Why Chinese companies rush to buy Manhattan's commercial property

Chinese investors' rapidly growing appetite for high-profile U.S. commercial properties has been highlighted as China's Anbang Insurance Group Co., the buyer of luxury hotel Waldorf Astoria, has agreed to buy 21 floors of an office building on the famed Fifth Avenue in Manhattan, New York City, recently.

The coveted building is located at 717 Fifth Avenue on East 56th Street. Anbang will buy it from Blackstone Group, the leading U.S. private equity firm. The cost would be between 400 million to 500 million U.S. dollars. It is said that Anbang would only buy the office portion, which starts from floor 5 to 26. The first four floors for retail are not included.

This Chinese insurer has made headlines with the acquisition of Waldorf Astoria, the landmark hotel on Park Avenue last October. Under the agreement, Anbang purchased the iconic luxury hotel for 1.95 billion dollars from Hilton Worldwide Holdings.

Anbang Insurance Group Co. is one of China's comprehensive group companies in insurance business. According to corporate sources, Anbang has been developing stably and reached a total asset of 800 billion yuan (about 130 billion U.S. dollars).

Anbang is not alone. Other Chinese companies are also caught in the craze of buying into Manhattan commercial real estate, which is regarded as a "safe heaven."

In June 2013, the family of Zhang Xin, chief executive officer of Chinese real estate developer Soho, together with a Brazilian partner bought a 40 percent stake in General Motors Building for about 700 million dollars. Shanghai-based Fosun International Ltd. bought the One Chase Manhattan Plaza, the landmark building of lower Manhattan in December 2013 from J.P. Morgan Chase & Co. for a consideration of 725 million U.S. dollars.

Also, the Bank of China reached a deal in December to buy a Manhattan office tower for nearly 600 million dollars.

Chinese companies believe that they could achieve stable returns from the U.S. commercial real estate. "Given the strong performance in the past, the group intends to realize long-term stable investment return by investing in high quality real properties in North America. Going forward it will increase the share of overseas assets in asset allocation, taking Europe and North America as priority areas," Anbang said after its Waldorf acquisition.

The recovering of U.S. economy has boosted the rents and transactions of office buildings, especially in big cities like New York. And foreign buyers are going after top-of-the-line properties in Manhattan.

The New York City property investment sales market saw 442 deals close last year, shattering the previous record of 346 deals in 2007. The year of 2014 was also the second most active year in terms of dollar volume, with 39.8 billion dollars in business volume, second only to the 48.5 billion dollars struck in 2007, according to a report of Jones Lang LaSalle, a real estate consulting company.

Looking forward, "foreign capital is likely to continue to aggressively pursue opportunities, seeking long-term capital appreciation in what is viewed as the world's largest and most stable market. The dollar is also rising against major currencies. Dividends and future sale prices will be exchanged in appreciated dollars to foreign investors. With many local private market and private equity funds also actively looking for new properties, there will be no shortage of demand for Manhattan office buildings, " Commercial Real Estate service company Colliers International said in a recent report.

For many Chinese companies, overseas investment is also a kind of asset allocation diversification. Anbang said it has developed a well-structured global strategy to seize the opportunities brought by economic globalization and deliver services to customers around the world following their steps of "going global. "

Slippery Situation: Oil’s Potential Impact on Real Estate

While it’s certainly good news for the majority of consumers, the sliding cost of oil and gas could gum up the works for some real estate owners and investors.

With crude oil prices hovering around $50 a barrel since the beginning of the year, industry watchdogs are voicing concerns about the threats to particular real estate markets and CMBS transactions.

Oversupply and weak demand have pushed crude oil down more than 55 percent from its recent peak of $107 a barrel in June 2014. For the regions and commercial assets that are fueled by the petroleum industry—including parts of Texas, Colorado and North Dakota—sustained low oil prices could lead to vacancies and reduced property incomes, several real estate observers cautioned.

That, in turn, could bring on a new wave of delinquencies on highly leveraged properties, as well as increased volatility in high-yield bonds, some said.

“What people are most worried about is exposure to real estate markets with a lot of oil-services tenants,” Trepp Senior Managing Director Manus Clancy told Mortgage Observer in mid-January, noting that so far the impacts are largely theoretical.

