Finance  ·  Sales

Foreign Capital’s Ongoing Push Into US Secondary Markets

Cross-border investors are capturing better returns and finding safer havens in places like Denver, Dallas and Austin


For many investors in commercial property, safety and a heightened consideration of downside risk reign supreme. For others, yield takes priority. For global real estate investors dabbling in U.S. real estate a year and half into the pandemic, both are certainly in play.

Overseas investors have been finding a cohesion of safety and relatively strong returns on their investments in U.S. secondary markets, as they’ve mostly pulled back from making flashy bets in core coastal markets, where global players have historically focused the bulk of their attention.

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So far this year, many overseas investors have been following in the footsteps of their domestic counterparts, moving to take advantage of favorable economic and demographic trends that have benefited U.S. non-gateway markets, such as Denver, Nashville or Raleigh, N.C., while also getting more involved in stable, burgeoning asset classes like multifamily and single-family rental homes — two sectors that had never really been top of mind.

German investor Commerz Real might’ve just recently bought 100 Pearl Street in Manhattan for $850 million, and South Korean firm JR AMC might’ve bought a 49.9 percent stake in 498 Seventh Avenue in Manhattan for $140 million from JPMorgan Asset Management in May, but that doesn’t necessarily help eliminate the stigmas stapled to primary metros still recovering from COVID-19.

It may not be a surprise that foreign investment activity in U.S. commercial real estate was up 48 percent in the second quarter — totaling $7.3 billion — from the same time last year, but investment activity in key secondary markets skyrocketed, while activity in Manhattan plummeted, according to data from Real Capital Analytics (RCA). Investment in Manhattan fell by 86 percent, while markets like Atlanta, Phoenix and Orlando saw a ton of activity — 21 percent, 65 percent and 137 percent leaps, respectively.

Market dynamics favor non-gateway cities, as it relates to the returns many overseas investors are targeting, said Alex Foshay, vice chairman and head of Newmark (NMRK) Capital Markets’ International Capital Markets Division.

“We are certainly seeing a migration towards markets offering more attractive returns than gateway, coastal cities,” Foshay said. “Office cap rates in the coastal gateways are in the mid-4s [percent] and below for the best-quality assets. It is starting, for some of these groups, to be harder to hit the levered cash-on-cash returns they are pursuing. For core overseas capital, this is the key metric they are looking at.”

Foshay said his team is selling a dual-asset Google (GOOGL) campus in Seattle, with a valuation that approaches $700 million and an in-place lease term of more than 15 years. He said he expects to reach close to a 4 percent cap rate, which doesn’t exactly match up with what many overseas investors want to spend time and energy pursuing. Many other secondary markets and the opportunities they can provide have proven to be more lucrative.

“[They’re targeting] levered cash-on-cash returns of 7 percent, and, in some cases, they’ve tightened it to a 6.5 percent cap,” Foshay said. “These secondary, top-tier, non-gateway markets can offer caps at 5 percent, and marginally above. They not only believe they are getting a more attractive return, but they are buying into a story they are increasingly familiar with: shifting demographics and the movement of the population within the U.S.

“They know, in many instances, that is what the smart domestic money is doing and they are following suit in that investment rationale,” Foshay added.

For Middle Eastern and Asian capital sources, “cash yield is a real driver,” said Noam Franklin, a managing director and head of the Eastern U.S. region for Berkadia’s JV equity and structured capital group, whose team sources equity from a variety of capital providers out of Asia and the Middle East. “They are not [internal rate of revenue] driven. Out of the gate, they want to know what the cash yield is that they will return to their investors overseas. Other secondary markets in the Sun Belt have better cash yields than in gateway markets — cap rates in certain markets are sub 3 percent. At some point, it doesn’t make sense to look at major gateways.”

Over the next three to five years, most foreign investors plan to further increase their investment volumes into U.S. secondary and tertiary markets, according to an Association for Foreign Real Estate Investors (AFIRE) survey of hundreds of companies — more than 60 percent of which were non-U.S.-based investment institutions — that was released in May. About 80 percent of those surveyed said they would increase their investment in secondary cities, and more than 60 percent would increase allocations to tertiary cities. A majority of participants — more than 60 percent — also said they planned to increase investment in U.S. commercial real estate more generally this year.

Austin and Boston are said to be the top two markets being targeted by international investors this year, followed by Dallas, according to the AFIRE survey. Only 21 percent of respondents pointed to New York as a top target market; 19 percent said Los Angeles and 17 percent said San Francisco.

South Korean investment firm Hana Financial recently partnered with U.S. developer Tishman Speyer on a $500 million investment vehicle that will target opportunities in secondary markets across the country — in regions where Tishman already has a footprint, as well as new markets, a representative of Tishman told Commercial Observer — with a focus on innovation and ESG (environmental, social and governance).

Over the last decade, foreign capital providers have gradually been diversifying in the U.S., from a geographical standpoint. The pandemic exacerbated the trend, as it did with so many other commercial property industry developments, such as technological innovation or sustainability efforts.

