What are some of the emerging trends that you all think will prevail throughout our time in the industry? For one, I think cheap debt will be a thing of the past when we look at the steady decline that the 10-year treasury has been on since 1981. How this will affect the identification and execution of new investment opportunities is perhaps another conversation entirely but I thought I'd get the ball rolling on this.
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Thinking about CRE on a really long time horizon is something I've been doing a lot of lately.
I have serious concerns about the long term viability of office. Preferences of young people to work from home, earnings growth via cost cutting (b/c it sure isn't going to come from the top line), and improved conferencing software will really impact the demand for space. Not to say it will go away, but I think a lot of suburban locations in secondary and tertiary markets will really get hit hard.
A lot of people now view grocery-anchored retail as a safe haven. Grocery centers around large population centers aren't safe. Amazon, Shipt, and Instacart will all force these centers to become quasi-industrial.
Probably sounding like an "Amazon will rule the world" millennial now, but hey, just my $.02.
Interesting thinking. I'm somewhere more in the middle. First of all, grocery-anchored centers' in-line space is typically filled with mostly "internet-proof" uses (e.g. schools, barbers, nails, restaurants, etc.). As to the grocery store - I think the typical store size will change, but I don't think people will ever stop wanting to actually pick out their produce and meats from the store. The average receipt will be smaller, sure, but I don't foresee these centers becoming "industrial" to any degree.
I agree with this to an extent but also feel that the 'cramming as many workers per SF as possible' is going to phase out as companies outsource back office functions at lower costs and 'people that matter' remain in physical office spaces. These people, from my experience thus far in the industry, prefer large offices (with doors) and do not want to be clustered in cubicle open office settings. I may be shooting in the dark here but I have a hard time believing that innovation -> increased efficiency in nearly every industry will not affect the square footage needed by companies.
Driverless cars are going to fuck shit up down the road. Should be interesting on how they impact urban property values. Green Street had an interesting report on this recently. It'll obviously be a bit before this comes to fruition, but it will happen in our lifetimes.
Link? Really want to read this. Can't find it after googling for about 30 minutes
If it's really recent then it won't be available to the public yet.
Get your tin caps on. Sea levels are going to keep rising, storms will disrupt coastal cities, and when we're a few decades older, resilient development is not going to cut it. Talk of "resilience" in development is mostly a marketing ploy to placate investors ; Its not going to go well.
Recent article about resilient developments: http://urbanland.uli.org/sustainability/incorporating-greener-design-te…
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And if Trump gets elected, capital will freeze up because of increased risk and uncertainty, driving us into another recession.
The rest of your post is really good, but good businessmen should be able to be aware of politics without being blindly partisan.
CRE your information and opinions are some of the most welcome on this forum. That being said, gotta be on the look out for that comedy. I think Build the Wall may have got ya.
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Long: apartments, mixed-use with retail, retail (certain types: restaurants, grocery stores, etc), industrial, co-working Short: office
Driverless cars should make parking codes easier on developers though.
One other thing that makes me nervous is that a lot of Boomers homeowners expect to cash the equity out of their homes at some point, and I think a lot of the people that own McMansions in the burbs won't be able to get out of their homes at the prices they are expecting. This could have a long-term impact on the single-family home market and many people's ability to retire/afford senior living and/or end of life care.
The senior market assumes the elderly will only cash out at 60-70% of market value. Housing is only one of many assets people dip into for senior housing.
Generally, though, I agree with your assumptions about the saleability of SF homes. Plus, I think millennials have different expectations for housing that gen x/boomers; i.e. smaller, more efficient, and higher quality.
Definitely wasn't suggesting that the elderly will only use home equity for senior housing, but your 60-70% stat really intrigues me. Is that number standard throughout the industry or is it just personal experience, not an asset class I am familiar with? Never really thought about how you qualify your residents.
I think transparency in the industry will increase allowing for firms to have more accurate data which in turn will lead to a greater level in efficiency of transactions and trades. Over the last ten years off-market transactions and non-arm's length deals have lead to returns that really couldn't be equaled by some other asset categories and I think the amount of similar opportunities will diminish. The industry is arguably in the stone age of accurate information and data in comparison to exchange traded assets. I am bullish long term on commercial real estate particularly in major cities. My Master's thesis was actually on the inefficiencies of the asset class and the future three years ago so spent a good amount of time thinking about this. I do feel like a wrench could be thrown into the system if you see dramatic changes to the 1031 process and alterations on tax advantages pertinent to the industry.