“Upon re-leasing, the office tenants in those spaces would look to either give up space or spend less money,” he said. “Houston seems to be ground zero for that concern.”

Mr. Clancy said the submarkets at greatest risk are the oilfield “man camps” in West and South Texas and North Dakota’s Bakken shale region, where oil workers drill for fresh supply.

“These are places where there may be a couple of limited-service hotels and multifamily properties and everyone is there just to drill,” he said. “Those will be the first places to close up and die if oil remains in the $40 to $50 range.”

Jana Partners, an activist hedge fund that once held a major investment in the recently spun-off oilfield lodgings company Civeo Corp. sold its entire $51 million stake in the Houston-based firm on Dec. 30, 2014, regulatory filings show.

The New York-based fund dumped its 12 million shares after Civeo announced plans to severely cut its 2015 spending to between $75 million and $85 million, from $260 million and $280 million in 2014, as previously reported. Civeo plans to close sites and further reduce its North American workforce.

Civeo’s stock closed at $3.14 a share on Jan. 21, down from about $25 a share in October 2014. Representatives for Jana and Civeo declined to comment.

Several other Houston-based companies that specialize in oil and oil services, including Baker Hughes and Schlumberger, have announced budget cuts and layoffs. Overall, oil company analysts have said they expect 500 to 800 U.S. drilling rigs to come out of service in 2015, the Houston Chronicle reported in late December.

Likewise, CMBS deals backed by properties with heavy oil-related tenant bases could also take a hit if oil prices remain at a sustained low for several months or more, according to Trepp and other industry sources.

“For the Houston market, the concern is that if you just took out a $100 million loan on an office property where you have three big energy tenants, your grade-A tenants may start to look like grade-B tenants,” Mr. Clancy said. “If oil prices remain low, the securitizer may wonder, ‘Will they shrink their square footage? Will they go out of business?’ he added. “Nobody can say for sure what will happen to these guys, so that’s where all eyes will be.”

One prominent B-piece buyer who spoke at CRE Financial Council’s January 2015 conference in Miami Beach said that some recently issued securitizations for non-prime Texas developments are in jeopardy with oil and gas prices down. That buyer, who could not be named due to a strict conference policy on attribution, said those CMBS loans had been originated with high loan-to-value ratios and that the properties’ projected revenue streams relied on continued oil sector growth.

Now that that growth has been stymied, the panelist said he fears the loans may be headed to special servicing in the near future. That speaker and other industry representatives at CREFC declined to go on the record with their comments.

To be sure, others see the drop in oil prices as a minor concern in the context of a stable economy and rejuvenated real estate industry.

“The geographic diversity of other assets in multi-borrower deals will mitigate oil price exposure for CMBS,” Mary MacNeill, managing director of U.S. CMBS at Fitch Ratings, told Mortgage Observer.

There are no records of a single-asset securitized loan on a property in Texas, according to Fitch. However, the loan could still bring down the cash flow of securitizations that hold other mortgages.

“Vacancies in certain markets will rise over time if oil prices stay low for a more protracted period,” said Ms. MacNeill. “Particularly for office properties in Houston or other oil-dependent markets.”

The city of 2.1 million people, which is commonly referred to as the “energy capital of the world,” houses more than 5,000 energy-related firms, according to city government data.

Among several buildings in Houston that could be exposed are two office properties: Two Westlake Park at 580 Westlake Park Boulevard, owned by Houston-based Hicks Ventures, and Two Allen Center at 1200 Smith Street, owned by Brookfield Office Properties, loan documents provided by Trepp show.

Two Westlake Park is 80 percent leased to ConocoPhillips and BP, while Two Allen Center is 52 percent leased to U.S.-based natural gas and oil producer Devon Energy Corporation. Civeo is based in nearby Three Allen Center at 333 Clay Street, also owned by Brookfield.

The Devon Energy lease does not expire until 2020, which gives the space “minimal near-term exposure,” according to a Brookfield spokesperson.

“While Houston is considered a resource market, its economy is clearly more diversified now than it was during the ’80s and ’90s,” said Paul Frazier, head of the real estate giant’s Houston region. “Furthermore, the mid-stream and down-stream sectors of the energy space are also prominent in our economy, which gives us a hedge against lower commodity prices.”

