Emerging Markets and Global Investment Opportunities
– A record setting flow of capital into China and abroad
– Current state of affairs in western and eastern Europe
– Emerging risks and opportunites in BRIC countries
– The rise of middle eastern captial in US investment sales
– Are US investors heading for a soft landing or hard fall?
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DARBI: Hello. This is Darbi Worley, your host for Capital Synergies Talk Show for Commercial Real Estate Investors. Capital Synergies is brought to you by Steelhead Capital, your commercial loan advantage. So today, we are pleased to welcome to the show Mr. Pete Culliney, Director of Global Research for Real Capital Analytics. Pete, welcome to the show.
PETE: Thanks very much, Darbi. Pleasure to be here.
DARBI: All right. So we're actually sitting here in the Real Capital offices in the southern [ph] area of Manhattan. Okay. So, Pete, your focus is on global markets for commercial real estate. Most of our listeners are U.S. investors but we hear more and more questions about overseas opportunities. So first off, has the U.S. economy caused what some people are calling a "global slowdown" or are other markets still performing?
PETE: The answer is both to your question, Darbi. Players in the United States were looking to global markets before the slowdown really started to set in. Global investors for the last couple of years, or shall I say U.S. investors for the last couple of years, have been looking abroad, diversifying their investment strategies, looking for more up and coming markets, trying to insulate themselves from U.S. markets. We were on great upswing in the U.S. commercial real estate in the last, you know, seven years. We knew that it was going to come to some kind of an end. It's not coming to a dramatic end. It's coming to a really nice end for the commercial real estate industry. Volume is off very much but prices have not suffered dramatically in the United States. Someone more overseas but there's opportunity out there in a lot of different markets and there's also a lot of emerging markets throughout the world. And I think that's what U.S. investors are looking to get into.
DARBI: So if you were to gauge the flow of U.S. dollars entering global markets versus foreign capital investments and domestic deals, what does this look like today?
PETE: Overall, capital is flowing both ways, into the United States and out of the United States. We're finding that about 70 percent of overall capital spending takes place in the country of origin. So about 70 percent of buyers worldwide are buying in their local market and then that other 30 percent is flowing one way or the other. So overall that 30 percent of the deals coming in to the U.S. and into other markets globally are funds coming from other nations.
DARBI: Okay. Where do you see this bulk of capital going in the near and longer range future?
PETE: The amount of money that's flowing into China is phenomenal. China is the largest center of investment for money coming out of Hong Kong, which is acting as a pump of funds into China. It's also coming from Singapore, it's coming from Europe, it's coming from other parts of Asia, and it's coming from the United States. Most of this is flowing into land for development where the government is really seeing huge quantities of land to account for the growth of cities. There are 20 cities in China that are growing tremendously, second and third-tier cities, and it's a huge opportunity for commercial real estate. There's a huge demand for housing, for infrastructure, and for retail and other kinds of shopping and all of the kinds of real estate of living for the developing Chinese middleclass. It's a huge magnet for investors from all over the world, both local Asian investors and global investors.
DARBI: Okay. So often when economic pressures increase as they have done in the U.S. lately, it's easy to kind of lose sight of the global picture. Why do you think it's important for commercial real estate investors to remain aware of what's happening abroad?
PETE: Global markets help U.S. investors hedge against what's happening in the U.S. markets. When the U.S. markets are tightening or slowing down, there are other opportunities in developing markets elsewhere. Western and advanced markets are also slowing down considerably throughout Europe but in Eastern Europe there's still a very fair amount of growth; the same thing in Asia. The numbers are very close at this point. We thought early in the year that - and we definitely continue to think that this year is going to be the year that the Asian markets see a higher level of volume perhaps than U.S. or European markets. It'll be the first time that anyone's ever seen that happen. And it has a lot to do with the tightening in the advanced western markets. Deal flow is down 70 percent to 80 percent in a lot of U.S., Europe, Eastern Europe, Germany, U.K. There's money out there but without credit, there's no way to leverage the deals and make the numbers work for a lot of investors.
So they're wondering where else can they put their money. The high prices of advanced western markets aren't quite making it but the advanced returns that are available in developing markets, buying into development projects, working with local developers to fund new deals, or buying deals that are in progress, which they call a "forward sale," which is a very popular kind of transaction in Eastern Europe where there's no old stock to buy but a lot of brand-new stock, both in shopping, apartment living, and office properties coming into the marketplace and investors are buying these properties now, when they're half or three quarters completed and that's continuing to fund the development cycle in these markets by giving the developers the next level of capital to start their next project after these projects that are coming to completion in '08 and early '09.
