OUR REVIEW OF COMMERCIAL REAL ESTATE INVESTMENT FLOWS IN AND OUT OF THE MIDDLE EAST

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1 MIDDLE EAST OUR REVIEW OF COMMERCIAL REAL ESTATE INVESTMENT FLOWS IN AND OF THE MIDDLE EAST Increase in cross-regional acquisitions and investment in the hotel sector IDENTIFY the key sectors, cities and markets attracting Middle Eastern Capital ANALYSE the changing strategies of outward investment from the Middle East DISCOVER our predictions for future Global Capital flows 216 CBRE Research 216 CBRE Research

2 CONTENTS IN AND : INTRODUCTION 2 IN: EXECUTIVE SUMMARY : EXECUTIVE SUMMARY 4 KEY FINDINGS IN: MIDDLE EAST IN 1: STRUCTURAL CHANGES IN 2: CURRENCY FLUCTUATIONS IN 3: WEAKER OIL PRICES PREVAIL IN 4: LOW VOLUME DEALS IN : CHALLENGES AND OPPORTUNITIES : MIDDLE EAST 1: MIDDLE EASTERN INVESTMENT IN 21 2: WHERE IN THE CYCLE IS THE GLOBAL MARKET? 3: SOVEREIGN WEALTH FUNDS MIDDLE EASTERN HOTEL INVESTMENT IN EUROPE 4: CONCLUSIONS AND LOOK Middle Eastern investors were major buyers of Commercial Real Estate (CRE) in 21. They accounted for 1% of all cross-regional investment. Since the bottom of the market in 29, their purchases have grown much faster than the market as a whole and faster even than other cross-regional investment. The destinations of investment flows from the Middle East are becoming more diverse. They are no longer concentrated in just London and New York. Other U.S. cities and Asian markets are moving up their agenda. The major Australian markets could be next. We expect investment flows from the Middle East to be substantial for the near future. Interest in the hotels sector will remain strong and the industrial and logistics sector will also take an increased share of Middle East capital. Sovereign Wealth Funds (SWFs) globally not just those from the Middle East are changing the balance of their portfolios. Alternatives, particularly real estate and infrastructure, are playing an increasing part at the expense of falling allocations to bonds. Other Middle Eastern investors continue to be active in the U.K., but after very high investment in 213 and 214 the SWFs avoided the U.K. in 21. However, the region s SWFs were extremely big buyers in the United States. The global CRE market had a difficult time in H The relentless growth in the total value of transactions stalled as investors in all asset classes became more wary of risk. However, there were some positive signs towards the end of Q Financial market indicators had returned to their earlier level until the U.K. referendum result injected a new dose of uncertainty. CBRE Research , CBRE Limited

3 IN IN AND : MIDDLE EAST INTRODUCTION SINCE THE FINANCIAL CRISIS THE INCREASE IN THE AMOUNT OF CROSS-REGIONAL 1 INVESTMENT IN CRE HAS BEEN RELENTLESS. FROM A LOW OF JUST US$ 18 BILLION IN 29, IT INCREASED TO US$16 BILLION (NEARLY NINE TIMES HIGHER) IN 21. THE GROWTH IN CROSS-REGIONAL INVESTMENT HAS BEEN MUCH FASTER THAN THAT IN OVERALL CRE INVESTMENT. IN 21 THAT WAS A LITTLE OVER FOUR TIMES ITS 29 LEVEL. The sharp fall in the oil price in H2 214 might have had a negative effect on flows from the Middle East to other continents. However, this was not the case. Acquisitions of global CRE by investors from the Middle East grew even faster and were more than ten times higher in 21 than in 29. The early data for 216 suggests that there will be an interruption to all of these trends. Overall investment has been materially lower in H1 216 than in H1 21. Further, the uncertainty in global financial markets that has followed the U.K. s vote to leave the EU means that overall CRE investment is almost certain to be down in 216. However, the drivers for strong demand for real estate assets remain in place and we expect that this is a hiatus in the growth of the market rather than a turning point. Pensions saving is growing rapidly in emerging markets because of the growth of the middle class and in mature economies due to underfunding of existing pensions Deregulation in Asia, which has been freeing up Asian institutions to invest internationally The very low yield on almost all government bonds The very high yield gap between CRE and bonds This last factor in particular has been an important driver of cross-regional real estate investment. Historically pension funds in many countries have invested a high proportion of their capital in bonds (government and corporate). They have been hit particularly hard by the long-term downward trend in bond yields and have been increasing allocations to real estate to boost their income return. 1 Cross-regional is used here to mean capital from one region making purchases of real estate in a different region, the regions in question being: Africa, Asia, Europe, the Middle East, North America, South America and the Pacific. This is as expected because in the immediate aftermath of a market shock investors will often go risk-off. This reduces their appetite for investing outside home markets. It is therefore more significant that the US$16 billion of cross-regional in 21 was well above 27 s, US$127 billion, even though total global CRE investment was 6% higher in 27 than in 21. The key drivers of the further strong growth in CRE investment (and cross-regional capital flows) in 21 were the same as in 214: The surplus of savings over investment opportunities continues to be a feature of the global economy Businesses are hoarding cash rather than using it to grow. U.S. businesses alone were estimated to be holding US$1.6 trillion in cash at the end of 21 With all this in mind, CBRE s 216 IN and : Middle East report sets out to answer the following questions: 1 Where and what have Middle Eastern investors been buying? 2 Where is the global CRE market in the cycle? 3 Was H1 216 an anomaly? 4 Will the low oil price impact on future Middle Eastern investment in global real estate? FIGURE 1: CROSS-REGIONAL CAPITAL FLOWS IN GLOBAL COMMERCIAL REAL ESTATE FIGURE 2: 1-YEAR GOVERNMENT BOND YIELDS Australia Germany Japan UK USA US$ Billion Real GDP Growth Forecasts Per Annum (%) H Jun Jun 1 Jun 2 Jun 3 Jun 4 Jun Jun 6 Jun 7 Jun 8 Jun 9 Jun 1 Jun 11 Jun 12 Jun 13 Jun 14 Jun 1 Jun 16 Source: CBRE Research, RCA Source: Macrobond CBRE Research , CBRE Limited

