ULI Product Council Outlook for Global Investment
Members of ULI’s Global Exchange Council discuss factors and trends influencing real estate investment and development decisions.
Political upheavals, refugee crises, climate change, terrorism, economic uncertainties—how much are these factors changing decisions about where and how to invest in the years ahead?
Kenneth Munkacy: There is a lot of volatility. The “Trump bump” has already been factored into the market. The post-Brexit settlement is still a question mark. The geopolitical tensions in Korea have certainly given people a pause. Against this backdrop, investors are increasingly concerned about the potential downside exposure and look to the markets where they can invest safely, despite all the static in the environment. In the United States, strong economic growth continues, which sustains demand from the user side and helps to drive transactions. Investors are seeing the Fed as supportive; unemployment is at postrecession lows; corporate earnings are strong; and capital markets have ample liquidity. Those are all good driving forces for continued investment.
Michael Newman: The majority of our deals are in the United States with U.S. investors and capital partners, but we’ve also been in central/eastern Europe since 1989, and recently we’ve been focused just on Poland. There’s quite a bit of concern and uncertainty throughout the world about where to find stability. The United States, in spite of all the difficult political conditions, is still a general safe haven where foreign and U.S. investors want to invest. We used to think that the countries in central Europe had stronger growth potential—and we still think they do—but they’re not without their political issues as well. Through much of Europe, including central/eastern Europe, there is a more nationalistic political mentality, and that may cause concern for some outside investors.
Sujan Patel: There has been a fair amount of volatility throughout the world in the last few years. In the United States, the market has been pretty resilient despite this, and that speaks to the strength of the U.S. economy overall. Investors still view the United States as a safe haven and a place where they’d like to invest capital, sometimes more from a capital preservation standpoint than a potential capital appreciation standpoint, especially given where we are in this economic cycle.
Philip Fitzgerald: In the end, most investors realize that life has to go on, and that people will continue to need a place to live, a place to work, a place to play. Of course, for a frontier market directly affected by those crises, the chance of attracting capital is zero—now. But there is new interest in emerging markets, probably because there’s a feeling that the United States is pretty topped out, at least in certain major core markets, where there’s more downside than upside at this point. The largest variable now is politics. When Donald Trump was elected in November, one investor I knew said, “We are not investing in Mexico, because he’s going to tear up NAFTA [the North American Free Trade Agreement] and everything is going to go to hell in a handbasket.” That hasn’t happened. The Mexican manufacturing base continues to do well.
Are the recent extreme weather events and earthquakes changing people’s minds about where to invest?
Fitzgerald: Post-Katrina, there was a knee-jerk reaction. Everybody said, don’t invest anywhere in the Southeast, Gulf Coast, or Atlantic Coast. But a season or two later, when there were no more calamities, everything went back to normal. So with the storms that hit Houston and Miami, people may be having that knee-jerk reaction again. But 2 million people are not going to move out of Houston. There may even be some interesting buying opportunities there as some investors pull back in the short term.
Newman: There is concern about these areas. In Mexico City, the buildings destroyed by the recent earthquake were older. Building codes aren’t the same there as they are in the United States. In Florida, after Hurricanes Irma and Jose, a lot of the buildings constructed with modern building codes have held up. We were under construction on a project in south Florida, and the hurricane caused only a short delay. We don’t expect any long-term impact market-wise or construction-wise. Given the nature of the demographics in south Florida and similar regions in the United States, we don’t believe that there will be a significant drop-off in long-term investment in these areas.
Patel: Investors tend to be cautious about certain markets with a history of weather-related issues, although sometimes memories can be short. Due to how far along we are in this economic cycle, some of these markets have come back in favor compared to where they were a few years ago. As we get further into any economic cycle, investors move toward secondary and tertiary markets for higher yields, including markets such as the Caribbean and others that are more prone to experience weather-related issues. The recent unfortunate events seem to have given many investors some pause once again, which can also create opportunity.
Which parts of the world are you particularly bullish on?
Patel: Depending upon someone’s return expectations, I believe that the United States offers the most favorable risk-adjusted return opportunity. It may be harder to invest opportunistic capital today, but you can still find opportunities to place core, core-plus, and some value-add funds capital as well as credit-oriented investment strategies. I’m bullish on the United States overall, and some unique opportunities to achieve opportunistic returns are starting to emerge once again. Europe is also an exciting place to invest, and a few years behind the United States in its economic recovery, creating a compelling investment opportunity.
Munkacy: In the United States, the multifamily sector remains very underserved, particularly in the workforce housing sector. In South America, the time has come for rental housing. The population dynamics are clearly sustainable; the lack of affordable for-sale housing makes the renter-by-necessity market appealing. There continue to be good debt vehicles in Europe. Japan still has a good story, too, but the North Korea situation is a concern there. Globally, urban infill housing and last-mile close-in urban warehouse space is a good risk-adjusted bet. The Andean region is a particularly good niche—Colombia, Peru, Chile—as is Mexico. They continue to be vibrant economies that are under-allocated historically, with good structured-debt opportunities. Their capital markets are immature relative to the opportunity set. Puerto Rico in the post-hurricane era provides extraordinary opportunities for housing, cell towers, and infrastructure, and is also eligible for significant federal funding.