DARBI: So let's look a little closer at some of these markets. There's been news that parts of Europe are seeing the same kind of hardships as we are here in the U.S. What's going on in Western Europe right now in terms of deal flow and property types?
PETE: The western advanced markets very similar to the U.S. markets, high reliance on the CMBS market to fund the debt that goes to making a lot of transactions over the last few years happen, comparing some statistics about CMBS issuings in U.S. and in Europe. We're seeing about 40 percent of U.S. and European deal volume. Western European deal volume is represented in the CMBS flow. So it's a tremendous amount of the market volume that was taking place over the last couple of years was being supported by that part of the debt market. With the evaporation of the CMBS market last August, September, a large significant part of the financing of these transactions have slowed down.
So we've just seen a tremendous withering of volume in U.S. and the major Western European marketplaces, London and in Germany, throughout the U.K. Prices are down in the U.K. more than in some other markets. Prices are not down so much in the U.S. because sellers are holding firm to what they're looking for. Their fundamentals are good; rents may still be increasing. They have good tenants; their tenants are not defaulting. So if the underlying fundamentals are strong, you're not having a capital call from your bank on your funding, then you can continue to work through the malaise and not have to sell your property for a return that's going to be sub par according to your planning.
DARBI: Right. Now you mentioned Eastern Europe before. Can you expound on that a little bit? Is there Overlay?
PETE: Sure. Eastern Europe is a developing marketplace. Eastern Europe is a place where a lot of these markets are in their first up cycle. These are places where the economy has changed radically over the last 20 years. And we've gone from a period of radical change from what happened in the late '80s and the fall of the Wall and crumbling communist systems, through a lot of political trouble and growing, shaking off the old. And it took these nations sometime to get their stride, but they're starting to really get into their stride now. And as I've been working on this global project, building a database and looking at every market here at Real Capital, it's been amazing to me the number of small markets that you wouldn't even think of where there's really exciting real estate activity going on, new modern shopping centers springing up for developing middleclass who wants to get out. They want to shop. They want to be out there. They want to buy consumer goods.
Anyone who travels throughout the world knows that there's a branded culture out there that you see everywhere you go. And there's something good and bad about being every corner of the world and seeing Prada everywhere you go. The good is that, wow, there's people here that can afford Prada and can afford to shop in this great shopping mall. So if you're in the real estate business and you see these quality shopping centers, quality live-work centers, nice office properties springing up, it's an impressive thing to watch in the real estate industry.
DARBI: Okay. So we've heard that for Asia the country again, as you mentioned, currently seen as the favored destination for foreign investment is China. Does your research…
PETE: Totally backs that up, yeah. I mean, the big - China they're buying a lot of developing land. It's just a huge country, so it has to be the biggest market. There's a whole…
DARBI: What do you think about this - the Olympics and all these protests and the torch Overlay?
PETE: Well, yeah, you know, they should have seen that coming, I think.
DARBI: Yeah.
PETE: I think the thing that's going to be the most interesting is if the Chinese are able to control the pollution issue there. And I come from here in New York where it's not the clearest of skies but it's not that bad. For athletes out there, I think that's going to - might - it could theoretically be an issue. You know, political issues that they have to deal with over there. And that's all part of the game.
DARBI: Yeah. Yeah, I do a sketch comedy here on Monday nights and we did a joke about the torch, you know, finally arriving in China and then they relit it and then they used it to ignite, you know, six new coal-fired power plants and garbage operators. You're laughing, not crying.
PETE: Yes. Overlay
DARBI: So it sounds like Japan may also be in financing troubles similar to ours. Is it true that they also relied heavily on the CMBS market? What's your take on that?
PETE: Yeah. It's - I mean, the numbers are much lower in Japan but they were - they are the real advanced, modern market in Asia. There's a couple of other smaller ones like Seoul. But China, Vietnam, and Malaysia, these are real developing up and coming markets. The advanced markets in that part of the world are going to be Australia, Japan, and these nations are going to therefore be part of the modern western financing system. They're going to have modern capital markets that use extensive REIT and other public structures and therefore they're also going to have public debt markets. So while they're not quite at 40 percent, Japan saw a significant amount of CMBS flow as well and their market has tightened as well but it doesn't seem as if this is going to really offset the economic gains that Japan has made over the last few years.
