Asian capital is retreating from more mature western markets as the late cycle limits opportunities for favorable core real estate investments, according to a recent report by commercial real estate services firm JLL.
Global cross-border transactions fell 17 percent in the first quarter when compared to the same period in 2018, the report showed. Of all the global transactions recorded in the quarter, just 40 percent involved a foreign buyer or seller, representing a 3-percentage point decline from the long-run quarterly average of 43 percent. The decline in international real estate activity is the result of reduced capital deployment into the US and Europe by groups from Asia, according to JLL director of research Lauro Ferroni.
As the real estate cycle matures in both Europe and the US, property investments are starting to look less attractive to Asian investors. Asian real estate buyers, who have long shown preference for trophy assets, are now losing enthusiasm as yields for these types of buildings have declined, Ferroni observed. Some investors have turned to making portfolio acquisitions instead, and Ferroni has noted an increase in the proportion of portfolios being bought by foreign capital in the US.
Asian real estate buyers are also facing rising currency hedging costs, making the US a less favorable investment destination, according to Ferroni. Hedging costs eat into already depressed US core real estate returns – total returns in US properties have fallen from 13.3 percent in 2015 to 6.83 percent this year to date, according to institutional real estate organization NCREIF’s Property Index. As a result, more activity is shifting to Europe, he added.
Commercial real estate transaction volumes in both the EMEA and Americas have declined over the past year, according to the JLL report. Volumes dipped by 8 percent from $67 billion in the first quarter of 2018 to $62 billion in the first quarter of 2019 in the Americas, while falling 22 percent from $64 billion to $50 billion during the same period in the EMEA region.
The slowdown in activity was driven by investors becoming more selective in anticipation of the market fundamentals softening, Ferroni explained. Finding mainstream investments with a clear exit over the next 2-3 years has become a focus. Transaction activity may have also fallen because many core assets are now held by long-term owners that have no intention of selling the property, he added.
Meanwhile, transaction activity picked up in Asia-Pacific, rising 14 percent from $39 billion in the first quarter of 2018 to $39 billion during the first quarter of 2019. The increased activity was driven by a surge of investment in China, which came in part from Chinese capital pivoting back to the home country as a result of the capital controls enacted by the government in 2017.
However, as mature markets like Europe and the US slow, China has also benefitted from an influx of foreign capital, with a quarterly record of $17 billion in transactions during the first quarter, Ferroni noted. Indeed, JLL reported that three of the top 10 recipients of global cross-border capital were Chinese cities. In Shanghai, foreign capital accounted for $2.6 billion of the $6.3 billion in real estate transactions reported during the first quarter of the year.
The second-largest economy in the world, China has seen rapid investment-grade real estate development over the last two decades, setting it up to become one of the more liquid property markets, Ferroni said. Developers are now looking to trade out of the buildings that they have built, creating opportunity for buyers.
Given that real estate dry powder reached an 18-year high of $295 billion in 2018 and institutional investors continue to show interest in the asset class, the slowdown in global activity during the quarter is a sign that the industry is showing discipline and restraint, Ferroni told PERE.