Tag Archive for: cre investment strategies

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Four Things You Might Be Underestimating About Industrial Real Estate

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As with so many areas of real estate, there was an operational and profit high during the last few years that was like an industry getting drunk and then waking up with a headache.

Looking back can create regret, but here are some things that MSCI in its Q1 2023 U.S. Industrial Capital Trends Report suggests are easy to underestimate.

1. Immediate Comparisons Are Unrealistic

Would you compare a little kid running around with a blanket tied around the shoulders like a cape to an actual superhero? Of course not. Nor would you reasonably undergo a once-in-a-blue-moon experience and then expect that should become an everyday event. That is the difficulty in looking at typical year-over-year business comparisons in industrial.

“Industrial deal volume hit a record high of $40.6b for any first quarter in 2022,” MSCI wrote. “The next-highest first quarter period was in 2020 when $34.4b traded. Any comparisons of the current quarter to these record high points for the market are going to look harsh. In truth, the market simply slipped back closer to a normal level at the start of 2023.”

According to MSCI’s analysis, average first quarter deal volume from 2005 to 2019 is $11.2 billion. This year’s Q1 transaction volume fits in with the past.

2. The Industry Was Already Gearing Up For Higher Rates

“It can be difficult to think in terms of anything aside from Covid given the collective trauma experienced, but back in the fall of 2019, investors began to adapt to a rising rate environment,” the analysis said, remembering that concerns about rates existed before the pandemic.

CRE professionals attending industry conferences at the time were concerned about the Federal Reserve tightening its balance sheet. But it had been more than a decade since the Global Financial Crisis. Realistically, how long would the Fed put off cleaning its inflated balance sheet?

“Investors wanted to focus more on asset types that had low capex relative to the NOI for a rising interest rate environment, and the industrial sector matched this need.”

3. Investors Were Under-Allocated

The MSCI report suggests that investors hadn’t allocated enough of their capital to the industrial sector. This was true for multifamily, as they reported in a separate publication.

“It is not yet clear that investors have the allocations that they desire as there are many moving parts in place. But with the RCA CPPI for industrial slowing to only a 3.3% gain from a year earlier and volume back to average levels, one might make that case.”

4. Cap Rates Are Up, But Not That Much

One of the stories floating around is the return of cap rates. They are up some, but that’s in comparison to the depths they visited in 2022. Cap rates are nowhere nearly as high as pre-pandemic levels.

“The RCA Hedonic Series cap rate reached5.5% in Q1 2023, up from a low of 5.2% seen in Q1 2022 before interest rates surged. Cap rates have increased only 30 bps in a time when the 10yr UST has increased 170 bps.”

 

Source: GlobeSt

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Seven CRE Investment Strategies For 2020

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With the Thanksgiving holiday weekend behind, it is not too soon to look at what will be the top investment strategies for next year.

Seven top CRE investment strategies for 2020 include:

1. Sell Overpriced Industrial Assets

The industrial market has been booming for the last few years and is the favored asset class among institutional investors. The market is “hot” because of the strong economy, increased demand for warehouse and distribution space due to rising Internet sales and last-mile same- day delivery of online goods. Cap rates for industrial properties have compressed 1.5% to 2.0% during the last 18 months and we would be net sellers of industrial assets in this market.

2. Acquire Beaten Up Retail Assets

Many shopping center and mall real estate assets are selling at 7.0% to 10.0%+ cap rates and some of these assets should be bought. Retail assets have been out of favor for the last few years and although there are tenant risks, with bankruptcies and store closures, they can still provide a higher risk-adjusted return than other CRE assets. A number of the public retail malls are also selling at deep 50%+ discounts to net asset value and are also ripe for a buyout or being taken private. These distressed retail deals are opportunistic investments and need significant renovation and releasing.

