Who’s Who Legalbrings together Jay Epstien of DLA Piper, Susan Talley of Stone Pigman Walther Wittmann and Javier Canosa of Canosa Abogados to discuss levels and types of activity, domestic and foreign investment trends and the potential impact of changes in interest rates on the real estate market.
Jay Epstien: While multi-family properties have continued to be actively developed and traded throughout the past several years due to the consistent availability of capital, office and retail properties have been the most active in the past year. In the office sector, although there are fewer deals, the dollar volume in the Washington, DC market is consistent with the prior year for the same time frame because several large deals have skewed the statistics. Retail assets, particularly grocery-anchored shopping centers, remain among the most active and aggressively priced property types in this cycle. In addition, well-located and well-tenanted malls are seeing record pricing as recently evidenced by the sale of a 50 per cent interest in a Jacksonville, Florida mall at a 4 cap rate.
Susan Talley: The Gulf Coast region of the United States is experiencing somewhat different trends than what Jay is seeing in his market. There is a boom in industrial development along the Gulf Coast, especially in Texas and Louisiana. A spike in natural gas production, caused by advances in drilling and well completion, is leading to construction of petrochemical plants, which use gas as fuel and raw material. At least a dozen projects, each worth billions of US dollars, are in the works. According to the Urban Land Institute’s Emerging Trends in Real Estate 2014, survey respondents believe that industrial projects are where the best opportunities for development exist. We are also seeing an increased focus on land use regulation in response to the rise of “fracking” (hydraulic fracturing) as a method of natural gas production. This increased regulatory effort is already triggering litigation over the respective priorities of federal, state and local legislative authority. In a completely different direction, new hotel developments, as well as purchases and sales of existing hospitality properties, are on the rise in the Houston and New Orleans markets.
Javier Canosa: Argentina as a whole has seen a sharp decline in real estate transactions; however, the most active areas in Argentina have been farms and large office space. This is because some families and companies have used the tax amnesty (available for certain financial instruments in the purchase of real estate property) to reorganise their assets and clear up any existing complications from past purchases.
Jay Epstien: US banks are flush with significant capital to support financing activity as a result of the US Fed’s activities. As a result, bank financing, particularly in the CMBS space, has been very active during the past 18 months. Life insurance companies have been active players in the market as well. For DC Metro markets, bank financing has probably been the most dominant given the available quality of product. Rates remain at historic lows in the US and, as a result, debt capital has never been more attractive. But lower sales volume continues to impact overall activity in the financing sector.
Susan Talley: My experience in the Gulf Coast market is similar to Jay’s description. US banks and life insurance companies are chasing good deals.
Javier Canosa: In Argentina we are always against the current. We have seen the real estate market retract for 29 months consecutively.
The contraction of the real estate market has a variety of causes: first, the exchange controls that limit (or ban) the purchase of foreign currency, hence preventing transactions in US dollars; second is inflation, which according to private consultants was 35 per cent and is expected this year to reach 40 per cent annually; and the final cause is the lack of resolution regarding Argentina’s default situation, which has gone on for 13 years.
Jay Epstien: There has always been a strong element of foreign activity in the major US coastal markets, particularly NY and Washington, DC. In the past 24 months, there has been an influx of new foreign capital from Norway and Korea, making their first major acquisitions in NY, DC and Chicago. In DC, for the first half of 2014, foreign investment was reflected in 50 per cent of the transactions. Suburban markets tend to be dominated by domestic investors split equally between REITS, operators, private equity funds and pension fund advisers. One of the key differences between the foreign and domestic buyers is the lower cost of capital and longer horizon of the foreign investors. With planned holds of 10 to 15 years or more, combined with the desire to invest $200 million–$250 million of equity (and sometimes more), the foreign players win more of the big deals.
Susan Talley: The rise in industrial development along the Gulf Coast has brought in major foreign investment. Petrochemical projects are being developed by South African, Austrian, Chinese, Taiwanese, German and South Korean companies, by way of example. The investments they are making are significant in terms of dollars. The development of these projects also bring with them the need for ancillary support facilities, including housing.
Javier Canosa: Argentina received plenty of foreign direct investment (FDI) for real estate deals between 2004 and 2009, when the market crashed.
The market crash began improving in 2010 when there was some FDI for real estate deals. Since implementation of the exchange controls in October 2011, FDI has once again crashed and has not improved since; on the contrary, we have seen foreign investors in real estate leaving Argentina.
There are many reasons for this. First, exchange controls have caused two exchange rates to exist. One is official, and only available for the sale of foreign currency. This means if you bring US dollars into Argentina, you have to sell them at the official rate (currently 8.15 pesos to the dollar). However, when purchasing dollars the official rate is unavailable. You have to resort to the “illegal” and “unofficial” rate (currently 12.60 pesos to the dollar).
Jay Epstien: There has always been an interplay between spreads and rates. As long as rates don’t move too much, eg, 50 bps, there should be relatively little impact. However, if there is a more significant move in rates, eg 100 bps or more, and spreads stay the same or widen, then there will be a dilution to value that will be reflected in pricing to achieve the same unlevered or levered returns at a higher cost of capital. As far as the activity in the legal marketplace is concerned, as long as capital seeking real estate investments remains in abundant supply, the transactional volume that drives legal work will be affected more by the availability of properties.
Susan Talley: I concur with Jay’s analysis. A modest raise in rates should not have much effect on markets or the legal practice. I have spent the better part of the last year working with clients who are anxious that each jobs report or meeting of the Open Markets Committee will result in a significant increase in rates. That dramatic increase has yet to materialise.
Javier Canosa: The market is so slow that perhaps a change of government in 2015 may bring about some hope.
In Argentina, almost all transactions have been done in cash since the mortgage market collapsed in the 2002 crisis. The mortgage loan market in Argentina remains stagnant at a meagre estimate of approximately 1 per cent of GDP; this shields the housing market from drastic house price changes brought by fluctuations in interest rates. The reference interest rates of the Central Bank have been increased by the Central Bank to 19.5 per cent per year.
With fiscal deficit, and no access to the financial markets by the government, the current situation is not expected to improve in the short term.