An Uncertain Certainty

U.S. commercial real estate remains a sound investment

If 2016 proved anything, it’s that making predictions is trickier than ever. Who knew the citizens of the UK would vote to leave the European Union? Or that a continued oil glut would keep energy prices remarkably low—to the benefit of some industries and the extreme pain of others. China was notable for not making many economic waves in 2016, although concerns still swirl around its slowing GDP and currency volatility. Add to that mix a global refugee crisis and a polarizing presidential election in the United States, and “uncertainty” seems like an understatement.

But despite the jolts and surprises of 2016’s global economy, the United States remains a magnet for investors who are seeking a safe haven for their capital. Indeed, while 2015 set a record for foreign direct investment (FDI) into the U.S. commercial real estate market—topping out around $91.1 billion, according to Real Capital Analytics—investment volume remained strong in 2016 as well.

Safe and Secure

In a world of increasing market volatility, “U.S. commercial real estate is the last hope,” says Lew Cramer, CEO of CBC Advisors, a Coldwell Banker commercial real estate brokerage. “Especially in bad times. It’s the last good investment holdout.” If U.S. commercial real estate fails as a safe investment, in other words, you may as well call it a day as far as investing is concerned.

Adam Gatto, senior vice president of CBC Advisors, agrees. Noting that the market is on a seven-year high, he says, “When the markets begin to decline worldwide or level off, it tends to drive dollars from foreign markets into the United States. Foreign investors view U.S. commercial properties as the safest investment.”

If United States commercial real estate is good in good times, it’s potentially good in bad times as well, with investors from politically or economically unstable regions seeking out U.S. real estate investments primarily as a way to safeguard their assets, rather than looking for a strong yield. Because of that, foreign investors may be willing to outbid U.S.-based investors for choice properties.

A domestic investor, then, might feel ambivalent about the influx of foreign capital. On the one hand, it’s keeping values up. On the other hand, they may face stiff competition for the most desirable properties.

If Cramer and Gatto are right—and they are deeply experienced in commercial real estate, foreign direct investment and global capital flows—a bearish world economy could actually be good for U.S. commercial real estate. The worse things get out there the more attractive U.S. commercial real estate becomes an asset preservation vehicle.

Snapping up U.S. properties benefits foreign investors in another way. At the first rumblings of economic malaise, says Gatto, many investors want to get their wealth out of their own currency.

Another driver of overseas cash into U.S. real estate: trade imbalances. Take China, for instance. “China has a huge trade surplus with the U.S.,” says Lina Svedin, professor of economics at the University of Utah. “That means they’re left holding dollars. Billions of them.”

It’s not just China, either. The United States has significant trading deficits with Canada, India, Saudi Arabia, Mexico, Japan and the EU, among others. For these nations flush with cash, reinvesting makes more sense than converting into their domestic currency. So trading partners plow those dollars into U.S. assets. And the asset of choice is high-value commercial real estate.

Investor Insight

Foreign investors run the gamut from massive international state-owned investment funds to large-scale institutional investors to wealthy individuals looking to secure their assets.

Gatto says foreign investors tend to fall into three categories. “First are the sovereign wealth funds (SWFs), which invest in large, institutional-type properties in primary U.S. markets,” he says. Indeed, SWFs have more than $6 trillion worth of assets under management. The largest, Norway’s SWF, is an $860 billion behemoth that has begun to turn its gaze toward assets across the Atlantic. Gatto explains that SWFs are risk averse and tend to hold property for 10 or more years.

The second category of commercial real estate investors is that of private equity groups (PEGs). These groups raise large pools of capital to invest in real estate opportunities. “PEGs tend to be more tactical in their approach,” Gatto says. “They will look for more speculative opportunities, such as value-added, development and

Portfolio Diversity

SWFs, private institutions, major individual investors and a consortium of small investors all face the same pressures. Whether they need to offload dollars, get out of their own currency or preserve wealth—three distinct but often overlapping imperatives—overseas customers appear poised to continue chasing U.S. commercial real estate for the foreseeable future.

There’s a problem: most of these buyers want the same types of properties in the same handful of locations. It amounts, in Lew Cramer’s words, to “a lot of liquidity chasing limited solid assets.” With the exception of Chicago and Dallas, the deluge of foreign cash lands on the two coasts. “Asians want to be on the West Coast, Europeans on the East Coast,” Cramer says (Canadians, in contrast, love Chicago).

“Places like the Intermountain West tend to be overlooked by foreign buyers,” says Cramer. Which leaves commercial assets undervalued, at least in relation to their coastal counterparts. True, the Intermountain West may lack the quantity of gigantic assets found in a place like Manhattan, but it contains vast quantities of small- to mid-size assets.

And where foreign investors have traditionally sought a single large investment in which to park a billion dollars, they are warming up to the idea of spreading that amount over a collection of multimillion-dollar properties. As an added bonus to the latter strategy, a diversified portfolio of retail, industrial, hotel and residential properties may make more sense than placing all their eggs in one basket.

Domestic investors in commercial real estate, seeing the competition for properties in the handful of FDI hot markets, often move inland to find their deals. They are not alone. Savvy foreign investors have begun to follow suit. The continental United States is so vast, however, and foreign money so relatively small—$91 billion hardly makes a dent in a $15 trillion U.S. commercial real estate market unless it’s highly concentrated—that FDI is unlikely to bid up inland markets significantly.

To give but one example of inland treasures waiting to be discovered, the greater Salt Lake City area has undergone a boom while other parts of the country dawdled under economic malaise. The region features a burgeoning tech corridor, a vibrant and expanding downtown and a major renovation of the Salt Lake International Airport.

Other regions, such as Colorado’s Denver-Boulder corridor, are experiencing similar economic expansion. The solid fundamentals of the Salt Lake City and Denver economies spell good news for commercial real estate. With workers flocking in to fill jobs, apartment vacancies are expected to continue to decline. Retail and industrial should perform well, as startups and established businesses jostle for space.

Commercial property values in places like the Intermountain West, however, represent a bargain when compared against well-known markets such as Silicon Valley. “Properties in the Intermountain West currently represent a particularly good investment strategy for foreign direct investment,” says Cramer.

Ultimately, regardless of the ups and downs of the global economy, foreign investors will continue to seek U.S. commercial assets as a safe haven for their capital and as a shock absorber for investor liquidity. As wealth continues to increase in the world’s developing economies, foreign investors will become stronger players in the U.S. commercial real estate market—bringing new competition and new capital into the market.