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What Real Estate Investors Are Bracing For Through Year-End

What Real Estate Investors Are Bracing For Through Year-End

Global capital markets volatility, a continued low interest rate environment and increased financial regulation are just some of the pressures real estate investors are facing at this point in the cycle, prompting strategy tweaks with a renewed focus on capital preservation.

“Financing was harder to get this year and will continue to be tricky in certain sectors. High Volatility Commercial Real Estate (HVCRE) rules, for instance, have made it harder to get financing for new developments. Risk retention rules set to go into effect later this year [are] already affecting CMBS. Obtaining financing for properties in tertiary markets has also grown more difficult,” says Greg MacKinnon, director of research for Pension Real Estate Association (PREA), a non-profit trade association.

Pricing on assets has stabilized since the end of the second quarter, according to MacKinnon, but lower returns are expected for 2017 and 2018. PREA’s consensus survey indicates return expectations of 8.4 percent on commercial real estate investments for full-year 2016, 6.8 percent for 2017 and 5.7 percent in 2018. “But we are living in a low return world. We are not at a peak, but at a plateau,” MacKinnon says.

So what are investors targeting this year? “Value-added, core and opportunistic funds continue to be the most favoured strategies by those investors that plan to be active in the real estate asset class, and appetite for these strategies remains relatively unchanged from the previous year. This suggests that investors are still targeting a diverse range of real estate exposure, with no significant move to either higher risk /return strategies or a flight to quality,” says Andrew Moylan, head of real estate products at London-based research firm Preqin. 

In the face of volatile capital markets trends, the Federal Reserve remains in wait-and-see mode, for now. During its July meeting, the agency indicated it may be inching closer to a hike later this year, though for now the rate remains the same. A small increase in interest rates would be welcome to some investors. Low interest rates can buoy certain property types, but as capital seeks to preserve itself, interest rates that are kept too low also pose a concern.

"Our investors worry more about negative interest rates. There is fear that we could go into negative interest rates,” says Jay Rollins, CEO of JCR Capital, a Denver-based alternative investment management firm.

"There is a higher degree of uncertainty among investors, and uncertainty is the enemy of both economic growth and capital market fluidity. At this point I would not be surprised to see more contraction in deal volume and easing off of transactions,” says Peter Muoio, head of research for Ten-X, an online real estate transaction marketplace.

Fallout from Brexit?

The knee-jerk reaction to Brexit and resulting short-term fallout, which included the freezing of U.K. property market funds, has leveled off.

"The severe concern we saw immediately following Brexit has faded very quickly. Outside of London, nobody is really panicking. Generally speaking, investors in the U.S. are taking a wait-and-see approach. It could take months to years to see the full implications of Brexit,” MacKinnon says.

Still, analysts and capital market experts say investors are proceeding with caution.

“The investor base is very nervous and waiting for a shoe to drop. Interest rates will be lower for longer. We have been in a sub-2.0 [percent] treasury environment for quite some time. Bonds are not paying as well and there is no earnings growth. We have seen pullback from investors, who remain cautious. What does that mean for commercial real estate? Investing will fall into two buckets: trophy properties in gateway cities and middle market properties. Trophy properties are sure to attract more international capital for safety reasons,” Rollins says.

"There is a little bit of confusion among investors about what to expect, and changes about where they are targeting capital. There has been less interest in development and more interest in core properties. Investors are scrutinizing risks more closely," adds MacKinnon.

Muoio contends that trophy properties in markets such as New York, San Francisco, Washington, D.C. and Miami should continue to “provide a store of value.”

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