4 IN IN: MIDDLE EAST : MIDDLE EAST EXECUTIVE SUMMARY EXECUTIVE SUMMARY While the Middle East remains a comparatively small investment market, investors are focused on development plays and increasingly on alternative investment classes, such as hotels, residential, education and healthcare. We can expect to see a continuation of the current land speculation trend, which has been responsible for pushing up land prices in many regional markets. However, as witnessed recently in Saudi Arabia with the implementation of a new tax system for undeveloped land, regional governments are becoming more proactive in their structural reforms as they seek solutions to social housing shortages and lower oil revenues. The long-term picture is likely to look somewhat different. Expectations are that a more formal institutional market will eventually exist, in a region where there is already world class infrastructure, a growing number of high quality office schemes suitable for international corporate tenants, strong local demand for prime retail, and a large number of high profile hospitality and residential properties, which combined, could establish a very solid base for developing an established real estate investment market. Against this backdrop, international education and healthcare operators continue to migrate into the region, driving competition and ultimately helping to raise standards. Interest from Islamic funds remains strong, with continued appetite for sale and leaseback investments within these Sharia compliant assets classes. Taken together, these market shifts are reflective of the encouraging investment potential of the rapidly growing education and healthcare markets. A major increase in capital flows from the Middle East came despite the fact that the oil price in 21 finished below its level at the start of the year. There is evidence to suggest that the (record) 69% jump year-on-year is due to SWFs continuing to change the weighting of their portfolios and including a higher proportion of property. Therefore, although investment across all asset classes may be down, SWFs have boosted overall outward capital investments from the Middle East into property. The jump in investment is even more substantial than the headline figures for acquisitions first suggest. In 213 and 214, Middle Eastern investors were fairly active traders of their real estate holdings and after accounting for sales of property, net purchases were about US$. billion in both years. However, this changed in 21 and sales by Middle Eastern investors declined. As a result, net purchases of global CRE were over US$16 billion. CBRE Research , CBRE Limited

5 IN IN: MIDDLE EAST MIDDLE EAST: THE IN SECTION IS DESIGNED TO GIVE THE READER AN INSIGHT INTO CBRE S THINKING ON THE CURRENT TRENDS IN THE MIDDLE EASTERN REAL ESTATE MARKET AND UNFOLD THE KEY CHALLENGES AND OPPORTUNITIES THAT IT HAS TO OFFER. IN CBRE 21, Research CBRE Limited , 216, CBRE Limited

