Coming out of 2013, the big institutional core real estate funds reportedly are scoring handsome low-to- mid-teens annualized returns, continuing an excellent run. Concentrating investments in the major urban areas has been paying off as capital continues to flood into these markets, creating cap rate compression in an ongoing low interest rate environment. Over the last several years, apartments had a nice spike, now industrial real estate is taking over, Class A office in the best submarkets generates NOI growth off renter demand for flexible and sustainable space, and those good old fortress malls continue to score, attracting all the top retailers, who winnow positions in lesser shopping centers.

But it has become very difficult to put money out as many of these funds attract queues of new investor who want in on the strong returns. Do you keep paying up for the best properties in the face of interest rates rising during your holding period and are there enough really top tier properties to satisfy the capital need? Or do you start taking chances on slightly less core acquisitions or take greater risks on more opportunistic build-to-core gambits in order to satisfy new commitments? Are we setting the stage for reversals in three or four years? When you look at the long-term numbers, core returns settle in the mid to high-single digits, and cannot sustain double digit performance. It all suggests it may be time to back off and become much more selective.

Of course, the core strategy of basically following the money and investing where the most affluent, secure Americans and business enterprises concentrate makes perfect sense. New York, San Francisco, DC and the other familiar 24-hour places (Seattle, Boston) almost cannot lose over extended holding periods. Pockets in-and-around the Los Angeles suburban agglomeration pay off for the same reason. Chicago and Miami can hold their own over time reasonably well too. Houston is certainly hot right now, although really cannot be considered a core play—it’s a bet on continued growth off the energy business.

At the same time, most other markets with thinner levels of wealth will be more subject to the vagaries of sketchy jobs growth and stagnating standards of living—where people and businesses cannot afford to pay up for real estate. They won’t attract offshore dollars looking to park cash either. The core money mostly stays away, and locals fail to see the big city run ups in rental rates and values. 

So today’s business headlines about JC Penney closing 33 stores and the federal government reducing private sector contracts by $58 billion take on added resonance. The Penney closings are at weaker malls, which now will be that much closer to going out of business or at least losing value. Fewer government contracts mean fewer private sector jobs—from defense contractors to not-for-profit organizations. That end up impacting office and consumer demand. The unemployment rate may be going down, but as we saw in the latest round of labor statistics the overall labor force has trouble growing and more people are just giving up looking for work.

We say do what core investors have been doing. Follow the money (the affluent). But at some point, starving the rest debilitates even the best.