Real Estate and Global Capital Flows
Coverage of the 2016 Global Investment Conference
BY Yaelle Gang | November 2, 2016
The impact of geopolitical pressures on commercial real estate markets has been mixed, and with it a net positive for the core commercial real estate market in the U.S. and a negative in more liquid public markets such as CMBS and REITs, according to John Murray, managing director, portfolio manager and co-head of U.S. commercial real estate at Pimco.
During his presentation, Murray said that U.S. commercial real estate prices have benefited from solid fundamentals, as evidenced with vacancies declining and rent rising since 2011. However, the primary price driver over the last five years has been strong capital flows, which led to steadily increasing transaction activity. Transaction activity has been particularly strong with cross-border investments, which increased by more than 300% since 2012.
However, he noted that, since 2015, the transactions by REITs have been declining and there has been a divergence between private markets and public equities. He said that
in the first part of 2015, fears over interest rate increases started to percolate and, in the summer of 2015, world events like the Chinese sell-off led to a disconnect between what was going on in the private market and the public REIT and CMBS markets.
Murray explained there was an indirect impact from the public market on the private markets via REITs and CMBS.
Geopolitical events are a major reason for the price dispersion in early 2016, according to Murray. When looking at the core markets, like New York or D.C., global demand for what Murray classifies as “safe yield” remains supportive.
“While the secondary market sees global sell-offs and oil in China as clearly being negatively impacted, I would argue that, in the core markets, and this has been the case for the last couple of years, these same geopolitical pressures are arguably positive for the U.S.,” he said. This
is because, from a global-demand perspective, real estate in major American markets is viewed as a safe haven, an inflation hedge and, to a degree, a currency play.
Murray explained that American real estate is also a diversifier for foreign investors outside of their home countries. For example, for investors from Asia, which make up 36% of cross-border transaction volume, the Chinese volatility and expected currency devaluation increased the demand for U.S. commercial real estate.
Another positive for this market is that foreign capital is under-allocated to U.S. commercial real estate. “As you look forward again in those core markets, not only do you have real demand today, but you have major funds saying that they’re still under-allocated,” Murray said.
Murray cautioned that there are still some additional downside risks to consider when it comes to core U.S. commercial real estate markets. These include the denominator effect, dwindling coffers from major foreign capital sources, negative selection that can skew price indices and change investor perceptions, and a global recession that may impact fundamentals. Some upside risks include the stabilization of China and rates dropping.
“What does that mean in terms of investing implications?” Murray asked. He explained that investors should be as nimble as possible in the current market. “What I would bet my money on is that there’s going to be more volatility.”