By Michael Brick
The New York Times

1/1/2003

SAN ANTONIO, Dec. 26 — An influx of investment capital from both Arab and Israeli investors, in roughly equal proportion, has made the Middle East the second-largest source of foreign investment in United States commercial real estate this year after Europe, where changes in German pension fund laws contributed to a surge in investment in American properties.

Within the last year, seven apartment complexes in San Antonio and six more throughout Texas were purchased by Alon U.S.A., based in Dallas, a subsidiary of the Alon Israel Oil Company, best known to American consumers for its Fina gasoline stations. The company paid about $180 million to United Dominion Realty Trust for the complexes, which were built from 1983 to 1995 and range from 140 units to 596.

Oil companies are major sources of the investment in American commercial real estate, as are wealthy families that have a long history of quietly investing in commercial real estate in the United States.

Increasingly, though, more money is coming from smaller investors and groups of investors. That shift is a product of a decade or so of efforts by financial institutions and money managers to create investment vehicles that can be marketed in the Middle East, especially to observant Muslims.

Low borrowing costs and the poor performance of world stock markets have contributed to an increase in investment in American real estate from many parts of the world. Australian and Canadian investors, in fact, each had greater increases than those from the Middle East or even Germany on a percentage basis last year, but from much smaller bases.

Real Capital Analytics, a research firm based in Manhattan that monitors property transfers in excess of $5 million, tracked almost $1.4 billion in commercial property sales to Middle Eastern investors in the last year, three times the $436 million tracked in 2001. The figure for this year, which was based on closed deals through November and those in contract, accounted for about 23 percent of foreign investment in commercial real estate.

"These numbers are likely conservative because many foreign investors, particularly from the Middle East, operate quietly and confidentially," said Robert M. White, the president of Real Capital Analytics.

Manhattan and the Washington area, typically among the most popular markets for foreign investors because they are easy to enter and manage from a distance, appear on the list of properties that Middle Eastern buyers acquired in the last 12 months, but they do not dominate it. The list includes St. Louis; Kansas City, Mo.; Woodland Hills, Calif.; Boulder, Colo.; and Chicago. The Kuwait Finance House closed on a $13.7 million purchase of an industrial park in Lebanon, Tenn.

Part of the reason these investors are spreading their money farther afield is the intense competition for premium office properties in Washington and New York, brokers and analysts said. The bidding wars among German pension funds are playing no small part in that.

"We haven't seen them very active as buyers in this market," said James S. Luck, a senior director of the real estate services firm Cushman & Wakefield who handles investment sales in Washington and its suburbs. Without the restrictions on their investments that pension fund managers face, Mr. Luck said, wealthy families and oil companies from the Middle East "have the ability to go where they think the deals are."

"They tend to be more entrepreneurial and opportunistic," Mr. Luck said. "They're clearly looking for higher yields than the stuff the Germans and the pension funds are bidding on."

From Israel, the most active investor was Alon U.S.A. Others that made the list from Real Capital Analytics were the Red Sea Group, a real estate investment company best known for hotel management and shopping mall development in Israel, and one listed as an "unidentified Israeli family."

From the Arab countries, transactions that listed Investcorp as the buyer dominate the list. Several major international financial institutions, including UBS and Citibank, manage money for Middle Eastern families or buy properties on their behalf as a nominee, as do specialty firms like the Carlyle Group and Investcorp, according to international real estate brokers, money managers and lawyers.

Investcorp, founded in 1982, has offices in New York, London and Bahrain. Its real estate team began operations about seven years ago and oversees a portfolio with a current value of about $2.2 billion, according to the firm.

Its clients, like those of the private banking divisions of multinational financial institutions and of the boutique investment firms, tend to be wealthy, private and secretive families. But through new investment vehicles, smaller investors, doctors and lawyers as opposed to scions of royalty and oil magnates, have become a force in commercial real estate markets now, too.

"A lot of these funds, the fund manager is a Western, United States company," said Michael J. T. McMillen, a lawyer with King & Spalding in New York whose practice concentrates on Islamic financing and project financing. "They're looking at this area, the Middle East, as a new market, and these investors are trying to get into the United States, so it's working very well."

Mr. McMillen, who has worked with institutions like HSBC Amanah Global Properties Income Fund and the Gulf Investment House of Kuwait, said Middle Eastern investors were starting to buy into offerings that require five to seven years to pay off as opposed to two- or three-year deals. They are focusing on commercial buildings with a single tenant and a purchase price of $15 million to $20 million, he said.

Among the obstacles to selling investment vehicles to Muslim investors is the prohibition in Muslim law against paying or receiving interest. This has been approached in a variety of ways to sell real estate investments, including the formation of a broad partnership known as a mudarabah, where some investors put in effort and others put in money. Mr. McMillen said some funds are now working to sell debt as well as equity investments, a more difficult proposition where interest payments are forbidden by religious custom.

"If we went to a bank in the Middle East that doesn't pay its depositors," Mr. McMillen said, "we could offer the bank the ability to pay investors 3 percent, keep 1 percent, and the cost of funds to U.S. developers would only be 4 percent."

He said that arrangements like the mudarabah have become particularly difficult to execute and potentially precarious since the advent of the USA Patriot Act. The legislation, adopted after the terror attacks of Sept. 11, lays strict controls on financial institutions.

The legislation is intended to spread regulation gradually across a wide swath of industries, and real estate companies are not considered first priorities. Still, several big domestic commercial real estate investors, especially the more sophisticated pension funds, are beginning to examine their new responsibilities and are casting a warier eye on foreign investors, especially those from the Middle East.

Under the coming regulations, said J. William Codinha, a partner with Nixon Peabody in Boston who specializes in white-collar crime, "they aren't going to be able to just take money in that is held in a trust; they have to know who the beneficiaries of the trust are."

That could be a costly proposition, one that Mr. Codinha said he was trying to persuade clients to build into their transaction costs.

Michael D. Allison, the chairman of International Business Research, a corporate security and investigations firm in Princeton, N.J., said such research on identifying investors and transaction partners could add $20,000 to $50,000 to the cost of a real estate deal.

"For an investor in Minneapolis, it's pretty easy to figure out what you need to know," Mr. Allison said. "Some guy coming at you from Lebanon, the resources available to you to unearth who the guy is and where the money is coming from is difficult, from the language issues to the paucity of information."