SPECIAL FOCUS: INTERNATIONAL CONNECTION

APARTMENT FINANCE TODAY • MARCH 2008

Multifamily Wins International Jackpot

Investors from overseas are pouring equity into partnerships with U.S. apartment developers.

By Bendix Anderson

Jason Ottman never got to clink a glass with his equity partners. Not when he attended the closing of the deal to build Alexan Westgate in Glendale, Ariz. Not when the project was finished.

Not even when the 251 apartments at Westgate sold in February for $185,000 per unit—as much as some single-family homes in Glendale— with the paint on the new building barely dry and lease-up not even begun.

Ottman, a managing director for Atlanta-based Trammell Crow Residential, never met with his equity investors because they are in Germany, working through Real Estate Capital Partners, an investment fund based in Washington, D.C.

Trammell Crow is just one of many developers in the United States relying on equity from overseas to help make development deals work, especially as chaos in the capital markets continues to make other kinds of gap financing less available.

“Right now, the institutional capital is on the sidelines,” said Mark Alfieri, senior vice president of real estate at Behringer Harvard, another U.S. firm that places foreign equity into apartment projects in the United States (see article on page 32). “It’s created an opportunity for investors like ourselves to jump in.”

The share of multifamily real estate investments in U.S. portfolios of international investors nearly doubled to reach 20 percent at the end of 2007, up from just 12 percent in both 2005 and 2006, according to a survey of the members of the Association of Foreign Investors in Real Estate (AFIRE).

That’s a big change for foreigners who up until last year had hesitated to invest in U.S. apartments and condominiums.

What’s behind the change? The weak dollar, strong real estate fundamentals, and new opportunities to participate in joint ventures with experienced U.S. developers have helped international investors get past their anxiety just in time to help developers with a much-needed shot in the arm of equity investment.

The weakening value of the dollar compared to other currencies—especially the euro—is probably the single strongest motivator for international investors to put their cash into U.S. properties.

On Jan. 14, it took $1.49 to buy one euro. That’s the dollar’s weakest standing against the euro since the European Union currency was introduced in January 1999 at an exchange rate valued at $1.18. In late 2000, at the dollar’s strongest point, it cost 84 cents to buy a euro; less than two years later, the euro had achieved parity with the dollar, and it’s been climbing ever since. That’s made investments denominated in U.S. dollars a bargain for investors with lots of euros sloshing around in their bank accounts.

Multifamily investments in the United States are also more attractive to international investors because real estate typically grows more attractive to investors when stock prices dip, as they have worldwide since mid-2007. AFIRE’s members, including institutional investors such as foreign pension funds, plan to increase their worldwide real estate investments by 20 percent, on average, in 2008.

U.S. real estate is almost certain to benefit from this trend. AFIRE’s members voted the United States “the most stable and secure country for real estate investment” with the “best opportunity for capital appreciation” in the world. They plan to increase the dollar amount of their U.S. real estate investments by an average of 16 percent in 2008, in addition to diversifying in real estate markets in China and Europe.

Still, multifamily has historically been a neglected asset class for these investors, making up just a tenth of their real estate portfolios.

That’s partly because to invest in apartments, international investors must overcome their unfamiliarity with the apartment business here, which operates differently than overseas. “It’s not really well understood,” said Jim Fetgatter, chief executive of AFIRE. “It’s a new product for them.”

For example, multifamily buildings in many European cities operate under different rules than American apartments, with much more government regulation. Also, apartments require a great deal of day-to-day management to keep the apartments full and tenants happy.

As a result, international investors have been more comfortable concentrating on office and retail properties, in which tenants typically sign decades-long leases. These properties need much less intensive management.

However, the lure of strong, consistent returns appears to be finally overcoming international investors’ resistance to sinking their cash into multifamily properties in the United States.

Since 1978, the average annual apartment return has been about 12 percent. That’s higher than the returns for privately held office, industrial, retail, and hotel properties, according to Gleb Nechayev, a senior economist for CBRE Torto Wheaton Research.

“Multifamily is perceived as one of the safest asset classes,” said Al Cissel, managing principal of the institutional multifamily group for Transwestern, a real estate investment firm headquartered in Houston.

To achieve these yields, international investors are following the lead of U.S. pension funds and investing equity in joint partnerships.

By partnering with experienced U.S. developers, foreigners can get comfortable with an unfamiliar property type and rely on their partner’s management skills to keep the project operating smoothly.

International investors are using these partnerships to invest in new multifamily construction. Once the projects are finished and leased, they are typically sold, allowing equity investors to reinvest their capital elsewhere and avoiding the headache of managing the property in the long term, another trend that has made investing in U.S. real estate much easier, according to AFIRE members.

About a third of the outside equity Trammell Crow uses in its new construction projects comes from overseas, according to Ottman.

In a typical deal, a construction loan from a commercial bank covers roughly 70 percent of the development cost. The remaining 30 percent is paid for with equity provided by Trammell Crow and outside investors.

Developers might wonder if partnering with international investors will add delays and complexity to their deals, with conference calls scheduled in the middle of the night to suit investors in other time zones and the need to hire a translator.

However, in Trammell Crow’s deals, the foreign equity adds no complexity, said Ottman. “We would never deal directly with an investor,” he said. Instead, Trammell Crow deals with the investor’s fund manager in the United States.

Working through an intermediary should not delay important decisions, because the fund manager is typically authorized by the investors to act on their behalf. “We can make decisions quickly,” said Karin Shewer, principal for Real Estate Capital Partners, which has provided international equity to several Trammell Crow projects.

Joint ventures with foreign investors can provide equity to condominium projects as well as to properties built as rental communities, said Ottman. For example, this January, Trammell Crow finished 171 condominiums at The Quarter, located in Glendale, Ariz., using equity provided by German investors through Real Estate Capital Partners.

Niche multifamily property types like seniors housing can also benefit from international joint ventures. “International equity sources have stepped up to the plate,” said Mel Gamzon, president of Fort Lauderdale, Fla.-based Senior Housing Investment Advisors. In the last two years, Gamzon has seen the amount of money flowing into seniors housing from overseas double.

Top Markets for International Investors

Here are the top markets for foreign investors in commercial real estate, according to a recent survey of the members of the Association of Foreign Investors in Real Estate (AFIRE). It’s not a coincidence that the list is dominated by tourist destinations.

“Foreign investors buy what they know,” said Dan Fasulo, managing director of Real Capital Analytics, a New York City-based research firm. “They like to send home postcards.”

1. New York City
2. Washington, D.C.
3. Los Angeles
4. San Francisco
5. Seattle
6. Boston
7. Chicago
8. Las Vegas
9. Phoenix
10. Orlando, Fla.