Why the US office property market is attractive to European investors
Continued high inflation and the Federal Reserve’s aggressive interest rate policy are impacting the US office property market. But it is still worth investing in this asset class.
For around three years, foreign investors faced challenges when investing in the US due to high hedging costs and travel restrictions imposed during the Covid-19 pandemic. However, the US economy recovered much faster than the European economy, returning to pre-pandemic levels by the end of the second quarter of 2021. Hedging costs fell. Union Investment resumed investing in the US immediately after travel restrictions were lifted in October 2021. In the three months that followed, the company acquired four properties worth a total of over EUR 376 million. Union Investment also began investing in two new asset classes in the US – grocery-anchored retail and multi-family.
The US real estate market is the largest, most liquid and one of the most transparent in the world, while offering attractive diversification opportunities to European investors such as Union Investment. Some 15 per cent of the Hamburg-based real estate investment manager’s property assets are located in the US.
Robust economic performance
Although hedging costs are now relatively high again, the US real estate market remains attractive compared with other countries because the US economy is expected to perform better than the Eurozone over the coming months. The economic fallout of the Covid-19 crisis certainly has impacted the overall US economy, but the resilience of the labor market and the news that GDP growth accelerated better than expected in Q3 suggests that things are stabilizing, albeit slowly. The war in Ukraine is likely to have less of an impact here than in Europe. Domestic demand and the labour market currently appear to be robust.
Nonetheless, pandemic-induced inflation, exacerbated by Russia’s invasion of Ukraine, is also affecting US markets. The Federal Reserve is pursuing a restrictive monetary policy to combat rising prices, which is ofcourse putting the brakes on the US economy. The real estate markets are not immune, with a negative effect on demand for office space also becoming apparent of late, especially since some companies are still reluctant to rent office space due to the ongoing discussion around flexibility and hybrid working.
However, an attractive, modern office with flexible configuration options is essential for a company’s image and corporate identity – for example, as a venue in which to meet clients, or when recruiting new employees. Because construction activity remains relatively strong, average vacancy rates in key US office markets have increased significantly in some areas over recent months. In San Francisco in particular, a noticeable increase in vacancy rates was recorded due to a rise in construction activity over recent years and a sharp drop in demand for office space.
Rising rents
Despite this trend, rents have risen slightly on average in recent months. In Dallas, Chicago and Atlanta, for example, they increased by more than one per cent. Dallas is the fifth-largest office market in the US and the fourth-largest metropolitan region in the country. Union Investment recently completed one of the largest letting transactions this year in Dallas when Texas Capital Bank extended its lease by 15 years. The Class A office building at 2000 McKinney Avenue is the bank’s headquarters. Alongside the lease extension, the tenant took on more space and the building was renamed “Texas Capital Center”.
Initial returns are stable
Initial returns, meanwhile, remain largely unchanged. Transaction activity has rebounded to pre-pandemic levels and is mainly being driven by healthy demand for trophy assets, i.e. high-quality properties with creditworthy tenants in central areas of major cities. In this vein, Union Investment recently acquired the Catalyst office building in Sunnyvale, California – a city which is regarded as the center of Silicon Valley. The property is one of the newest trophy office buildings in this popular office submarket.
Going forward, the US real estate market will continue to offer strong investment opportunities compared with other countries. Union Investment is aiming to further boost its exposure to overseas real estate because of the important role global investments play in diversifying our portfolio.
Author: Matthew Scholl, Executive Director and Head of Investment Management Americas at Union Investment.