I very much agree. Commercial real estate volume is almost entirely predicated on the 1031 exchange - at least at the private capital level.
That is always something I've wondered about and need to do some reading on. Maybe someone here can fill me in - but where the hell did the 1031 come from? Like how can you do that??? My only theory is that states might want to increase commerce and investment (and in a roundabout way, taxes) within their borders.
I believe the concept is that if you and I exchange 10 mil properties, no cash is actually generated even though theoretically a 10m sale was made, thus there would be no money to pay the tax.
Just my $.02 but I find people generally over hype how helpful the 1031 is. You're just delaying the tax bill. If you don't use it you can reset your tax basis and post-depreciation write off CF on the new property works out to be very similar to the higher value property you would have gotten through the 1031 with little to no tax basis. I've never actually worked it out, but I've heard the two can be very close.
It's about reinvestment, yes, but also increase the property tax base. Folks with long holding periods in CA where property tax is maxed out 1 - 2% annual increases will sit on their low tax assessment versus selling, paying taxes on the gains. The exchange incentivises this low tax base owner to sell and buy a new building that can bring in 10x more tax revenue.
Tax policy is usually always about incentivising certain behavior. This is why booz and cigs are taxed so high...to take away the incentive of this behavior.
The bit on market data and transaction efficiency is definitely something that I expect to strongly affect the markets. As more players become privy to the same high quality/accurate information, it will become more and more difficult to achieve outsized returns. However the great thing about RE is it will likely always remain heavily relationship driven, so regardless of how efficient the markets become, those off-market opportunities will always exist. Just another reason to keep growing your networks.
While I'm certainly long multifamily - and as a product type think it is most robust and sustainable - I think investors will be chasing cash flow assets in the near-term. Too much new product coming online and not enough rent growth potential (without wage and employment growth to match) for multifamily appreciation to keep running as it has. In metro areas you're already seeing a lot of money 1031'ing from apartment into mailbox money type scenarios (i.e. single tenant retail) and folks chasing that extra 100bps of yield. Many of the big apartment REITs (Aimco, for example) have frozen buying.
Then again, what do I know? At this rate folks will be happily snatching up 2% caps..
Well, saying you're long multifamily means that you're a buyer at today's prices. I agree with everybody's sentiment, and it's certainly no secret: the next generation of homebuyers is at a disadvantage, and are more likely to rent.
BUT, has that idea been overemphasized? Are prices TOO high today even considering the circumstances? Is there really room for continued rent growth given stagnant wages and increasing debt burdens?
Can you elaborate on this? Why do you think the decline of the 10-year will result in cheap debt being a thing of the past?
Edit: How can I delete this? Accidentally replied to myself.
you are forever shamed.
The 10 year treasury literally has nowhere to go but up. The steady decline of the 10 year since 1980 has not only helped bring about the cap rate compression we are seeing now but has also given shops the green light on refinancing repeatedly at continually decreasing rates. This led to many bad loans being made on subpar assets but valuations supported this lending activity. Trending interest rates in the upward direction should weed out the bad deals from getting done as required debt yields will demand much higher NOI across the board. Perhaps I could have been more clear but all I'm saying is that I think the bar will be set higher on projects to obtain financing.
For interest rates to rise a substantial improvement in the economy needs to happen. Many economists are arguing--wrongly--that we are in a period of "secular stagnation" (basically, long-term diminishing marginal economic growth), which means long-term growth should remain mediocre, if true. I would argue that we can achieve 3% GDP growth again with fundamental changes in public policy, but I don't see that happening any time in the foreseeable future. So with mediocre growth and no inflation, we should continue to see cheap debt into the foreseeable future.
People have been saying that since like 2009. And seven years later... it's lower than ever. First-world countries have ventured into negative rates, and our own Fed has said that negative rates here in the U.S. are not out of the question. The "______ has nowhere to go but up" (be it interest rates, prices, etc.) is a dangerous mindset IMO.
