How To Profit From Foreign Investment In Real Estate
Though investors don’t always capitalize on it, history has a way of repeating itself. In fact, when I saw this last trend, I had to dust off my DVD copy of Back to the Future just to reminisce.
If you’ve been around long enough, you no doubt remember the prevailing fear that Japan was going to own the United States through its massive buying of real estate in the 1980s.
#-ad_banner-#Back then, strong economic growth in Japan drove a buying spree for U.S. commercial property and businesses. A weakening dollar after the historic 1985 Plaza Accord made dollar-denominated assets cheaper and foreign investors jumped in to take advantage of the opportunity.
Nearly 30 years later and we seem to be right back to where we started. It looks like stronger U.S. economic growth and a surging dollar is driving foreign investment this time but the ultimate effect is still the same; real estate prices in the United States are heading higher. Take a lesson from history and position your portfolio to take advantage of a foreign buying spree in real estate.
The Greenback Makes A Comeback
While the greenback has pared its recent gains over the last couple weeks, the dollar index is still up more than 8% from the year’s low in May. The break from its long-term trend to weakness has made returns on U.S. investments more profitable for foreigners and it looks like dollar strength could continue.
The U.S. economy, projected to grow by 3% next year, is set to outpace other developed economies like Japan (0.6%) and the euro area (1.5%). Whether an increase in domestic interest rates come sooner or later, the Federal Reserve is set to start normalizing rates next year. Combine this with America’s still developing energy boom and you get a stronger dollar for some time to come.
Not only is dollar strength boosting foreign investors’ returns, but economic growth is contributing to the rebound in real estate prices. Sales of commercial properties jumped 33% by volume in the first quarter of the year and pricing gains were reported across all property types. Prices for some property types have even rebounded past previous peaks in primary markets like San Francisco and New York.
Foreign investments in U.S. real estate hit a record in 2013 with the Chinese alone buying $14 billion in property, double their 2012 purchases. Jones Lang LaSalle, a real estate investment firm, forecasts total foreign property investments to top $50 billion this year, nearly 30% higher than the $38.7 billion in 2013.
Asian buying of $522 million in U.S. multifamily property in the first eight months of 2014 is already nearing the amount spent in 2013 and will set a record for the full year. Purchases by Asian investors increased by 8% over the same period last year, with the top two markets — San Francisco and Los Angeles — accounting for 55% of total buying since January 2013.
Taking Advantage Of West Coast Growth and Demand
On the strengthening trend to foreign purchases of U.S. commercial property, one REIT stands out as particularly attractive. Essex Property Trust (NYSE: ESS) completed its $16.2 billion merger with BRE Properties in April to expand its portfolio across 233 multi-family properties. The company likely has an advantage on strong Asian buying with its portfolio of West Coast apartment properties, most of which are in strong markets in California.
Management expects the merger to take approximately 12-to-18 months to integrate the two companies and fully realize benefits with cost savings and higher funds from operations.
Job growth on the West Coast has outpaced the national average with cities in the Essex portfolio reporting 2.4% job growth in the three months to August, above the national average of 1.9% over the period. Personal income growth in the company’s portfolio cities has also outperformed with 5.1% growth, a full percent higher than the national average. A graph from the company’s recent investor presentation shows demand growth for new housing is expected to outpace supply, supporting multi-family prices.
Essex Property beat expectations with second quarter funds from operations of $2.08, above consensus for $2.03, and revised its full year guidance to a midpoint of $8.39 per share. Shares trade at 23 times full year funds from operations, a premium on the average of 20.5 times for apartment REITs, but reasonable given the strong portfolio of properties. Funds from operations could grow to $9.60 next year, leading to my target of $220 per share.
Economic growth should continue to support fundamentals for the multifamily market with foreign buying helping to boost asset prices. Essex is particularly well positioned to take advantage of both these trends, capitalizing on stronger growth and foreign interest in California. A buy-under price of $200 still leaves a 10% upside to my target on top of the 2.8% dividend yield.
Risks to Consider: Rising rates in the United States could temper investor enthusiasm for real estate. Though apartments are relatively safe from higher rates and foreign buying should support the group, be ready for higher short-term volatility.
Action to Take–> Record foreign investment, especially from Asian buyers, in U.S. real estate looks to be a strong trend going into next year. Apartment REIT Essex Property Trust is a best-of-breed with its West Coast portfolio and could significantly benefit from its recent merger with BRE Properties.
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