As the global economy emerges from the credit crisis, real estate offers some compelling opportunities for investors in the U.S. and Canada.Investors can access this asset class globally in a number of ways: through direct investments, unlisted private funds, via publicly listed companies or Real Estate Investment Trusts (REITs) and Exchange Traded Funds (ETFs). Real estate investments are categorized as either core, core- plus, value-add or opportunistic depending upon the level of risk vs. return that they offer. At the low end of the risk vs. return spectrum, core real estate can offer expected returns of approximately 6% with a higher component of current yield and more stable cash flows. At the high end of the risk vs. return spectrum, opportunistic real estate can offer expected returns of 15% plus, albeit with a lower current yield and less predictable cash flows.
As the U.S. economy continues its unsteady recovery, the U.S. real estate market presents investors with a unique opportunity to acquire distressed assets. There are $181 billion in known distressed assets, with nearly 24% in office and 21% in multi-family.1 The large number of distressed assets that were acquired by banks and companies at the peak of the cycle now require recapitalization. In an effort to improve their balance sheets, banks may accelerate their real estate divestitures. The challenging IPO market may force capital-starved companies to seek alternative sources of capital. As a result, investors with access to equity and/or debt can acquire these distressed assets at attractive valuations.
There are several factors for non-U.S. investors to consider when investing in U.S. real estate through private vehicles, especially the Foreign Investment in Real Property Tax Act (“FIRPTA”) which was enacted by the U.S. Congress in 1980 and encompasses all forms of U.S. real estate. In general, non-US investors do not incur U.S. tax liability from income and gains realized from investing in various types of U.S. assets (e.g. equities and bonds) however, they are subject to FIRPTA on gains realized on the sale of a U.S. corporation or REIT that owns U.S. real estate or on a capital gain distribution from a REIT. Investors can mitigate or eliminate FIRPTA through standard or leveraged blockers or through non-U.S. blockers.2
Outside of the US, Europe and Canada are experiencing very different economic environments that offer investors distinct opportunities. Europe is seeing a slow and tiered recovery. The ongoing sovereign debt crisis will constrain bank lending and therefore net new supply of commercial real estate. Many government-owned banks are seeking to reduce their total commercial real estate exposure by 2013. As indicated by several key private equity players, some investors have scaled back their investment or withdrawn from the European market entirely. Meanwhile, Canada’s stable economic and political climate makes the property market highly attractive to both domestic and international investors. With many investors seeking an asset class that offers diversification, lower volatility, current yield and a degree of inflation protection, the Canadian real estate market is well positioned for investment.
Ultimately, the economic downturn and subsequent uneven recovery has introduced opportunities for both distressed sellers and sophisticated investors in the public and private global real estate markets alike.
Eric Bonner is Senior vice-president, Brookfield Asset Management LLC
1 Real Capital Analytics.
2 A blocker corporation is a type of C Corporation in the United States that has been used by tax-exempt or foreign investors to protect their investments from taxation when they participate in private equity or hedge funds.