Tom Fish, co-head of real estate investment banking in JLL’s capital markets group, also said that Houston’s economy and real estate market are adaptable enough to handle a shock to the oil industry.

“I don’t expect developers and projects to be going bankrupt or for there to be a string of foreclosures because of over-leveraged debt,” said Mr. Fish, who is based in Texas’ most populous city. “The capital markets for new development are efficient enough to withstand distress in the market,” he said. “I was here during the oil downturn of the ’80s and I don’t think we’re there again.”

Still, Mr. Fish said that there are concerns about the future of office and high-end multifamily properties in Houston with crude oil prices at such a low.

“Those have been the two most active sectors of construction in our city for the past few years,” he said. “If oil prices were to stay below $50 a barrel for several years, it would take its toll, but we are a long way from reaching a point where we see a lot of defaults.”

For the time being, low oil prices create a boon for retail companies, medical facilities, technology firms, and low- to moderate-income residences, Mr. Fish said.

“We’re a consumer-driven economy,” he told Mortgage Observer. “There’s no better way to turbocharge that than to put money back into consumers’ pockets.”

Is Houston the Next Gateway City?

Institutional investor demand for Houston commercial real estate, coupled with job growth, a less expensive cost of housing and movement of oil and energy industries into the city is leading local players to predict that the most populousmetropolis in Texas could become the next gateway market. "Houston has always been a strong market for institutional investment, but it is now viewed as a gateway city," Kevin Roberts, the southwest president at Transwestern, said. "Today, it is considered one of the top tier investment markets in the U.S."

Las yea, the city was ranked fourth in the U.S. for foreign investment and fifth globally, according to the Association of Foreign Investors in Real Estate. "This was a huge improvement since not all that long ago, Houston was not a primary investment market for foreign capital, because most foreign investors were going toward gateway markets such as Los Angeles, San Francisco, New York, Washington, D.C., and Boston," Tom Fish, executive managing director at JLL, said. "[The city has] recently been perceived as a gateway market in the eyes of foreign investors, and [it] now has a healthy amount of foreign bidders."

Consolidation of the oil and energy industries into Houston has created internationally competitive jobs that draw foreign capital to the region, Kevin Roberts, the southwest president at Transwestern, said. He explained that Houston is predicted to be the number one supplier of oil and gas in teh United States in 2015.

Because of this, there has been a rapid increase in foreign investment from Mexico as well as an in-migration trend, according to Jan Sparks, managing director of structured finance at Transwestern. "There is significant influx of wealthy Mexican nationals into Houston, predominantly in Mexico City and Monterrey. Houston offers a stabilized, safer environment for them to raise their families and conduct their business. Commuting to numerous cities in Mexico from Houston is easy and inexpensive. They can get in and out of Mexico in the same day if they desire," she said.

The city has seen in-migration from the Northeastern, Midwestern and Western parts of the U.S., Roberts said, as people seek to take advantage of low-tax business opportunities. "Our governor has been very aggressive in trying to attract people to those businesses," Fish said. "The one thing that is interesting about the oil business is that it's not just people in hard hats drilling. It also produces an enormous amount of technology jobs, and a lot of people are coming in from places like California to fill those positions."

 

Job growth in Houston, which is seeing 80,000-100,000 new jobs created each year, is close to double the national average, Fish said. This means the office sector has seen a lot of demand, Sparks said, as it has been an efficient way to place large amounts of equity for the past two years. Houston now has more office space under construction than any city in the country, according to Fish, a vast majority of which is already leased.

 

Multifamily is also one of the leading product types in Houston this year, Roberts said, with more than 17,000 multifamily units delivered in 2014 and nearly 15,000 of those units abosorbed. "Many members of Generation Y are coming in and renting these urban, multifamily units," Roberts said. "Sixty percent of Generation Y renters think that they'll move within the next five years, so they're willing to pay up for apartment units because they are renters by choice."

 

With all of the new construction, Fish said that he believes there is enough discipline in the market to limit it to the best products that are able to get capitalized. "We have had a terrific four years of double-digit rent growth, and as long as we continue to experience the job growth that we are now, I think we'll be able to absorb the units that we have coming in," he said. "Even though construction prices are going up because of the heightened labor market, I think the future of Houston looks pretty healthy. There's always a little bit of caution about what will happen in the oil industry, but I'm very optimistic."

