Disappointing housing data has been one of the weak links in the US recovery, but commercial real estate (CRE) is becoming a more attractive asset class for sovereign wealth, pension funds, and wealthy families abroad who want are looking for income products that will survive the coming rise in interest rates.

CRE Multi-housing

“Instead of taking a hit with rising interest rates, they are looking at real estate as a bond surrogate, particularly where they can get cash flow or an interest payment like a bond,” says Tim Ng, managing director and head of research at Clearbrook Global Advisors in an interview with Aleksandrs Rozens for Bloomberg Briefs. “They see it as an inflation hedge.”

 

Strong demographics pushing CRE, multi-family buildings: Ng

There are two big trends that Ng see driving the interest in commercial real estate. First, he estimates that office space growth is going to be around 1% for the next couple of years, which should support CRE rents as long as the economy continues to recover. Second, the combination of a weak labor market, rising housing costs, and student debt means that only 27% of first-time home buyers are buying single-family, suburban homes, down from 40% in 2000. Multi-family buildings are taking up a lot of the slack, attracting interest from overseas investors.

“Investors are buying because the market technicals are positive in terms of occupancy, consistency of cash flow and eventual price appreciation,” says Ng.

Overseas capital moving beyond New York

Foreign investment in New York real estate is nothing new, but Ng sees growing interest in other major cities like Chicago and growth cities like Austin, Texas. But just because a city is growing doesn’t mean that foreign capital will finance construction. According to Ng, reliable cash flow that acts like a coupon is what really drives these investments, and foreign capital is looking for established buildings with predictable financials. The idea is that as interest rates rise the dollar will get stronger against their currencies, protecting their investment from inflation.

One place that foreign funds are finding good deals is with banks that have decided to sell CRE as part of their overall program of de-risking and improving capital ratios. Investors are looking for property that has been bank-owned for years or decades, and in many cases hire the bank to continue operating them after the deal is finished.