6 IN 1: STRUCTURAL CHALLENGES IN Despite the maturing nature of the region s real estate sector, the Middle Eastern investment market continues to see only marginal investment volumes as compared to more developed marketplaces in Europe, Asia and the Americas, with just a small number of major institutional real estate investment transactions completed over the past year. In part, the low volumes are driven by a divide between the expectations of potential investors and owners, and while assets do change hands, it is clear that Middle East investors, landlords and owners remain net buyers and long-term real estate players looking for income preservation rather than to build revenue and trade assets. This is a strategy that has also been widely adopted by major private and state-owned developers which typically build and then hold their properties for the long-term, cultivating income-generating assets and by doing so, have ultimately evolved into some of the region s largest asset managers. As a result, some of the region s largest owners of real estate are developers and financial institutions, and as a further consequence of their develop-to-hold and buy-to-hold strategies, prime commercial properties, such as the major malls and the majority of commercial offices, are rarely transacted. Whilst local REITs and real estate investment funds remain proactive in their search for suitable quality assets, with only a relatively small number of international players making regular purchases, the market still lacks a level of critical mass. This situation results in bidding wars between the same small pool of investors, underlining the lack of product depth and relative immaturity of the investment market. Evidently, there is a mismatch between the supply and demand of investment assets, and despite significant development of both commercial and residential properties in recent decades, the number of commercial transactions involving foreign investors does not adequately reflect the interest in real estate in the GCC market as a whole. If the relative illiquidity could be solved in the region, then the UAE in particular would see substantial inbound capital flows. Dubai has already cemented its position as the market of choice for new regional entrants, and along with the depth of the labour pool and quality of the transportation infrastructure, the Emirate clearly has the fundamentals to help drive future investment volumes higher. Add to this, the commercial sector remains in a positive position, particularly for good quality, efficient and well-located buildings, and it is understandable why it is also the typically starting point for new real estate investment searches in the region. It is clear that the asset focus of investors is being heavily influenced by the market s structural challenges, with limited commercial investment driven by the underdeveloped nature of the market and unwillingness on behalf of owners to part with prime assets. This has led to the evolution of an investment market that is not truly institutional in nature and is instead dominated by the sale of development land and individual residential units. The commercial market is further constrained by restrictions on foreign ownership titles across the region, which has meant that major retail mall transactions are sparse at best. However, with Middle East economies feeling sustained pressure on revenues due to a prolonged period of lower oil pricing, we can reasonably expect to see the region s real estate markets opening up as governments slowly start to remove barriers in order to stimulate growth and encourage higher levels of foreign direct investment into real estate. Ultimately, every country in the region has a ready-made investment market, with huge volumes of occupied commercial office stock, with long term leases to various government institutions, as well as the significant occupations of many large family conglomerates and privately held businesses. Evidently, this is a product that would be very well aligned with the requirements of many international investors, and thus by releasing this capital to the global investment market, there could be sizeable resources that could then be made available to support and fund new initiatives and infrastructure projects, which lie at the heart of government public spending strategies across the region. Ultimately, this would also signify a turning point for the region s investment market. Lack of market transparency Limited liquidity Immature nature of REITs and investment markets overall Restrictive foreign ownership laws High land prices IN 2: CURRENCY FLUCTUATIONS Global currency fluctuations over the past two years have made the Middle East a far more expensive investment destination for a large portion of foreign capital. With the majority of the region s economies pegged to a dollar weighted basket, the recent strength of the greenback has had a broadly negative impact on overall deal volumes, constraining investor appetite and creating more attractive external destinations for real estate investment. Since early 214, both the British pound and the euro have lost around 2% of their value against the US dollar, whilst the Chinese yuan and Indian rupee have fallen by around 7%, making dollar denominated or linked purchasers, such as investments into Middle East real estate markets, significantly more expensive. The same fluctuations have also had a negative impact on major regional tourism markets, such as Dubai, with many key source markets suffering from reduced spending power, which has contributed to the slide in hotel Average Daily Room rates (ADR s). However, whilst the Middle East may have become less attractive from a currency perspective over the past two years, European markets have inversely become increasingly appealing for outward bound capital, at least until the recent uncertainty brought about by the UK s BREXIT vote which has subsequently clouded the picture. IN Previous Middle East: IN and reports have provided in-depth reviews of the main challenges that the local real estate markets face. The key hurdles that were identified include: Lack of investment grade product Shortage of willing sellers Long-term hold approach favoured by many local investors CBRE Research , CBRE Limited

7 IN 3: WEAKER OIL PRICES PREVAIL IN Crude (WTI) oil prices ended H1 216 at just below US$/dollar/barrel. However, having fallen below $3 per barrel at the end of 21 the current price represents something of a recovery, although clearly it is not yet sufficient to prevent the occurrence of significant budget deficits during 216. The recent improvement in oil pricing has been driven in part by disruptions in supply, particularly in Venezuela and Canada. However, regardless of the recovery in pricing, most analysts believe that the Middle East is set for a prolonged period of lower growth, which will create an environment which forces structural reforms, reduced public spending and the introduction of new taxes and duties to the region. The UAE and Qatar are best positioned to withstand the ongoing economic slowdown, with their significant financial reserves helping to insulate their economies from more severe deficits. However, this does not mean that they will escape without the implementation of wide ranging spending cuts and expected policy reforms aimed at streamlining fiscal operations. As has been the trend, the welfare of their citizens will remain a top priority, with social and hard infrastructure continuing as the main component of budget allocations. Overall, the current economic outlook for the GCC region suggests weaker GDP growth over the next three years as compared to what was expected two years ago. The UAE is now forecasted to grow by around 2.2% during 216, against an achieved 4.% in 214. Bahrain which recorded economic growth of 4.% during 214 is forecast to expand by 1.2% in 216. Future projections have also been reduced, with growth of 4% or less across all GCC economies over the next three to four years, with oil prices expected to remain low during this period. However, interestingly Dubai is expected to outperform wider regional trends, with a forecasted GDP growth of over 4% during the period The Middle East s real estate sector continues to offer attractive investment opportunities, but so far the market s full potential is still to be realised amidst limited availability of investment grade product, low investment volumes and a general disconnect between the valuation of buyers and sellers. Despite these challenges, we expect to see the market open up in the coming years as regional governments assess new avenues for capital raising amidst an environment of lower hydrocarbon revenues and tighter liquidity. Matthew Green, CBRE - Head of Research & Consultancy, Middle East IN FIGURE 3: ECONOMIC GROWTH IN SELECTED MIDDLE EASTERN COUNTRIES Saudi Arabia Kuwait Qatar Bahrain Oman UAE 6 4 GDP Growth per annum (%) (f) 217 (f) 218 (f) 219 (f) Source: Oxford Economics CBRE Research , CBRE Limited

