What's Next: Follow The Money

LOS ANGELES-As financial intermediaries on the forefront of investment real estate finance, we have the privilege of interacting with entrepreneurial clients who share their strategic insights with us. As a result, oftentimes, our clients become the early adopters as the market cycle evolves. Utilizing this knowledge, I'd like to offer three insights, which I trust will be helpful to you.

Insight One: Apartments—No more low-hanging fruit:

We owe a lot to multifamily. This asset class led many investors and lenders off of the sidelines and greased the wheels of the new investment cycle we are now enjoying. In primary markets, prices and rents have made significant upward moves making it difficult to pencil new acquisitions. Niche opportunities will remain for savvy, value-added investors, but the margins in stable, investment-grade apartments have been squeezed.  

Many investors targeted returns over the past decade by utilizing a two-thirds, one-thirds rule wherein two-thirds of the return on investment is derived from appreciation (fueled by cap-rate compression), and one-third comes from cash flow. This equation was informed by decades of declining interest rates. Now the formula is flipped. A higher portion of total project returns must be derived from cash flow because exit cap rates may be higher as interest rates normalize in the coming years. Where can investors buy strong future cash flow?

Insight Two: Retail—The next frontier:

Apartment leases are short term and income adjusts to the current market relatively quickly. On the other hand, retail rent rolls, with longer-term leases, often straddle the current rent trends creating opportunities for investors. Look for rent rolls that have lease rates negotiated during the downturn that may be rolling over the next few years. Rents in primary markets have moved up significantly from their lows, providing significant potential upside. Further, there are well-located retail properties that suffer from a suboptimal tenant mix. Some of our clients are purchasing centers that can attract service retailers with a higher immunity to internet sales or that possess a proven multi-channel sales strategy, successfully utilizing a physical store format complimented by online sales.  

Retail is meaningfully leveraged to housing. If you believe that the current housing trend has legs, retail will benefit. I think that we are at the beginning of a multi-year housing recovery. House price appreciation will have a significant macro economic impact and will prove to be a sizable catalyst for retail sales and higher rents.  

Speaking of housing, many of our clients started buying rental housing in 2010. We have since arranged debt and equity for bulk purchases of single-family homes. In the past 12 months, buying rental houses, en masse, has become a big business. Most of the investment models we have seen assume a healthy amount of asset appreciation to make the expected returns. I believe that this appreciation will be achieved.

Insight Three:  Residential Land—Buy it:

If you believe that house price appreciation will continue, why not skip the house buying frenzy and pick up some quality residential land instead? No other investment has greater leverage to house price appreciation than land. Financing, both debt and equity, is flowing into the land market, creating a dynamic set of opportunities for experienced land investors.

Our founder, George Smith, often said that the best way to predict the future is to follow the money. This has never been more true than it is in today's market. This sound advice has served our company and our clients well for four decades, and will remain a guiding principal for investors for many cycles to come.  

David Rifkind is principal and managing director of George Smith Partners. The views expressed in this column are the author's own.