Over the hill?
The annual meet of the Pension Real Estate Association in the US capital saw much attention paid to the current economic climate, getting back to the fundamentals that underlie the real estate market. Real estate is not alone in contending with extreme liquidity, low yields, rising expenses and replacement costs, and growing risk premiums among other challenges. It was also impossible to avoid the gloom in the housing sector, as sales of both new and existing housing stock continue to decline and prices plummet - although this is largely seen as a natural correction to the housing overrun. However, the news from other investment sectors was not as grim.
There was a general consensus that multi-family (properties constructed for use by multiple families) was “flying high.” Rentals are booming, fueled by key current demographic trends - the echo boomers (children of the baby boomer generation) who are moving out on their own and into apartments, and also recent waves of immigrants who start out in apartments.
In terms of development, class A apartments in some markets can prove to be a development opportunity, especially since raw material costs, particularly for lumber, have fallen from their post-Katrina highs, and as housing construction slows, more supply is available for commercial projects. Some of the best development opportunities may be found in ethnic centres, but lenders and investors are reluctant to move in, according to Charles Wurtzebach of Henderson Global Investors.
In the office sector, occupancy is well up, and although rents are at their lowest for around 40 years, some real rent growth is starting to be seen, particularly on the coasts. This means that capacity has leveled out after the overbuilding of the last decade. However, caution remains the byword, noted Mary Ludgin of Heitman, who pointed out that there is a risk of ego-driven building. The office sector tends toward volatility overall, and while the move will be toward more stability, it will remain volatile.
The challenges facing the industrial sector could create opportunities. Much current warehouse space is badly outdated and needs either dramatic improvement or rebuilding to meet current size demands and the need for flexibility. Purchasing existing warehouse stock can be risky, because there is a chance that the building, even recently built, is already out of date, as space needs change quickly. Many new developments can be up to 1m sq.ft. (92,940 sqm).
In terms of development, warehouses are cheap and quick to put up, and if the location is right, near key transport hubs, then there is good value there. Good prospects exist now in Chicago, which is great for logistics (although a notably poor performer in the office sector); Kansas City, which is the nation’s second biggest rail convergence; and near some major ports, including the LA basin.
Retail is ever in flux. As Mary Lundgrin of Heitman said, “Change is the only constant in retail,” stressing that location is key. Peter Schaff, regional CEO, North America, for LaSalle Investment Management, had an intriguing gauge for measuring the value of a location. In his view, you only need a good base - not a great one - as long as there are no multiple other options or development opportunities. “Supply constraints and more important that market growth are a defence against future change,” he maintained.
The conference also noted a move away from out-of-town shopping centres anchored by big department stores - but there are different points of view about what will succeed these. On one side of the debate stand supporters of “lifestyle centres,” smaller unanchored centres of between 100,000 to 1m sq.ft., which avoid the high operating costs of shopping centres and offer homes to big box retailers as well as smaller chains. On the other side are the proponents of “new town centres,” mixed-use retail and leisure environments. In fact, David Zoba, COO of Steiner & Associates, a developer of such mixed-use centres, went so far as to claim that “the single-use retail environment will be obsolete within 20 years.”
Overall the market is highly competitive at the moment. There is increased interest domestically from institutional investors who want to increase their real estate allocations, although this amounts to a continual inflow rather than a flood, noted Nori Gerardo Lietz, managing director of the Pension Consulting Alliance. Of the $60bn (€47bn) of new capital going into real estate this year, the bulk of new capital went to direct investment, with only 10% to REIT strategies. On the other hand, most incremental capital was allocated to value added or opportunistic funds. This is a key point, stressed Lietz - the activities of the largest funds are those that affect capital flows.
“The amount of equity required to play has significantly reduced,” noted Mark Gibson, executive managing director of Holiday Fenoglio Fowler, a commercial real estate financer. This lowering of the barriers to entry has eased the way for new entrants, particularly smaller funds that want to establish a toehold.
There were many supporters of REITs - Devin Murphy, managing director and global head of real estate investment banking at Deutsche Bank Securities, claimed that REITs are good value relative to NAV, and that “real estate is cheaper on Main Street than on Wall Street.” However, getting back to fundamentals, Jeremy Siegel, professor of finance at the Wharton School, University of Pennsylvania, expressed his view that REITs are not such good value at the moment. In his view, REITs are expensive relative to bonds, which themselves are already expensive. For investment’s sake, stocks currently offer the best value.
There are also significant inflows from the offshore market, betting on the dollar. Some American investment managers noted that for the most part, non-US investors seem disinclined to invest in US markets at the moment. The difference in returns between US real estate markets and many European and Asian markets has evaporated, and in addition, many foreign investors believe that the value of the dollar will continue to fall, noted Charles Wurtzeback of Henderson Global Investors. Among Europeans, Germans are net sellers at the moment, although there is significant interest from Ireland, Greece, Spain and the Middle East.