8 IN 4: LOW DEAL VOLUMES IN According to the Dubai Land Department, during the first six months of 216 a total of AED113 billion in real estate transactions were completed in Dubai s real estate market alone, with a majority by foreign investors. This figure underlines Dubai s position as an attractive investment destination for regional and global investors, although it also underlines the relative immaturity of the region s investment market from an institutional sense, with land transactions accounting for the vast majority of the total with around AED84 billion, whilst single units sales accounted for close to AED2 billion. Completed building sales comprised just 3% of the total, although this included mortgaged properties which actually made up the vast majority of all registered transactions, rather than genuine institutional investment sales. The market size is further quantified by our regional level analysis of investment data collected from RCA Analytics and CBRE s own internal research on completed transactions between 214 and H1 216, which together amounted to less than AED billion, (excluding government to government, development sites, etc.) for the entire GCC region. It is important to note that transparency of data in the Middle East is rather limited and investment volumes may consequently be far higher than the reported levels, which in turn makes it difficult to have a complete view on investment activity and completed transactions. Regardless, it is clear that the region is still in a nascent stage with regards to institutional investment. FIGURE 4: SELECTED REAL ESTATE INVESTMENT TRANSACTIONS IN THE MIDDLE EAST (21 & 216) As highlighted, the majority of transactions completed in the GCC are either for vacant land plots or for residential units, rather than whole asset sales. This is not always a specific shift in strategy, but more of a reflection of the significant challenges facing investors in sourcing suitable product, underlining the reluctance of many owners in parting with their prime assets. This is a key obstacle in establishing a more developed and liquid real estate investment market. There are moves being made towards rectifying this, with the maturing nature of the commercial office market helping to ensure that longer term corporate leases are being agreed, thus ensuring that institutional grade assets do at least exist. The regulatory environment also continues to strengthen, with the government committed to improving the market through the implementation of new laws aimed at protecting the end-user and by increasing FDI through the creation of a more investor friendly environment. Whilst there are numerous explanations for the region s low investment volumes, the main factors are the lack of investment-grade product made available for sale (rather than a complete absence of end-user demand), restrictive property ownership laws, the long-term hold mentality of many regional players and the lack of market transparency. That said, during 21 and H1 216 a small number of notable transactions were completed, including the Kuwait Investment Authority (KIA) purchase of the Standard Chartered Bank headquarters office building in Dubai, which transacted for a reported 6.% yield. However, as has been the trend, investment volumes remain very low. Property Location City Country Sector Size Year Al Quoz Al Khail Road Dubai United Arab Emirates Industrial 9 Plots 216 Al Falaj Daman House Standard Chartered Bank Tower Saadiyat Beach Residences Phase 1 Kenzi Mecca Hotel Al Mujamma Street 3th Street, Main Island Sheikh Zayed Road Muscat Oman Hotel 1 Keys 216 Abu Dhabi United Arab Emirates Office 2, sq ft 216 Dubai United Arab Emirates Office 22, sq ft 216 Saadiyat Beach Abu Dhabi United Arab Emirates Residential 28 Units 21 Jabal Al Kaba Street Mecca Saudi Arabia Hotel 79 Keys 21 When entering the region, the majority of institutional money starts with a mandate to source long-term income generating commercial assets, but these strategies have a tendency to evolve quickly when it becomes apparent that access to this stock is challenging. As a result investment portfolios are often more weighted towards hospitality and residential properties, with only smaller proportions of commercial, industrial and specialist assets. Looking in more detail at recent institutional investment volumes (214 H1 216), we can see this strong emphasis towards the hospitality sector, representing around 47% of the total known transactions, although these figures are slightly skewed by the presence of a number of sizeable deals. The allocation of residential (full buildings) follow next, comprising 2% of the total spend. The allocation towards commercial is small in comparison to norms in other more mature markets, with 23% for offices. Other sectors, which include retail, industrial and education and healthcare comprise roughly 1% of the total. IN : CHALLENGES AND OPPORTUNITIES In the short term, the Middle Eastern investment market is likely to remain focused on development, until such time as governments appetite to part ways with their occupied stock. Therefore, we expect investment opportunities in commercial real estate to remain relatively infrequent, with investors instead focusing on development plays, and investment into alternative asset classes, such as hotels, residential, education and healthcare. We can also expect to see a continuation of the current land speculation trend, which has been responsible for pushing up land prices in many regional markets. However, as witnessed recently in Saudi Arabia with the implementation of a new tax system for undeveloped land, regional governments are becoming more proactive in their structural reforms as they seek out solutions to social housing shortages and lower oil revenues. The long-term picture is likely to look somewhat different, with expectations that a more formal institutional market will eventually exist, in a market where there is already world-class infrastructure, a growing number of high quality office schemes suitable for international corporate tenants, strong local demand for prime retail, and a large number of high profile hospitality and residential FIGURE : INVESTMENT MARKET ALLOCATION (214- H1 216) 2% Hospitality 23% 1% Office Source: CBRE Research, RCA Analytics Residential Other 47% properties, which combined could establish a very solid base for developing an established real estate investment market. Alongside the more traditional asset classes, the private education and healthcare sectors are also witnessing a period of increased development as their awareness, rapid population growth, government reforms and private sector participation continue to drive industry demand. These asset classes are now a key focus on the national agenda with numerous announcements geared towards improving and expanding the region s offering. International operators continue to migrate into the region, driving competition and ultimately helping to raise standards. Interest from Islamic funds remains strong. There is continued appetite for sale and leaseback investments within these Sharia compliant assets classes. Taken together, these market shifts are reflective of the encouraging investment potential of the rapidly growing education and healthcare markets. IN Source: CBRE Research, RCA Analytics CBRE Research , CBRE Limited

