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Smaller American cities are attracting investment capital from overseas

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There are four simple rules about capital investment, especially in commercial real estate: It will flow to where it's most wanted, where it's respected, where it's safe, and where it has the highest probability of market-rate adjusted returns.

And that’s exactly what’s driving international capital into commercial real estate right now in the U.S., in ways that will impact everything from rents to the eventual shape of our skylines.

Global investors, concerned by a cooling Chinese economy and ongoing concerns related to Brexit and the future of the European Union, are increasingly turning their attention to the U.S. for safety, cash-flow, higher returns and stability, bringing much of the investment capital that used to flow into Europe and China with them.

Some investment is even coming in from Venezuela, which is mired in strife and turmoil, and many other South American countries.

The result?

The big gateway city markets in this country—New York, L.A., and Miami, for example —where international investors tend to focus their attention, may be overheated. Prices in those cities, particularly in real estate, are reaching all-time highs, reducing the potential upside and pricing out even deep-pocketed investors.

As a result, major metros like New York may be in the 9th inning for investors — everyone is getting in their last at-bats. But the music could be over soon. All markets eventually cool off or plateau, as what goes up, comes down eventually.

Yet, there is another side to this trend that’s worth noting.

Given the overheated gateway markets, international capital is now seeking purchase in second-  and third-tier American cities —places like Denver, Phoenix and Nashville​.  In communities like these, the economic impact from energy (think fracking) and manufacturing (think self-driving cars) are likely to mean rising incomes and values. 

Some of these cities are just plain hot. The cost of doing business ​in Nashville, for example, is 20% less than the rest of the country. Others are experiencing population and job growth where investors are finding greater value and greater potential returns.

Salt Lake City, for instance, posted some of the fastest job growth in the nation last year at 3.4 percent and payrolls were at an all-time high. ​ And in Raleigh, N.C., highly paid millennials now account for more than 23 percent of the city's population.  They need places to spend that income and their spending will help other local businesses as well.

On the one hand, this is great news for the U.S. as more capital is infused into local markets, which creates construction jobs, provides new space for companies, and frees up capital for sellers of existing assets to deploy into other investment opportunities.

But the impact on prices in the tertiary markets remains a question. Excess capital has been inflating real estate prices in gateway cities for a variety of reasons, including foreign investors viewing them as more stable when held up against other, riskier overseas markets. This risk can take the form of both economic and political.

Over time, this trend may begin happening in places such as Oakland and Tulsa as overseas investors pile in, creating opportunity for the average American seller, and more competition for local buyers seeking to buy property in their own city. The potential is there to begin pricing out domestic buyers in mid-sized cities, much as they have been priced out of many major markets.

But one thing is clear: international interest in the U.S. is not going away.

In fact, the potential changes that are coming to domestic regulations, infrastructure spending, energy development and more all point to a U.S. market that will continue to be very attractive for overseas capital for the foreseeable future.

Brian Watson is Chairman and Chief Executive Officer of Northstar Commercial Partners

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