Brokers are doing their job well. In an environment where deals fall through off rising rates, which I assume means they were too sensitive to debt anyway, properties are trading at cap rates where even with aggressive leverage, they will likely deliver sub 15% IRRs, and sub 8% coc returns after fees, if you're following a traditional PE model.
The only way I realistically see these metrics being surpassed is if rent growth rises yoy, with little investment into a property, so basically buying a product and expecting it to rise in value without changing it. Which is fine, but I fail to see how so many 'PE' groups continue to place capital.
The idea behind a PE investment is that the group's expertise will be used to create an asset that will be able to deliver returns superior to those of traditional public equity and alternative markets.
Question for brokers working with institutional clients or family offices; what is the rationale of clients making investments into sub 4 cap properties? Are all of these going to local guys looking to preserve family wealth, or some other strategy that does not look for short-term returns? I'm trying to better understand competition and their perspective.
Question for young guys working in PE; how are your bosses selling sub 4 or 5 cap properties to LP's or large investors in your fund if the retail-price tag on most assets in most classes has close to negative leverage without major overhauls, which implicitly bring on more risk, and will deliver sub 20% IRRs?
Taking a broker's underwriting package might get there, but almost without fail, every broker underwriting i've seen misses details material to returns/the deal, or assumes rent growth with little investment in a market with no wage or job growth.
Am i thinking about this too much, or am i missing something? Would love to hear some thoughts.
Few thoughts on this (apologies in advance for the stream of consciousnesses nature of this):
That's my two cents on some of your questions; that and two dollars will get you a cup of coffee.
If you are a fund manager at a pension fund, your investment philosophy is "overpay for quality real estate". A mass marketed core deal with nothing funky is going to have plenty of these types ready to back up a dump-truck of kindergarten teachers retirement money to close the deal. Especially now 6 months into the year, if you are still sitting on a lot of capital to deploy, you will up your bet and pray some foreign capital that just wants to watch the world burn doesn't snag it in best and final.
The only way to really make money in this market is through seeking out opportunities where you see a market shift which will lead to rent growth or through active investments into an asset. The funds who are making extremely high returns are seeking investments where they can do both. Boots on the ground and changing a market is how you make real money in this industry. Real estate values are intertwined with index rates and as they rise values fall. So dumb money buying core assets aren't going to do so well in our current environment. In my view, we are at a crossroad where less sexy real estate that trades at lower multiples (IE 10 CAP deals) are less risky than core assets where small incremental macro market changes can kill value. I personally am still bull on the market and still see opportunity but am only looking for deals where I see large market changes occurring.
The 10 year is almost at 3%. The day it gets to 4%, those buying RE at 4 caps are going to be dead men walking. Hold it out, let these people get crushed. Let the pension funds and family offices lose value, I won't shed a tear for these people when the market crashes. The problem with the human brain is that everything is short-term. We are at 9 years since the bottom and people have pretty much forgotten about basic economics. Turn on CNBC or Bloomberg and notice how every analyst looks like they are on Fentanyl and paint a rosy picture.