9 : MIDDLE EAST THE INCREASE IN CAPITAL FLOWS FROM THE MIDDLE EAST TO GLOBAL COMMERCIAL REAL ESTATE IN 21 WAS MARKED. IT WAS DRIVEN BY SWFS IN PARTICULAR THOSE FROM QATAR AND FROM THE UAE. THERE IS EVIDENCE TO SHOW THAT FLOWS IS THAT FLOWS FROM THE MIDDLE EAST TO GLOBAL REAL ESTATE WILL REMAIN HIGH AS SWFS GLOBALLY INCREASE THEIR WEIGHTING TO REAL ESTATE. CBRE Research , CBRE Limited

10 1: MIDDLE EASTERN INVESTMENT IN 21 Last year was one of very strong growth in direct investment around the world by investors from the Middle East. After a pause in 214, purchases by Middle Eastern investors jumped to nearly US$24 billion in 21 in 2 different countries. The region s SWFs were responsible for the majority of this investment, with purchases of US$13.6 billion. High net worth individuals and investment syndicates (private capital) were again active in 21 acquiring another US$4 billion after the US$4.6 billion in 214. It is also worth noting that in addition to the direct CRE investment captured in these figures, investors from the Middle East are also active investors in residential property 2 and are often involved in funding development of commercial property. This increase in capital flows from the Middle East came despite the fact that the oil price finished 21 below its level at the start of the year. The slight rally in the middle of the year fell away quickly in the second half. There is evidence to suggest that this is due to SWFs continuing to change the weighting of their portfolios and including a higher proportion of property. Therefore, although investment across all asset classes may be down, SWFs continue to spend on direct CRE in order to increase their portfolio weighting. FIGURE 6: CROSS-REGIONAL INVESTMENT BY ME BUYERS 2 UK USA France Germany Italy RoW The jump in investment is even more substantial than the headline figures for acquisitions first suggest. In 213 and 214 Middle Eastern investors were quite active traders of their real estate holdings (after accounting for sales of property, net purchases were about US$. billion in both years). However, this changed in 21 and sales by Middle Eastern investors declined. As a result, net purchases of global CRE were over US$16 billion. The most notable change in 21 was the sharp jump in acquisitions in the U.S. This came partly as a result of two major transactions, which between them totalled well over US$ billion: Qatar Investment Authority s purchase of a 44% share in Manhattan West ADIA s acquisition of a U.S. industrial portfolio (jointly with CPPIB) However, purchases of US$9.8 billion in U.S. real estate in a single year represent a significant ramping up of Middle East investors exposure to that market. The lumpy nature of CRE investment means that variation from year-to-year is to be expected, but this goes beyond that. There are a number of possible reasons for the change, but currency and economic outlook are at the front of the queue. FIGURE 7: CONSENSUS FORECASTS FOR GDP GROWTH IN 21 GDP USD$ Growth Billion (%) September 214 Forecast USA Source: Consensus Economics Inc. Actual The decisions behind the high levels of investment in the U.S. were mostly made in late 214 and early 21. At that time economic forecasts for the coming year suggested that the U.S. was going to experience the fastest GDP growth of the G7 countries forecasts that were justified by the actual economic growth that year. The US$ exchange rate was also highly volatile at that time. The dollar strengthened against most major currencies, and particularly the euro. Between June 214 and March 21 the dollar went from buying.73 to.93 (a 27.% increase) and also strengthened against the Australian dollar (24%), yen (18%) and pound (1%). UK Canada Germany Japan France Italy The combination of these two factors made the U.S. a sensible target for investment. Between 28 and H1 216 the Middle East accounted for 18.% of cross-regional investment in the world s 2 most popular cities for cross-regional investment. In absolute terms London has seen by far the most ($28. billion). The purchase of major strategic assets by Sovereign Wealth Funds in Hong Kong, Singapore, Milan and Atlanta accounts for the over-representation of Middle Eastern investors in those markets. 2 FIGURE 8: GLOBALISATION OF INVESTMENT MARKET IN 21 US$ Billion H1 216 Source: CBRE Research, RCA Cross-regional capital flows into global CRE increased to $16 billion in 21, up 22% year-on-year. The Middle East was the third largest source of capital in 21, with $24 billion invested outside the region. NORTH AMERICA 4 US$ BILLION ASIA 2 US$ BILLION MIDDLE EAST 24 US$ BILLION 2 Investment in the Multi-family sector in the Americas is captured here, but otherwise residential is excluded. Source: CBRE Research CBRE Research , CBRE Limited

