Where do we go? That’s the question paramount on many investors’ minds these days. Oil and related energy costs may have peaked, signaling a potential end to the latest inflation cycle. The economy has been slowing but still appears to remain relatively strong and sustainable. But the massive U.S. federal debt that has been run up and is now being added to via the funding of recently enacted federal programs remains a concern.
Within real estate markets, nearly everyone agrees the office market has been severely affected by the work-from-home movement that was under way prior to — but accelerated dramatically by — the pandemic. Many employers are finding it difficult to lure workers back to the office. In the long run, this means lower demand for office space, which most investors believe means a huge bifurcation between those properties that will emerge as winners and those that will emerge as losers. Location, of course, will continue to be key, but configuration also will make a difference. Factors such as building age; energy efficiency; air quality, water quality and related health issues; public transportation accessibility; tenant amenities; flexibility of special layouts; and digital backbone infrastructure all will separate the winners from the losers.
The problem, as investors see it, is the differentiation in value between the winners and losers has not yet been appropriately reflected in the valuation numbers, which has brought transaction volume in the office sector to a nearly screeching halt. It is almost impossible to find financing for office acquisition or development, even at onerous terms.
Retail also has been redlined by many investors, with the only sweet spot being a handful of still-prosperous U.S. regional malls (mostly owned by large public REITs) and well-located, well-underwritten neighborhood and community (necessity-based) retail shopping centers.
Industrial property continues to enjoy most-favored-nation status, but some investors are concerned about the potential weakening demand if the now long-overdue recession finally rears its ugly head.
Multifamily also continues to attract a disproportionate share of investor capital, even though the multifamily market is also becoming divided into the haves and have-nots, with some markets still producing robust rental rate increases and others suffering from gradual or even dramatic rental declines. In this market, selectivity and expertise have never been more important.
Specialty property types such as self-storage, life sciences, medical office, cold storage, data centers and student housing also continue to draw investor attention. The two greatest concerns here continue to be scalability and the high level of expertise required to properly execute investment strategies in these arenas. There simply may not be sufficient supply available to meet investor demand, leading to price inflation, which creates risk should a construction boom in one or more of these sectors lead to an eventual oversupply.
The residents of senior housing facilities — particularly nursing home residents — have been hit hard by COVID. While more private senior housing formats such as independent living, assisted living and specialty care have weathered the storms of the pandemic better, many investors temporarily have redlined the entire sector.
Meanwhile, as we’ve noted in our quarterly webinars on the NCREIF Fund Index – Open-end Diversified Core Equity, the composition of the NFI-ODCE has been undergoing dramatic change over the past 10 to 20 years. Retail and office — once the cornerstones of the NCREIF Property Index and later NFI-ODCE — have been replaced by industrial and multifamily as the dominant property types driving index returns. Also noteworthy has been the rise of the “other” property type categories, including, again, such nontraditional property types as self-storage, life sciences, medical office, cold storage, data centers and student housing.
As one investor at our September Editorial Advisory Board meeting for Institutional Real Estate Americas noted, investors don’t really have a choice. Their investment strategies are tied to their asset allocation plans, and while some are feeling the pinch of the denominator problem with the recent decline in stock market performance, the majority are still feeling the pressure to continue to invest to meet their real estate allocation targets.
There’s plenty of dry powder sitting in funds and waiting to be called in separate accounts. This is particularly true in funds with more opportunistic strategies because market opportunities — with properties still priced to perfection — are almost impossible to find.
Will the current market break and reprice? Eventually. Trees don’t grow to the sky. And there’s always a limit to how long any bull market for any asset class can last. The problem is, we as an investment community have never been very good at calling the turns.
As Helen Keller allegedly observed, a turn in the road doesn’t have to mean the end of the road, so long as you make the turn. But to “make” the turn, you have to see it coming.
On the Florida motorway where I now live, it’s common to see billboards and digital signs carrying the message, “Alert drivers avoid accidents.” If ever there were a time to be alert, now is the time. In other words, it’s important to be careful. Be very, very careful. It’s a wacky world out there.
Geoffrey Dohrmann is chairman, CEO and editor-in-chief of Institutional Real Estate Inc., parent company of Real Assets Adviser.