Real estate has long played an integral role in global investors’ portfolios, and there is a shift occurring in markets where the investment capital is flowing. For the past two decades, when foreign investments surged from places like China, Canada and Europe, there has been very little change in the markets where these investments were placed. Los Angeles, New York City and Washington, D.C. have historically been the targets of foreign investors, but recently interest in secondary markets has skyrocketed.

Changes in Core Markets

Over the last several years, the makeup of foreign investments in core markets like New York City has shifted. Historically, the majority of capital flowed into Class-A trophy office deals. Currently, markets are experiencing increased activity, albeit at smaller transaction sizes. So, what does this shift mean? David Amsterdam, President of Investments, Leasing and Colliers’ U.S. Eastern Region, states, “this tells us that foreign investors are looking for opportunities in different market segments. They can’t find an appropriate risk-adjusted return on trophy office deals, so we are seeing a willingness to invest outside their traditional investment spectrum, to capture yield. Sometimes this means investing in different asset types as well as classes and sometimes this means investing outside of these core cities entirely and instead looking to secondary markets.”

Valley of the Sun and Investment?

Phoenix, AZ is an attractive market for a variety of reasons beyond the 300+ days of sunshine a year. Home to Arizona State University — with more than 4,000 graduates a year in their engineering and biotech programs — the Phoenix labor pool is one of the most skilled in the nation. It’s no wonder there are more than 80 tech companies along the 101-loop alone. Phoenix, with its population of more than 1.5 million people, is the most populous capital city in the United States (4th largest overall), posting the second-highest population growth in 2017.

People are flocking to this sunny mecca, along with solid cross-border investments. While the #1 metro for cross-border investment was New York with $5.5 billion in the first half of 2018, Phoenix came in at #6 with $1 billion, only behind the other primary U.S. investment markets of Los Angeles, Washington, D.C., San Francisco and Chicago.

What’s even more remarkable is the number of single transaction deals that occurred in Phoenix for the first half of 2018. While monitoring all the capital flowing in is a strong indicator of foreign interest, much of that can be attributable to a portfolio, where the investor isn’t singling out a specific market. Yet, in 2018 there were 80 transactions in Phoenix by foreign investors.

What is the driving force for investment in the market?

In the case of Phoenix, it’s multifamily driving the market. Multifamily investments provide foreign investors a sense of security since the financing options are non-recourse to the investors and there is overall demand for housing. Foreign investors like the security of the U.S. economy compared to other countries and the tangibility of real estate as an investment. Phoenix is attractive compared to other cities in the U.S. due to both employment and population growth. The Phoenix-Mesa-Scottsdale market has posted growth rates well above its long-term average over the past three years, according to the RealPage Q3 2018 Apartment Market Report. In turn, this makes investment in multifamily real estate one which is accretive and will see an increase in capital values.

Slow and Steady Wins the Race: Minneapolis

While Phoenix is a high-growth city attractive to foreign investors, another city is also gaining quite a bit of traction in terms of foreign capital: Minneapolis, MN. Colin Ryan, Senior Vice President of Investment Properties at Colliers International says, “Minneapolis may not be as high-profile as its larger cousin, Chicago, but the diversity of businesses provides an ideal hedge against a slowdown in any one industry. This, coupled with an affluent and growing population base triangulate to the exact investment thesis foreign investors are looking to capitalize on.”

From food to finance and healthcare to retailers, some of the highest quality brand name companies in the world call Minneapolis and its twin city next door, St. Paul, home: Target, United Healthcare, Best Buy and General Mills are just a few. Of all the Fortune 500 companies in 2018, 18 are headquartered in the Minneapolis/St. Paul metro area, amongst the highest Fortune 500’s per capita. Beyond public companies, the Twin Cities are home to Cargill, the largest privately-owned company in the U.S. with 150,000 employees and $110 billion in revenue.

Most foreign investors already own assets in Chicago, New York and Los Angeles and are now looking to expand their investment targets to capture the upside embedded in key secondary markets like Minneapolis. With an average cap rate of 6%, the yield premium is +100 basis points greater than Chicago and nearly 200 basis points greater than NYC, D.C. and San Francisco. The market has grown significantly over the past several years, at #16 for CB investment in 1H18 compared to its #30 spot in 1H16. With a premium yield and a strong employment base from multiple industries, Minneapolis becomes a logical and attractive market for inbound capital.

Risk Diversification is Changing Investing

While foreign investors will seek iconic, trophy Class A-office buildings in major markets like New York, Chicago and Los Angeles, diversification of risk is changing the nature of investing. With cap rate compression and tepid fundamental growth in some primary markets, investors are capitalizing on higher growth markets that provide premium yields with a safe and secure economic base like Phoenix and Minneapolis. Other secondary markets are poised to benefit from this investment strategy, and it’s only a matter of time before additional markets experience this foreign capital investment growth.

This article was written by the U.S. Colliers Editorial Board, whose mission is to produce new and noteworthy commercial real estate thought leadership pieces to create conversation around proactive content. The Editorial Board focuses on CRE trends in the United States, and is comprised of Colliers marketing, research, communication and service line leaders.