During the first day of this year’s winter conference of the Association of Foreign Investors in Real Estate (AFIRE), delegates were preparing for a coming blizzard. In 24 hours’ time, 12 inches of snow would descend on New York City, but the conference was more concerned with another, political storm in full force.
The theme of the conference was ‘strategies for uncharted waters’ and the 300 delegates might well have been wondering how best to navigate the markets under a Donald Trump presidency.
A marked shift towards market pessimism was reflected in the results of AFIRE’s latest member survey, conducted in late-October. Joe Walsh of the Graaskamp Center for Real Estate and Urban Land Economics at the Wisconsin School of Business, noted that, when the survey took place, the majority of respondents viewed the election of Trump as a negative for investment. When asked what they saw as the greatest risks for US real estate, interest-rate increases, economic slowdown and a Trump presidency came up the most.
During a live poll at the conference, around half of delegates said they had a higher expectation of an economic downturn than they did in late-October.
Nonetheless, the US is still seen as the most stable market in the world, and the best opportunity for capital appreciation, despite expectations that cap rates will rise slightly higher. And the US also ranked first in terms of deal execution, followed by Germany and the UK (Germany climbed to the number two spot, taking the UK’s place). Germany’s rise is reflected in Berlin’s ascension to second place in the ranking of best global cities for real estate, following New York City.
The popularity of real estate as an institutional investment opportunity has not diminished in the wake of current uncertainty, yet in fact opportunities are thin on the ground and competition for deals is strong.
“There is not that much attractive to buy right now,” said John Kukral, president of Northwood Investors. “The stock market and bonds are not looking that great, and if investors can allocate more to real estate, they will.”
Kukral also emphasised that he would like to see a good portion of return coming from cash flows these days and is shying away from development risk.
The sentiment was shared by Mark Gibson, chief executive of HFF. He said that core is being redefined, with the consistency of cash-on-cash becoming a driving force in the definition of core. Strong cash flow, in fact, is perceived as a risk mitigant as we move toward the end of the cycle – and for some investors, core real estate, defined in this way, is becoming a surrogate for fixed income.
When talk turned to sectors, it was industrial that came up the most. Soultana Reigle, managing director, PGIM Real Estate, said “industrial is the belle of the ball, from liquidity, investment, and fundamentals perspectives”. Her group, focused on value-added real estate, is also bullish on multifamily.
Chris McGibbon, managing director and head of Americas at TH Real Estate, had a similar view. He noted that nearly everyone is underweight industrial, because it is a challenging market to scale. TIAA is also positive on housing, honing in on what he called “B-minus to B-plus housing,” steering clear of luxury condominiums, a segment overbuilt.
McGibbon also noted growing market interest in thematic investing, focusing on sectors that are a little off the radar, such as healthcare, technology, sustainability and urbanisation. Another interesting prospect could be the merging of open-ended and closed-ended funds, creating new and unique fund structures.
But the spectre of a downturn was never far from people’s minds. “This is year seven of a cycle and I cannot guarantee that there will not be a dip,” one investment manager reported saying to investors who he met in Asia. Another warned: “We are at the long end of the cycle. We do not predict a downturn but we have to anticipate it.”
As a result, it was agreed, maintaining tight underwriting standards was essential. Kukral was outspoken on this point. “In 2007, the assumptions were horrible,” he said. “It was not all leverage. When assumptions creep up, valuations get out of whack.”
There was some concern as well about the effect construction would have on occupancy, based on a perception that construction is booming. However, only 1.4% of stock is currently under construction – this compares favorably to the build-up to previous downturns, which saw ratios of 3% in 2007 and 4% in the early 1990s.
Although construction has started up again, construction financing has remained hard to get. Most banks have slowed construction lending by 10% to 15% year on year, said Diana Reid, executive vice president, PNC Real Estate.
“I have never seen a market with really solid fundamentals yet pricing on construction loans is up – there is much wider pricing because not as many lenders are willing to take the risk,” she noted.