Tag Archive for: commercial real estate assets

How CRE Investors Can Still Create Value In A Rising Rate Environment

10349421 - hand of businessman holding dollars

A building that makes “no sense” to most investors could be a diamond in the rough to another — and knowledge and information is key in the current rising rate environment, according to one industry watcher.

“You can’t add value to bonds — and unless you own a VC firm or you’re Warren Buffett or Elon Musk, you really can’t create value by owning stocks,” says Marcus & Millichap’s John Chang. “Other than owning a company or a franchise, only real estate allows investors to roll up their sleeves, either physically or metaphorically, and create value in an investment.”

And Chang says this happens in one of three ways: repositioning, management, or knowledge.  Repositioning can be as simple as upgrading common areas and as complex as transforming high-rise office towers into apartments (a trend that’s happening at a rapid rate in some major metros).  It can also fall somewhere in between those extremes: think moving a Class C property to Class B or repurposing an outdated shopping mall into a mixed-use asset.

“Creating value in management can also run the gamut,” Chang says. “At the simplest level, an investor may see some high value but basic operational things that can be done — perhaps just cleaning up a property, adding professional management and moving the rents to market. Something more complex may be re-tenanting a building. An office investor I know bought a very large property with an enormous vacant space. He already had a major tenant lined up so he bought the building, restructured the space a bit and then plugged the new tenant in. Boom: the building went from 25% occupancy to 90% occupancy and the property value changed dramatically.”

Chang also draws on another anecdote, this time in the multifamily space, to illustrate this point further. He says an investor he knows with a great apartment management team bought several small- to mid-sized near the ones he already owns and leveraged that team across multiple units.

And finally, there’s knowledge, which Chang says is “all about finding market inefficiencies and exploiting them.” This could include acquiring assets based on emerging demographics or population migration, or could come on the heels of a major employer changing its HQ location or in advance of a tax or policy change. Chang says there are ample opportunities to “capitalize on information where the pending changes are not baked into an asset’s price.”

Several recent examples bear that out: the global supply chain dilemmas plaguing virtually every sector of the economy have prompted many companies to consider re-shoring or near-shoring to mitigate those types of risks in the future.

“These and more opportunities are out there, and a lot of them will make sense regardless of rising interest rates or other factors affecting the market,” Chang says.

 

Source: GlobeSt

,

Higher Inflation Means More Competition For CRE Assets

currency-rolled-up-to-form-bar-chart_inflation_65571224_s-770x320

Supply chain problems, labor shortages, and the housing shortage are all fueling inflation to eye-popping levels – and for CRE investors, that will mean greater competition for assets.

Headline inflation is up 7.1% from last year, the biggest uptick since 1982. And that rising inflationary pressure is forcing the Fed to switch gears and tighten policy.

“This will in turn put upward pressure on interest rates, raising the cost of capital for CRE investors,” says Marcus & Millichap’s John Chang.

Supply chain is the first contributing factor to inflationary pressures.

“It’s hard to move products from the manufacturers to the customers,” Chang says.

He points to shortages in raw materials, limitations on foreign port capacity, shipping container shortages, backlogs at domestic ports like those in Los Angeles and Long Beach, and a shortage of trucks.

“Basically, people want to buy more stuff than our supply chain can handle right now, so there are shortages and that means prices go up,” Chang says.

Retail sales are up 16% over 2019 numbers, while the amount of product moved by trucks in the US is down 5.1% over the same period.

The second issue? Labor shortages, which continue to stoke inflation.

“Quite simply, the US has never experienced a labor shortage like this,” Chang says. “At least not in the last 22 years, when records have been kept. As a result, companies are competing for personnel, and that’s driving up wages.”

Average hourly earnings are up 5% over last year, and sectors like accommodations and food services have seen labor cost increases of more than 15%.

“Rising wages create broad-based long-term inflation,” Chang says.

The third challenge is the housing shortage: there are not enough houses to buy or apartments to rent right now, and the problem will likely continue at least in the near term. There are currently about 1 million houses for sale in the US right now, about two months’ worth of supply; typically, four to six months’ worth of supply is required to maintain stability in the market.  Housing prices shot up 14.9% last year in response to the shortage.

In addition, there are only about 480,000 apartments available for rent, a vacancy rate of 2.6%, the lowest on record. Rents rose 15.5% last year.

“The Fed will be taking action to curtail the rising costs,” Chang says.

He notes that Fed Chairman Jerome Powell has already announced plans to accelerate the end of quantitative easing that was put in place during the pandemic, and says this will likely put upward pressure on long-term interest rates. The overnight rate is also on track to increase three times or more this year, which will put upward pressure on short term interest rates.

“As a result, interest rates are likely to continue to rise,” Chang says.

The ten-year Treasury rate is already up about 30 basis points from the beginning of December to a little over 1.7%. For investors, this will equate to more competition.

“Commercial real estate is viewed as one of the best places to invest money during periods of high inflation, especially properties that can increase rents with the market, like apartments, hotels, and self-storage properties,” Chang says. “Rising interest rates, and increased investor demand, implies that levered yields will compress this year. Basically, more commercial real estate buyer competition will push cap rates lower while the cost of capital, or interest rates, rise. That means CRE levered returns may tighten. But several property types still offer higher yields, like well-positioned office assets, retail assets, medical office buildings and some hotels, and properties in softer markets harder-hit by COVID restrictions could also offer higher yields and stronger multi-year returns.

 

Source: GlobeSt