Connect Money Real Assets Capital Raising Event Recap: Allocating to CRE
Following a difficult 2023, institutions that can provide liquidity or have the flexibility to deploy additional capital will be able to capitalize on some unique and compelling risk-return opportunities over the next several years, according to a panelist discussion at last week’s Connect Money Real Asset Capital Raising event in Chicago.
The event kicked off with a discussion, “Investing in Commercial Real Estate.” Experts detailed the various ways investors can allocate capital given the challenging landscape amid the higher-for-longer interest rate environment.
“From a multifamily standpoint, I don’t think we need serious rate reductions to be able to invest successfully in the current environment,” Marc Turner, Managing Director of Investment Management at Origin Investments, began the discussion.
Turner added that the “bigger problem” is the volatility in the interest rates market, with rates almost doubling over the past two years.
“The higher-for-longer has taken the new supply starts almost to a screeching halt,” Turner said. “Today, new completions are outpacing new construction starts by the widest margins since 1975,” suggesting much of it has been due to tighter lending standards, particularly from regional banks.
Turner noted the U.S. housing shortage, citing a two million deficit, and elevated interest rates is only going to “exacerbate that problem.” However, he believes that we’re nearing an “inflection point.” Over the next decade, he said that supply-demand imbalance is going to translate into stronger rent growth.
Alexis Sofyanos, Director of Investor Relations at TruAmerica Multifamily, echoed that optimistic view. “A higher cost of capital has impacted valuations, and for those who may have investments that are over-levered or have looming maturities, especially for multifamily, will be interesting to watch for pockets of opportunities.”
Meanwhile, higher-for-longer has had little impact on a firm that invests in debt free properties. Corey Nolen, VP, Wholesale Distribution, Cove Capital Investments, said that as a debt free firm, he is not too concerned about interest rates. He noted that given higher interest rates he has noticed “a lot” of forced sales, but as an all-cash buyer it means there are good opportunities.
“If you can structure your capital stack in a way that allows you to take advantage of the current market there can be opportunities that we have seen in the last several years,” said Nolen.
On the levered side, Geoff Flahardy, President of Strategic Relations at ExchangeRight Real Estate, said the decline in valuations given higher rates has offered attractive buying opportunities in the CRE space.
“Average cap rates (18 to 24 months ago), when we were putting on a 10 or 20 property portfolio, were in the mid 5% area, and now they’re in the low to mid 6%,” said Flahardy. “On the highest quality, net-lease (Kroger, Publix) is cheaper and really good for the [DST] 1031 investor.”
The panelists also discussed the various metrics, other than interest rates, they use to influence their overall CRE investment strategies. Origin’s Turner said transaction activity is an important variable when it comes to multi-family.
Compared with 18 to 24 months ago, when transaction activity was minimal, bidders are now “bidding with an intent to win a bid,” in a sign that the space may be turning a corner. “Lenders are starting to call their brokers and ask what’s it going to take to win this bid,” he said.
TruAmerica’s Sofyanos added that she is looking at the rent-to-income ratios of a property or market across the portfolio for signs of improvement, while Turner added that he uses the same metric, noting that it is “probably the single fastest predictor of rent growth.”
Meanwhile, Nolen said that given the firm’s all-cash strategy, its lead-time is much shorter. “If we find an opportunity, we can act quickly,” he said. “We’ll look at less traditionally desirable assets. We haven’t bought a multi-family [property] in two years.”
The panelists also offered their views on where the opportunities in CRE lie. Nolen said he is seeing cap rates moving faster in certain areas than others, particularly in smaller products between $5 million and $20 million – an area Cove Capital has been targeting, especially multi-tenant retail and multi-tenant flex industrial.
ExchangeRight’s Flahardy added that to meet the needs of the firm’s investors, such as capital preservation and stable durable income, their focus is on properties that are resilient to economic volatility. “We’re going to stay focused on the highest quality credit tenant that has the longest history of operating successfully in necessity retail, industrial or healthcare. We’re going to stick with triple net-leases.”
The discussion concluded with the panelists’ thoughts on reasons why investors should allocate to real estate and where does it fit in the portfolio. Flahardy said that, outside of a 1031 exchange, clients should have a minimum of 10% to 20% exposure to real estate.
“When you had 10% to 20% allocation in a typical 60/40 model, it reduces volatility, and that’s proven over and over again,” he said. “It helps balance the risk profile and increases the returns in that overall portfolio.”
