The United States commercial real estate market has long been a top destination for foreign investors to place their capital and, for the most part, that hasn’t changed in the post-pandemic era. What has changed is, like in the U.S., investors from abroad have shifted their main focus to sectors that are higher in demand, including multifamily, leaving the troubled office sector with limited transaction activity. But cross-border office investment in the U.S. isn’t dead. Globally, the interest in snapping up office properties remains strong but, again, like their U.S. counterparts, foreign investors are contending with high interest rates and the seemingly immovable gap between the price sellers want and the amount buyers are willing to pay.
With cross-border and domestic activity combined, transactions in the U.S. real estate market remain muted to say the very least. Investors from some countries, including China, have all but crossed the U.S. off their list. “Chinese commercial real estate investors are turning away from the United States for several reasons,” Juwai IQI, an Asia-based global real estate technology group, said in a recent report. “The American commercial market is struggling with higher interest rates and fears that property values may take a more significant hit in the months ahead.” Additionally, China is having its own real estate problems, as its market is in a slump. Recent news like top Chinese property developer Country Garden’s abrupt withdrawal of a $300 million share placement only served to increase concerns regarding the possibility of the country’s real estate market moving toward recovery in the foreseeable future. Banks are providing real estate companies with cheap loans and extending loan maturity dates in an effort to bolster the domestic market, which will likely encourage borrowers to spend more of their funds at home.
Concerning office properties in particular, the numbers tell a rather grim story. According to research from CommercialEdge, U.S. office sales in the first half of 2023 totaled $14.8 billion, compared to $43.7 billion in the first half of 2022. Low office transaction volume in the U.S., however, is not indicative of foreign investors’ lack of acquiring office properties. The beleaguered office sector, plagued with high vacancies, may have fallen out of favor among the worldwide investment community, but it is still a target for foreign investors.
At the beginning of the year, roughly 90 percent of non-U.S. respondents to a survey conducted by AFIRE, the association for international real estate investors focused on commercial property in the U.S., indicated that the attractiveness of the office sector as an investment would only decrease somewhat in 2023. Essentially, it’s difficult to ascertain trends given the lackluster transaction activity, but Canada and Europe are offering a glimpse into what will be a major selling point once sales pick up. Canada, which has been the biggest cross-border investor in U.S. real estate for years, and Europe now consider sustainability as a major factor in a property’s desirability. “For the European and Canadian investor, their sensitivity to sustainability issues is so much higher than other foreign investors,” Gunnar Branson, CEO of AFIRE, said. “Eighty-six percent of investors we surveyed attested to their belief that the commercial real estate industry is not pricing climate risks into proformas and valuations.” Many investors find that buildings in the U.S. are not appropriately priced for climate-related risk. Canadian and European investors are not only highly sensitive to their respective regulatory environmental requirements for real estate investing, but they are also looking deeper at green issues, not just considering topics like embodied carbon, but also evaluating the green levels of such building components as concrete.
The focus on building sustainability is hardly new for Canadian and European investors, but the topic intensified considerably for Europeans in 2022 when the Eurozone regulatory environment substantially increased requirements for real estate. “It’s not just this incredible year of weather disasters and heat waves and everything else. This is something that has been building over time and now the bar has been raised,” Branson added. “But you can’t paint everyone in the U.S. with the same brush. You have many, many institutional investors in the U.S. that get this big time and they see it as a part of their acquisition strategy.”
For Canadian and European investors that have become increasingly beholden to certain sustainability standards in their respective countries, property sustainability takes on an especially high level of importance as these international buyers are usually long-term investors. A building’s sustainability profile must endure so that after, say, a 10-year hold, the residual value of the property is strong. These cross-border investors don’t want to buy a dirty building. “Some of the Europeans, especially, just aren’t investing in buildings that don’t meet their standards,” said Branson. “They are saying that they are only going to invest in highly sustainable buildings or invest in buildings that they believe they can improve. They have a requirement to improve their real estate portfolios.”
Despite certain cross-border investors’ growing commitment to property sustainability, it is impossible to ascertain if that talk of avoiding “dirty buildings” has evolved into a bona fide practice, as the low level of office transactions doesn’t allow for the identification of such a trend. Office transactions will pick up pace eventually, as buyers and sellers become more in sync with valuations. And when that time comes, it could very well be that a “brown discount,” or a cut-rate on a property with low sustainability ratings, could lure Canadian and European investors with the cash to upgrade a property to their standards. Many in the investment community are awaiting that fire-sale of properties that occurred in the 1990s following the savings and loan crisis, but that simply isn’t happening, and it probably won’t. However, the U.S. may be able to reel in those reluctant foreign investors by offering a markdown on properties that can be brought up to snuff in terms of sustainability.