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Seven CRE Investment Strategies For 2020

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.

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The ‘Incredible’ Flow Of Capital Into Multifamily Is Expected To Increase In 2020

The U.S. multifamily sector has emerged as a top investor target during this cycle, and despite concerns of a looming recession, industry leaders expect the flow of investment to only increase next year.

Top capital markets executives, speaking Wednesday at Bisnow’s Multifamily Annual Conference New England, said they expect equity and debt flow into the sector to continue to rise. They said they see institutional investors allocating more money toward multifamily, banks aggressively competing to provide loans for apartment and condo projects, and Fannie Mae and Freddie Mac beginning a new spending cycle next week with a combined $200B budget.

All of this competition to provide equity and debt for multifamily projects has narrowed the yields on these deals, but with uncertainty in other sectors of the economy, experts believe investors will be happy to accept slightly lower returns.   Gregory Bates, the chief operating officer of developer GID, said his firm manages money for some of the world’s largest pension funds and sovereign wealth funds. He said they remain bullish on the multifamily sector. GID’s portfolio comprises more than 30,000 residential units and it has a 10,000-unit construction pipeline.

“Real estate allocations are going to stay where they are or go up,” Bates said. “Apartments and industrial are at the top of everyone’s list … There are terrific tailwinds on the capital side.”

Walker & Dunlop Managing Director Andrew Gnazzo also foresees an increase in institutional investment.

“Life insurance companies this year have allocated more money to multifamily, and everything we’re hearing is they’re going to allocate more in 2020,” Gnazzo said.   In addition to large amounts of incoming equity, Gnazzo said debt providers are also clamoring to loan money on multifamily projects.   “There is an incredible amount of capital in the debt space,” Gnazzo said. “There is a really nice bucket of capital on both the debt and the equity side.”

The inflow of debt is not just seeking apartment projects, Cornerstone Realty Capital President Paul Natalizio said, but lenders are also bullish on condos, a sector they have had concerns about in the past.

“There is a surprisingly very strong market for condos,” Natalizio said. “It’s an entirely different market now. Lenders will tell you there are not enough condos … Banks have come a long way in that area, they’re very aggressive.”

Fannie Mae and Freddie Mac are also expected to pour more money into the multifamily space in the coming months.

The two government-sponsored enterprises pulled back on spending over the summer, experts said, but last month the Federal Housing Finance Agency announced new loan purchase caps that will allow Fannie Mae and Freddie Mac to spend a combined $200B over a 15-month period from the start of Q4 through the end of 2020.

“The clock starts Oct. 1,” National Multifamily Housing Council Vice President of Capital Markets Dave Borsos said of the Fannie and Freddie allocation. “From that point to the end of 2020, each enterprise will have $100B to purchase loans.”

Gnazzo said this is an encouraging sign for multifamily owners and developers who utilize debt from Fannie and Freddie.

“As Q4 goes on and into Q1 and Q2, I think [Fannie and Freddie] will put their foot on the gas; they have to spend $200B,” Gnazzo said. “It’s encouraging for all that have enjoyed agency debt.”

The inflow of money to real estate comes as economic indicators, such as the inverted yield curve, point to a coming recession. Investment managers and brokers said capital providers are looking to multifamily real estate as a more stable sector than other portions of the economy, and are willing to accept lower returns than they may have in previous years.   Bates said his firm, GID, believes there will be a “hitch” in the economy at some point and it will slow the net operating income growth of apartment buildings. He said this may hurt investors who buy projects with three- or- five-year sale horizons, but those with time to wait should still see positive returns. He thinks investors are adjusting their expectations accordingly and would be happy with returns in the 6% to 7% range.

“Every investor we know, they won’t tell you this today, but 10 years from now they’ll be tickled pink if they get 6[% returns],” Bates said. “They think there will be a scarcity of product and believe producing 6 or 7 is going to be incredibly attractive relative to other global options.”

The expected returns on a multifamily project vary in different markets, CBRE Capital Markets Senior Vice President Todd Trehubenko said.

In Boston, where Wednesday’s event was held, he said investors’ return expectations have dropped from the 9%-to-10% range to the 5%-to-6% range.

“The amount of money out there chasing deals is astounding, and you have groups willing to accept low returns,” Trehubenko said.

Weston Associates Head of Acquisitions Elliott White agreed that return expectations are down for the Boston market, leading his firm to look elsewhere.

“A ton of institutional capital is coming in and saying, ‘We can’t buy anything with less than [10% returns], so my advice would be don’t buy deals in Boston,” White said. “The Boston market is still strong and will stay strong, but it won’t be the same source of high-yield investments.”

White instead said he is looking at the Mid-Atlantic, Gulf Coast and Midwest regions as areas providing higher returns to investors. The Davis Cos. Vice President of Investments Rachel Edwards agreed that investors need to look south for better yields.

“I do have to leave [Massachusetts], and the Southeast is the place I’m focused on now, from the Mid-Atlantic to Florida,” Edwards said.

Her firm is far from alone in moving south to find yield.

“It’s getting pretty competitive down there,” she said.


Source:  Bisnow

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