Exclusive Real Estate Analysis by CBRE in bizbahrain Magazine December 2015 issue
In light of weak oil pricing, and with Middle Eastern markets and economies so heavily reliant on natural resources, the need to diversify existing portfolios internationally became not only more immediate, but also more pronounced. This has resulted in more diverse flows of capital from the Middle East and into the global real estate market.
Focusing on the SWFs as the region’s main outbound institutional investors, it is unlikely that governments will make radical decisions to change existing capital allocations. CBRE Research believes that only new allocations of capital might be affected. Thus, while SWFs will remain important market-makers in global commercial real estate, their acquisition strategies will not be as influential as would have been the case if oil prices had not fallen. In monetary terms, this will probably mean $7-9 billion per annum of SWF investment going into direct global real estate in the near-to-mid-term.
Non-institutional capital, on the other hand, is set to notably expand its international activity, with private HNWIs particularly active due to their ability to take decisions relatively quickly. This will translate into a considerable increase in the total outbound non-institutional investments from the Middle East to around $6-7 billion per annum.
A more balanced investor mix also means an even greater diversification in their geographical focus and strategies. This change brings lot size implications too. Geographically, the most notable impact will be for the Americas region, where CBRE Research expects to see a significantly stronger presence of Middle Eastern capital than has been the case in the last five-to-six years.
As for the question of weaker oil pricing and its potential impact on the outbound Middle Eastern capital flows – to a larger degree it is a matter of magnitude and timescale. With local markets and economies so heavily reliant on natural resources, the need to diversify existing portfolios internationally became more pronounced. But just how much will the outbound Middle Eastern investors’ strategies change as a result? And, most importantly, can we measure the impact?
GLOBALISATION AND WEAKER OIL PRICING: IMPACT ON THE MIDDLE EAST AS A SOURCE OF CAPITAL
The Middle East continues to be one of the most important sources of cross-regional capital into the global real estate market. With $14 billion invested outside of the home region in 2014 – the Middle East was the third largest source of capital globally. North America retained the first position, with almost a half of all cross-regional flows ($66.5 billion), Asian investors came second with $28 billion. With $13 billion, the European investors were in fourth position. Relatively speaking, outflows from the Middle East are already very high. The GDP of the region is only a seventh the size of that of North America. When looking at the main sources of cross-regional capital, it is also worth remembering that the strength of North American region on the global scale is somewhat inflated by the large number of US-based fund managers actively raising capital from outside their region.
While all of the above holds true, weaker oil pricing became a pressing topic of discussion towards the end of 2014. Overall, 2014 saw a slight dip in outbound capital from the Middle East – from $16.3 billion in 2013 to $14.1 billion in 2014. While it is easy to think that this might be reflective of more cautious behaviour from natural resource based sovereign wealth funds (SWFs), it is not as simple.
As for the question of weaker oil pricing and its potential impact on the outbound Middle Eastern capital flows – to a large degree it is a matter of magnitude and timescale.
While the latest 2014-Q1 2015 results remain strong, it is difficult to believe that there will be no impact from weaker oil prices in the medium term. In order to make a fair assessment on the subject, a number of key aspects need to be addressed:
The extent to which oil prices are expected to recover
This report will not be making attempts to carry out a detailed analysis of oil pricing. A much simpler approach will be taken instead – one that relies on independent forecasts. Almost regardless of the source – be it Oxford Economics or NYMEX future prices – as we stand the marketplace is expecting oil prices to recover and stabilise somewhere above $60 per barrel, with current pricing movements within a band of $62-67 per barrel. While not a remarkable recovery, this is still significantly above the levels reported back in March this year, so the trend is slightly upwards, albeit the likelihood of further price recovery in the short-term is slim.
