After years of record foreign office acquisitions in DC, overseas capital ebbs for the first time since the recession
Net foreign investment sharply declined in 2018 and fell into the negative in Q1 2019
Though overseas capital flooded the Washington, DC office market at record levels from 2015-2017, net foreign investment (purchases by foreign investors minus dispositions by foreign investors) sharply declined in 2018 and fell into the negative in Q1 2019. As the nation’s capital, this government-anchored, cyclically durable and globally recognized office market will always hold appeal for foreign buyers, but a number of factors have created headwinds recently for cross-border investment:
- Lack of Trophy offerings: Foreign investors in Washington, DC heavily favor the downtown Trophy office segment, and over the past few years, there has rarely been more than one Trophy asset for sale at a time. It has been seven months since the last Trophy sale, and there is currently just one Trophy building being marketed. For comparison, over the preceding five years, a Trophy office building traded hands every four months on average.
- Pricing/rent disconnect & cap rate compression: The competition for DC’s limited Trophy offerings has led to a series of record-priced sales over the past few years despite a complete lack of underlying rent growth. In fact, Trophy rents declined by 2.4% between 2017 and Q1 2019. Absent any growth in rental income, Trophy cap rates compressed to an average of 4.0%-4.25%, pushing many investors to seek higher yield in other real estate markets or other asset classes altogether. A thinning buyer pool in the face of elevated pricing expectations caused nine buildings to be pulled from the market in 2018 after failing to achieve their pricing guidance, including two that were targeting more than $1,000 p.s.f.
- Rising hedging costs: Fluctuations in the U.S. dollar have driven up the hedging costs associated with owning dollar-denominated assets including U.S. real estate. Currently exceeding 2% of total investment for European buyers, these costs erode potential returns and dramatically narrow the field of office investment opportunities that make financial sense.
- Tightened CFIUS restrictions: As a result of the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), a broadened range of foreign investments are subject to review by the Committee on Foreign Investment in the U.S. (CFIUS). This process has the potential to impede or prevent foreign purchases of buildings that are leased to the federal government or are even proximate to such buildings. Needless to say, a sizeable portion of the Washington, DC office inventory falls into these categories.
- Although these factors have dampened demand and volume in Q1, expect foreign capital to return to Washington, DC over the remainder of the year. There are currently four stabilized, core-profile Trophy/Class A offerings on the market alongside an additional six coming to the market, according to JLL Research, and these opportunities are certain to attract overseas investors.
Source: JLL Research