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“Make sure you can back up your underwriting assumptions. Those assumptions in place the last few years—using modest income growth, easily accessible debt, low interest rates—those aspects are changing. Deal volume is down so far this year. Buyers are looking at rate changes and cost of debt and [are] not willing to pay—sellers saw assets go for high prices last year. Sellers are not feeling pressured to sell right now, especially if they have cash-flowing assets. Now we are at an impasse.”
“Conceding the uncertainty in the magnitude and exact timing of long-term rate increases, we cannot dismiss the impact of higher risk-free yields on the performance of real assets. Nor can we ignore the longevity of this economic expansion and the likelihood of a contraction before monetary policy normalizes fully.
Investors and lenders should be careful of overly general assessments of price responses to changes in interest rates. Depending on a range of factors, including the density of investors and lenders in a particular location and market segment, adjustments in cap rates and debt yields will not be uniform.
Constraints on timing are crucial for investors when making investment decisions in this environment. Investors with defined time horizons and hard exit requirements for their funds should be cautious in navigating secondary markets. Having to exit at the bottom of a cycle in locations that exhibit severe liquidity constraints during the cycle's trough will exacerbate losses.”
“More often than not, a gradual rise in interest rates signals that stronger NOI growth is right around the corner. The Fed is raising rates, in part because they see a stronger economic trajectory is forming. A stronger trajectory means stronger leasing fundamentals (strong demand for space, occupancy gains, rent gains, more free-flowing debt). Build-to-core strategies, redevelopment projects and value-add are likely to benefit the most from the stronger growth scenario and offer higher yielding opportunities. Markets that have strong employment growth and low levels of construction are also attractive.
Don’t fight aggressive foreign capital for core assets. Instead, take advantage by selling some core assets at a premium price and reinvest in other geographies/product types where new construction is limited and where foreign capital is less likely to go (yet), such as: most secondary markets (all product types), suburban office in most markets, smaller warehouses along the supply chain, most niche product types (e.g. data centers, medical office). Those investments offer more upside and less competition from foreign capital. A corollary is that as more investors are ‘pushed’ into different markets and strategies, liquidity will improve creating the potential for a virtuous cycle.”
“We are in a window of time that offers an opportunity for investors—it is also a window for sellers. Rising interest rates and a wait-and-see stance regarding tax reform, regulatory easing and infrastructure spending proposed by the Trump Administration have created a pause in the marketplace. These factors are resulting in an exaggerated slowdown in commercial property sales. Sales declined in the fourth quarter of 2016 by approximately 15 percent and have slowed further in the first quarter of 2017. I say that the slowdown is exaggerated because we have healthy property fundamentals and rising rents in most property types and less leveraging in this cycle. On the lending front, as interest rates went up in the fourth quarter, lender spreads came in and absorbed the impact to a large degree. As interest rates keep climbing, there will be less margin for spreads to tighten further and borrowing costs will go up, but they are expected to do so in line with job and rent growth. We don’t anticipate seeing the interest rate spike that we saw in the fourth quarter, which was tied to the presidential election outcome.”
“Few would argue that there is more uncertainty plaguing the market today than there was a year ago, although things always look better in retrospect. At this point in 2016, there were tremendous concerns centered around the oil markets and accompanying stock declines, yet the S&P 500 has climbed 14.8 percent from one year ago—who would have predicted? As for commercial real estate, apartment rents are up over 3 percent this year and office rents are up 2 percent. Yes, the landscape is bumpy across the U.S., with some metros outpacing others. Investors would be wise to look to the apartment and office markets in those markets with strongest job growth, including Dallas, Orlando, Nashville, Atlanta and Jacksonville. Job growth has been positive in nearly every metro with a few showing small losses—namely, Fairfield County, Conn., Tulsa and Milwaukee. The retail sector is still suffering from some major structural shifts, but many neighborhood and community center shopping centers that we track still see positive rent growth, although growth rates have been very low. The industry that has fared the best of late is warehouse/distribution and flex/R&D that have seen tremendous growth from e-commerce. Those on the coasts and in the central parts of the U.S., such as Chicago, have seen the most growth.
In general, we advise that investors look at the fundamentals and not worry as much about the broader macro uncertainties. In this year’s case, the uncertainties stem from the new administration and the mixed reports on how it will proceed with its agenda. It is too soon to make any predictions on much, but the fundamentals are still expected to stay sound as they have over the last few years.”
“For multifamily, one investment theme is to look to the post-housing bust markets. They were slow to recover economically and demographically, but this also held back development. Now they are growing robustly, but have tame supply pipelines so the outlook for fundamentals is good.
Gateway cities, particularly New York and San Francisco, have a good deal of development coming on-line and are going through digestion issues.But investors with long-term capital may want to take advantage of any near-term dislocations in these markets.
For office investment, head west. The non-Bay Area markets on the West Coast are ‘Goldilocks markets’—they have healthy economies and good demand, but not too much supply.
In retail, ‘demographics is destiny.’ We are seeing better opportunity in the Southeast, Southwest and West than in the North and Northeast because the population is growing faster there, helping to offset the multiple headwinds brick-and-mortar retailers are facing.
The Las Vegas hospitality segment looks good now because travel is up, but the long workout from the over-building of the last cycle and the sharp drop in visitors during the Great Recession has constrained development. Miami, New York City, the Bay Area and Seattle are dealing with excess hotel supply situations, as a substantial number of rooms are coming on-line. These are also the markets seeing more competitive threat from Airbnb. They are also more vulnerable to slowing foreign travel to the U.S., owing to the strong dollar, weak economies abroad and declines in bookings since the election because the U.S. is perceived as less welcoming.”
“The investment cycle has toned down a bit from the peak year of 2015. Sales volume is a bit soft at the start of 2017, but pricing has softened only a little. The yield curve suggests the next recession is at least a year down the road, and probably longer. The Federal Reserve has penciled in two more rate increases this year, meaning that rates will remain low by historic standards. The labor market is hot, but overall growth, as measured by GDP, is unlikely to reach the Trump administration’s informal goal of 3 percent. It may be closer to 2 percent this year. Add it all up and you get an investment cycle that is in its latter innings, but the innings are long and drawn out. Industrial and medical office assets are among the solid performers that can produce good returns now and will have staying power through the next downturn. Gateway cities are pricey, but the next tier of markets—traditional growth markets such as Dallas and Atlanta, along with Millennial magnets such as Nashville, Denver and Portland—will hold up well.”
