Family offices have long viewed commercial real estate as an attractive asset class. Some invest in real estate as part of a diversification strategy. Others focus on it as a core discipline.
Regardless, of where it fits in their portfolios, these investors are actively assessing how COVID-19 is transforming the real estate sector, what markets are the most attractive globally and how they should deploy their capital going forward.
These were some of the themes touched on during a virtual event last week that brought together ultra-high-net-worth individuals (HNWIs), family office staff/members and investors. The event was hosted by Respada, a global investor-led platform supporting those types of investors.
“One challenge we have is looking at the current crisis through the lens of the financial crisis,” said Timothy Savage, a professor of real estate at NYU's Schack Institute of Real Estate. “I don’t think that is the correct way to look at the current crisis, because it’s not a financial crisis. It’s a natural disaster that has impacted human capital without necessarily impacting physical capital.”
Savage was one of four real estate specialists that presented to the HNWI audience.
Some of the notable differences in the current crisis is that there is a great deal of liquidity in the market, interest rates remain low, and unlike the past recession, oversupply is not a major issue. That liquidity is encouraging as it could lend itself to a speedier recovery for commercial real estate, added Romel Cañete, vice chairman of Newmark.
“On the buy side, you still have a lot of money chasing deals, although there is certainly a shifting of focus either from a perspective of asset class or geography,” Cañete said during the event. For example, New York City is not the darling for global investors that it was prior to COVID-19. In addition to the pandemic, there is a quality of life issue and behavioral change that has pushed New Yorkers to live outside of the city. “That changes the dynamics of the investment and of the community as well,” he says.
On the sell side, owners are looking to either defensively shore up cash reserves to weather the downturn, or proactively generate more dry powder for potential buying opportunities ahead. However, pricing discovery remains a significant impediment to investment sales activity globally.
As discretionary investors look to rebalance portfolio allocations to real estate, they continue to struggle with the challenge of underwriting and valuing assets. Panelists suggested sticking to the basics of valuation, including the original mantra of commercial real estate—location, location, location, noted Savage. Investors also need to be taking advantage of the technology and data science available today, he advises. Predictive algorithms can help to identify those areas that will outperform in rents and where vacancies might be lower than expected, he adds.
In addition to location, timing on both the acquisition and the exit are important aspects to being able to generate alpha returns, added Erez Cohen, co-founder and co-CEO of Urbiam Property Group, a real estate development firm based in Mexico City. In addition to his more than 15 years working in commercial real estate investment and development, Cohen is the author of the book Real Estate Titans: 7 Key Lessons from the World’s Top Investors.
Industrial is clearly the favored asset class today. There is a lot of capital crowding into that sector globally, which is creating cap rate compression. “If I was part of the decision making for a family office right now, I would say don’t pursue what everyone else is pursuing. I think there is a lot of really interesting pockets within real estate,” says Cohen.
For example, retail is still very compelling for assets that can offer the hyper convenience or service model that will do well, especially if it can be acquired at 40 percent of replacement cost. There also are many REITs all over the world that remain significantly under-priced, adds Cohen, “In general, I am very optimistic, and I think it is a really great time to be investing right now,” he says.
Transaction volume has dropped sharply and remains subdued amid pricing uncertainty. According to CBRE, third quarter investment sales were down 59 percent year-over-year in the Americas, down 37 percent in the EMEA and down 27 percent in Asia Pacific. However, even as transaction volume has dropped, cap rates on stabilized assets have not moved significantly, notes Savage. The main reason for that is the decline in long-term interest rates. For example, the 10-year Treasury is hovering at about 80 basis points. Those low interest rates have essentially absorbed the negative impact on cap rates, he adds.
“In Latin America, we’re definitely seeing a huge decrease in transactions occurring, and it is very hard to find that price discovery,” agreed Cohen.
Will COVID-19 spur long-term shifts?
Another challenge for investors is weighing potential long-term effects of the virus that could impact demand for space. COVID-19 has further accelerated growth in e-commerce, which is benefitting industrial and reducing demand for brick-and-mortar retail space. However, it remains to be seen how remote working and hybrid models could influence the demand for office space in the future. Social distancing and remote working will likely continue well into 2021 until a vaccine is more widely available to the public. Panelists agreed that it is less clear how the pandemic is likely to change the demand for office space in 2022 and beyond.
Trends are not going to be the same in all global markets. For example, work-from-home scenarios were challenging in Hong Kong where the average family lives in a 500-sq.-ft. to 600-sq.-ft. home. In the U.S., it is too early to tell whether the need for more space to accommodate social distancing is a temporary reaction to COVID-19, or whether it will be a behavioral change that ends up shifting the entire paradigm of office use, notes Cañete. In light of that uncertainty, large office users are kicking the can down the road and signing shorter term lease renewals of between two and five years. That is very atypical for New York City tenants where more than 100,000-sq.-ft. tenants typically renew for 10 years or longer, he says.
Savage does not expect work-from-home to be permanent or have a long-term impact on urbanization trends and the important economic role that cities play. In the US., 40 percent of the population lives on 2 percent of the land, noted Savage. However, there could be some impact on lease term structures. There was already some move to shorter term office leases before the pandemic as some space users sought greater flexibility to account for co-working and other workplace trends. “I think one of the more permanent changes in this situation is to punch through that mindset of a 10-year lease, at least in the U.S.,” he said.