Most people likely know of an American shopping center, hotel, or apartment complex owned by an investor from another country. However, investors from around the world not only buy commercial real estate properties, but they also lend for CRE development and financing. How do these loans impact local CRE buyers? What about the domestic economy as a whole? Read on to find out more about how foreign lending affects the domestic commercial real estate market.
What Does Foreign Lending for CRE Look Like?
Money flows into the commercial real estate loan market from all over the world. The most significant investors are typically from Europe, the Middle East, and Asia, principally Japan, China, and South Korea. These lenders originate loans for hotels, office buildings, and apartment complexes as well as the other forms of CRE.
They often lend for first mortgages and also do refinancing for value-add property upgrades. In addition, they may write mezzanine loans, which are a blend of debt and equity financing. These are higher-risk loans because their payment has a lower priority than other debt in the case of foreclosure.
At one time these investors wrote most of their loans in major cities such as New York, Los Angeles, Boston, and Chicago. More recently they have expanded into slightly smaller metropolitan areas such as Kansas City, Nashville, and Orlando.
Foreign lenders also work with U.S. banks that want to offload large CRE loan positions. The American lenders are originating the loans, then selling pieces of them to insurance companies, investment banks, and hedge funds in Europe and Asia. In general, foreign banks have lower risk-adjusted return requirements, and CRE owners get extra leverage in their financing at more favorable rates.
Why Foreign CRE Lenders Lend
Two big reasons are the relative stability of the American economy and the chance to earn larger returns than in their home countries.
Americans often see their economy as unsettled, but, to much of the world, the U.S. has comparative stability. This country isn't likely to see extreme taxation or radical change in the basic economic structure when a different party comes to power. In much of the world, government seizure of assets is a possibility, but no one expects that to happen here.
The U.S. is still a driver of the world economy, and American CRE assets continue to have growth potential. For many foreign investors, putting part of their portfolio in America is an attractive way to invest in real estate.
Yields that are too low for domestic lenders are often more than adequate for foreign investors. For a development investment, a foreign group might accept an internal rate of return (IRR) that's a third less than what a U.S. lender would insist on. Similarly, for a project that produces cash flow, the foreign investor might accept a third lower return percentage than the American group would require. Foreign lenders are often comparing their IRR and cash returns to the even lower numbers that they might have to accept back home.
Why U.S. Commercial Real Estate Owners Borrow
The lower rates that foreign lenders offer on many deals are an obvious attraction to borrowers. However, foreign lenders aren't only in the CRE market with high-quality, low-interest loans. Foreign investment is also a source of funding for short-term, higher-risk loans. This often comes into play on transitional loans or commercial bridge loans for hotels, apartments, shopping centers, and other CRE properties that are not stabilized and don't yet qualify for long-term financing at attractive rates.
For developers and CRE owners who are willing to cede some equity, foreign lenders will frequently provide a lower rate on mezzanine loans.
Impact of Foreign Commercial Real Estate Lending
Nobody doubts that foreign lending has an influence on the American CRE market. The question is how big and how multifaceted that influence is. Some of the impacts include:
- Spurring growth. When there are more lenders offering attractive rates on stable loans as well as more creative financing for riskier loans, more people will buy commercial real estate. This not only affects the metropolitan areas where most of these loans are given; there's also a spillover effect. Both domestic and foreign lenders who invest in CRE will branch out and become more active in medium-size and even smaller cities.
- Inflationary impact. Any time the cost of borrowing goes down, the price of the assets tends to increase. Commercial real estate is no exception. There's been inflationary pressure on CRE properties such as office buildings and multi-family housing developments.
- Tougher competition for U.S. lenders. Foreign lenders and American lenders find themselves going after the same deals. U.S. investors must either lower their rates to compete or extend their reach by moving into more geographically diverse markets.
- Potential volatility. The amount of capital that's available from some countries can change in a hurry depending on their own economic and political issues. CRE owners can't assume that the same level of foreign borrowing opportunity will always be there.
Foreign CRE lending matters not only to commercial real estate; it affects the entire U.S. economy. In general, foreign money flowing into the U.S. is a good thing for the country. Many investors, both local and abroad, look at American CRE loans as a solid investment opportunity in a reasonably stable economy. It's likely that foreign lending will continue to have an overall positive impact on commercial real estate, so in addition to considerations like the difference between residential and commercial property taxes, commercial real estate buyers should take a moment to further educate themselves on this and similar topics.
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