Coming to America

The world’s largest sovereign wealth fund is planning to enter the world’s largest commercial real estate market. The timing of that decision suggests that, for some foreign investors, returns aren’t everything.

If everything goes according to plan, Norway’s Government Pension Fund Global will begin pumping capital into US real estate next year. The NOK3.7 trillion (€506 billion; $661 billion) sovereign wealth fund, the world’s largest according to the Sovereign Wealth Fund Institute, plans to gradually invest one-third of its five percent target for the asset class into the American market.

Such a target is expected to translate to about NOK250 billion to NOK300 billion of investment in real estate outside of Norway by 2020, based on the state fund’s current value and projections used by the country’s finance ministry. As of the end of the third quarter, it had just 0.3 percent invested in real estate, all in Europe.

The US is an obvious choice for Norway as it looks to expand its real estate investments.  After all, the country outranks all other nations in terms of both the value of institutional-grade commercial real estate located within its borders – some $6.8 trillion – and the percentage of commercial real estate it holds – slightly more than a quarter of the world’s inventory, according to Prudential Real Estate Investors.

Norway, however, will be entering an already crowded playing field in the US, which has been a top destination for foreign real estate capital over the past couple of years. Increased competition for core trophy assets in the US has driven up pricing, making it more difficult for investors to meet their return targets. In fact, total real estate returns in the US have been declining since the fourth quarter of 2010, when returns were 4.62 percent, and came in at 2.34 percent during the third quarter of this year, according to data from CBRE Global Investors.

In the face of such challenges, the Canadian Pension Plan Investment Board told PERE last month that it eventually may look more to other markets for real estate investments. To achieve higher returns within the US, investors will need to be more comfortable taking on more risk, such as develop-to-core strategies or buying properties in secondary markets or with higher vacancies, as opposed to fully-occupied assets in top-tier markets.

Of course, not all foreign investors are return-driven. For other groups, the attractiveness of the US has more to do with its status as the home of the world’s so-called safe-haven currency and its greater transparency and clearer legal framework relative to many other real estate markets. And despite uncertainty relating to the fiscal cliff, the country still has a stronger economic outlook than Europe and Japan and is the developed economy that is the furthest along in its deleveraging process. Additionally, from a returns perspective, the US also is expected to outperform Asia and Europe over the next five years, CBRE Global Investors stated.

Indeed, for investors such as the Government Pension Fund Global, the decision to enter US real estate reflects a strategy to be a more diversified investor and ensure that a certain amount of capital is invested offshore for wealth preservation. As one firm that is advising Chinese investors on US real estate investments told PERE this week, when it comes to hitting higher real estate returns, those parties aren’t looking to the US. Rather, they’re focusing on China itself.