New York City represented almost 32 percent of all cross-border allocations in 2011, which made it far and away the most active market in the country, according to data from Marcus & Millichap (MMI). A decade later, through the first half of 2021, the city makes up just 8.9 percent of all cross-border investment, behind San Francisco (10.4 percent), which ranks first. Cross-border allocations have gradually declined in New York, Washington, D.C., Los Angeles, Miami and Boston over the past decade, while allocations to markets like Dallas-Fort Worth, Seattle-Tacoma, Phoenix, Philadelphia, Austin and Charlotte have climbed.

Domestic migration patterns, strong job growth, healthy cash returns and the historically low interest rate environment — which has made hedging against the U.S. dollar more feasible — has primed U.S. secondary and tertiary markets for waves of foreign capital investment.

“The most important factor is the cost of hedging against the U.S. dollar. It’s hugely under-calculated in all of this,” Foshay said. “2018 and 2019 were weak years for overseas investment, because German open-ended funds and [South] Korean institutions were effectively priced out of the market, due to relatively higher U.S. interest rates, which resulted in higher costs of hedging against the U.S. dollar. If that changes, and there’s an increase in inflation and costs go up, we’ll likely see a retreat of some of this [overseas] capital.”

Canadian and South Korean investors have led the way this year, as global investment volumes in the U.S. have started to creep back up from last year’s lull, albeit nowhere near the historic levels of 2018 and 2019, before Chinese capital retreated from the space, according to a midyear 2021 report from Marcus & Millichap. Industrial and multifamily have been the leading asset classes targeted by foreign investors.

A recent Newmark report says the majority of investment interest has focused on either offices with long lease terms and credit tenancies, or the more hyper-competitive sectors that have won the COVID-19 era: logistics, life sciences, data centers and multifamily.

Industrial in secondary markets quickly became the center of attention for foreign capital — despite the lower yielding profile of the real estate — given the security it provides, with the backdrop of booming e-commerce sales and the proliferation of the prevalence of speedy, last-mile delivery.

In the 12 months ending in the first quarter of this year, 90 percent of international capital went for multifamily, office and industrial assets, at a relatively even split, according to a second-quarter report from Marcus & Millichap, which wrote that “this distribution marks a notable increase in trades for industrial facilities and a decrease in office transactions in response to the health crisis.”

The U.S. housing market screams safety, and when considering the returns secondary markets have generated, it’s one area foreign investors — large and small alike — have flocked to in the last year and a half. Different segments of multifamily outside of urban centers, as well as single-family rentals, have become prime targets for foreign investors, who historically haven’t dabbled in the area — other parts of the world have been slower than the U.S. in adopting and implementing vast networks of purpose-built multifamily and housing.

“The backdrop is that multifamily has performed well through the Global Financial Crisis and the pandemic, and international demand there has picked up through the pandemic, and, as they are seeing it buck the trend, it has reassured overseas groups,” Foshay said. “The strong rental growth characteristics and strong inflationary hedge it offers, given that its leases roll annually, are highly attractive investment characteristics for the environment we all think we’re headed into.”

It is likely, though, that going forward, many overseas investors won’t make big strides in the housing market via direct investments, instead partnering with established domestic real estate companies who can inject local expertise.

“We’re going to see a lot more partnerships, like joint ventures and co-investment, or fee-based asset management,” Foshay said. “By nature of the asset class, it requires on-the-ground, active management.”

Middle Eastern investors, in particular, saw the pandemic as an opening to significantly grow their exposure to U.S. commercial real estate, moving away from their historical focus on European markets like London, Paris, Geneva and Milan, given the outsized impact COVID-19 has had on Europe.

“For the Middle Eastern groups we work with, pre-COVID, they were looking at a lot of offices — core-plus in major gateway markets,” Franklin said. “Now, these family offices and institutions want to be in the multifamily space and in secondary markets; they see the shift in office cap rates in NYC, and cap rates and population growth in places like Atlanta and Austin. They don’t necessarily understand purpose-built rental because it doesn’t exist all over the world, but collections have been up and it’s been a good performer. They are not interested in multifamily in New York and Boston, but in Dallas and Austin and Atlanta.”

Many investors have also already recognized that ground-up, opportunistic and value-add development plays could net them premiums against existing stock in many secondary markets that are still prime for construction activity.

“We expect [investors] will start to migrate further out to potentially some value-add and opportunistic overseas LP [limited partner] capital coming into development opportunities,” Foshay said, adding that most of the demand in the last 18 months has centered around core and core-plus investment. “More groups in those hot sectors like multifamily and logistics [will likely start] committing to forward funding and forward purchases that can offer them a more attractive yield to overall cost.”

The pandemic really opened the door for global investors to become formidable U.S. secondary market players, and they will likely present and active for as long as these markets continue to perform.

“My long-term view is that these markets are here to stay,” Franklin said.

Mack Burke can be reached at