DARBI: Okay. So amidst all this slowdown, we've heard that investment in Asia and South America doubled in the first two months of this year, especially in the BRIC countries: Brazil, Russia, India, and China. What does your data say about that?
PETE: That's exactly what our data says. I mean, these nations, these areas of the world are still booming. They're the developing economies. Now, it's easy for the numbers to double when the numbers are kind of small. And the investment flowing into these places compared to the flows into Western Europe or flows into the United States into cities like New York, London, Paris where the numbers are in the multiples of billions, it's a smaller number of billions in these other nations. Eastern Europe is similar.
It's really the case down in South America where it's only been the last couple of years where people are starting to look there. Some long-term players like (Inaudible 0:11:22) have been down there for years, and they're really involved in the marketplace. But for the most part a lot of the new players since this BRIC phrase was coined a couple of years ago, I think by Morgan, people have been looking more and more at the South American portion of it and questions about Brazil come to me hot and heavy on an almost a daily basis from our client base. Questions on these other parts of the world as well, Russia, Eastern Europe, they've been hotter longer. The spike has been Brazil and other South American countries in the last couple of months.
DARBI: Okay. So what about if it was your money? If you were considering a cross-border investment yourself, where would you go?
PETE: I've got a fairly decent risk tolerance, so I would definitely be thinking about these things. You know, it's the risk-reward balance that comes in a lot of real estate. This isn't New York City. It's not a New York City office building. That in a lot of ways is a bond with a high-quality tenant that you know it's going to be there and paying for a long period of time. You go to Brazil or Poland or Romania and you have to make friends and partners with local groups. You have to hope you get in with the right people. You're vetting a lot of relationships.
But there's a lot more risk and there's also the chance for a lot more reward. And that's the game. So if you are a foreign investor and you know that you're going to get your, you know, 5 percent to 8 percent return for your investors and you're going to buy a high-quality office building in a high-quality, well-known marketplace, you're not going to (Inaudible 0:12:53). If you're going to buy an up and coming kind of office building where you're hoping to have in a developing market where their value is going to have a greater increase, you would think about maybe buying a quality office building at places like that and U.S. investors are.
There's also the risk that could come with being in one of these markets that if something happens in their economy, if there's some kind of political upheaval, that's not the way Brazil is operating these days or has been for years, so there's a lot more comfort with how these things, you know, will go forward and a lot more comfort with that you're going to be able to put your money in, you'll be able to get your money out with a very nice return.
DARBI: Okay. So let's move back over to the U.S. commercial real estate trends. There's word of a fairly strong push from wealthy Middle Eastern buyers to pick up real estate investment trusts in our market, particularly apartments. Is this trend anything to be concerned about? What are your thoughts on that?
PETE: If they're paying quality price then buyers and sellers are happy. That's what a good marketplace is all about. If people want to bring their money here - the great thing about a real estate investment is they can't take it home with them, you know.
DARBI: Yeah.
PETE: They can come and they could buy art, they can buy cars, they can buy anything and ship it away and we could think that we're losing something. They could - you know. But with an office building, apartment building, any kind of real estate investment, it's here. It's going to stay here. Do they maintain it? Do they upkeep it? Do they continue the quality of the investment? And is it going to grow for them? Yeah. And then maybe the next time around an American will buy it. We've seen it happen before and everybody makes a profit. Whenever anyone worries about one class or other of an investor coming in, I think it's just more activity; it's good for the marketplace.
DARBI: So the same thing happened with Australia in recent years with U.S. commercial properties. What's going to shake down from that? There are several Australian investments.
PETE: Well, the Australians have made a couple of really large investments in the United States over the last couple of years. Now (Inaudible 0:14:49) into some debt problems in the last couple of months and there's some issues whether they're going to have to unload some of their holdings here in the United States because they were over leverage. We'll see what happens with that.
Again it's all the business - do you over leverage, you stretch yourself too far in the credit crunch. There's a massive credit crunch going on. If you are in a situation where you were going to have to refinance at the end of 2007, you've got significant problems right now and we know who the players are that are caught in that kind of trap. But we also know that most players were not caught in the have-to-refinance-now. Maybe they'd like to but with rates are coming down, properties are still strong, hopefully there's not going to be a lot of distress in the marketplace that, you know, creates underlying weaknesses and causes a rough market. At this point, it seems as if soft landing is, as people were talking about, is kind of where we're at.
