How Not to Run In An Uncertain Economic Environment

HOUSTON—Without a doubt, the US economy is sending mixed messages about its health. On one hand, the job market remains robust despite September’s lackluster numbers. (US payrolls only added 136,000 jobs, underperforming economists’ expectations, but the unemployment rate fell to fell to 3.5%, a 50-year low). On the other hand, US manufacturing has sunk into a recession, according to the Federal Reserve, which reports that output has shrunk in the past two quarters this year. Then there is the yield curve, which has been inverting over the past year. However on Friday one portion of it—the spread between three-month and 10-year US Treasury bonds—turned positive last week for the first time since the summer.

Companies are turning to various strategies to stay on top of these trends. In some cases investors have decided to hoard their dry powder to wait for distressed buying opportunities. Most investors, though, are keeping a hand in the market but modifying their strategies.

Speakers at the Annual Transwestern Real Estate Forum Institutional Insurance Investors Symposium, held this summer, discussed exactly this: how they were managing investments at the end of this cycle.

They also noted that—keeping in mind these comments were made in July—there were increasing signs of caution in the commercial real estate community despite its solid fundamentals. Paul Hanson, a managing director of Northwestern Mutual Real Estate, for instance, said he had some qualms about being in the market right now because of the timing, but the fundamentals remain solid so Northwestern continues to invest in it.

This year, Northwestern Mutual Real Estate has increased its amount of equity placements, especially in the apartment and industrial sectors. More recently, the company has shifted towards acquisitions—Hanson said that this year, half of the company’s equity production may well be in acquisitions—after being primarily a development shop for years. The company decided to prune its portfolio after a good look at the environment, Hanson said. “It’s a good opportunity to take some gains and harvest those and bring new properties into the portfolio. So we’ve been looking to maintain the size of our accounts at least or potentially grow them.” He said Northwestern is looking “for opportunities where we think we can find something that has replacement costs or close to it, and/or in markets where we can necessarily develop.”

Another example of a company tailoring its strategies to the current environment is PGIM Real Estate, which has primarily been focused on joint venture multifamily development. The company stays competitive by being “extremely picky on submarkets,” Rob Mason, executive director of PGIM Real Estate, said at the symposium. Industrial is also a big focus, he said. “We want to grow the industrial portfolio, so our focus has been on building an empire in the Sunbelt for the most part.”

The team is on track to meet its goal for the year, however, he pointed out that the environment for deals is getting more difficult to navigate and it takes more calls to get a transaction done. “You’re having to have 20 balls in the air to have two kinds of hits,” he said.

Scott Coté, executive vice president and co-head of Real Assets at Aegon Real Assets US, and another participant in the symposium, is also fairly confident that a recession, or at least a downturn, is coming—the only question is when. It could be anywhere in the next 19 to 24 months, or perhaps sooner as geopolitical risk creates more downside.

In response, the company evaluated its private strategies and landed on multifamily—workforce housing in particular—as resilient to a downside scenario in the economy. The company is partnering with local developers, usually though a JV equity structure, Coté said at the event.

All told, Aegon Real Assets US has picked 17 markets located in the “smile of the US,” he said. “New York’s a great market, but rent controls ruin it for investment and multifamily. But even down in Florida and in the Central US there is Denver, Salt Lake, Phoenix—we see a lot of opportunities there.”

“We’ve had this strategy in place for about a year and a half now. And the good news is we’ve levered and we’ve delivered really solid results,” he concluded.