Industry Insights

Forum Highlights Strong Real Estate Market, Confidence in Raising Equity

February 2015

Once again, the annual West Coast Information Management Network Winter Forum was attended by hundreds of senior real estate executives representing fund sponsors, investors and lenders as well as an array of professionals serving the real estate opportunity and private fund investing space in the U.S. and abroad. Here are a few key takeaways from talking with forum attendees and attending sessions and panelist discussions about a range of current trends and economic developments affecting real estate developments, fund sponsors and private investing.

Investment Sources

It appears the U.S. real estate market is enjoying a period of increasing valuations across the board, fueled by a strengthening economy and a flood of generally positive economic indicators for employment, wages, consumer spending, inflation and continued availability of cash in the queue awaiting deployment through lenders and equity providers. The Federal Reserve’s official end to its quantitative easing program hasn’t affected the outlook in the near term. Declining oil prices, while buoying consumer spending, could impact real estate valuations in certain markets in Texas, Oklahoma, the Dakotas and Wyoming if low prices are sustained for any significant length of time—and many believe oil’s short-term declines could be with us for a while.

In addition, a poll of U.S. and foreign fund managers showed confidence in raising capital for closing the equity needs of new funds in the pipeline is high, at least through the next 12 to 24 months. Beyond 24 months, however, the crystal balls became cloudy and expectations were far less clear.

Of particular note was strong sentiment with respect to Asian investments in U.S. real estate, especially for established markets in larger U.S. cities. High-quality real estate with attractive locations is attracting the most attention from both U.S. and Asian capital. Panelists noted Asian capital is seeking security in U.S. real estate and, depending on which of nine Asian regions capital is originating from, expectations for cash returns are down in the 4 percent to 6 percent range. Based on comments from a panelist working in the Asian niche, Asian capital has few alternatives at home with the perceived safety of U.S. real estate. Capital from U.S. counterparts, on the other hand, is seeking returns at least 200 basis points higher—and in many markets, expectations are much higher. Equity transactions dominate funding from U.S. capital sources while Asian sources are seeking a blend of equity and debt transactions. Asian capital is at the beginning of a cycle of deployment into the U.S.—capital from these regions is being amassed by Asia’s emerging economies. As these economies develop, an acceleration of capital inflow to the U.S. is expected.

By and large, U.S. capital seeking real estate is sticking close to home. Assembling European real estate requires knowledge of more than 50 niche markets—unless U.S. investors have experienced local knowledge and feet on the ground, it’s difficult to manage the risk in Europe. While the Fed ended U.S. monetary easing, the European Central Bank launched its government bond-buying program, which is expected to pump hundreds of billions in new money into the eurozone. There likely will be more to come regarding Europe.

Real Estate Fund Trends

The overall sentiment is there’s not much U.S. tax or regulatory headwind impeding real estate fund development, syndication and investment, except in states like California, Illinois, New York and Pennsylvania, which go after taxes on fund management fee income by sourcing the income based upon the state of residence or domicile of fund investors. The IRS also continues its crackdown on companies set up as limited partnerships to avoid self-employment tax on net-cash-flow distributions to limited partners, making it risky to continue structuring management companies in this manner.

Finally, the U.S. Department of Treasury has issued proposed regulations on the allocation of partnership liabilities and disguised sales. The proposed regulations cover four major provisions:

  • Changes to the allocation of recourse partnership liabilities under Section 752 that could cause many obligations that would be recourse under the current regulations to be treated as nonrecourse obligations
  • Changes to provisions related to the allocation of excess nonrecourse obligations under Section 752 that would change the current profit-based allocation to one based on a liquidation value percentage
  • Clarifying changes to Section 707 disguised sale regulations regarding the exception for debt-financed distributions of preformation expenditures
  • Effective date provisions, including the seven-year transitional rule applicable to the allocation of recourse partnership liabilities

If made final, these proposed regulations could affect funds that make certain debt-financed distributions as well as partners relying on the current regulations for partnership liability allocation.

Additional Topics

Panelists view the Foreign Account Tax Compliance Act as the new Y2K—although it was initially seen as problematic from a compliance perspective, it’s now seen as having few significant implications other than documentation and timely filings. Compliance with U.S. Securities and Exchange Commission registration requirements for fund managers providing investment advice with respect to securities with $100 million or more under management was covered again this year. Those planning to raise capital by selling limited partnership interests in funds holding real estate exceeding $100 million should seek legal counsel. Those required to register must adopt a customized compliance program; they also may be subject to financial statement audit requirements and a host of other compliance requirements.

One trend discussed during the forum was the millennials’ impact on the real estate market. The choice of housing for this generation is not necessarily dependent on where a person’s job is located. Instead, location comes first and finding jobs second. The growth of “18-hour” cities in secondary markets is increasing the demand for downtown multifamily units offering high-end amenities, such as communal space and accessibility to mass transit.

In addition, ecommerce is changing the development of distribution centers. With consumers no longer accepting long shipping delays, ecommerce retailers are moving away from having a handful of large distribution centers to having smaller distribution centers throughout the country, putting retailers closer to the end purchaser and reducing shipping times and cost.

If you’d like more information about these topics and how they could affect your organization, contact your BKD advisor.

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