Illustration: Chris Harnan
Industry pros offer their best ideas on where to deploy cash in commercial and residential property.
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This was supposed to be the year that real estate got some relief from higher interest rates, which have roiled the industry for the better part of two years.
But hotter-than-expected inflation has cast doubt on the Federal Reserve’s plans to cut rates in 2024. That’s pushed mortgage rates higher, squashing hopes for a thaw in the housing market. Woes in commercial property, meanwhile, have been slow moving but significant, particularly when it comes to office buildings.
The rise of work-from-home has dampened demand for office space and higher borrowing costs are making it difficult for strained building owners to refinance their debt. With more than $1 trillion in commercial property loans set to mature by the end of next year, buyers, sellers, banks and brokers are contending with just how much values have fallen. In some cases, major commercial assets have sold for steep discounts.
But for savvy investors, crises present opportunities. To identify where those lie in the current environment, Bloomberg News interviewed four real estate experts and asked for ideas for individual investors with cash to deploy in property. Their answers varied from student housing to publicly traded office REITs and funds that invest in apartment buildings. One also made the case for buying land, seeing an opportunity to capitalize on the shortage of homes available for US buyers.
Aside from being potentially lucrative, real estate also ignites personal passions. We also asked the experts where they would invest for both fun and solid returns if they had money to put into a personal property project. Their ideas included everything from escape homes in Uruguay, to buying a winery and developing a driving range.
A ‘Perfect Storm’ for Apartments
The idea:
We’re in a “perfect storm” of macro trends making investing in multifamily ideal right now. The average person always needs a place to live. But barriers to entry for home ownership have increased with higher interest rates and prices. Income levels and demographics of the average renter will continue improving. Prices are also likely to fall from a recent peak. From 2021 and into 2022, low rates and migration sparked rent growth, which inflated asset values and brought about record supply. That will lower prices in the near-term, but they will recover because of a drop-off in permitting. That means a tighter supply when these projects come to market around 2025 or 2026. It’s a perfect storm with a sunrise on the horizon.
The strategy:
We try to play in landlord-friendly environments that still have a high barrier to entry. The two almost never go hand-in-hand. Historically, we have found success buying older building (built in the 1980s to early 2000s) that draft off the growth of new supply. With the high cost of construction it is very difficult, if not impossible, to build new apartments that cater to the median-income renter. As a result we have focused on owning assets that are purchased well below replacement cost and are well positioned to allow for rents that cater to the average earner. The markets we are in are Texas and Western states. Migration to Texas has been phenomenal. It’s a very landlord-friendly market. But we apply a risk premium to Texas because there has been so much development there that oversupply could be a problem.
My thinking on the average investor’s play has changed. Previously I would have recommended syndication: splitting money across different markets, pooling it with other investors to back a diverse set of projects. But a lot of syndicators have had trouble with liquidity and raising capital when problems arise. Instead, I would find a well-regarded sponsor with a fund specific to my thesis. I would do a lot of diligence on the fee and carry structures. Funds tend to have the built-in strength of liquidity you don’t get with a syndicate. You also get better risk-adjusted returns with covenants around reserve and allocation requirements.
Buy Land to Bet on Housing
The idea:
There is a need for housing that is going to continue as a result of demographic changes in the US. The population continues to grow, both internally and through migration. We’re seeing Baby Boomers sell their homes and look to move to Southern states where prices have been more affordable and, generally, the weather is better. At the same time, there is a generational transfer of wealth taking place that is helping Millennials and Gen Z buy homes. Couple that with limited supply from underbuilding in the past decade and the fact that resales are down because people don’t want to move and surrender their cheaper mortgages, and you get a compelling case for allocating a portion of your portfolio to residential.
The strategy:
You could take your funds and put them into a rental house and do extremely well with appreciation. But as an investment, you’re subject to external pressures such as making sure you have tenants. As far as investing on your own in undeveloped land, one might think it’s possible to buy a piece of property and flip it easily, but you could really get burned by the cost of development, servicing it with water and sewer facilities, and environmental regulations.
I’m very bullish on the land market and I believe the right way to go is to look for some diversification. Some of the new funds we’ve put out are all equity and backed by land assets that sell residential property to developers over time. These days, you see developers looking to buy land inventory “just in time,” right when they are ready to begin development. Our funds help turn what is generally not a cash-flowing investment into one that generates income on a monthly basis because we are selling over time, capitalizing on that shift we’ve seen in the way new home builders are buying land.
In Office, Hunt for the Best
The idea:
Most people know the challenges offices face right now. It’s work from home. It’s users realizing they were leasing way too much space over the last decade. It’s a really tough backdrop from a supply and demand perspective. But this asset class is well suited to investing in public real estate investment trusts (REITs). We think public REITs are trading at a 30%-50% discount to private (“non-traded”) REITs. Part of that is because public REITs reprice every day in the stock market, whereas private REITs are priced with a lag — monthly or quarterly. That arbitrage is enormous at the moment and we think it’s a huge opportunity.
The strategy:
If you can buy high-quality REITs that own the best buildings at a discount, that’s the way to play office. There’s a very clear trend in offices — the newest and the best buildings perform best. You see a huge difference in occupancy between the best and the rest. Take Boston Properties (BXP). Two of their marquee assets are San Francisco’s Salesforce Tower and the Embarcadero Center. The occupancy rates in those buildings are in the high 80s and maybe even 90%. The broader San Francisco office market is below 70%. This trend exists across the board.
Financial strength of the landlord is also hugely important. Typically when tenants lease office space, the landlord pays for a portion of the build out. Tenants want to know if landlords can pay for improvements and maintenance. There are a lot of distressed office owners without enough capital to do this. As a result, they can’t even sign leases because it’s a competitive market. You need a landlord that’s financially strong, which disproportionately is with the best public REITs.
The Case for College Dorms
The idea:
University housing has changed significantly in the past few decades. There has been a move away from basically rundown apartments that were owned and maintained by local families. Now, there is a whole class of institutional owners that have built high-quality, purpose-built student housing. It indexes well against inflation and the fundamentals are strong. There’s been a curtailment of supply as a result of construction costs, higher interest rates and land pricing. Meanwhile, there is significant growth in demand at top-tier public universities. Eighty percent of students typically live off campus, but only about 20% of off-campus residences are purpose-built, so there’s room for enhancement.
The strategy:
You can invest in student housing in the US through a private investment directly in an asset or into a fund that is being sponsored by an investment manager. You really want to look for breadth of experience operating at scale in lots of different markets.
As far as where to invest, private colleges tend to house a larger percentage of their students than public schools, so the opportunity is smaller. The pandemic accelerated the consolidation or demise of many schools. Meanwhile, the large flagship public schools are becoming bigger. If they grow in enrollment, they’ll have more demand for housing. With student housing, there is basically a bullseye, and that’s the university campus. You want to get as close as possible to that school. But you have to be careful. Some public schools have enormous campuses, which can create the false perception of being close to campus but really the place is so big students have to take shuttles or ride bikes to get around. A good transaction would have good proximity to where students need to be or want to be, which is either student nightlife or classes.
