America on Sale: Foreign Investors are Cashing In

Doomsday predictions in the U.S. commercial real estate market are becoming more prevalent on a daily basis and the potential for commercial mortgage defaults is said to reach $1 trillion by 2012.

Doomsday predictions in the U.S. commercial real estate market are becoming more prevalent on a daily basis and the potential for commercial mortgage defaults is said to reach $1 trillion by 2012. Pinpointing the parties accountable remains an open-ended inquiry, and the cumulative effect this poses on the psyche of the international investor has yet to play itself out. A breakdown of the current state of the commercial real estate market is necessary to uncover the emerging trends shaping the modern objectives of foreign investors—who are swarming to cash in on American investments.

An investigation into the specific impacts of the recession on U.S. commercial real estate begins with a look at current distress levels estimated (by Real Capital Analytics) in more than 8,400 properties, a value amounting to at least $176 billion. In lieu of these statistics, one dominant trend is the growing interest and subsequent shift to Asian markets, arguably the modern epicenter of real estate activity. While New York remains the most active commercial real estate market in North America, it ranks 13th with Chengdu, China among the most active global markets, and falls closely behind Hong Kong.

Other factors, as reported by The National Association of Realtors (NAR) in their December 2009 fourth quarter data, reveal that construction spending hit the lowest level in more than six years, due to reduction in home building and fewer commercial projects. Adding to the list of challenges is the evolving price gap between buyers and sellers, the effect of which is hampering numerous deals. The gap occurs when rising commercial inventory, particularly distressed properties, weighs heavily on a plummet in pricing. And simultaneously, many owners and developers remain committed to their projects—with prices reflecting modest room for flexibility while not compromising the parties’ position—even when buyers expect considerable price discounts.

Concerns of a double-dip recession, combined with the possibility of further depreciation of commercial property, instill an added layer of hesitation amongst both U.S. and foreign investors. At the other end of the spectrum, conservative investors guided by the prospect of long-term financial returns, find refuge in leading markets such as China, London, Paris and Tokyo. International players once on the periphery, namely Moscow, Brazil and the Middle East, have recently demonstrated slight growth. But despite these concerns and trends, opportunity in U.S. markets is far from dormant. In the wake of the recession-plagued economy, indicators that the real estate market will bottom out in the second quarter of 2010, a relatively weak dollar, and high standards of business practice all merge together to create a big incentive for foreign investors to focus their attention on the sudden prospect of capital appreciation and acquisitions. Under this scenario, foreign investment in the U.S. is expected to surge, with a trend towards multifamily-residential, office, and finally, the hotel sector.

Having recorded an 80 percent decline in office building acquisitions in fourth quarter of 2009 from the same period one year earlier, foreign investors have moved to the multifamily-residential market. Recent surveys indicate a return of the perception that the office sector will register the fastest market recovery, followed by the multifamily and industrial sectors; examples to the contrary make it difficult to predict actual foreign investment preferences nationwide, and suggest the importance of local economies and real estate specifics. For example, in the New York City real estate market, more than 20 distressed commercial properties have attracted foreign investors in the second half of 2009. The trend has continued through the first quarter of 2010 with substantial activity seen from foreign investors. Washington D.C. and New York continue to dominate the investment landscape, with overall activity estimated at $4.7 billion. San Francisco, Boston and Los Angeles closely follow.

In a historic comparison of foreign investors in the United States, the breakdown in current trends may constitute a significant increase of interest from investors in Asia—specifically South Korea, as a direct result of the recent changes in legislation that make foreign real estate investment significantly less burdensome. European investors, particularly from Russia and Ukraine, also are drawn to the United States by the prospect of secure capital investments, diversification, and evolving local currencies in comparison to the dollar.

One of the most significant obstacles to a recovering U.S. economy continues to be the securing of a commercial real estate loan. More stringent borrowing requirements and the high cost of loans threatens domestic investment and continues to deflate asset prices. But even in light of such difficulties, the pool of foreign investors can be expected to collectively hold over $1 trillion in commercial real estate worldwide in 2010, with over $200 billion in the U.S. alone. These investment increases are materializing as of the second and third quarter of 2009, with the expectation of continued growth through the next two years.

The latest Association of Foreign Investors in Real Estate (AFIRE) survey conducted in the second quarter of 2009 expected a recovery of the U.S. real estate market in the second quarter of 2010. With optimism continuing for foreign investors in the U.S. commercial real estate market, we are seeing the activity translate into completed transactions.

(Edward Mermelstein is managing partner at Edward Mermelstein & Associates PC, located in New York City and Moscow.)