How globalization impacts Asian capital flow into U.S.
Randall Zisler, Ph.D.
Chairman and co-founder, Zisler Capital Associates LLC, Denver
Globalization entails closer integration of the countries and peoples of the world. The failure of our world is not that we have too much globalization, but that there is too little.
“Who imagines that the welfare of Americans would be improved if their economy was fragmented among its 50 states, each with prohibitive barriers to movement of goods, services, capital and people from the others?” writes Martin Wolf in his book, Why Globalization Works. “In such a Disunited States without interstate direct investment, capital markets or trade, the decline in standards of living would be precipitous.”
Matthew Zisler
Co-founder and managing principal, Zisler Capital Associates LLC, Denver
Globalization can have profound long-term effects besides enhancing trade. Trade helps introduce and diffuse goods, new ideas, people and disease. However, globalization is not an unalloyed good. For example, the Black Death, or the bubonic plague of 1348, originated in Asia and followed the trade routes through the Black Sea into the Mediterranean and then spread throughout Europe, reducing the population between 35 and 50 percent. The plague dramatically changed the ratio of wages to land rents and helped bring about significant technological and political change, the Protestant Reformation being just one example.
Cross-border real estate capital flows. We learn in introductory economics that capital should flow to developing countries where there is a capital shortage. However, in practice, we find that the net capital flow is from developing to developed countries, where there is a capital surplus. Net real estate capital flows from developing to developed countries (Asia to the U.S. and Europe), and from developed to developed countries (U.S. to Europe). A more sophisticated view is as follows: Developed countries have more secure and better defined property laws, deeper and more developed capital markets, greater macroeconomic stability, impartial courts, less graft and greater political stability.
China and other Asian Pacific countries continue to generate significant current account surpluses, which they invest primarily in the U.S. and Europe and in many assets classes, real estate being just one. The U.S. runs a large and growing current account deficit, drawing in the world’s available surplus. Our country is a net importer of goods and a net exporter of dollar-denominated financial claims, much of which the owners of these claims, developing countries, invest in the U.S.
In a closed economy, savings must equal investment. However, in a globalized economy, goods, services and capital flow across the borders of open economies. In an open economy, such as the U.S., savings need not equal investment. The difference is the current account, which equals either savings minus investment or, equivalently, net exports and net investment income. The U.S. trade deficit is approximately equal to the trade surpluses generated by South Korea, Japan, Singapore and China.
Of the capital flows from the U.S. destined for offshore property markets, 65 percent targets Europe. And 46 percent of capital that flows into U.S. property comes from Asia or the Middle East.
The wall of Asian property capital. There is a myth of the Asian wall of capital. Brokers often say that the flow is so great, especially in the gateway cities, that the flow distorts prices. However, capital flows into U.S. property comprise a very small percentage of total property flows, even in gateway cities. This inflow is less than 4 percent of the total inventory. These flows likely do not affect average property prices.
This leads some to wonder, do Asians overpay? Asian capital flows generate big headlines, but anecdotes – even those promoted by brokers – do not constitute evidence. Asians are more likely to buy lower cap rate properties than U.S. or other foreign investors. This observation reflects, in part, their preference for central business districts and gateway cities. Their preference for gateway cities may reflect the unsupported assumption that gateway cities offer greater liquidity at the time of exit.
Using a database of 22,504 office and industrial transactions from 2000 to 2016, we econometrically modeled cap rates, statistically controlling for many variables. Average cap rates (holding other variables constant) are 46 basis points lower for Southeast Asian investors or, equivalently, prices are 6.2 percent higher.
Do these investors overpay? In the short run, maybe. Over the longer run, they most likely do not. Asian investors, in their zeal to establish secure investment beachheads and exercise first mover advantage in the U.S., while minimizing mistakes, may be able to justify aggressive pricing. Asians do not necessarily overpay.
Asian investor perceptions and opinions. Asian Pacific investors embrace, often uncritically, the following preferences (in descending order of priority):
- Diversification. Are most investors naïve diversifiers? Yes, and Asian investors are no exception.
- Market timing. Are investors closet timers? Yes, and with dubious results.
- Liquidity. Many think, let’s focus on gateway cities! Even though 70 percent of institutional-owned property is located in gateway cities, liquidity is not a function of metropolitan statistical area size.
- Bond-like characteristics. “Real estate is a bond substitute.” More often than not that claim is true, although tenanted real estate is a hybrid asset with bond- and equity-like features that can be mutually reinforcing or offsetting.
- Growth. The goal of investing in high-growth markets is not necessarily a good idea. Higher-growth cities typically are smaller cities and often are more volatile.
We conclude that Asian investors probably suffer from the same biases, misinformation and received wisdom as U.S.-domiciled investors.
Good news for Denver. Asian flows into the U.S. real estate market likely will increase substantially over the next 20 years due to dramatic Asian wealth creation, persistent U.S. trade deficits and a still attractive U.S. real estate business climate.
As Asian investors acquire more experience, net capital inflows will diffuse to nongateway cities, such as Denver, which will receive a proportionately higher share of the net flows from Asia. Nongateway city cap rates may compress as a result of the growth and reallocation of these flows. Asians today are more likely than U.S. or other foreign investors to buy lower-cap-rate properties – 46 basis points lower.
