Though the real estate sector has already experienced one of the longest expansions and recoveries in U.S. history, the industry continues to perform strongly and with few warning signs of an imminent downturn. But that is a 30,000-foot view of the business. To dig more deeply into the particulars of real estate property types and the economic forces that affect it, Albert Haworth, CEO of Preferred Capital Securities, and Chuck Schreiber, CEO of KBS, joined us for a webcast on the subject that can be accessed on the Real Assets Adviser website on the Videos & Podcasts page.
The following is a distilled version of their comments.
Where are the prime investment opportunities in 2018?
Albert Haworth: There are many outstanding areas of opportunity in all aspects of real estate, but I think ultimately what it comes down to is a selection of the management team. You can seldom go wrong in the long term with real estate when you have outstanding management and you pay attention to location.
Chuck Schreiber: We are favorable toward institutional-grade real estate. The lifeblood of the real estate investment business is the tenant, and we believe during the last seven to eight years the tenants have gravitated to real high-quality institutional-grade real estate.
Higher interest rates are coming. How do you expect them to influence real estate investing?
Haworth: It clearly will, your costs of financing go up, but the flip side of that album it means that you have either a healing economy, underlying or you have inflationary trends underlying in the economy, both of which tend to be historically very, very good for real estate.
There is a trend toward product sponsors going directly to investors, rather than using broker/dealers as middlemen. Why has this new strategy emerged?
Schreiber: One thing that has happened with technology is a financial adviser or the investor has the ability to really educate themselves. There is so much material that people can review on different products, different strategies, different investments over a period of time. It takes their commitment of time to learn about the investment opportunities and more important the risks that may be related to those opportunities. So we are seeing that individuals want to research, and they really have the ability to educate themselves and become comfortable with finding and identifying the appropriate opportunity for them. We are seeing that trend and I think it is going to grow substantially over the next few years. The commission broker will not be endorsing this. They may view this as competition. Frankly, I don’t think it is competition because they have an investor who wants to invest through them in a quality investment that provides a commission to them. They can sell that. But it’s a wonderful new opportunity for investors.
If inflation comes — as many are assuming — do you anticipate that being an advantage or disadvantage to real estate holdings?
Haworth: Historically, where we see inflation, we see the ability to pass on those costs in the form of higher rents. It is one of the reasons why an investor holds real estate. Historically, it tends to be very positive in times of inflation.
Do you anticipate growth in online investment offerings and, if so, will it be driven by younger demographics?
Schreiber: The statistics are pretty interesting. Two years ago we got involved in this strategy and my thought was that the typical investor would be a brilliant engineer at Google who got a bonus and was looking to make a $10,000 investment in some real estate. That has not been the case at all. The average age of the investor online is 50 years old and investing $50,000 to $200,000.
People are making more money. Do rising incomes negatively affect multifamily as people might choose to buy rather than rent?
Haworth: We don’t think so, even though it’s understandable that one believes that higher household income would result in more homes being purchased, and I think there is some merit to that. What I’m really trying to say is the next 20-plus years are very favorable to almost all forms of housing, particularly multifamily housing. In addition, one of the things that we have done in the United States is to regulate housing prices indirectly through regulations, increasing costs substantially, and making the basics of supply/demand attractive for multifamily for the long haul.
How does a fund sponsor de-risk real estate investing for its subscribers?
Schreiber: The fact that the sponsor may have a fund gives them a lot of flexibility. One of the flexibilities they have is to sell assets. The greatest challenge in the marketplace is competition from a new property. If somebody owns an office building or multifamily project, and a developer is going to build a brand new project right next door, that is the biggest risk real estate investors face. If faced with that risk, a fund sponsor has the ability to sell his asset.
It is investment catechism that non-correlated assets are essential to a well-diversified portfolio, so what are some of the non-correlated assets you’re currently high on?
Haworth: Real estate — in big, global, general terms — is all about supply and demand and location. Chuck brought some very valid points here about fund management, and there is this concept today about fortifying portfolios with portfolio diversifying investments, or PDI’s. The reason for PDI’s is so you have something other than stocks, bonds or cash that doesn’t necessarily move in concert with the volatility of the daily trade markets, but gives you long-term, stable capital appreciation, nice dividend payments and some predictability in a portfolio.
Given that the economy is changing so rapidly, how can investors be assured that their real estate fund is acquiring and divesting properties in a manner that keeps the fund current and producing optimal yields?
