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What Institutional Investors Want in this Stage of the CRE Cycle

With core assets delivering thin returns, institutional investors are looking at value-add and redevelopment opportunities.

Whether it’s in a more favored sector like multifamily, a less attractive sector like retail or a somewhat in-between sector like office, the best paths for institutional investors to drive value these days are the ones less traveled.

That’s the assessment of Jacques Gordon, global head of research and strategy at real estate investment management firm LaSalle Investment Management. And other experts in the sector echo those sentiments.

Gordon says purchasing and then improving an undermanaged apartment complex or value-add office building stands to deliver a better payoff, in many cases, than snapping up a stabilized property. He also notes that pursuing retail assets that feature experiential components or that could be remerchandised also provide opportunities to seek value in a sector that’s been largely out of favor among institutional investors in recent years.

Byron Carlock, leader of the U.S. real estate practice at professional services firm PricewaterhouseCoopers (PwC), says that while “a lot of dry powder” is sitting in the private markets, there’s still significant transaction volume. In the second quarter of this year, overall deal volume was relatively flat compared with the same period in 2017, according to a PwC report.

Moving forward, Carlock expects value-add and redevelopment to be two of the most active acquisition categories. Furthermore, Carlock believes a new federal law promoting redevelopment in distressed “opportunity zones” around the U.S. could extend the current real estate cycle.

A recent report from Gordon and his team at LaSalle Investment Management, a JLL subsidiary, peels back the layers on some real estate sectors and redevelopment strategies that could greatly benefit institutional investors.

“The way the real estate investing game is being played by investment managers today is to first try to find a good idea, like repositioning apartment buildings, and then executing it as quickly and quietly until the idea gets fully priced in the capital markets,” Gordon says.

In the multifamily sector, Gordon and his colleagues say in the report that they’re still attracted to suburban apartments “but are turning some attention back to urban locations.”

The report notes that some urban markets initially affected by the latest rise in supply are now seeing supply levels decrease. Therefore, some urban markets might be investment targets in the next year. Meanwhile, levels of new supply in suburban markets remain mixed, the report adds.

Gordon says revamping an apartment complex that’s, say, 20 years old so that it appeals to the core 25- to 35-year-old renter could yield “very good” results. Not every apartment renovation will succeed, he says, but it’s got a better chance of performing well if sufficient “value engineering” is done for apartments and common areas to ensure the reward is greater than the risk.

“Real estate has got to be an actively managed asset class,” Gordon points out. “You no longer can just buy a building, kick back and collect the rent checks, and expect everything to go great.”

Gordon says institutional investors also can find value in the battered retail sector, which has been buffeted by concerns over the impact of e-commerce. A “smart investor,” he says, isn’t dissuaded by the uncertainty rattling the retail business.

In fact, despite all the gloom and doom that has beset the retail sector, a new report from Cushman & Wakefield predicts that overall vacancy rates for retail will barely budge during the next couple of years—from 6.6 percent in 2018 to 6.8 percent in 2020.

“A smart investor can realize that if everyone’s fleeing a sector as big and broad in America as shopping centers that there may be better value there, and that is the case,” Gordon says. “There’s much less money chasing shopping centers today than there is multifamily or logistics.”

Several hundred class-B or class-C malls in the U.S. are candidates for adding assets like apartments or hotels to empty pad sites and turning the existing property “inside out,” Carlock says. As result, he adds, a mall “becomes a relevant piece of real estate again when it may have fallen into irrelevance.”

To be especially smart about buying a retail asset, an investor must carefully consider the trade area as well as the strategy for attracting more shoppers and boosting rental rates, Gordon says. For instance, he goes on to say, if the aim is to make a retail center more “experiential,” an investor must look at what that will entail. Does it go beyond stepped-up food and beverage offerings? Where will the experiential components go?

“The brick-and-mortar store is not irrelevant. It just needs to be, in many cases, redeveloped to become more relevant,” Carlock says.

As for the office sector, LaSalle’s Gordon once again turns to the notion of rejuvenating an existing property rather than buying a new one. In doing so, though, an investor must weigh the mix of:

  • In-house and nearby amenities, such as restaurants and coffee shops.
  • Services provided by both landlords and tenants, including health and wellness classes.
  • Community-building aspects along the lines of those you’d find at coworking spaces.

Gordon says the office sector is undergoing a “real sea change” in terms of how tenants and landlords must collaborate to create “durable, lasting and attractive” work environments for occupants, from baby boomers to millennials and beyond.

The LaSalle report notes that “cracks are beginning to show” in the pricing of office properties that don’t offer amenities either inside or outside a building.

According to Carlock, about 80 percent of U.S. office stock was built before the 1990s, and some of it “needs to be redone to satisfy current demands.” However, he adds, “office space is not always out of date as we move to the office of the future.”

Repurposing an existing office building to beef up amenities and other features could be a particularly attractive investment tactic now, given that the Cushman & Wakefield report highlights a “strong wave” of office development in 2018 that’ll put downward pressure on effective rents in some markets.

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