“You’ve raised capital—now what to do with it?” That is a common question heard throughout the commercial real estate industry these days. So it is no surprise that it was one of the key trends highlighted in the Emerging Trends in Real Estate 2016 report recently released by the Urban Land Institute and PwC.
The volume of capital going after commercial real estate is probably higher than it has ever been before, says Mitch Roschelle, U.S. real estate advisory leader at PwC. “There is just this tremendous wall of capital that is interested in real estate,” he says. Having ample capital to do deals is not a bad problem to have. Yet investment managers are feeling pressure to put that capital to work in a highly competitive marketplace.
The challenge of placing capital is likely to persist in the near term. The flow of capital into U.S. real estate continues to increase, with total acquisition volume for the 12 months ending June 30, 2015 at $497.4 billion, up 24.6 percent year-over-year, according to the Emerging Trends report. The report also predicts that the majority of investors will have capital available for commercial real estate investment in 2016 that is equal to or greater than 2015 levels.
One solution to satisfy that voracious demand is to simply make the pie bigger. To that point, investors are broadening their targets to include more options. The Emerging Trends report anticipates increased capital flows in 2016 to three key areas: 18-hour cities, alternative property types and older assets that could be good fits for renovation, redevelopment or conversion projects.
According to the report, the top five 18-hour cities to watch in the coming year will be Dallas/Fort Worth, Austin, Texas, Charlotte, N.C., Seattle and Atlanta. The shift of investor attention to such secondary markets is already well underway. Instead of just the seven or eight core coastal markets that everyone loves, there is more movement to the second-tier markets, including Portland, Ore., Denver, Minneapolis and Atlanta, says Earl Webb, president of U.S. operations for Avison Young in Chicago. Investors recognize that there is good economic and demographic growth occurring in those markets, as well as a healthy supply of high quality real estate assets, he says.
Some investors have already expanded into specialized niches such as farmland and self-storage facilities, and according to the Emerging Trends report, the definition of what constitutes real estate is likely to continue expanding. Investors are moving cautiously and incrementally when it comes to broadening their investment targets, adds Roschelle. For example, investors that may typically invest in downtown or suburban office buildings are more willing to consider medical office properties. Likewise, apartment investors are expanding into student or seniors housing. “What they are trying to do is look at areas where everybody else isn’t looking,” he says.
Investors willing to consider alternative assets on the fringes of commercial real estate, such as cell phone towers, car dealerships or ski resorts, is something that’s occurring more on a case-by-case basis, notes Webb. Generally, investors are sticking with the four main food groups of office, industrial, retail and multifamily, where they are more comfortable. However, more investors are willing to take on greater risk within those sectors, such as investing in new development or redevelopment opportunities, he adds.
Successful fundraising is not a new phenomenon. Investment managers have certainly had plenty of cash at their disposal in past cycles. So placing that capital is not an insurmountable challenge. And, for the most part, investment managers are also willing to be patient in finding the right opportunities.
Investors remember having capital ready to be placed in 2007 and 2008 and those that rushed to place that money had a tough time getting returns in 2009, 2010 and 2011 as yields dropped precipitously, says Webb. “I think everyone learned from that experience,” he notes. If the market is frothy and pricing is aggressive, the prudent course is to not pressure the investment advisors and managers to put the money out at the cost of making wise investments, he says.
“I don’t think what is happening today is any different than what happened 10 years ago, other than the amount of transparency that exists today with investors is greater than it has been at any other point in time,” adds Roschelle. There is more information on the amount of capital flowing into commercial real estate. That transparency also creates more accountability, where people who have raised the capital have to explain what they have done with it and why, he says.