The multifamily housing market looks set to capture a larger share of the growing inflow of foreign capital into U.S. markets.

Many experts are also anticipating some of the growth will come from countries that haven’t been particularly active here recently, such as Pacific Rim nations, with Germans and Australians perhaps reducing their activities. Large, institutional-grade communities are expected to be popular with offshore buyers, but some experts believe there will be additional activity in mid-sized, stabilized Class A and Class B properties in second-tier “heartland” markets as well as currently over-supplied major markets in the next year or two.

What they want

By most accounts, less than 10% of the offshore dollars invested in U.S. income properties last year landed in the apartment category. Led by Australians, who have become the most active offshore investors by far in recent years, foreign players have focused most on high-profile office high-rises and shopping malls of late.

The quest for such trophy assets, along with particularly fevered competition (and hence lower investment returns) in the multifamily arena, help explain the general de-emphasis of the sector in recent years even as offshore investment activity has accelerated. Indeed, according to a recent survey by the Association of Foreign Investors in Real Estate (AFIRE), apartments are now at the bottom of offshore buyers’ shopping lists with respect to the major income-property types.

That’s a reversal from a half-decade ago. “Apartments have moved down the list as the investment of choice” for foreign investors, said Bob Safai, founder of investment brokerage Madison Partners. That’s mostly due to the “irrationally exuberant” prices many domestic investors have paid under optimistic assumptions about future rental-rate appreciation, and about where capitalization rates will be when a property is eventually sold, he said.

But offshore appetites may be doing another about-face. Safai and other sources suggest that some of the large offshore players are now taking aim at big apartment communities.

Most foreign apartment investors have tended to stick with small- and mid-sized properties in recent years, noted Hessam Nadji, the managing director overseeing industry research at investment brokerage Marcus & Millichap (M&M). But now some of the big offshore real estate players who traditionally targeted high-profile commercial properties are migrating toward the multifamily sector, he said.

And with new players supplementing active investors, Nadji observed that offshore capital flows into the domestic multifamily marketplace are already growing dramatically, even though apartments accounted for only 7% of foreign investments in real estate last year.

Foreign investment into U.S. apartments increased more than 18.5% to $925 million in 2005, up from $780 million the previous year, according to M&M. “We expect a similar rate of growth in foreign purchases of apartments this year,” said Nadji. At that rate, 2006 activity would approach $1.1 billion.

Meanwhile nearly two-thirds of AFIRE’s survey respondents indicated that their appetite for U.S. assets this year is stronger than it was a year ago. The association is anticipating about $21 billion in offshore investments into U.S. income properties this year, up from about $20 billion in 2005.

Where the investors are

Nadji expects to see more capital coming from Japan, China and Middle Eastern nations in the next couple of years, likely accompanied by a decline in activity from European investors including those from Germany, England and Holland.

In the West Coast markets where repositioning specialist Kennedy Wilson Multifamily Management Group is active, President and CEO Bob Hart is already seeing more Japanese capital joining some of the German investment funds. Illustrating that some offshore players (but certainly not all) are comfortable with joint venture arrangements, Kennedy Wilson Multifamily partnered with three Japanese investors in repositioning projects before selling a 20% stake in the multifamily group to Japan’s publicly traded Kenedix real estate company earlier this year for $9 million.

Australian investment funds and real estate companies, which are known for their U.S. retail property purchases, also remain “far and away” the biggest offshore force in the multifamily sector, added David Baird, national director of investment brokerage Sperry Van Ness’ (SVN) multifamily practice.

Aussies accounted for 44.4% of the offshore apartment investment activity last year, according to SVN and Real Capital Analytics (RCA).

Next up were U.K. investors at 26.7% of the activity, Middle East buyers at 15.3%, Germans with 8.7% and Pacific Rim investors with 4.9%. Baird also noted that some Canadian outfits are active in U.S. apartment investments as well as condo conversion and development ventures.

Madison’s Safai is also seeing more Chinese equity targeting U.S. real estate, a trend he expects to continue as the mainland increasingly embraces a market economy. He’s likewise seeing a new “trickle” of Korean capital.

As for global real estate investment strategies, for many offshore buyers it’s first a matter of seeking out the most attractive economy – and the U.S. wins hands down, according to Safai. Indeed, AFIRE reports that the U.S. has topped the global property appreciation list for a half-decade running. Then comes the tough task of determining which particular markets and property types will generate the best risk-adjusted returns.

Most of the active players don’t get as much bang for the buck back home, Safai and others explained. For example, Australian investment managers continue raising plenty of capital but there’s too much cash chasing too few available Australian properties, said Safai. “They’re just not getting the returns they want,” agreed SVN’s Baird.

Likewise, more investment capital is now “moving out of Japan” due to the still-low investment yields there as well as the higher profits stemming from economic improvement, said Hart.

“You look at their cost of capital, and U.S. yields look rich to them” despite the considerable erosion in U.S. apartment cap rates of late, Hart said.

Some offshore investors even see U.S. apartment properties as priced cheaply compared to their homelands, Baird said. For example, German investors might have to spend the equivalent of $200,000 per unit back home, earning a yield in the 4% to 5% vicinity. “But you can buy for half that [price per unit] here, and get a better cap rate too,” said Baird.

Desirable deals

Baird described the typical offshore investor as “mid-cap” in size. “Some of it is institutional,” he said, “but that’s not coming here at the pace we’re seeing with individuals and private groups.”

Most tend to seek professional property managers to contract with on a fee basis, rather than forming true equity joint ventures with local partners, he added. Real newcomers unfamiliar with U.S. marketplaces are more likely to form joint ventures, he said.

But most just don’t need equity contributions from local partners, and are looking to invest their cash profitably over long-term holds.

As for target property profiles, Baird agrees with M&M’s Nadji that some of the deeper-pocketed players will pursue more jumbo-sized apartment communities – but perhaps not the highest-profile properties in the best-known markets. “Most of the offshore players are reluctant to compete head-to-head with our [real estate investment trusts] for trophy properties in the major coastal markets,” Baird said. “So they’re looking more at secondary and tertiary markets.”

Many investors tend to target large deals and hence demonstrate a clear preference for sizable property portfolios or at least multiple large properties in a particular market, Baird said. RCA reports that offshore buyers accounted for only 2% of overall U.S. apartment investment activity last year – and 8% of the “core”-category deals (i.e., larger, stabilized communities). Foreigners also accounted for 12% of last year’s transactions larger than $100 million, and 8% of deals in the $50 million-$100 million range.

A lot of offshore investors today are also targeting markets temporarily facing “concession issues” so they can ride the upside as supply-demand fundamentals improve, said Baird. Hence offshore buyers have lately seemed focused to some degree on relatively over-supplied apartment markets such as Dallas, Denver and Atlanta.