Despite lots of negative reports about the oil and gas industry, Middle Eastern investment in global real estate has held up well – with the US an increasing focus. Doug Morrison reports
Barely a day goes by without news of the fallout from the prolonged slump in oil prices, whether it is the latest round of job losses and corporate profit warnings, or dire talk of fiscal deficits among some of the oil-dependent states. Yet the recycling of surplus oil revenues from the Middle East into global real estate – a major component of the market for so long – has held up extraordinarily well.
The latest capital flows research by JLL reveals that Middle Eastern investors maintained their level of investment during the first half of 2016 compared with a year ago, whereas North American and European investors were net sellers. JLL’s research also shows that Middle Eastern investors were second only to their US counterparts as a source of capital during the first half.
And in an otherwise muted second quarter of global investment activity – 8 percent below the same period last year at $155 billion – it was the Qatar Investment Authority (QIA) that stood out from the crowd with the $2.5 billion acquisition of BlackRock’s Asia Square Tower 1 in Singapore – one of the biggest deals worldwide.
As JLL says, all of this activity came despite reports of Middle Eastern investors’ decline as major forces in cross-border property investment due to the drop in oil prices, which have plunged to below $50 a barrel at various points since their 2014 high of $112. By the middle of 2015 it became clear that this was no market blip. The main oil-producing states were struggling to come to terms with a new era of low oil prices, and the widespread fear was that with competing demands on their capital surpluses they would have to reduce their allocations to real estate investment in 2016 (see panel below).
“I’m not sensing that at all,” says Andrew Angeli, head of UK research at CBRE Global Investors. “In fact, I’d argue that real estate is the perfect asset class to off-set the volatility seen in commodity markets. They have an asset where they are able to deliver a reliable, long-term income stream.”
He adds: “In terms of allocations over the past year, frankly we haven’t seen a moderation in Middle Eastern capital being deployed to global property. What we have seen, though, is that London has dropped down the list in terms of favoured location to deploy capital.”
Angeli’s observations are borne out in figures provided to Real Estate Capital by Real Capital Analytics (RCA). These reveal that Middle Eastern investors have dramatically increased their exposure to US property since mid-2015, largely at the expense of London – their traditional first-choice destination – and Europe generally.
According to RCA, Middle Eastern players invested $14.38 billion in US real estate in the year to end June, which is the most capital they have ever deployed in the US over a 12-month period.
Tom Leahy, RCA’s director of market analysis for the EMEA region, suggests the shift in focus to the upbeat US real estate market is partly a reaction to the prevailing risks in Europe, notably around the uncertainty before and after the UK’s referendum vote on its membership of the European Union. “They also want big lot sizes and there are more opportunities to invest large amounts of money in the US than in Europe,” he says.
Another key factor, says Leahy, is the US government’s decision last December to relax the tax on foreign institutional investors under the 1980 Foreign Investment in Real Property Tax Act. This law had made investing in US real estate a non-starter for many overseas players but the reforms mean they are now treated the same as their US counterparts. Early estimates indicate the changes could generate an additional $20 billion to $30 billion of investment in US commercial real estate in 2016, albeit not all from the Middle East.
Both JLL and RCA predict that the US will continue to attract global capital although the headline numbers mask a hugely complex pattern of investment by Middle Eastern sovereign groups. As Angeli says, the shift in focus to the US is largely restricted to the gateway cities of New York, Los Angeles and Washington DC. And though the net allocation to Europe may be lower than in previous years, he says, “it is still a big number”, despite the post-Brexit uncertainties surrounding the London market.
Angeli adds: “A lot of these sources of capital are still new to investing in global real estate. ADIA (Abu Dhabi Investment Authority) and the Qataris have been doing it for a while but there are other institutional sources in that diverse region, and so moving from a 0 percent capital allocation to property to 5 percent, 10 percent or 15 percent over a short time is actually substantial. And in that environment, global cities benefit, and London benefits even in this period of economic and political uncertainty.”
The Asia-Pacific region is also losing out to the US this year when it comes to Middle Eastern capital, according to JLL although the firm believes the Asia Square deal marks “an important strategic shift” by the QIA and is likely to be the first of many acquisitions by the group in this region over the next few years.
Like Angeli, Fadi Moussalli, head of JLL’s International Capital Group, Middle East and North Africa, believes the real estate industry needs to draw a distinction between the bigger and experienced sovereign wealth funds and some of the newer institutional players in the region. He points out that the leading funds, such as the QIA and ADIA, have “some investment momentum and can recycle dividends”, and are therefore less influenced by the sustained low oil price.