11 FIGURE 9: MIDDLE EAST INVESTMENT IN KEY MARKETS (28-H1 216) US$ Billion Total Acquisitions Share of all Cross-regional Investment London New York Paris Singapore Washington DC Hong Kong Milan Los Angeles South Florida Atlanta Chicago Moscow Frankfurt Tokyo San Francisco Sydney Share (%) Source: CBRE Research, RCA Markets where Middle East investors are underrepresented and which therefore might be targeted in the future are also of interest. Tokyo (7th) and San Francisco (8th) are very popular destinations for other cross-regional investors, but have attracted far less than their fair share of Middle Eastern capital so far. Sydney, Melbourne and Brisbane all feature in the top 2 destinations for cross-regional CRE investment, but have attracted very little investment from the Middle East. A possible explanation for this is lack of diversification. Commodities play a major role in the Australian economy. As a result, Australian property markets might not offer the same diversification benefits to Middle Eastern investors as to those from other regions. However, lack of opportunity may have also contributed. Investors from the Middle East tend to target strategic assets and these do not come along too often in the Australian markets. The sector split of direct CRE investment from the Middle East saw a material change in 21. In the five years between 21 and 214 the office sector dominated purchases by Middle East investors accounting for 3% of the total, with hotels a distant second at 17%. In 21 hotels and offices were tied, with purchases totalling US$8.2 billion (3% of the total) in each sector. Industrial also saw a sharp increase in 21 to 9% of the total in 21 compared to just 3% over the previous five years. The sector makes up a significant part of the global market (typically about 11.%), but smaller average lot sizes make it harder for cross-regional investors to target. Consequently, greater investment from the Middle East is likely to come in the form of portfolio transactions or the purchase of whole platforms, including the asset management capability. Here we pick up on a number of the trends described above; the impact of oil price evolution on SWF investments and the drivers of the changes in sector choice of Middle Eastern investors. With the figures for H1 216 suggesting that the growth in global CRE investment turnover may be slowing, we start by considering where we are in the cycle. CBRE Research , CBRE Limited

12 2: WHERE IN THE CYCLE IS THE GLOBAL MARKET? In Q4 21 the total global value of CRE investment transactions reached US$296 billion, beating even the highest single quarter in the years running up to the global financial crisis. Despite this there were already signs that the Bull Run, which started in late 212, was losing momentum. The rate of growth in turnover had been easing off in Q2 and Q3 21, particularly in the Asia Pacific region, and a high proportion of the U.S. market was being made up of large entity-level transactions. These indications were crystallised in Q1 216 when, after turnover of US$186 billion for the quarter, the rolling 12-month total dipped for the first time since Q A number of factors contributed to this drop off in global CRE investment activity in 216, some temporary and some more structural. A major driver though was the perception in H2 21 that the world was a riskier place. 1 Financial markets got more worried about global risks in mid-21 2 Buyers started to worry about property yields that were at historically low levels if risk was back on the table 3 Vendors started to worry about assets failing to sell if buyers were being more cautious and being stigmatised as a result 4 Supply of, and demand for, investment real estate declined The most obvious sign of nervousness in the financial markets was the sharp spike in the VIX 3 (a measure of volatility in the U.S. S&P share index based on the prices for options). Over the last months of 21 there were regular headlines about big movements (both up and down) in stock markets around the world showing that this was a global rather than a U.S.-specific phenomenon. Other indicators painted a similar story. The spread between AAA and BBB rated US$ corporate bonds increased steadily between July 21 and February 216, a clear sign that investors were more risk averse. Government bond yields were also quite volatile over this period, which included an increase in the U.S. Federal Reserve Funds Rate in December, the first since June 26. All of these factors fed through into the sharp fall in the level of CRE investment transactions in Q The length of time that it takes real estate transactions to go from initiation to execution is the reason why it took so long for these market factors to show through in the available real estate data. What caused the increase in perception of risk is harder to determine. Ultimately it looks like the combination of a number of factors. The Chinese economic slowdown and tightening of U.S. monetary policy are at the top of the list. Neither of these were new, but the combination seemed to spell danger. By the middle of 216 the financial indicators referred to had mostly returned to their levels in H1 21 (that is until the result of the U.K. s referendum suggesting that this change in sentiment in the markets was temporary rather than heralding a turning point in the cycle. Despite the increase in the Fed Funds Rate last December, the U.S. Federal Reserve has been clear that it will be cautious about any further increases. In China, fiscal stimulus and relaxed monetary policy is keeping the decline in economic growth under close control. Looking ahead, there are indications that the property market is following the lead of the financial markets and recovering from its Q1 216 drop, albeit with the same sort of lag as before. However, the U.K. s decision to leave the EU has injected further uncertainty and it will take some time before the implications of this for the global property market are understood. In the meantime, many investors are likely to respond with caution. FIGURE 1: GLOBAL COMMERCIAL REAL ESTATE INVESTMENT TRANSACTIONS FIGURE 11: GLOBAL RISK INDICATORS APAC EMEA Americas 12-month total AAA-BBB Spread S&P VIX (rhs) 1-year Bund 3 1, US$ Billion , US$ Billion Percentage (%) Q2 28 Q4 29 Q2 29 Q4 21 Q2 21 Q4 211 Q2 211 Q4 212 Q2 212 Q4 213 Q2 213 Q4 214 Q2 214 Q4 21 Q2 21 Q4 216 Q2 4/1/1 /1/1 6/1/1 7/1/1 8/1/1 9/1/1 1/1/1 11/1/1 12/1/1 1/1/16 2/1/16 3/1/16 4/1/16 /1/16 Source: CBRE Research, RCA Source: CBRE Research, Macrobond, CBOE 3 CBOE (Chicago Board Options Exchange) Volatility Index CBRE Research , CBRE Limited

