Local real estate markets are going global

Dr. Nikodem Szumilo, Fellow in Economic Geography and Real Estate, London School of Economics

Dr. Thomas Wiegelmann, Managing Director, BLUE Asset Management GmbH, Munich and Honorary Adjunct Professor, Bond University

Across the globe real estate investment is growing at an unprecedented pace but the industry is changing as investors increasingly look beyond their local markets. The global trend to invest in foreign Real Estate appears to be driven by an increasing share of institutional portfolios being allocated to this asset type. As domestic markets of developed economies mature and offer low yields, investors turn their attention to other geographies. From a global selection of Real Estate markets the ones that attract the most foreign capital are not growing at the fastest rate or offering the highest yields. Instead, investment is attracted to places that are liquid and transparent.

The rise of international Real Estate as an asset class

The typical portfolio allocation strategy is to allocate around 40% of its value to equites, 40% to bonds and split the remaining 20% between various “alternative assets”. In the third category, Real Estate attracts the most capital and is the most significant “alterative asset” class. In fact, it accounts for almost half of investment not allocated to stocks or bonds and its share in institutional portfolios continues to grow.

According to a forecast produced by JLL total Real Estate investment over the next 10 years will exceed $1 trillion. As its value is currently close to $700 billion it represents an expectation of a significant expansion of this sector. As an asset class and an investment product Real Estate appears to be growing in significance at an unprecedented rate and faster than any other asset class. This trend is not only observed across the globe but appears to be very closely related to international flows of capital.

Direction of global flows

In the recent past various countries increased the value of capital they invest abroad. While North America, Asia, and the Middle East are still the primary sources of cross border investment and account for around 70% of its total value, China is the most common example of a country that continually increases its foreign financial interests. The same trend is observed in Taiwan, Singapore, Norway, Africa and Latin America. On the receiving end, the top spot is firmly held by Europe were around 65% of all investments is made by non-European investors. North Americans continue to be very interested in this market and flows of capital between the two continents have been a strong trend over the past decade.

Easy access to capital, attractive exchange rates and demand for high quality assets in transparent markets were the key drivers of this phenomenon especially for institutional investors. With insurers as well as pension and sovereign funds seeking safe assets with good returns across the globe in 2015 around 20% (around $35 billion) of all capital invested in commercial real estate came from these institutions.

Where does the capital go?

However, the future of global Real Estate investment will be determined by global and regional political and economic conditions. When the investment environment suddenly deteriorates capital flows have a tendency to reverse very quickly as funds return to the regions and countries of their origin. If the risk of investing in abroad suddenly becomes too high, international investors act swiftly to protect their assets.

Global political conditions appear to be changing increasingly quickly which makes country risk difficult to predict. Security threats, national and international political tensions and progressing radicalization of beliefs create an environment that deters international investment in large fixed assets with high transaction costs. This leads to a high correlation between the stability of local and regional investment environments and inflows of international capital. In addition, factors such as liquidity, rule of law, clarity of regulations and access to high quality information are critical in attracting international institutional Real Estate investors. This means that while stock markets of merging economies are increasingly interesting to equity traders, Real Estate investment concentrates in the most established metropolitan areas which offer much more mature markets. Just 30 cities account for around 50% of the total transaction volume and the top four (New York, London, Paris, and Tokyo) contribute 20%. While those locations offer unparalleled liquidity they also are amongst the most transparent markets in the world.

As Real Estate is considered as an “alternative” to bonds and stocks a similar level of transparency will be expected. This leads to investors demanding ever higher standards and an expectation that eventually informational efficiency of Real Estate markets will catch up with the main asset classes. This gives rise to an interesting phenomenon as highly transparent markets appear to be receiving more international capital than high growth locations. Since 2011, cross-regional capital flows have grown twice as fast as intra-region investment (Americas, EMEA, Asia-Pacific) and are likely to continue to grow further and reach $500 billion (50% of global transaction volume) by 2020. Unlike equity investment, this capital is likely to flow to locations that offer transparency, security and liquidity rather than the highest risk-adjusted returns.