When I began writing this story on the search for yield in a low-yield environment this week, it had a familiar ring. Turns out this was the same gist of a story I wrote in 2007 — at the last peak of CRE valuations.
Back then, I wrote: Companies are less likely to bite on deals, but there is no lack of sellers pushing product and capital doesn’t appear to be too constricted, just that lenders are a little more demanding.., The majority of real estate CEOs and senior executives expect 2007 to be a year of revenue growth and higher profits, marked by a race to find appropriate investments and take advantage of growth opportunities in a market that continues to be flooded with capital.
Here is what Jeffrey R. Immelt, then chairman and CEO of GE, had to say of the CRE environment in 2007.
“What we look for is opportunities where we think we can underwrite a transaction that has an opportunity for rents up or a change in the portfolio by reinvesting,” he said. “We also see market opportunities inside the U.S.; cap rates have been very favorable, and the liquidity out there is just tremendous, as you know, with all these investment pools that need to get some good returns.”
We’re hearing similar talk again this year as investors search for opportunities at a time when asset appreciation is harder to come by.
“Across the globe, the fundamentals of supply and demand appear to be well-balanced going into the second half of the year in most of LaSalle’s major markets,” said Jacques Gordon, global head of research and strategy at LaSalle Investment Management, a subsidiary of JLL. “Furthermore, turmoil in capital markets might also open higher-yielding buying opportunities from distressed sellers.”
“The market right now feels relatively fully valued and buyers are adjusting to new norms of lower interest rates and lower revenue growth on the horizon,” notes Chad P. Tiedeman, senior managing director at Phoenix Commercial Advisors in Phoenix. “Core markets with strong barriers to entry have more runway in regards to rental growth and cap rate compression in our opinion. This will mainly be driven by the ‘flight to quality’ security of the U.S. combined with increased demand from foreign capital and pension fund advisors.”
However, unlike in 2007, we’re hearing some major investors beginning to walk back their expectations.
GIC, which manages the Singapore Government financial reserves, sounded that tone this past week when it issued its annual report.
Like GE back in 2007 GIC has been investing heavily in U.S. real estate. It acquired a 21-campus portfolio of 18 student housing complexes for $1.4 billion; it acquired stakes in eight shopping centers for $2.3 billion; and went in with Prologis on a $4 billion fund to acquire 77 logistics properties.
But GIC said it will proceed with more caution going forward.
“These difficult investment conditions can stretch for the next 10 years,” said Lim Chow Kiat, deputy group president and group chief investment officer of GIC. “GIC is prepared for this protracted period of all-time low interest rates, modest global growth prospects and high valuations of financial assets.”
Returns are determined by starting valuations, and in the U.S. values are near historical highs. GIC said that will make it harder to match profit levels seen over the last few years. In addition, interest rates will eventually increase, which will also weigh on asset prices and reduce potential returns.
GIC said it expects to see lower returns over the next several years and it plans to adjust its investment strategy to diversify across different regions and different assets.
What’s an Investor To Do? Niche Plays Hold Promise
Such divergent thinking has investors and investment managers speculating on how to proceed. Should they explore new asset classes, different portfolio construction approaches and/or different markets?
Already this year, they seem to have made some decisions. We looked at what investors were buying in the first half of 2007 vs. the first half of 2016. And, today’s investors are targeting completely different property types than previously.
Office properties were dominant investment in the first half of 2007 with 910 sales priced at more than $8 million. This year there has only been 687 such deals – 25% fewer.
As it has been for a few years, multifamily continues to be the dominant property type for investment with 1,347 deals in the first half of 2016 compared to 936 in the same 2007 period – 44% higher.
Industrial and flex properties were more preferred in 2007 compared to this year where far more deals are occurring in retail, mixed used and health care properties.
LaSalle in its investment outlook concluded that niche property sectors, including health care, self-storage, lab space, manufactured homes and student housing, are likely to offer more growth and less volatility than major property sectors such as apartment, industrial, office and retail.
“Investors should focus on long-term demographics, technology, and urbanization (DTU) trends when considering investments during the second half of 2016,” said Bill Maher, head of research and strategy for the Americas at LaSalle. “This includes mixed-use properties, ‘next tech’ knowledge markets, and emerging millennial neighborhoods for retail and apartments.”
“The search for yield and security has been an ongoing dilemma for investors for some time and alternately a boom to sellers who have used this phase of the cycle to achieve above average exit numbers,” said Michael Early, first vice president Capital Markets Group for Cushman & Wakefield Thalhimer in Richmond. “This has been done to reposition a portfolio or simply secure strong returns while parking capital in an anticipation of an inevitable return to a more normalized environment at some stage in the current economic cycle.”
Such was the case too at the last peak in 2007 pre-Lehman Brothers collapse.
For current holders of properties, current conditions offer an exit strategy for those who bought into a secondary market and did not take advantage of peak pricing at the end of the last cycle, Early said.