13 3: SOVEREIGN WEALTH FUNDS In recent years Sovereign Wealth Funds (SWFs) have been the main source of cross-regional investment into direct CRE from the Middle East. They accounted for 38% of all purchases from 27-21, a total of US$41.6 billion. The biggest share of this has been property in the U.S. (US$14.6 billion) and United Kingdom (US$11.3 billion). In 214 Middle East SWF investment in real estate dipped to (just) US$4.8 billion. In 21 they were strongly back in the market, making acquisitions totalling US$13.6 billion. Purchases in the U.S. were a big part of this. Hong Kong also made a major contribution courtesy of ADIA s acquisition of a % stake in three major hotels (the Grand Hyatt, Hyatt Regency and Renaissance Harbour View). There were also large acquisitions in France and Italy. Asia has not been high up the target list for Middle Eastern SWFs in the past. However, that it is on the agenda for the future has been shown by Qatar Investment Authority s purchase of Asia Square Tower One in Singapore for a reported $2. billion in June 216. Notable by its virtual absence in 21 was the United Kingdom. Between 27 and 214 the U.K. was the leading destination for Middle East SWF capital, but 21 saw purchases totalling just $2 million. This may have been foresight regarding the outcome of the U.K. s EU referendum. However, it is more likely to be the result of falling economic growth in the U.K. and portfolio balancing after very high U.K. investment in 213/14. The sector distribution of SWF purchases has also undergone a significant change. Offices made up the biggest share of purchases at 34% of the total by value, but this was well down on their 64% share of investment over the five years from 21 to 214. In contrast the share of hotels jumped from 17% to 31% in 21 and industrial also saw a big increase to 11% of investments. All of the Middle Eastern SWFs are commodity based in terms of their ultimate source of capital. Yet the jump in investment in global CRE has come despite weakness in the oil price at the end of 214 and throughout 21. This is affecting growth in the total size of SWFs. Figures from the Sovereign Wealth Fund Institute suggest that the total assets under management (AUM) of Middle Eastern SWFs dropped by 4% between March 21 and March 216. A possible explanation for this combination of falling AUM, but increasing investment in real estate, is a strategic decision to increase portfolio weighting to real estate. There is evidence to support this explanation. A number of SWFs have announced that they are increasing their target allocation to real estate. Invesco surveys 4 have consistently shown that sovereign investors want to increase their allocation to real estate. At the start of 21 the proportion reporting an intention to increase their real estate allocation was 63% and this increased further to 67% at the start of 216. The Sovereign Wealth Lab is a research group at Bocconi University which tracks the transactions of SWFs. They estimate that over a third (3.9%) of their foreign investments in 21 were in the real estate sector. This is probably an over-estimation. Although SWF s transparency has improved, information is not available for all, or even a majority, of their investments. Direct real estate transactions are more likely to be known and are therefore over-represented in the available data. However, this still suggests that global SWF investment strongly favours the real estate sector at the moment. Even if the amount of new capital coming into the funds is declining, the process of reweighting the $2.9 trillion 6 dollars of capital that Middle East SWFs have already invested in all asset classes is a major undertaking. This would result in continued high levels of real estate investment by the SWFs for several years to come even if overall assets under management do not increase. FIGURE 12: CROSS-REGIONAL COMMERCIAL REAL ESTATE INVESTMENT BY MIDDLE EAST SWFS FIGURE 13: CRUDE OIL PRICE Purchases Sales IMF Oil Price Index US$ Billion Oil Price Index H1 216 Jan 13 Jan 14 Jan 1 Jan 16 Source: CBRE Research, RCA Source: Macrobond 4 Invesco Sovereign Asset Management Study 213, 214, 21 and 216 The Sky Did Not Fall : Sovereign Wealth Fund Annual Report 21. Centre for Applied Research on International Markets, Banking, Finance and Regulation, Sovereign Investment Lab, Università Commerciale Luigi Bocconi. 6 According to the Sovereign Wealth Fund Institute ( the global assets under management of sovereign wealth funds as at March 216 are $7 trillion. Of this they estimate that $2.9 trillion is in the sovereign wealth funds of GCC countries. CBRE Research , CBRE Limited

14 The Middle East SWFs constitute a material part of global capital flows. From 28 to H1 216 they accounted for 9.% of all cross-regional investment into the 2 largest global markets. London and New York have been their favourite markets in absolute terms with purchases totalling US$9.4 billion and US$8.4 billion respectively. However, in relative terms their presence in New York (18% of cross-regional investment) and Paris (16%) is particularly strong. Middle East SWFs have made purchases of major strategic assets in Singapore, Hong Kong, Milan and Atlanta, which accounts for their overrepresentation in those markets. Looking at where they are under-represented in the direct market can also be informative as these might be targets in the future. The Australian markets Sydney, Melbourne and Brisbane are all in the top 2 destinations for crossregional real estate investment from all sources. However, they have attracted very little investment from Middle East SWFs. This may be due to the influence of diversification as a driver for SWF investment. Commodities play a major role in the Australian economy. As a result it may not offer the same diversification benefits to Middle Eastern investors as to those from other regions. San Francisco (8th), Berlin (1th) and Boston (11th) are also popular destinations for other cross-regional investors, but have been almost absent from Middle East SWFs shopping basket. FIGURE 14: MIDDLE EAST SWF INVESTMENT IN KEY MARKETS (28 - H1 216) US$ Billion Total Acquisitions Middle East Share of all Cross-regional Investment London New York Paris Singapore Hong Kong Milan Los Angeles Washington DC Atlanta South Florida Toyko Moscow Seoul San Francsico Boston Berlin Middle East Share (%) Source: CBRE Research, RCA CBRE Research , CBRE Limited

