What Investors Are Looking For

Transcription

1 What Investors Are Looking For by Matt Baron, NAIOP Chicago Staff Writer This is a summary of the March 20, 2014, meeting of the Chicago chapter of NAIOP, the Commercial Real Estate Development Association. Its members gathered at the Riverway Auditorium in Rosemont to hear insights from a panel of experts, and active investors, as they discussed current trends in the debt and equity markets and what today s institutional investors are looking to buy. Among the many questions they addressed: How is investment in core product structured to meet current yield requirements? How is capital allocated to non-core product, and how has the underwriting changed? The moderator for the panel was Tony Pricco, Principal, Bridge Development Partners, LLC; and panelists were Paul Boneham, Executive Vice President, Bentall Kennedy; Steve Roth, Executive Vice President, CBRE; Laurie Smith, Principal, Blue Visa Capital Management; and Paul White, Managing Director, LaSalle Investment Management, Inc. Fittingly, the start of spring was only a few hours away as panelists gathered to discuss what investors are seeking. The calendar s changing of Seasons echoes a sizable shift in the marketplace after a period of retrenchment, investors are eagerly searching for ways to make their money blossom after the long, cold economic climate that characterized the recession. In his opening remarks, Paul White said there is less product available for sale, and less development occurring, with most of the capital market activity occurring in the major coastal markets such as Atlanta, Houston and Los Angeles and inland markets that include Chicago, Dallas and Memphis. Steve Roth said the tremendous lack of supply of A quality product has led to a question about where institutional money will go whether to an A market with B product, or to a B market with A product. I think that generally speaking, we re seeing the institutions preferring to buy the A product in a B market right now, said Roth.

2 Laurie Smith, whose company focuses on non-core type acquisitions, began her comments with a what a difference a year makes observation that, after experiencing a paucity of opportunity in primary markets, investors now are much more willing to go to secondary markets. Investors tell her and colleagues to find opportunity wherever it may be: Any idea will be welcome because they need to find a place to put their money that s going to give them something more than an 8 percent or 9 percent yield, she said. Roth said there is now a much wider disparity on pricing, between A and B products, than previously. In his initial comments, Paul Boneham noted that it s a great time to be a seller. It s a great time to be a borrower. We have been working very hard to buy product but we have equally taken advantage of the obvious opportunity to be a seller, Boneham said. We sold about $1 billion worth of property last year, we ll sell about $1 billion this year, and it is a lot of fun to be a seller right now. Many of his firm s sales were B industrial product and/or product in secondary markets, so there s no shortage of buyers for C product and tertiary locations. It s a real robust market right now. Roth asked if cap rates decline to about 5.5 percent, whether that would be a reflection of fundamentals or too much capital. It s both, said White. Clearly the amount of capital is part of that, but also the fundamentals in Class A major markets are very strong. White cited a study last year that found Class A vacancy rates in major markets are 30 to 50 percent below the overall vacancy rate. Smith said a flight to quality is one basic reason why Class A has bounced back stronger: You re not going to get fired from your job if you re buying a Class A product typically, right? Panelists were asked how debt is coming into play to boost yields. We use debt quite often, Smith said. It provides you with cash flow even if there s vacancy in that product you re getting a great cash-on-cash yield, even with product that is maybe 75 percent occupied, which is compelling.

3 You don t have to rely on your back-end residual for all your IRRs, your returns. That s very compelling, she added. It s allowing distressed product to have some flow that it might not have had in past cycles. Boneham said most of his clients have very low leverage, around 25 percent. You can get the best of the best in terms of debt pricing for the most part, using the leverage to an extent just recovers the fees so that the base rate is also the delivered rate to the client, said Boneham. People are chasing pricing down more than chasing risk up, said Roth. there tends to still be discipline in the capital market from a debt standpoint. You re seeing that somewhat across the board, people are pushing the pricing down. Our concern is primarily with rising interest rates, Smith said. what is the next buyer going to look at in terms of the cap rate? So we re trying to pay a lot of attention to the forward yield curve, and some sort of spread over that forward yield curve. Let s not pretend that a fixed cap rate today is going to be the fixed cap rate tomorrow. Cap rates are mostly between 5 and 6 percent across the country, similar to levels in , and investors are keeping a close watch on what impact rising interest rates will have on cap rates, said White. At some point, there will be some inflection point, he continued. I think clearly, when the Treasury went from 1.7 to 2.7, (there was) no change in cap rates at all, so it completely absorbed that. Now, the looming question: When does the weight of capital start to recede and you say, I can t pay the same cap rate, said White. Somewhere between the low- and mid- 3s is when he believes the cap rates will rise. For more than 30 years, Boneham s firm has focused on a build-to-core strategy. The company s sweet spot the past three years, he said, has been urban high-rise apartments, with eight projects totaling $1.5 billion in gross construction value. The projects have performed swimmingly, Boneham said. The question is, Where are we at in the cycle now? Because land costs are up, construction costs are up, and rents are starting to hit an affordability ceiling. It s been a great run, but now we re looking, what s next? The next obvious choices are industrial and office, which is very intriguing, he continued. One CBD office his firm is developing now is a 240,000-square-foot building in Hollywood that is focused on the studios, the content, the tech that supports the content production.

4 His firm hopes to do one or two more of those projects this year. A key consideration for each panelist is how long they plan to own a development in Smith s case, because her firm is in and out of deals relatively quickly, a construction delay or an unexpected increase in cost can swiftly erode the positive aspects of a development. Later, she added, The worst thing that happens is you sign the lease, then you do the financing, and the interest rates go up and you ve destroyed your return. On the topic of the state of Illinois fiscal woes, panelists said it didn t have an especially negative effect on interest in the market. Chicago is still absolutely in the mix of the major markets, White said. Some may shun Chicago for office, certainly suburban office, but the other three property types are definitely in the mix In the past three years, we have invested a lot of industrial money in Chicago, Atlanta, Dallas it s just easier to buy there. Boneham noted his company is quite heavily invested in Chicago. It all depends on product type. It s always been difficult for us to invest in industrial here because there are cornfields as far as the eye can see and so there is no real constraint on supply. We re very focused on the urban markets in particular, he added. We like the downtown, we have an office there, we have apartments there, a couple of projects in the suburbs. We have significantly reduced our footprint here in the suburbs. Now, does the discussion of politics in Chicago and the fiscal state, does it come up? It really doesn t, Boneham observed. We see it as a very vibrant, dominant primary market and a place we have to have a footprint. In response to a question from moderator Tony Pricco over how real estate allocations may change in the next 12 to 24 months, Smith said that she is hearing more aggressive sentiment from investors. Now what we re hearing is, Find us a place where we can get some yield, bring us any type of opportunity that is differentiated. Is it an industrial platform? Is it self-storage? said Smith. You re looking to find a way to go to their investors and say, Ha-ha, I have a brand new idea. To me, it looks like they are releasing the reins on the risk perspective a little bit. If interest rates rise and bonds become more attractive, it could siphon some money from real estate in the future, White said. On the other hand, an abundance of international capital wants to flow into the United States.

5 The U.S. and the U.K. are kind of number one and everything else is a distant (second) for foreign investors to allocate real estate capital, he noted. Meeting Sponsor: NAIOP Chicago 1700 West Irving Park Road, Suite 208 Chicago, IL Main: (773) Fax: (773)