While an impending economic downturn was front of mind for most US managers and investors in 2018 and 2019, avoiding highly priced assets will be in focus in 2020.
US executives tell PERE a downturn could be short-lived, or that the current cycle might protract a little bit longer. For them, the goal will be finding favorably priced assets that can serve income-driven strategies.
“The focus is going to be on more consistently reliable cashflows in solid markets where some level of repositioning may be required, but where we feel that the discount to replacement cost, relative to the growth potential in rents, offer a significant arbitrage,” Los Angeles-based asset management firm Oaktree Capital Management’s head of global real estate John Brady told PERE.
For Brady, the US office sector shows promise. Brady predicts there will be pressure to sell office assets given how many core investors are overweight on the property sector these days. This presents an interesting opportunity because there are numerous markets where the replacement costs for offices is significantly higher than the purchase prices, he said.
Bridge Investment Group partner Inna Khidekel observed how one could buy office assets at about a 50 percent discount to replacement costs in some US secondary markets. She says, for these, a cap rate of approximately 7.5 percent upon entry is acceptable. “If you’re buying at a 7.5 percent cap rate, even if you achieve no leasing and no operational value, you’re still generating strong cash flows in this environment on a relative basis,” Khidekel said.
Many US cities have favorable demographic tailwinds too. These secondary markets are experiencing a net inflow of migration, office-using employment growth leading to strong tenancy absorption with little to no new office supply, according to Khidekel. These demographic shifts mean that the overall net operating income growth in certain secondary markets are much stronger than in gateway markets, she said.
While not bullish on the general office sector, Nuveen Real Estate- the real estate investment arm of insurance service company TIAA- believes office markets with a high concentration of tech jobs will continue to outperform in 2020. However, Nuveen Real Estate Americas head of research Melissa Reagen warned that the high capital expenditure requirement in office investment could eat into the total return. A sector that requires less spending on building improvements might be a better bet, she said. Industrial, for example, requires less capex investment and continues to be of interest for Nuveen Real Estate.
“[Industrial] is fully priced- you’re not going to get any bargains in the sector but that said, it’s hard to figure out how would I actually lose any money in the sector,” Reagen said. “Even if it only gave you a 5-6 percent return, in some sense, that’s all what certain core investors want.”