Investment lessons: Outbound Middle East capital seeks emerging asset classes

The value of global commercial real estate investments declined by 29 per cent in H1 2020 compared to H1 2019, according to our latest figures, as the impact of Covid-19 became evident.

Despite this, Middle East investors remain active players on the international real estate stage, making purchases of more than $2.8bn in H1 2020 (roughly the same level as in the corresponding period of 2019). While the overall deal volumes remain mostly unchanged, there have been essential shifts in investment patterns.

Sector shift towards logistics
Middle East investors have become increasingly opportunistic over the past few years, more actively playing the cycles and riding global waves. This has remained the case over the past 12 months, with a notable increase in interest in the logistics sector and other emerging asset classes such as data centres, student housing, and senior living. Two significant drivers have shaped this interest: The availability of higher yields (in line with investors moving up the risk curve) and the strength of occupier demand, boosted by the rapid growth of e-commerce sales globally.

Investors from the Middle East respond to these trends by actively seeking opportunities to purchase existing logistics assets, as an investment in current income-generating assets – the likes of Amazon, DHL, FedEx, and Home Depot –  can achieve long term cash on cash returns of 7 per cent to 9 per cent per annum in some US markets.

Also, given the current shortage of suitable existing supply, some Middle East investors are considering funding new developments as returns of 30 per cent to 40 per cent are currently being achieved from the logistics sector. This marks something of a new venture as many Middle East investors have traditionally sought existing assets that provide income from day one.

Another critical driver of the move into the logistics sector is portfolio diversification, which helps investors ensure that their portfolios are appropriately positioned and can withstand cyclical downturns. In general terms, the logistics sector and other alternative assets are more defensive, being less dependent upon short term economic conditions and supported by long-term leases of 10-15 years.

The attraction of indirect investments
In addition to purchasing direct real estate assets, Middle East investors have also increased their exposure to real estate through indirect mechanisms such as funds, and the purchase of interests in both listed and non-listed companies holding real estate. While it is impossible to quantify this exposure with a high degree of accuracy, we estimate it could be more than $5bn, which places it on par with their investment in direct real estate in 2019.

Investing through these indirect vehicles offers Middle East investors greater diversification and smaller average lot sizes. Investing in funds also provides private individuals and local players with access to opportunities in a wide range of markets with little knowledge or experience. The theme of asset-based investment strategies operated by global fund managers are typically generating higher returns than more opportunistic or transaction-driven approaches.

Syndicating platforms
Another sign of the increased interest in direct investment has been the rapid growth of syndicating platforms as a significant source of outbound capital from the region over the past ten years. These investment vehicles pool together equity from various investors who share standard investment guidelines and allocate the equity to real estate assets on behalf of the investors on a deal-by-deal basis. Those groups usually have a 5-year investment horizon, use leverage for all of their acquisitions, and are mostly driven by the cash-on-cash metric.

Growth of private investors
One of the significant shifts evident over the past few years is private investors’ increased importance relative to the sizeable Sovereign Wealth Funds (SWFs). This trend has continued in 2020. Private investors, or High Net Worth Individuals (‘HNWIs’), have always accounted for a substantial share of the Middle East’s overseas investment flows. Today, many of them are increasingly concerned about the region’s geopolitical instability, translating into increased demand from HNWIs to invest in foreign real estate markets for diversification and wealth preservation reasons.

Our figures show that private Middle Eastern investors pumped almost $5bn into overseas real estate in 2019. In reality, this figure is probably something of an underestimate, as HNWIs typically use adhoc vehicles or entities named after the newly acquired building, making it difficult to link the transaction to a specific individual source. While future private investors’ forecasts should be treated with caution, we estimate that these flows from the Middle East could increase by circa 20 per cent per annum (to around $8.7bn by 2025).

Looking ahead
Heading into the last quarter of 2020, the real estate market will be met with uncertainty, as the impact of the Covid-19 is likely to remain uneven, favouring some asset classes over others. Sectors with resilient income such as logistics and industrials and some alternative long-income sectors such as healthcare and education, are likely to perform better.

The considerable levels of dry powder available in the market across the Middle East is expected to target diversification opportunities and long-term higher returns.

Fadi Moussalli is the executive director – International Capital Group at JLL MENA