Dubai-based Moussalli says: “I think there will be winners and losers, and the smaller sovereign groups will be more impacted than the bigger funds. For the smaller sovereign wealth funds, during 2015 cash allocations dried up, full stop. They were asked by their managers to put the pipeline on hold just because the money was no longer there. That is still the case although the overall sentiment has relaxed a little because oil is no longer at $30 but at $50. So the more we get back to the $70, $80 price the more this overall mindset will change and we get back to the 2012-13 [real estate investment] levels.”
Even so, most research dwells on the trends among the sovereign groups without fully reflecting the growing importance of private Middle Eastern investors, for whom the combination of the oil price and the geo-political turbulence in the region is like “a perfect storm” for investment in safer havens, according to Moussalli.
“The number of private investors we’ve been talking to has increased like never before, and all of them have the intention to buy overseas as a hedge to the Middle East situation. Does that mean all of them invest? Not necessarily but certainly the intention is there, and the volumes have increased.”
Flight to safety
One beneficiary of this capital flight to safety is 90 North Real Estate Partners, the London-based investment adviser chaired by entrepreneur James Caan, which has built close relationships and co-invested with a small group of equity partners from the Middle East. Since co-founders Nick Judd and Philip Churchill launched 90 North in 2011, the firm has closed 25 deals, together worth over $1.4 billion, in the US and Europe. “There’s a hunt for yield, but more than that, a hunt for safe yield,” says Judd.
90 North completed its latest acquisition in July, paying Standard Life €70 million for the newly built global headquarters of construction group Heerema Marine Contractors (HMC) in Leiden, the Netherlands. According to Judd, this is typical of the real estate in demand from private Middle Eastern capital, involving $28 million of equity and the remainder in debt from ING Bank, and importantly a blue-chip tenant on a 20-year lease.
“What we like are relatively safe and boring investments in new or nearly new buildings,” says Judd. “This is about wealth preservation but the income is a very important component. We believe this strategy will stand the test of time, particularly at a time of increased economic and political uncertainty.”
Judd suggests that 90 North’s latest deal also reflects the fact that, post-Brexit, Middle Eastern investors are looking more closely at mainland Europe rather than just targeting London. Angeli agrees: “Germany is attractive for Middle Eastern capital, as it is for global capital of all persuasions.”
Twist in the tale
Then again, the post-Brexit devaluation of sterling against the US dollar offers another twist to the London investment story for funds from Middle Eastern states, given that oil is a US dollar-denominated commodity.
Whichever market finds favour with Middle Eastern investors in the coming months, Judd believes that 90 North and the property industry generally will continue to benefit from their need to diversify, but he is not complacent. “Definitely not. What happens if Saudi Arabia or Kuwait starts issuing bonds at 3, 4, 5 or 6 percent? If the yield on its sovereign debt goes up then real estate might not look so attractive, bearing in mind the risk premium and its illiquidity.”
JLL’s Moussalli, meanwhile, claims that the inherent attraction of property to Middle Eastern investors is “truer than ever”. By way of conclusion, he translates an Arab proverb: “Real estate can get sick but real estate can never die.”
When the alarm bells began ringing
For many observers of the prolonged slump in oil prices, the alarm bells started ringing last September when the Saudi Arabian government announced it was delaying some of its own infrastructure projects.
For more than a year up to that point the political leaders of the Middle East’s biggest oil producer had ignored the evident nervousness in financial markets and said little publicly about how they would deal with low oil prices.
But Saudi Arabia’s postponement of infrastructure spending was the clearest official signal yet that cheap oil and a resulting slump in revenues were starting to hit home. It also acknowledged that oil prices were likely to remain low for far longer than Saudi Arabia and its OPEC partners had initially anticipated.
Prices have remained low since mid-2014 partly because OPEC has maintained high levels of production in a bid to retain market share when demand is down, particularly from a slowing China economy.
This has left much of the world’s oil production loss-making. Figures compiled by Deutsche Bank in 2015 show the minimum price per barrel that governments of the leading oil producers require to break even with their public expenditure commitments. They are nearly all above $50 and some are above $100. Earlier this year oil prices crashed below $30 although they have since rallied to over $50.
Countries such as Bahrain are already in fiscal deficit, and the outlook remains bearish – Moody’s Investors Service has forecast that its deficit will widen to 16 percent of gross domestic product in 2016 from 13 percent last year.
As Fadi Moussalli, a Dubai-based director of JLL, says, the long-standing motivation by the region’s major sovereign wealth funds to invest overseas – in all asset classes, not just property – revolves around trying to “de-correlate” their economies from the oil sector. “But to diversify you need to have those oil surpluses,” he concedes.
Nick Judd, co-founder of 90 North Real Estate Partners, points out that Saudi Arabia is trying to transform itself into a “knowledge economy” by 2020 but what happens in the meantime? “This in no way denigrates what’s going on the Gulf right now but the investors we see believe that the Gulf has a real structural problem that is manifesting itself virtually every day, and that is its over-reliance on oil.”