Fitzgerald: In Latin America, countries to watch include Argentina, where the economy is doing significantly better. President [Mauricio] Macri’s administration has made some fundamental changes. I hope that they bear enough fruit that the electorate will see fit to continue the program, but I have my doubts. The real estate seems a bit overpriced to me, because a lot of investors moved early and got good value. Brazil is going through what I would consider chemotherapy. With the anticorruption probe of the government and the prosecutions, hopefully enough people will be held accountable, and that will serve as a deterrent in the future. Peru is being overlooked again. It has an oversupply of office space, but the rest of the real estate property types there are likely somewhat undersupplied. The Colombian economy is chugging along nicely, and the FARC Peace Accord is going to pay some interesting dividends. People are bullish about the prospects of less conflict and more peace there.
Are big data and other technologies transforming the global real estate investment market?
Patel: Absolutely. It’s in the early stages for the real estate industry, but investors are very interested in finding ways to capture data and analyze it to make smarter investment decisions as well as paying attention to how technology is impacting asset classes and markets, including creating new asset classes and alternative investment and capital-raising platforms.
Newman: There is better technology for underwriting and analysis, as well as in building systems and tenant interface, and that streamlines the due diligence process, but I haven’t seen anything from a technology standpoint that has greatly influenced a capital partner’s decision to invest in a certain deal or not.
Fitzgerald: Here in the United States, we’re investing in markets where there is an intersection of four industries: technology, life sciences, energy, and trade. The first three are heavily dependent on people with advanced degrees and advanced technological education. Those jobs used to be clustered in places like Silicon Valley, which meant employers had to pay relocation costs to bring recent graduates there, and they had to pay them a premium because of the high cost of living. But with the advent of reliable and robust high-speed communications, a lot of these industries are locating part of their operations to places where technologically skilled people already are living, which often have a lower cost of living. You don’t have to put all your employers in Palo Alto anymore. You can put them in cities like Indianapolis, Houston, Austin, or Miami.
What other challenges are real estate investors strategizing about?
Munkacy: Infrastructure. It’s an international problem. I don’t think the real estate industry focuses enough on roads, bridges, tunnels, and ports. Aging infrastructure is the big Achilles’ heel of the United States, whereas inadequate infrastructure hinders emerging-market growth. Not all countries have the ability, like China does, to control the economy and direct infrastructure improvements. Most emerging markets lack sufficient infrastructure to get to the next economic level; unfortunately, they are fixated on having consumption drive the ship, as opposed to investing in essential capital budget items to drive productivity.
Patel: I think we’re going to see interest rates continue to trend up, and there is much discussion about the resulting impact on pricing and valuation of real estate, combined with debate around growth expectations. Due to the abundance of capital targeting real estate, especially in the United States, valuations are likely to continue to be stable overall for the next few years.
What trends or forces in the global real estate market should we be paying more attention to?
Newman: There aren’t as many bidders on properties as there were a couple of years ago. I think that may be tied to the uncertain political landscape. Certainly in Illinois, where I’m based, there is less capital out there to buy core deals at the prices that were being achieved a year or two ago. With the issues in North Korea and Washington, D.C., people may just be waiting to see how things shake out and see what the Fed does with interest rates. There is a lot of debt in the marketplace, so if you’re a borrower right now, you are getting many more aggressive quotes from lenders than you had in the last few years. There is a lot of equity, too, but it’s more on the sidelines at the moment. I think in the first part of 2018 there will be more activity. There are still a lot of capital sources that want to invest.
Munkacy: The market is oriented more toward cash flow and downside protection, with investors less focused on earning residuals than they were before. In times like these, it makes sense to try and get 70 percent of your total returns from cash, as opposed to looking for back-end appreciation. For global funds, the challenge is to find pockets of opportunity in as many alternative asset classes as possible, like structured debt, cell towers, hospitals, education buildings, student or senior housing, and infrastructure with annuities like toll roads. Global investors are now pursuing a broader landscape of alternative real estate investing.
Patel: I think technology’s impact is the area that everyone should be focused on the most. We also have to focus on how the younger generations live, work, and play, and on how they think about incorporating real estate into their lives. Lots of people have been posturing that millennials mostly want to live in central business districts in the major gateway markets. But I think we will be seeing a shift, in the next five to ten years, of a large population of millennials moving to certain suburban markets—suburbs that have good transportation into central business districts and that have the ability to accommodate density from a live/work/play standpoint.
Members Contributing Their Insights:
Philip Fitzgerald, chief executive officer, 7 Bridges Capital Partners, Santa Monica, California; member, Global Exchange Council
Kenneth Munkacy, senior managing director, Kingbird Properties; assistant chair, Global Exchange Council
Michael Newman, president and chief executive officer, Golub & Company, Chicago; member, Global Exchange Council
Sujan Patel, cohead of U.S. investment management, Colony NorthStar, New York City; member, Global Exchange Council