Strategic allocations and decision-making processes within the SWF sector
The way in which capital allocations are made and how strategies and investment remits are set vary greatly from one SWF to another. However, in terms of timing, the decisions for the calendar year ahead tend to happen in the second half of the year. This might well be one of the reasons why we have continued to see a stream of large acquisitions by SWFs into H2 2014 and H1 2015. However, taking into consideration that there has already been some recovery in oil prices, albeit small, and as current economic conditions in the region are robust enough, it is unlikely that governments will make radical decisions to change existing capital allocations.
Therefore, CBRE Research’s view is that existing holdings will not change – and it is only new allocations of capital that might be affected. The worst case scenario will lead to less spending by SWFs than may have been the case otherwise. However, due to the high competition in the global market, most still have substantial unspent allocations. This will mean that near-term SWF investments will continue unabated, and it is only in 2016, and possibly not until 2017, that we will see material changes.
The growing importance of non-institutional investors
In light of the above, the potential for non-institutional investors (be it property companies, high net worth individuals (HNWI), equity funds or any other form of private capital) to expand their international real estate investments is of growing importance. Up until 2012, the majority of international capital flows from the Middle East were of a private nature – driven by HNWI and property companies/developers. In recent years their presence in the global real estate had not actually changed that much, fluctuating in a fairly narrow band, with an average annual turnover of around $5 billion during the 2010-2013 period.
CBRE Research believes that weaker oil prices were a strong contributing factor to this, triggering and speeding up international deployment of private and other non-institutional capital. With local markets and economies so heavily reliant on natural resources, and oil in particular, the need to diversify existing portfolios internationally became more immediate.
WIDER INVESTOR BASE= GREATER DIVERSIFICATION OFOUTBOUND MIDDLE EASTERN CAPITAL
2014 saw a major shift in Middle Eastern international investment strategies towards greater geographic and sector diversification, with activity spreading across more second-tier locations in both Europe and the Americas.
Who is investing
As private non-institutional investors emerged as a major new source of outbound capital from the Middle East – the 2014 data and research show both, a greater allocation of investment to real estate, and further geographical diversification away from the home region. This has had a particularly significant impact on Europe – where their combined real estate investments grew by 56% year-on-year to €4.4 billion ($5.8 billion). This led to a shift in the balance between institutional investors and non-institutional, with the non-institutional capital accounting for close to 60% of the total Middle Eastern investment in Europe in 2014. Qatar, predominantly driven by its SWF’s activity, was by far the largest source of Middle Eastern capital in 2014, with $4.9 billion invested. However, off the back of the earlier mentioned rise in international deployment of private and other non-institutional capital from the region – Saudi Arabia has emerged as a significant new source of capital.
Most importantly, this greater diversity of Middle Eastern investor active is a sign that the local investor base is developing and becoming more complex in nature – a healthy attribute not only in the context of the global real estate market, but also in terms of importance to the wider development of the commercial real estate market in the Middle East.
Wider Geographic Spread
The destinations of Middle Eastern capital in 2014 were increasingly diverse. London, while retaining the top spot, was no longer as dominant, with a 32% share of all Middle East outbound investments in 2014, compared with 45% in 2013. Activity was spread across more second-tier locations in Europe and the Americas, albeit some of the top 15 markets made the list off the back of only one or two large deals. In fact, there are the first signs that a greater proportion of Middle Eastern capital is targeting the US. In Q1 2015, for example, the $5 billion invested globally was almost equally split between Europe and Americas, with Miami, New York and Washington featuring strongly. While keeping in mind the ‘bulkiness’ of many Middle Eastern investments, it is quite likely that, in line with a widening investor base, geographic preferences are also shifting.
Going forward, however, the Americas region in particular is likely to see more capital flows than what would have been the case due to the more balanced mix of institutional and non-institutional capital.
Expanding Sector Preferences
The theme of diversification has not bypassed sector allocations. While sticking to offices as their investment of choice, Middle Eastern investors are also becoming more active across a wider mix of sectors.
