Where is the Yield for Investors?

LOS ANGELES—Developing medical-office buildings and paying close attention to timing in each market are two ways investors are increasing yield in a low-cap-rate environment, said speakers at RealShare National Investment & Finance here last week. Speakers at the “In Search of Yield: The Outlook for Investment” panel indicated the market was in for a correction at some in the relatively near future, although it may be up to three years before that occurs.

Moderator Michael Zietsman, managing director for JLL, asked the panelists where we are in the cycle, and Lynn King-Tolliver, SVP for Heitman Capital Management LLC, said, “Although this recovery has been long in the tooth, it could be 24 to 36 months before we see an adjustment. What will be the trigger? We don't know.”

Christopher Flick, SVP for PIMCO, said US real estate can be likened to “the cleanest dirty shirt” as compared to other global markets. “We worry about rates moving, but it's not the rates but how the market reacts to this” that matters, he said.

Geoff Davis, president and senior principal for HREC Investment Advisors, said the cost of debt is still attractive in the hotel market. “As rates go up, there will be an increase in values. There will be upward pressure on interest rates after 18 to 24 months.”

Zietsman asked Davis how hotel prices today compare to those during the peak, and Davis said they're “somewhere between the trough and the peak. There's a bit of a reset going on.”

Paul Feinstein, managing director—wealth management and senior portfolio manager for UBS, said “No one knows where we are in the cycle. It's bifurcated on timing, but there are opportunities in all areas.”

Zietsman said the market has had such a good run that we may not be exercising the appropriate amount of caution in anticipation of another downturn. “We should be drinking water, but we're drinking tequila.” He asked the panelists what should be giving us a cautionary stance.

Flick said we have to look at the job base. “We're looking out for diminished job growth since it's difficult to predict jobs.”

King-Tolliver said her firm is “underweighted in office overall and overweighted in multifamily. “In a low-yield environment, you want the very best assets that are the most defensible for the long hold.”

Zietsman asked if the panelists were seeing the gap between the highest bidder and the second in line thinning, and Davis said, “It's difficult to pick a winner when there are so many bidders, plus foreign capital is buying more mainstream and core assets. The Chinese and Taiwanese are seeking safety and yield; there's lots of foreign money in US hotels.”

Zietsman said there is execution risk with foreign investments, and Flick said he his firm hasn't seen a lot of foreign capital in his dealings.

With regard to secondary and tertiary markets, King-Tolliver said, “We are a core investor. We need to look at what drives investment in each market. For multifamily, studying this allows us to be active across the country. We need to be where it's good even when the market is not doing well. Office and industrial aren't like that.”

Feinstein said his firm is looking for cash flow, particularly between 7% and 12% returns, and Zietsman asked where the panelists have found great returns. King-Tolliver said, “While excellent forwards were done during the recession, there was a larger premium for doing it. Now, it's just a core yield. It's not about yield premium anymore; it's about how to achieve yield that will outperform the market.” She added that her firm is “very active in the construction of medical-office buildings because of the growth in the aging population and Obamacare. We're being more active in alternative product types.”

Davis said in order to get higher yield of 18% + IRR in hotels, you have to get into development, and Flick said his firm is focused on opportunistic investing. “Spreads are small now. We're thinking about the search for yield in all product types.” He added that household formation has been down, but is starting to tick back up. “We will see more housing demand if household formation goes up. We're looking for strong downside protection and we focus on cash flow. Duration really matters in cash flow.”

King-Tolliver emphasized the importance of studying “the ability to maintain financial structure through stresses. You need to keep an eye on the pipeline.”

When Zietsman asked the panelists where they are finding deals today, Flick said, “We track CMBS maturations, but we won't know how this will pan out until it happens.” King-Tolliver added that his firm is looking at opportunities to recapitalize investments.