It seems like being long multifamily is consensus , so you guys would be buying at current multifamily valuation?
My shop has been overweight multifamily since '10 - '11 and we believe in its long-term prospect but the current pricing really scares me. I would say I am neutral on multifamily. My prediction for casualties of current trends would be power centre and suburban office.
Seniors housing
This.
Worst time ever to buy Cre the past couple of years, stay in cash and buy multi family at 4 percent higher caps than today sometime down the road
What makes you think cap rates would see such an upswing?
Interest rates will be up 4
A lot of interesting thoughts, but mostly common "knowledge." I think if the past is any indicator it's that we really don't know what the next few decades will hold and we will probably be really surprised by what actually transpires, and we'll look back and say, "Wow! That was so obvious. Why didn't I recognize that?"
Personally, I'm long on seniors housing and self-storage. Seniors housing for the obvious reason that there is still insufficient nursing and transitional facilities for the massive aging demographic. Self-storage I'm really long on because it is recession proof (actually, it is somewhat counter-cyclical), the facilities are becoming architecturally attractive, rents are on par with multifamily rents but expenses are much lower, and the commercial/industrial land is often under valued/mispriced because it's often priced for users with higher levels of expenses. Another reason I'm long self-storage is because REITs, such as Public Storage and CubeSmart, are turning self-storage into an efficient, professional business the way REITs did with multifamily 25 years ago.
I also think urban office in the major metropolitan areas will remain pretty strong long-term as there is a demographic shift of young, college-educated workers moving to cities. Also, human beings are social creatures and I think the trend of teleworking will reach a point of diminishing growth. I'm a believer that autonomous vehicles in the next 2 decades will make miserable commutes and miserable/expensive urban parking a thing of the past, which will discourage teleworking.
I think low interest rates are the new normal at this juncture. So long as the economy remains mediocre, interest rates will remain low. And I don't see any indication that the economy will return to "normal" 3% GDP growth any time in the foreseeable future.
Oh, and as a sidebar, I'm also long on luxury residential real estate. Despite the mediocre economy, the wealthy are doing extremely well and I don't see that changing. Also, the developing world--especially China--has a huge number of nouveau riche who want to store their wealth in hard assets.
I'm all on board with the self-storage thoughts. I've done several SS deals in the past year and they are by far the best deals (read: lowest on the risk spectrum and highest on the profitability spectrum). It's actually astounding how few knowledgeable players are in that space at the moment.
The self-storage REITs still have tremendous amounts of room to grow and consolidate the largely private and mom and pop shop industry as they collectively control less than 20% of the entire market even though they have been growing at a staggering rate. To continue this growth, they need more local GPs to aid in the development and redevelopment efforts for their brands, so I expect more players to continue entering this market for many more years to come.
Storage in otherwise strong markets did very poorly throughout SoCal during the recession. Generally speaking, debt service comes at 65% occupancy and cash flow at 80%+. Many buildings in strong suburban communities like Rancho Cucamonga had low occupancy (sub 80%). Rancho is a desert community where folks need places to store dirt bikes and buggies. HH income is high. Yet this market and many others struggled during the recession. It was a blood bath.
The owners that made it had sub 40ltv leverage or oodles of cash like a REIT or a fund that could handle a few years of negative cash flow.
Well, each market is its own population. Southern California took some of the worst of the housing collapse.
We've been working on self-storage deals with going in returns on cost in the double digits, suggesting total mispricing of the underlying land. I know that Public Storage is considered by many to be the single strongest REIT in the world. I'm definitely long on this industry.
People are missing some things. Of course senior housing and mulifamily are things to keep your eye on - millenials and baby boomers are the two biggest cohorts in our country. Other things to be aware of
What global events are going to cause foreign money from entering the US? There's so much money that's keeping the growth in RE going from abroad right now. What's the impact if that flow of money stops and there's outflows?
Driverless cars - Something like 15% of all downtown metros are comprised of parking lots or structures. That's a huge opportunity for mixed use development. Also - will people move out of their 300sf microunit downtown and into the suburbs because they can get driven to work while they sleep and Uber/Google gets them to work?
