European pension funds looking to expand their property investment horizons would be well advised to consider the US. As well as being the largest economy in the world, the US creates jobs, income and wealth at a faster pace than other developed countries. All of these factors – jobs, income and wealth – translate into real estate demand and potential returns. The US property market, once notoriously volatile and pro-tenant, has been effectively restructured over the past decade, with many of the excesses removed. At the same time, property markets in the US are very different from their European counterparts, and represent a very diverse set of opportunities.
That the US is the largest potential market for real estate investors is not subject to debate. The US economy accounts for approximately 43% of the output of mature developed economies, those typically suitable for pension funds and other institutional investments. Some 40% of institutional real estate value is located in the US. The UK is the second largest market for investment real estate, with approximately 16% of total stock.
Many European property investors are active in the US or have been over the past 25 years. Those that invested in the 1980s are likely to have suffered through poor returns in the early 1990s, but there have been many changes to the real estate investment and lending businesses since that time. British, German and Dutch investors are the most active in the US direct investment market, with Dutch investors favouring publicly traded real estate securities.
The US real estate market is very broad and diverse. Real estate data is readily available on more than 50 cities and their surrounding areas. However, US pension funds have concentrated 47% of their real estate holding in 10 key cities.
Some real estate data is readily available – particularly new supply, absorption (demand) and vacancy rates. Economic and demographic data is also easy to come by. Detailed rental rate information and initial yields on buildings that that been sold is harder to find.
The US real estate market is primarily suburban. Only 37% of US office space is located in central business districts (CBDs); almost all of the warehouse, retail and apartment stock is located in suburban locations.
Attitudes towards new development vary widely across the country. California, particularly the San Francisco area, and the northeast (Boston and Washington) tend to limit growth and development, while many other parts of the country are more open to new construction.
The real estate services business (construction, leasing, management) is made up of a handful of national companies plus numerous local and regional companies that are often very effective in their own markets. National companies have strong teams in major markets, but local companies often dominate smaller markets.
We recommend that risk-averse European pension funds investing in the US overweight industrial and retail over the next year or so. In round numbers, the distribution of institutional investments in the US is 40% office and 20% to each of the following: retail shopping centres, industrial and residential apartments. Hotels also have a small place in US portfolios.
Shopping centres are our top pick for 2004. Despite low initial yields, rents at top-quality retail centres are generally stable or growing, as retailers continue to look for growth opportunities. Industrial investors should favour the major markets, which are capturing a disproportionate share of national demand. In addition to underweighting apartments, we recommend that core investors underweight the office sector in 2004, as rents will continue to fall in most markets. Core investors should stay away from the hotel sector.
As investors move up the risk–return spectrum looking for higher return properties, office properties will play a greater role. Office properties outside of Washington, DC, and New York (two very expensive markets) offer one of the few property types that can be purchased below replacement cost, as there are fewer bidders for office assets. Selective opportunities exist to fill up vacant space, although rents are not likely to rise for several years. For opportunistic investors, we place a significant overweight on hotels and a market weight on offices. Opportunistic investors should also look in Mexico, though local knowledge and/or partners is crucial.
Is now the right time to invest in US property? Real estate prices are definitely not cheap, at least by historical standards. Low borrowing costs have driven down initial yields to as low as 6–7% for the highest quality properties. (These are still higher than is available in European markets.) On the other hand, the US economy is clearly improving, and recent expansion cycles have lasted for many years. Property markets are at or near the bottom, and occupancy and rental rates are likely to rise as the economy improves. Institutional property returns hit 9% in 2003, after a low of 6.8% in 2002. Leverage (or gearing) increases the cash on cash returns to 8–10%. And finally, European investors have the benefit of investing with much-appreciated euros and pounds.
The US property market is large and varied. Some of the key things to keep in mind when structuring an investment programme are as follows:
q Investments in US property over the next year or so should be based on a long-term hold. Prices are on the high side, but long-term economic growth will reward those who invest in the right property types and markets.
q Consider commingled funds – managers of these vehicles are large organisations with deep resources or specialised local knowledge, and have strong incentives to succeed. Dozens of commingled funds are available to suit many different investment styles and strategies.
q Concentrate 25–50% of a US portfolio on the core markets of New York, Washington, Chicago and Los Angeles (and Toronto for those considering the whole of North America). The rest of the portfolio should focus on the 25 largest cities.
q Carefully consider the trade-off between growth and income. The core markets are primarily income plays, while much of the economic growth in the US takes place in the Sunbelt markets such as Florida, Texas and Arizona. Those are also the markets with the fewest constraints on new supply.
Like most real estate markets world-wide, the U.S. real estate markets are characterised by tepid demand, falling rents, yet high prices. The high prices are a direct result of low interest and inflation rates, but also the fact that US real estate is less risky than it once was. European investors have reason to be cautious in 2004, but a long-term programme to invest in U.S. property over the next decade will likely result in solid returns (8–10% unleveraged) as the US economy continues on its long-term growth path and property markets recover.
Bill Maher is xxxx at LaSalle Investment Management

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