Top Plays for 2014
The past few years have seen dramatic changes in the way investors have approached the commercial real estate market. Investors emerged from the Great Recession with a degree of caution and uncertainty combined with resilience and flexibility as they sought out new growth markets and areas where yield could improve without undue risk. The shifts in attitude have been interesting to follow and show that CRE investors are a hardy lot, undaunted by the economic downturn in the long run and training their focus on new sectors with new strategies.
“In 2011, investors were defensive, focused on core markets and still protecting capital,” Peter Muoio, chief economist with Auction.com, tells Real Estate Forum. “Apartments were the favorite sector, along with core markets. 2012 was a transition year, since investors gained more investing confidence as the year progressed. Investors were still investing in core markets, pushing cap rates down, and investors started to look for more yield, with CRE as a major play, amid ongoing quantitative easing. Hotels, industrial and office were in favor.”
Muoio defines 2013 as the year core markets became more richly valued and investors started seeking better yield in secondary and tertiary markets. “Retail was last to the dance in becoming a favored investment sector, and ardor for apartments cooled.”
Dan Fasulo, managing director of Real Capital Analytics, which provides current and comprehensive data on commercial real estate investments, says that 2013 was a year when capital started moving en masse from higher-priced locations and property sectors to lower-priced geographies and segments of the market that hadn’t recovered as much as others after the downturn. He adds that values have been greatly regained since 2011.
“Geographically, over the past two to three years of the real estate recovery, we’ve seen values and activity levels in the major markets basically approach 2006 and 2007 highs once again,” says Fasulo. “In the top submarkets of the primary markets, you could argue that values have surpassed 2006-2007 highs. Some markets have gotten way too pricy for a vast number of institutional investors who need a certain rate of return on their investment. Yields have gotten too low, so this has encouraged investors to basically expand the number of markets that they’re targeting.”
Most investors have continued to invest in core and core-plus opportunities this year, and in some instances value-add transactions have occurred, says Marisha Clinton, director of research, capital markets, for Jones Lang LaSalle Americas Inc. “This strategy is similar to that seen in 2012, as investors have remained cautiously optimistic. No matter the opportunity, occupancy remains key, and the search also continues for yield and well-located assets.”
Accordingly, Clinton adds, for Q3 2013 the transacted occupancy rate across all property sectors combined approached a historically high level, coming in at 93% as safety remained strongly desired amidst a volatile market. “Despite the ebbs and flows of the market, however, the lending environment remains favorable, and capital is still abundant from domestic and international sources to support investment activity.”
Since investors began turning to secondary and tertiary markets, lenders not coincidentally needed to move to those markets as core-market pricing grew too high, Fasulo says. “There are five to 10 gateway markets: Boston, New York, DC, L.A., San Francisco, Seattle, maybe Chicago for retail and multifamily and maybe Houston. So, you have this massive wave of capital in 2013 that slows from primary to secondary locations: Texas, Denver, Florida, Phoenix, the Carolinas. Not surprisingly, that’s where we see the biggest increases in values over the past year. The smartest money was out probably at the end of last year. There was some selective picking going on as early as late 2011, early 2012. But that kind of wave movement really started just about 12 months ago.”
Studying the quality of properties purchased is another way to assess investment activity in recent years. According to Fasulo, “If we go back a few years, just when we were coming out of the post-Lehman financial crisis in 2010-2011, most investors were in core properties that were well leased with long-term income and tenants in place. But as those core properties became more expensive, investors went out on the risk spectrum and bought properties with vacancies. You saw investors buying assets that needed a significant amount of capital. You saw them take on those more-complex types of situations that they weren’t willing to take on a couple years ago—you saw very little of it in 2009-2010. Now, there are lenders to finance those types of transactions. There are bidders, more investors willing to take on a challenged property.”
Fasulo says this phenomenon is everywhere, as major core investors such as Brookfield Properties bought vacant office properties in markets like Houston and Denver. “These were illiquid assets during the downturn. The macro strategy was to buy it, clean it up, fix it and lease it, and hopefully your return is higher than if you had bought a fully leased building.”
Looking at the various sectors can also chart shifts in investor attitudes, Fasulo says. “Multifamily and CBD office were the first to recover. At the beginning of last year, this opened up a historically wide spread between the cap rates of apartments and CBD office and everything else. This encouraged investors to make almost sector bets on retail and suburban office. That spread would close over time, and the other sectors would see lower cap rates vs. apartments, and CBD office would go down. Blackstone bought major portfolios of suburban office, retail and limited-service hotels, and they will be rewarded on many of those purchases.”
Nicholas Schorsch, chairman and CEO of American Realty Capital Properties, tells Forum that his firm’s strategy is pretty simple: “to build the best-quality net-lease REIT possible.” The firm recently closed a merger with CapLease and is preparing at year-end to close the ARCT IV merger, which will give it roughly $10 billion in assets, not counting the merger with Cole Real Estate Investments that takes it to $22 billion.
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