Schreiber: I encourage investors to educate themselves on the investment strategy, the investment criteria and confirm that the sponsor is dedicated to that criteria and does not deviate from it as the market gets more challenging. If we go through some change in the market, I do not think it makes sense for a sponsor to modify the criteria. I think it may be a time to stop raising capital and tell their investors, “Hey, look, we are going to run this fund and in the event we see opportunities we are going to modify the strategy and the investment criteria.” In other words, operate at a level of integrity that maintains the investment criteria. I encourage investors to educate themselves and, in the event there are questions, get on the phone with the sponsor and ask how they plan to handle the situation. I helped start our investment business back in 1988–1989, during a real estate depression. It was the worst real estate market that we have seen. In 1990, you could not even sell a building because you could not get a loan. It’s important that investors confirm that the sponsor has experience and has managed assets through those kind of challenging times.
What will be the property type of the year during 2018, and why?
Haworth: Almost all forms of housing. It goes right back to the fundamentals that we talked about before, supply/demand, environmental regulations, cities constraining the number of housing units, the cost of financing, and financial regulations that have placed huge financial constraints on developers in terms of their ability to procure favorable rates of financing. Despite all that, I like housing because the supply/demand aspect is going to be there.
Schreiber: For the short term, 2018 through 2019, I agree with Al, multifamily is a great investment. The demand today is just phenomenal and that is going to continue for another year or three. It is very difficult for people to buy houses in many markets, but the reason there is demand for multifamily is that the new projects are just sensational.
There are many observers who think we are on the cusp of an economic downturn. Are you seeing any red flags within the real estate business that indicate investors might be looking at diminished returns in the near term?
Haworth: It depends on specific markets. If you look at the large cities on both coasts, you can certainly make an intelligent view that these tend to be overpriced markets. I think it is really back to the basics. An earlier point I want to go back to, it is selection of the management team — that is critical in these cases. Over the last 50 years, we had six major economic cycles. You want individuals who know how to weather those vagaries of the marketplace. We will have a recession; the question is how deep and broad and in what communities?
Schreiber: We decided back in 2010 to focus on high-quality office and multifamily. That is our area of expertise. CBD office investments have been so successful because of the minimum amount of development of speculative offices across the country. In the last three years, 50 percent of all the new office buildings that have been built are in New York City and Washington, D.C., so we have all these markets around the country and, there are not enough buildings. The demand in those markets is great. We are very enthusiastic about the office markets over the next two or three years. We don’t see a large competition from new buildings even though many markets are growing. There are a number of great buildings around the country in central business districts that are 100 percent leased.
In the event of an overall economic downturn, what real estate property type (or two) do you think will be especially durable?
Haworth: Grocery-anchored shopping centers. It is where you and your family go to buy bread, butter and eggs. Our wives go to the hair salon, the nail salon; there is the pizza parlor that our kids go to when they win a championship game. Again, some of the supply/demand basics of economics, these types of retail centers haven’t been built since the last great credit crunch. There is a huge demand, and many existing retail centers are getting long in the tooth; some of them have been in existence 15 or 25 years. We also like suburban office for a whole variety of reasons, the bulk of which is they are not building many new buildings, so the competition isn’t there, yet the demand is strong because businesses are expanding.
Schreiber: I agree with Al in part. Big-box retail is gone, and I can’t imagine it will ever return. But we do need a carton of milk. We do need to go buy hamburger patties, so the well-located retail property is extremely valuable. It is best to focus on real estate investments that are located very close to the areas people want to live. The reason why there is a Google bus that shows up in downtown San Francisco to pick up employees and take them to their Silicon Valley corporate campus is because the employees want to live in San Francisco.
Make the case as to why you consider real estate an asset class for all seasons — during good times and bad, during rising high interest rates and inflation, during liberal and conservative political climates.
Haworth: The reason real estate is great for all seasons is primarily use, whether you are building for people where they are working or where they are living, there is a utility. People have to have a place to come together to live and to work. On the financial side, when you look at real estate indexes, you see quarter, over quarter, over quarter for decades — notwithstanding that brief period of time in the last credit cycle — real estate has just simply outperformed. If you look at 2008 where the S&P from the top to the bottom was off by 54 percent, real estate was off by a little over 30 percent. Not only was it more resilient, it snapped back quicker.
Schreiber: If an investor is looking for an investment, specifically for a longer-term investment with consistent revenue flow, consistent cash flow and a potential for appreciation, the opportunity is there in real estate. There are very few alternative investments I see that provide that opportunity with a lower risk, with the integrity of cash flow and the opportunity for long-term growth and returns.