One of the morning sessions at DLA Piper’s 15th Global Real Estate Summit, on “Investing Capital in Times of Change,” drew an attentive audience in Chicago as a diverse panel of four experts both discussed issues at the macro level and drilled down into the tactics of fund-raising and investing.
Moderator Stephen Quazzo, CEO of Chicago’s Pearlmark Real Estate, a boutique real estate manager and principal investor, began by asking, “How do we marry the needs of the investor today … with the challenging environment for finding good investment opportunities in real estate? You hear about the ‘wall of capital,’ trying to find a home, so how do you navigate that?”
“We pretty much get up every day and just try to make the operating platform better,” answered Randall Rowe, chairman of Green Courte Partners, which focuses on manufactured housing, airport parking and senior living. The company, which typically raises a new fund every three years, closed last week on their latest, of about $500 million, Rowe said.
“Basically, money’s free”
A key feature of where we are now, said Pamela Herbst, managing director and head of direct investments at AEW Capital Management, is that “Basically, money’s free.” Right now, she added, “Probably one of the best strategies is leveraged core, but core investors don’t like leverage.”
Low interest rates hurt core funds, Herbst continued. “I’m concerned that more value-add and opportunistic funds are going to be competing for our core capital.” She’s less bullish on office: “Just the cost to bring tenants in is getting incredibly high,” but is really bullish on exurban apartments.
An important point, Herbst said, is that investors are starting to understand that, historically, 80 percent of the return from core real estate was from income. “Core real estate really was supposed to be a long-term investment, where you got diversification, it was an inflation hedge, and all those good things.”
“The investor community is starting to get more and more concerned” about negative appreciation, said Christopher Merrill, co-founder, chairman & CEO of Harrison Street Real Estate Capital of Chicago. “People are thinking about, ‘How do I get my capital more defensive?’”
“Late cycle, we always see people coming into the niche sectors,” Rowe commented. “People start running out of other things to invest in and start to think more broadly. It’s not any different this time around. In the example of manufactured housing,” he added, “if it’s fully leased and it’s pretty, the cap rates have been driven down in many cases below 4 percent, because people perceive them as being very safe.”
“To generate returns, we have to lean more toward a value-added strategy,” Rowe said. Green Courte is currently turning around a badly neglected manufactured housing community, but, he explained, this takes a lot of resources, so you cannot do many deals of this sort, and you have to be very confident that the return will be there.
Green Courte bought the asset for about $28 million and anticipates putting $12 million to $14 million into it and ending up with an asset worth about $70 million. How? Rowe explained that 4 miles from this property, Warren Buffett is building an intermodal facility with 7 million square feet of distribution space and 11,000 new jobs—“and there is no housing. Affordable housing will be an issue no matter where we are in the economic cycle,” he predicted.
Investors and managers
Susan Swanezy, a partner at Hodes Weill & Associates, highlighted some of the evolving issues between investors and investment managers. Through all of its offices, her firm meets with probably 250 managers a year, yet works on maybe six to eight new strategies a year, “so we’re highly selective,” she said. “Investors are defensive with their positions” and have been for a couple of years, and even in opportunistic strategies, they’re looking for income.
In addition, Swanezy said, “It’s a much more extensive due diligence process,” with an emphasis on cash flow and executing the strategy in a reasonable period of time, given the pending correction.
Though diversified strategies are still popular, she continued, “We’ve seen a lot of investor interest in niche strategies, not surprisingly.” Hodes Weill took on a life sciences strategy two years ago and are also working on a co-living strategy, as well as setting up funds or programmatic ventures in student housing and senior housing.
In an observation supported by other panelists, Swanezy said that investors are reducing the number of managers they work with—and want to do more with those managers they keep. “Investors are very interested in co-investment strategies,” she said, and are likelier to use funds to access strategies they can’t access on a direct basis.
“There’s a huge consolidation right now,” agreed Merrill. “You talk to an investor, they’re saying, ‘Look, I’m working with 20 managers, I have to cull it down to 10.’”
Swanezy noted that investors are much more involved these days, often raising specific concerns regarding ESG (Environmental, Social and Governance) considerations, especially among larger investors. Investors also are looking for diversity in platforms, such as women and minorities, and not just at the organization’s lower levels. These expectations by investors are helping to drive consolidation among investment managers, she added.
Herbst put the conundrum this way: “A lot of clients want smaller firms, that can be nimble,” but the costly administrative/IT/analytical overhead is difficult for smaller firms to handle.