The more diverse sector preferences are clearly evident in the US. Here investors have historically bought office buildings and trophy hotels in New York, Los Angeles and other gateway markets, but fierce competition for these assets from Chinese investors and other global capital sources means that they are increasingly seeking alternatives. Industrial has certainly got their attention; in April of this year CBRE represented USAA Real Estate in the $725 million sale of a 14.2 million-sq ft portfolio to the Abu Dhabi Investment Authority. In this sector they will also find competition from Scandinavian, other European, Asian and South American investors. Acquisitions in second-tier markets have to date been limited to the multifamily sector, but interest continues to grow.
Hotels took a strong second position in 2014, with a 16% share of outbound investment from the Middle East, and this positive sentiment towards the sector has continued into 2015. This follows a trend of wider investor interest towards alternative real estate sectors, which was confirmed by CBRE’s 2015 Global Investor Intentions Survey.
It is well-known that most Middle Eastern investors like the ‘visibility’ and ‘trophy’ aspects of direct real estate investment, and hotels suit their culture of aspiring to own prominent buildings. They are very familiar with the hotel sector in their home market – so extending this expertise
and transferring the skillset internationally is a logical step. This is similar to Chinese investors who often take a development route when investing in real estate abroad, in search of higher returns and with the added comfort of a strong development expertise gained at home. Furthermore, if bought with a current hotel operator in place, hotels require little or no active asset management from the investor side. This suits Middle Eastern buyers who are unlikely to have representatives/large teams on the ground in overseas markets. This is also one of the reasons why the latest results showed a more diverse geographic span – with a greater spread of locations when it comes to hotel investments in both Europe and in the US, as well as a growing number of multi-family acquisitions in the US’s second-tier markets.
MEASURING THE IMPACT
There is no doubt that Middle East will remain one of the most important sources of cross-regional capital in the global real estate market. The weakening of oil prices, while being a negative event, has brought some positives with it too. First and foremost, it has triggered a widening in the Middle Eastern investor base and a more pronounced need for international diversification.
The latest market developments highlight the potential for private, non-institutional capital from the Middle East to become a significantly more important investor group internationally. As this growth unfolds – the non-institutional investors will bring more diversity to overall Middle Eastern investor strategies.
The most immediate change will bring down the average lot size, as non-institutional investors tend to target assets in the circa $50 million category. This extends naturally to a more diverse geographic focus and investment strategies – a trend already felt in the market so far in 2015, but expected to become more pronounced in the next 6-18 months. In particular, CBRE Research expects the Americas region to see more capital flows from the Middle East, with Europe no longer as dominant as has been the case in the last five years.
Sector preferences will also grow more diverse, with offices remaining the largest sector, but growing investment in hotels, as well as all other sectors. Hotel acquisitions are already in second position, but are likely to feature even more in the next 12-18 months. This is due to strong sentiment towards the sector, as well as non-institutional capital making new investments, in some cases their first overseas, using the hotel expertise they have gained in their home markets.
Looking ahead, we expect SWFs from the Middle East to remain important market-makers in global commercial real estate, albeit not as strong in their acquisition strategies as would have been the case if oil prices had not fallen. It is very unlikely that the governments will make radical decisions to affect the existing capital allocations. As it stands, only new allocations of capital are likely to be affected. Translating this into monetary terms – this will probably mean $7-9 billion per annum of SWF investment going into direct global real estate in the near-to-mid-term, compared to what would have otherwise been in the range of $9-11 billion per annum.
Non-institutional capital is expected to be only slightly behind this at around $6-7 billion per annum of international investments. This is higher than the CBRE Research predicted last year ($4-5 billion per annum) and reflects growth in activity by these investors as they actively seek international diversification.
Our main conclusion is that a significant proportion of wealth accumulated in the Middle East will continue to be natural resource driven. Thus, regardless of investor type, diversification, and international diversification in particular, will be the key to Middle Eastern investors’ strategies. This leads us to believe that an average of around $15 billion per annum will flow out from the region and into direct international real estate in the near term, with additional capital flowing into indirect real estate investments and developments.