DARBI: Okay. Of all the trends in the global and national marketplace, is there one that you think is potentially the most problematic for American investors?
PETE: Again, it's always the risk-reward play, you know. Are there things that could happen in certain markets that could be really bad for investors? You know, there are all these issues. How do you get your money out of India? How do you get your money out of somebody's developing markets? You know, you can put together a portfolio in Malaysia. Are you going to be able to float it on the local stock exchange and bring your investment back home? Or are you going to have to just continue to roll that forward and hope that at some point, the capital flows are going to work a little bit more in your favor?
In a lot of these markets, they recognize that in order - and they're enhancing their systems. They're bringing in REITS. They're bringing in other public entities that make the markets a lot more efficient and make it a lot more transparent because they know in a lot of these developing nations that transparency brings deal flow, brings happy buyers and sellers, brings better prices for everybody. They know that happy investors who don't come up short and are able to go home with their profit or understand their loss are happy investors who are going to come back. Investors who feel they got burned by a political system going to be gun-shy investors who are not going to come back. So as the world develops and the world evolves, I think a lot of the developing nations realize that they want happy investors bringing their money in and out of their markets.
DARBI: Okay. So just to recap, what are some of the encouraging trends for U.S. investors? I think you've touched on a few of them. If you can kind of hit the highlights.
PETE: Encouraging trends for U.S. investors, I think that the home market is solid and stable. It's an encouraging trend. There's not a lot of pain out there here or in Western Europe. Volume is really down. But prices are still stable and I think that's something that's really a tremendous strength to our market and everyone should be kind of happy about that. A downturn or a softening without a lot of pain is, I think, a good thing. You know, I know a lot of people profit on the pain but it's a balance. And I think that where the market has - in the West has found a pretty nice balance as it slowed down. And I think that as the economies get through this credit issue and start to pick up, real estate is going to be at a nice plateau to start picking up again in the western markets.
If you are a risk player, a value-added player, you're into development, you're looking for higher returns, I think there's a tremendous amount of opportunity out in the world that an investor who is looking for that can really be happy with. I think the ability to invest in development in Asia and in Europe and in Central America gives you a tremendous amount of options to look at in terms of the economies that you're dealing in and the currency issues that you may or may not want to take into effect as to why you may or not want to get into a Euro or into a South American currency.
I think it's great to have a variety of opportunity plays. Variety of potential distress plays may be coming up for the people in the western markets who really got hurt by the credit crunch but it's not a tremendous part of the market. I think overall the market is really pretty stable. So while some people maybe aren't that busy these days, I think that the pain is not so thorough is really a great sign for the marketplace.
DARBI: Okay. Well, if listeners want to get this kind of investment research data on a regular basis, what kind of subscriptions are available from your company, Real Capital Analytics?
PETE: We publish a variety of monthly capital trends reports on the U.S. market, looking at all the common property types: office, industrial, retail, apartments. We publish a quarterly hotel transaction that looks at the world. And we now publish a global capital trends report that comes out eight times a year being fed into the famous Real Capital Analytics Online Database. You can go in and you can see the actual transactions that are taking place behind the numbers, which adds a lot of transparency to the marketplaces and a big value of what we bring to the market. So if anyone goes to www.rcanalytics.com, they can download some of our sample global reports. First couple of issues are there for free. Sign up for a free trial. And if you're interested in becoming a client, we have a lot of subscription options available.
DARBI: And they can sign up right on the website. Okay, so give that website address again.
PETE: The web again is www.rcanalytics.com.
DARBI: Excellent. All right. Thanks, Pete. This has been a very insightful discussion on commercial real estate and I'm sure our listeners appreciate your spending time with us today. So, guys, if you are an investor looking for expert assistance with financing commercial real estate, be sure to check out the new commercial loan programs offered by Steelhead Capital, your commercial mortgage advantage.
Again that web address is www.steelheadcapital.com. This has been Darbi Worley, your host for Capital Synergies. Pete, thanks again for joining us and we hope to speak with you again soon.
PETE: Thank you, Darbi.
DARBI: This has been Darbi Worley, your host for Capital Synergies. We will see you next time.
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