5 Forces Directing CRE Capital Flows
- Oct 16, 2019
These are interesting times for the real estate capital markets. Despite the growing wall of money dedicated to property investments and the decreased cost of borrowing, transactions have slowed down. A panel of experts at the New York University Schack Institute’s annual Women in Real Estate Symposium discussed the key factors controlling investors’ purse strings.
“People are looking for, of course, good risk-adjusted returns today,” said the veteran executive Wendy Silverstein, who served most recently as chief investment officer at WeWork. “It’s nothing really remarkable. What’s remarkable is if you can still find them and not be kidding yourself about what is really going on in the world.”
1. Interest Rates
In light of uncertainty in the economy and the real estate cycle, Silverstein observed, wise investors are spreading their bets rather than focusing on a single asset class or location. They are also taking advantage of low short-term interest rates to increase leverage at reasonable rates, rather than betting on cap rate compression.
“(Levering up) is the way to play the low interest-rate game as it exists today,” said Silverstein. “But to start to buy assets late in the cycle at a high price and kid yourself on the exit cap rate is, as I said, a slippery slope.”
Meanwhile, it may be wishful thinking on the part of investors that interest rates will continue to fall. “The Fed came out saying most people from the investment community have a more…call it bullish view that the interest rates will drop than they will probably actually do,” said Anjum Sharma, head of Northeast acquisitions and dispositions for Brookfield.
2. The Bottom-Up Approach
There are still positive macroeconomic trends in the market today, including job growth and wage growth. But investors also need to watch micro-economic trends, particularly on the building level, said Sharma. At Brookfield, her team takes what she refers to as a “bottom-up approach,” even in in strong markets like New York City and Boston. By focusing on properties where there is a high probability of tenant renewals and tenant “stickiness,” Brookfield avoids incurring frequent tenant improvement costs and lost rent during the marketing period.
“These are real drivers to what is going to happen to your bottom line, and real estate is such a cash flow-driven analysis that you have to be focused on that,” said Sharma.
3. Relative Returns
While investors have continued to increase their allocations to real estate, many are underinvested today as buying has slowed and competition for assets has intensified. “So the denominator is growing and the numerator is stagnant,” said Karen Horstmann, head of Equity Acquisitions at Real Alliance Real Estate of America, which invests on behalf of German insurance companies. (The firm recently bought a 49 percent stake in 26 floors at 30 Hudson Yards for $384 million.)
“What that’s doing is shifting the focus more toward relative returns while the historic focus has been on nominal returns,” she said.
Investors are also focusing on net returns vs. NOI yield. “You can’t spend NOI,” she said. “You can spend cash. You really have to be focused on efficient buildings, long lease terms, tenant retention.”
4. The Reinvention of Real Estate
Investors are also driven by the reinvention of real estate, including the shift of retail to experiential users, the transformation of multifamily properties into amenity-rich communities, the emergence of flex office space and the tremendous influence of e-commerce on industrial. “The game is really about finding how to stay ahead of the curve—where are the trends going, and how can you be on the leading edge of that,” said Horstmann. “And that’s where you can find pockets of growth.”
The market’s definition of a strong tenant is also shifting, according to Horstman. A lot of capital has moved to the West Coast and to buying properties that are, in some cases, leased to single tenants in the media and tech industry that are not yet profitable. But that’s where those expanding industries are today.
“You have to pay attention,” said Horstmann. “It’s a growth area of the economy. Some of the financial (tenants) have not been as strong in terms of growth in terms of what space they need, and tech, life science…Part of your portfolio should have exposure.”
Increasingly, investors are buying properties that will allow them to control their environment and provide tenants with an ecosystem. “The sum of the parts is greater than any individual assets,” said Horstmann, who while at Norges Bank oversaw its investment in Manhattan’s 12-building Hudson Square development. “You can really control the whole environment.”