2019: It’s Time To Get Disciplined About Pricing

The acquisition environment, in many ways, will be similar to the latter half of 2018. It won’t be completely similar though and there is one key difference of which buyers need to be aware, according to says Joe Gorin, Co-Head of Goldman Sachs Asset Management’s Private Real Estate team: the risk of overpaying is growing greater.

It’s a nuanced shift from the first part of last year, Gorin says. “The best investors will still be rewarded and those who are a little outside of their expertise could find themselves overpaying for some of the opportunities out there right now.”

The reason why is simple: because pricing has increased, cap rates have compressed. Gorin doesn’t anticipate further cap rate compression, but sellers remain as aggressive as ever and expect very high prices for their product. “So we are entering an environment where it’s increasingly important to be really disciplined in your approach.”

Gorin spoke in-depth with GlobeSt.com about this and other trends he expects to see in the coming year. Following are excerpts from that conversation.

Upside Vs Base Case Underwriting

We are operating in a backdrop of relatively strong fundamentals in terms of demand. We don’t expect to see a lot of rent growth over the next few years; we’re kind of past peak in terms of rents in a lot of markets. So because of that investors, to get money out, will be forced to buy based on their upside underwriting versus their base case underwriting. And that is a dangerous way to underwrite. We always buy on our base case. We filter out 95% of the deals that come across our desk.

The Bid Ask Gap

Anecdotally we have more evidence of a bid ask spread that’s developed over the past few months in line with increasing interest rates and the 10-year Treasury moving up to 3.2-3.25% at certain points last year. We’ve also seen Libor move up and that hasn’t come down in correlation with the 10-year. I would say that the fairway for deals is narrowing as people become a bit more disciplined with their investment strategy. There are deals that are missing guidance and that obviously is equal to, or synonymous with, a bid ask spread.

We’ve seen it on a number of multifamily deals recently that have come to market where the brokers have guided to a number and we’ve decided to not pursue the opportunity and then we’ve gotten a call back that they missed their guidance and there’s a new pricing threshold. Then we may go back and participate.

Creating Alpha

With a backdrop of relatively low growth, it’s all about the alpha that you can create. I think what you’re going to hear more about in 2019 is product innovation within real estate. How people are utilizing real estate differently in terms of industrial and robotics and innovation within healthcare and biotech. How coworking is affecting office buildings. The potential impact of autonomous cars. We are very focused on ESG. That can drive additional alpha and profits within our portfolio that are separated from just the basics of rent growth and absorption.

The Cycle

Obviously the cycle has gone into a double header and I don’t know if it will go into a triple header, but we don’t see anything shutting down over the next 12-to-24 months.

The Opportunities

We’re going to see more core-plus opportunities and there will still be value-add opportunities that present themselves. But you’ve got to be very targeted in your approach to value add now.

Market Liquidity

There is no shortage of liquidity. It’s not that deals are getting pulled from the market because they couldn’t find buyers. It’s more of just the pricing relationship and the spreads that people can achieve. So while the public reach probably has scaled back the most, the private sector that’s done a great job of filling any voids created from the public side.