 

Although the market in Houston has been favored among investors for a couple of years, according to Roberts, he doesn't believe Houston has seen its peak yet. "Many use baseball analogy that we're in teh middle innings of an extra innings baseball game," Roberts said. "Fundamentals in Houston and the economy's supply and demand equilibrium are very much in check, and I do believe that this current cycle will have a very nice run. I don't think we're close to the end. I think we have several years in the future to enjoy this momentum and continue to build on it."

Liquid Apartment Lending Market Sees Conduits Rising

Commercial mortgage-backed securities lenders are gaining market share in the apartment market as Fannie Mae, Freddie Mac and the life insurance companies have been less active  than during the same time last year.  "The agencies have become more active after starting the year slowly," said Faron Thompson, international director in JLL's capital markets group. "Borrowers have more choices than they've had since 2007. There are a number of different programs and a complete smorgasbord of opportunities."

There were about $706 million of new apartment loans in the first half of 2014 - about 2% less than during the same period in 2013. But Fannie Mae, Freddie Mac and the life insurance companies have seen their volumes drop about 13% year-over-year, according to a new report from JLL, citing data from the Mortgage Bankers Association. CMBS Lending volumes are about 19% higher.

Although Fannie Mae and Freddie Mac had a slow start to the year, this changed after Mel Watt to the reins of the Federal Housing Financing Agency in February. Watt succeeded Ed DeMarco, whose tenure was marketed by curtailing lending efforts with the aim of making Fannie Mae and Freddie Mac smaller and smarter. "[Watt] wanted Fannie Mae and Freddie Mac to make smart loans and well underwritten loans. He was not trying to put them in a volume box or keep them from responding to the market's needs," Thompson added.

Market participants have observed that in recent months, the GSEs have worked hard to be more competititve with the conduits. Dan Lisser, principal and senior managing director at Johnson Capital, observed that the GSEs became more aggressive when restrictions under DeMarco, such as reducing portfolios by 10% annually, were lifted. "For borrowers, [the liquidity] will continue to keep cap rates low as they can get attractive financing," Lisser said. "It will be very good for sellers as well, as they will see great pricing."

Peter Donovan, a senior managing director at CBRE, told REFI he is not surprised to see the increase in competition from the agencies. "I think they're doing it in a disciplined way," he said. "I dont like the word 'aggressive,' because I don't see it as a bad thing. This is not 2006 or 2007, where underwriting has seemed to go a little too far. It's always been fairly compeititive, but in a healthy way."

Thompson noted that earlier this year, CMBS pricing was almost in line with the GSEs. "But right now, agency pricing is anywhere from 15 to 35 basis points tighter. The gap has widened again," he added, noting that gSEs offer a product that is more customized that the so-called "cookie cutter" CMBS loans.

Ray Potter, founder of New York-based advisory company R3 Funding, illustrated. In March, the firm was working to arrange a loan on a portfolio of Class B apartments in Gates, NY, that was shopped to CMBS and GSE lenders. At that time, the CMBS lender was the aggressive. But three months later, the same borrower was looking for a loan on six similar properties in the same area. This time, a Freddie Mac lender offered termes that were much more aggressive, including a four-year interest-only period and a spread that was 20 bps tighter. "It was a pretty easy decision to go with the Freddie Mac lender - there was more IO, more proceeds and a tighter spread," he added.

There continues to be a divergence between the type of borrowers that CMBS lenders and GSEs are looking for. CMBS lenders tend to offer higher pricing and pursue smaller borrowers, Donovan noted. Both groups of lenders, however, are similar in terms of client base and execution. That means increased competition from Fannie Mae and Freddie Mac may affect borrowers in small ways, such as providng another year of interest-only or a particular structure that is more effective, he added.

On the syndicated lending side, the GSEs are about 20 basis points cheaper than the bank market right now. "But if you compare teh syndicated loan product to Fannie Mae and Freddie Mac, it's very different. The execution is more like a CMBS loan, whereas we are floating-rate, three- to five-year lender," Galligan said.