HUGE demand for SF housing in the next 15-20 years - People like to think that MF will be strong forever but I disagree... Millenials have a lower birth rate and are renting longer. This eventually will change as people like me in their 20s who go on to their 30s and 40s DEMAND a 1,500 sf home instead of a tiny 500sf apartment they share with their wife and their soon to be sons and daughters. Also, parking/driving/etc. will be immensenly easier when I'm 15 years older.
MF will be strong for another 10-15 years but after 10 years you'll see single family housing growing fast as you get a huge cohort of people transitioning from apartments to SFR.
Note: I'm close with someone who runs an architectural firm and they work with almost all of the top developers around the country and do some projects abroad. They don't do any condo projects because of liability concerns. There's this huge glut in the condo market (at least in SoCal) where the only things being built are ultra-expensive condos because it's all 5%ER and foreign chinese, russian, and middle eastern money buying the inventory.
As an average homeowner, it's tougher to find that desirable condo for let's say $200,000 where you build some equity in it and sell it for $280,000 5 years down the road and move into your $400,000 started home in SoCal. All the new condo inventory priced to the moon. I'm curious what's going to happen in LA if the market turns and all that foreign money runs away from the condo market - i'm thinking its going to get hit hard.
In 15 years there will be other generations after the millenials who will continue to drive MF demand. But I do agree with you that the millenial generation will cause huge SFR demand in the future.
My concern about driveless cars is how much more traffic it will bring. Supposedly there will be more cars on the road and given the traffic it is today in major metros, I don't think it helps your commute.
Assuming most or all cars become autonomous, it almost doesn't matter how many cars are on the road. Virtually all traffic backups are the result of inefficient human driving. For example, slow drivers in the left lane (in the U.S.) are shown to create traffic jams. People who don't know how to properly enter highways cause jams around entrance ramps. Traffic accidents create backups. Even when all drivers do everything right having just one driver who taps their breaks a little too long can cause a chain reaction in heavy traffic. And in a day when all cars are autonomous (this is 50-100 years away with much better computer technology), traffic lights go away and cars going all directions through intersections can continue without stopping by having each car communicate its speed and speeding up or slowing down by the amount required.
Eliminate the human element and you relieve society of practically all traffic.
Also, I believe the Greenstreet report on driverless cars said that for every ridesharing vehicle out there, it reduces about 9-15 cars on the road.
Senior housing, medical offices & hospitals.
Senior housing certainly will be huge but the lack of rent growth of senior housing will deter some investors. The reason why MF has taken off in such a crazy way was due to investors seeing very high rent growth.
Senior housing, Creative Office and Self-Storage all seem to be strong candidates in my book. Senior housing for all the obvious baby boomer drivers, but I specifically like skilled-nursing facilities. SNF's have a barrier to entry due to the amount of "approved" beds for each region and I've also seen deals where these are leased on a NNN basis to a proven operator.
Creative office should excel because of the millennial stance and the co-working space argument. I believe there will be opportunistic opportunities as typical office space phases out and companies pivot over to the cooperative spaces.
Self-Storage will remain robust because as someone mentioned previously, its essentially counter-cyclical. In downturns people will downsize and need to store all of their sh*t somewhere, and when the economy is hot, such as now, storage will still be needed by businesses that are doing well and people that are buying things they do not need.
I also think MF will rage on, but I do believe it is bid up currently and a bit saturated.
I am short large retail power centers and shopping malls.. E-commerce is too convenient for our microwave society. Not to mention if Amazon can get same-day shipping or something of the like. It will be interesting to see what these shopping malls and department stores will be re-purposed as down the line.
Private, for-profit development development of SNF beds is a dying industry. They are expensive to build, they are elderly waiver (low income) and thus require higher cap rates, they are a PITA to operate due to regulation, and nobody wants to send their Mom/Dad to a SNF facility with all the other senior options coming online. In short, returns are squeezed. I think values-based and non-profit providers will continue to develop SNF facilities here and there, but I disagree with the sentiment that they will go on a huge run.
The only exception of this is a couple of the transitional care/rehab models that are more amenity rich. These are short-term stay only. Mainstreet is doing the bulk of these deals using the lease structure you mentioned. Coincidentally, Mainstreet is affiliated with Welltower (aka Healthcare REIT).
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