3. Invest In Data Analytics Companies

One of the key growth areas of CRE is in data analytics. Data analytics encompasses all aspects of big data for CRE including; demographics, ownership data, property data, historical value information, sales/lease data and financial analysis. The data analytics space is very fragmented with a few large companies like CoStar, RealPage, REIS (a unit of Moody’s) and many local and start-up companies. These larger firms have been acquiring smaller competitors to expand their service offerings and customer base. Recently, CoStar acquired Smith Travel Research, the leading hotel/lodging consulting firm, for $450 million and RealPage acquired Buildium, a property management software firm, for $580 million. As the industry grows, there will be more consolidation and an opportunity to acquire these smaller private firms and even establish a platform to consolidate these entities.

4. Sell Overpriced Core Assets and Reinvest In Opportunistic Assets

The risk and return for various CRE investment strategies range from the lowest risk, core investments, which are typically fully leased, institutional quality, Class A properties with little or no leverage, to value-added strategies which are higher risk strategies that involve some property redevelopment, tenant adjustment or leasing or with operational problems to opportunistic strategies, which are the highest risk category that involve a high degree of redevelopment, leasing, tenant relocation or change or may be in financial distress. Many core properties are still trading at 3.0% to 4.5% cap rates and should be sold. The proceeds should be reinvested in higher return opportunistic strategies, as discussed in #2 above, buying beaten up retail assets.

5. Provide Participating Mezzanine Loans

Even though there is a lot of capital sloshing around chasing deals, there is a dearth of debt/equity capital for the portion of the capital stack above the first mortgage at about 65%-70% and below the minimum owners’ equity investment of 10.0%. This slice of 20% of the capital stack is ideal for a participating mezzanine loan. The participating mezzanine loan may have terms as follow; interest rate at LIBOR plus 4.0%+, loan fees of 1.0%-3.0%+ and 20.0% to 30.0%+ ownership of the deal. The mezzanine lender will typically not be secured by a second lien on the property but by an ownership guarantee and assignment of the owner’s interest in the property. The lender is entitled to the equity kicker because it is taking some of the equity risk of the project. Internal rates of return of 12.0%-15.0%+ can be delivered with this strategy, which is very attractive for a fixed income investment.

6. Perform A Systematic Review and Analysis Of The 15 CRE Risks

As we have discussed before, there are 15 risks inherent in CRE investment as follows:

  • Cash Flow Risk-volatility in the property’s net operating income or cash flow.
  • Property Value Risk-a reduction in a property’s value.
  • Tenant Risk-loss or bankruptcy of a major tenant.
  • Market Risk-negative changes in the local real estate market or metropolitan statistical area.
  • Economic Risk-negative changes in the macroeconomy.
  • Interest Rate Risk-an increase in interest rates.
  • Inflation Risk-an increase in inflation.
  • Leasing Risk-inability to lease vacant space or a drop in lease rates.
  • Management Risk-poor management policy and operations.
  • Ownership Risk-loss of critical personnel of owner or sponsor.
  • Legal, Title, Tax and Political Risk-averse legal, tax and political issues and claims on title.
  • Construction Risk-development delays, cessation of construction, financial distress of general contractor or sub-contractors and payment defaults.
  • Entitlement Risk-inability or delay in obtaining project entitlements.
  • Liquidity Risk-inability to sell the property or convert equity value into cash.
  • Refinancing Risk-inability to refinance the property.

All investors that own CRE should perform a detailed and systematic review of the above risks and their potential effect on an asset or portfolio.

7. Acquire Small Capitalization Public And Private REITs

There are more than 30 public REITs with market capitalizations less than $1 billion that are trading at or less than their net asset value. These REITs are ripe to be acquired or taken private by other REITs, real estate private equity firms or other institutional investors. It also may be possible to get control of the board of directors of some of these REITs via a proxy contest.

Any acquisition or merger opportunity will have to comply with the REIT tax rules including, the 5 or 50 rule which states that 5 or fewer individuals cannot own more than 50% of the value of a REIT during the last half of the year. Also, more than two-thirds of REITs are incorporated in the state of Maryland which has broader liability protection, more flexible voting provisions for stockholders, easier Bylaw amendment provisions, better protection against hostile takeovers and easier stock issuance procedures. Notwithstanding a Maryland incorporation, there are still opportunities via a friendly acquisition or proxy contest.

 

Source: GlobeSt.