joint venture with Chicagobased investment manager, Heitman. Through this joint venture, the pension fund was able to acquire a portfolio of industrial properties located mainly in the Inland Empire, Los Angeles and Seattle markets. For office deals in particular, because of the need to generate higher yields in excess of 5.0 percent, South Korean income-driven investors have targeted less of the Manhattan properties where cap rates on Trophy assets are in the lower percent range, and more of the CBD office assets located in Chicago and elsewhere where they have a greater likelihood of yielding higher target returns. Also in terms of money-raising, South Koreans remain focused on Class A CBD versus Class B assets, given the lower quality and less attractiveness of the lower class properties. Largely priced out of Manhattan and San Francisco, the ongoing trend we are seeing for the South Koreans is indeed greater activity for Class A properties located in Chicago and even Washington, DC, as well as in rising secondary markets such as Houston, Seattle and Denver, in an effort to generate the required higher yields. South Korea s $1.38 billion allocation to U.S. real estate and the number of properties in 2013 Australia s $2.68 billion allocation to U.S. real estate and the number of properties in 2013 Off-shore activity by institutional investment managers help position Australia as a top U.S. market player As U.S. real estate markets continue to improve, the Australians have become more open to investing outside of their own domestic markets. As such, they seek greater direct ownership via partnerships, with fund managers offering sector-specific expertise. We see this trend emerging from Australia s pension (Superannuation) system, which is world s fourth largest asset pool and real estate comprises close to 10.0 percent of its allocations. During 2013, investment manager QIC generated the bulk of U.S. real estate investment activity for Australia. A leading manager of superannuation funds, QIC transacted just under $1 billion in retail activity across various markets, namely in the states of California, Nevada, Virginia, West Virginia and Pennsylvania on behalf of Australia. Additional activity includes an $800 million 50.0 percent interest deal for Manhattan retail where Westfield REIT was the buyer. China s most active buyers Hotel Dev Site $0.01B, 1 $0.01B, 2 Retail $1.74B, 10 Location Type Apartment $0.06B, Industrial 2 $0.02B, 2 $0.84B, 5 Acquisition Price (US $ in billions) Number of Properties QIC Brisbane Investment Manager $ Westfield Sydney Public REIT $ Grocon Melbourne Private Developer $ $0.86B, 4 Industrial $0.51B, 23 Over the next few years, we expect Australia to become an even bigger player in the U.S. real estate market. Also coming out of Asia, we expect Singapore to continue to be a significant source of foreign funds into the U.S. During 2013, the Sovereign Wealth Fund GIC (Government of Singapore) was a large player in the market, as sizeable full-service resort hotel deals were transacted across Hawaii, Arizona and California. During 2013, Australian investors have allocated $2.68 billion (up from $1.04 billion for all of 2012) to U.S. real estate across 22 properties (compared to18 last year).
7 7 Jones Lang LaSalle International Capital Sources - U.S. Inflows Singapore s $2.21 billion allocation to U.S. real estate and the number of properties in 2013 Apartment $0.00, 1 Dev Site $0.28B, 2 Hotel $1.50B, 4 Industrial $0.01B, 2, $0.37 Retail $0.05, 1 FIRPTA update and investment structures formed around the issue Tax issues in the U.S. remain relevant for most foreign buyers, especially surrounding the Foreign Investment in Real Property Tax Act (FIRPTA). When initially passed in 1980, FIRPTA generally discouraged foreign investors from buying U.S. property by requiring them to pay taxes on any realized gain upon the disposition of the asset. In addition, upon acquisition, the purchaser of U.S. real estate is required to have withheld 10.0 percent of the purchase price upfront at closing to actually cover the tax liability upon the ultimate asset sale. While this has not stopped foreign capital flow activity into the U.S., it has somewhat curtailed the amount of overall investment. However, it has been recently proposed to allow exemptions for foreign pension funds and sovereign wealth funds, just as U.S. pension funds are exempt from the taxation of U.S. real property investments upon disposition. If the act is in fact repealed, this will put foreign players on equal footing and provide for the greater sourcing of capital and ultimately increased U.S. real estate investment volume activity. pool resources. While Trophy assets remain highly desirable by many, their values are often higher, and naturally require a greater source of funding. In addition, there is a learning curve when it comes to U.S. real estate investing for the first time, and in this regard, we sometimes see international buyers team up with domestic investor types. This is typically done to either become knowledgeable about an asset type or market, or to leverage the financial skills and relationships that the partners have with additional U.S. funding sources. In some cases, we also see international investors acquiring a minority interest in a property for these very same reasons. International capital source outlook New sources of foreign capital into the U.S. are constantly emerging, with a continued surge anticipated this year from Asia and specifically Singapore, South Korea and China, which is exporting capital on a large and increasing scale. Year-to-date, Singapore additionally ranks as the number two most active currently behind Norway, as the Norwegian sovereign wealth fund has again publicly stated another increase in its allocation to U.S. real estate above its already 5.0 percent level. Foreign investors continuously recognize real estate s role for capital appreciation and as an income producing hard asset, which also serves as an inflationary hedge. Foreign investors are also becoming more knowledgeable of the broadening U.S. recovery and are placing more bets across an increasing number of markets, as they grow more comfortable in the assessment of risk. As such, we expect the U.S. to continue to be the safe haven and destination of choice for international capital in 2014 and beyond, with a continued top focus on high-quality office assets and growing interest in residential development in prime and surrounding markets. For now, as a way around the taxation issue, some foreign investors have partnered with publicly traded REITs. Under current law, foreign shareholders owning 5.0 percent or less of a publicly traded REIT are not subject to U.S. federal income tax under the FIRPTA provisions upon the sale of the REIT shares or the receipt of a capital gain distribution from the REIT. Accordingly, it comes as no surprise to see some of the dominant overseas players increase their level of REIT partnering. In other instances, simply partnering with non-reit entities, forming platform deals, or taking on minority stakes has been a way to minimize the ultimate tax liability. Additional benefits of partnering As U.S. real estate markets improve further, more foreign investors are eager to come off of the sidelines. Typically for the first-time foreign investor into the U.S., we will see players team up to share risk and
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