Key Drivers Behind Foreign Investors [Download PDF]

Ever since June 2006, the date Emaar Properties acquired John Laing Homes for $1.05 billion in an all-cash transaction, conjecture has focused on where money from the United Arab Emirates might strike next in the U.S.

Earlier in 2008, unsubstantiated reports asserted that Emaar had bid to buy Lennar. And prior to its recent recap by MatlinPatterson, word is Standard Pacific was in Emaar?s sights. ?Yes, there was interest from overseas,? Standard Pacific CEO Jeffrey Peterson noted during a Bank of America investor presentation in June, when asked if the company had been approached by ?any sovereign funds or international buyers.?

Certainly, Lennar and StanPac are not the only ones who?ve caught the eye of those in the global investment game. Fact is, countries like China, Canada, Hong Kong, and Kazakhstan have investors who are more than keen to seek returns in U.S. residential real estate.

Conventional wisdom about foreign investments in residential real estate tends to focus on sovereign wealth funds, with most prospective activity in buying companies and their operations.

Lately, though, talk has broadened to include how overseas wealth may seek straightforward land purchases, and whether those investors? funds differ from the ones seeking the M&A deals.

Money Talks

Not so long ago, China prohibited ownership of real estate within its borders, according to CP Morgan CEO Tom Eggleston, who previously headed up a venture that was the first 100 percent foreign-owned company allowed in China. Through this experience, he became acquainted with some China-based investment firms that were in their infancy in 1990, but have grown as the Shanghai and Hong Kong stock markets matured.

Today, Eggleston is working with a China-based group called E-House whose mission is to help the Chinese identify international real estate investments. He describes E-House as an investment firm that intermediates for marketing purposes--i.e. translates marketing materials and takes part in live presentations to groups of prospective Chinese investors in the E-House offices.

CP Morgan is a significant developer in Indiana and has earmarked some of its land holdings–including finished lots–for E-House marketing. The company translates the marketing materials into Mandarin and conducts presentations for groups of wealthy, sophisticated investors several times a week.

Barratt American CEO and principal Mick Pattinson has hosted potential investors from London on more than one occasion. ?They see the standstill nature of the California market, and they can feel the pent-up demand accumulating as they tour sites,? he says. ?They see the absence of sticks in the air; there?s hardly any construction going on. These are savvy people, and they can see our industry

At its most simplistic, favorable currency exchange rates pique the interest of foreign investors as they consider that the distress of land means buying assets at pennies on the dollar combined with a huge home currency to dollar advantage. But while many in the industry see offshore investors becoming major players in the land game, a learning curve factors into the prospective timeline.

Irvine, Calif.-based Land Co. Development Inc. has made a business out of supporting the acquisition process, and president Billy T. Chen has worked first-hand with investors from Asia to Australia. ?They come over to the U.S. for a week with their money, and then realize that they don?t really know how to underwrite these deals,? says Chen. ?They don?t really understand the U.S. market, and it takes time to get up to speed.?

Paul Grover and Barry Gross, partners at Strategic Land Advisors in Irvine, have experience with money from India, Korea, and Kazakhstan. They agree that investors typically underestimate complexities about land as an asset with variable returns.

Says Gross, ?There is quantifying the development, plus legal, political, environmental concerns, and then projecting the costs going forward–what will it take to grade a hillside, construct a park, move a road, build a sewer treatment plant? Those kinds of things give a little anxiety to foreign investors because they don?t have direct familiarity with manufacturing the lots.?

That being said, foreign money tends to be more patient than traditional banking or private equity capital. Many see that distinction as one that will create near-term wins.

In development, pricing risk is not easy. According to Gross, private equity compensates for an inability to measure it; many just raise the price of their money to cover the gap. ?It?s why the pricing of the money has gone into the 20s,? he says.

Initially, some foreign money sources placed capital in large investment funds with an expectation of 15 to 20 percent internal rates of return (IRR). After the Bear Sterns debacle, many became less enamored with dealing through funds and have started to look at more direct investments.

In contrast, the new strategy of these investors is for less aggressive returns. ?Where [private equity is] looking in the 20 percent to 25 percent [range of returns], these are really in the 10 percent to 12 percent range,? says

?They have longer-term horizons than Americans,? says Grover. ?It may take 10 years to get to the levels they are looking for, but at that time, they can realize a 2x or 3x multiple on their money. They are looking at parking capital, adding value, then realizing it in terms of multiples.?

One way foreign investors are looking to add value while the market recovers is to reconsider the planning and entitlement of a project. ?Before you would exercise a $50 million loan draw to improve a property, it makes sense to rethink the plan and look for better value,? says Grover. ?In some cases, it might mean losing some lots and lightening up the development cost side to make it more profitable.?

The level of commitment of these investors is unclear, but one thing is certain: Intense scrutiny is required on every project, and the money will be made by those that understand that best. ?I don?t think we?ll see this money deploy in a big way at first,? says Chen. ?But I am sure they are tracking everything that is going on and waiting for their time.?

–Lisa Marquis Jackson