15 MIDDLE EASTERN HOTEL INVESTMENT IN EUROPE Authored by Joe Stather, Senior Analyst, CBRE Hotels Many GCC nations are looking to rebalance their economies so that they are less dependent on the volatile commodities market. The tourist industry is one of the industries being targeted. Across the region there are many examples of key infrastructure development: transport gateways, malls, theme-parks and exhibition centres, all of which help to drive visitor numbers. A further consequence is rapid expansion in the region s hotel bed stock. Investors and operators within the region have shown a strong belief in this economic goal. Encouraged by government incentives, they have committed to substantial hotel development despite the challenging trading landscape. There are 26 hotels (81,91 rooms) currently under construction in the GCC region, so the rapid supply growth will continue in the short to medium term. However, as a result, revenue per room (RevPAR) has fallen sharply in 216. The region s SWFs and Ultra High Net Worth Individuals (UHNWI) typically seek stability and security in their investments. As a result they have not concentrated their hotel investment in the domestic market. Instead, they have diversified through the acquisition of high-end, luxury assets globally. Such hotels attract significant investor interest. However, Middle Eastern investors low cost of capital and long-term outlook means that they are often able to out-bid the competition. The number of trophy hotels in Western European capital cities is limited and they seldom come to market. As a result, Gulf capital appeared to be moving further up the risk-curve. In 214 and H1 21 there were several hotel transactions outside the luxury tier and in less recognised cities. However, circumstances have changed. Since the middle of 21 GCC investors seem to have returned to their risk-averse approach. As is discussed elsewhere in this report, that change has not been limited to the hotels market or indeed to investors from the Middle East. SWFs and UHNWIs interest in high quality assets remains robust. This is shown by a number of recent transactions. Al Habtoor Group, on behalf of a consortium, recently purchased the palatial Hotel Imperial, Vienna for 7m ( 7,246 per room, yield of circa 3%). This was their seventh overseas hotel investment and second in 216. Nozu Hotels & Resorts also completed the purchase of The St. Regis and The Westin Excelsior hotels in Florence. Both are considered destinations in their own right owing to their cultural and historical values. Between 28 and 21 more than half (6%) of the investment in hotels from the Middle East has been into Europe. However, there are signs that investors are increasingly looking elsewhere as well. Most notable have been ADIA s acquisition of a % stake in three major hotels in Hong Kong and Al Faisal Holding s of The Manhattan at Times Square. In total, Middle Eastern investors purchased over $4 billion of hotels in Asia and the Americas in 21. This was more than in the previous seven years combined. Our expectation is that the low oil price and general risk aversion will continue to shape Middle East investors hotel investment. The result will be a more cautious approach and further concentration in very high quality assets, for which the price is high but the risk is relatively low. Lack of trophy asset opportunities has also resulted in other approaches to de-risk investment. The use of third-party operators has become more prevalent in the wider-hotel sector and is now being adopted by Gulf investors. It is also worth remembering that not all investment originating from the Middle East is the same. There are Middle Eastern investors with strategies very different from those typical of the region s capital. CBRE Research , CBRE Limited

16 4: CONCLUSIONS AND LOOK The increase in capital outflows from the Middle East to global commercial real estate in 21 was marked. It was driven by SWFs in particular those from Qatar and from the UAE. The evidence is that flows from the Middle East to global real estate will remain high as SWFs globally increase their weighting to real estate. The destinations of Middle Eastern investment in 21 and H1 216 show a departure from recent history, with substantial investment in North America (nearly all in the U.S.) and greater flows to Asia. Both of these had previously been under-represented in Middle East investment, so this suggests a move to a more balanced distribution of assets to achieve greater diversification. With substantial ground still to make up, this trend can be expected to continue. Looking further ahead, the main Australian cities, which are strongly favoured by other cross-regional investors, but have seen little investment from the Middle East, could also become targets. Diversification by sector also seems to be influencing investment activity. From 27 to 214, offices accounted for 4% of all outflows from the Middle East into direct investment in CRE. Although this is not far above the average for cross-regional investors from all continents, who have historically shown a bias to the office sector, it is well above offices 38% share of the overall market. Middle Eastern investors favoured alternative to the office sector is hotels, which represented 3% of investment in 21. We also expect the proportion of industrial to grow. Historically less than % of Middle East investment, industrial made up over 9% in 21. Industrial is typically a bigger proportion of the market in North America than in other regions, so if the strong flows to that region continue, so too should the growth in industrial investment. Over all of this sits the question of the property cycle. Market activity in H1 216 was well down on that in H1 21. However, we believe that this was due to factors outside the property sector which have since dispersed. The result of the U.K. s referendum has injected a new supply of uncertainty into global markets. To an extent this is balanced by the fact that global bond yields have fallen sharply and the yield gap of real estate over government bonds is bigger than ever. Michael Haddock Senior Director, EMEA Research FIGURE 1: REAL ESTATE SPREADS 216, PRIME OFFICE (NET) YIELD RELATIVE TO 1-YEAR GOVERNMENT BOND Americas Asia EMEA Pacific Prime Office Yield 1-year Government Bond Spread 6 4 Prime office net yield (%) Shanghai Hong Kong Los Angeles New York London WE Seattle Miami Bsoton Milan Seoul Madrid San Francisco Washington DC Chicago Paris Sydney London City Melbourne Atlanta Berlin Frankfurt Source: CBRE Research CBRE Research , CBRE Limited