CIM Group on driving returns beyond market trends

Charting a new path for returns means getting back to basics, says Jolly Singh, a principal of portfolio oversight at CIM Group.

This article is sponsored by CIM Group

In a world where investors are waiting for their sails to catch the wind leading back toward financial returns, Jolly Singh, a principal of portfolio oversight at CIM Group, says his team is bringing the oars out to row. Early in his career, Singh watched his team of 30 be taken down to just three by the global financial crisis, but today he is stewarding billions-worth of investments through the tumultuous market, using in-house expertise and hardened principles to create value across property sectors and risk profiles.

Considering the evolving dynamics in the real estate market, what are the current drivers for increasing returns?

Jolly Singh

In the recent past, we have seen sector trends and highly accretive leverage were key drivers to returns. Obviously, we have seen interest rates rise, so leverage has become less accretive. Business plans today cannot rely on leverage to drive returns. As it relates to sector allocation, it is not as simple as betting on sectors like industrial or multifamily anymore.

Today, there are very different supply-and-demand fundamentals across subsectors. It is very important now to identify the exact subsectors that are attractive in growing geographic markets. While it is crucial to bet on trends you believe in, it is also imperative to create value within the assets you are purchasing. We believe tailwinds will continue to be there, but to grow NOI it is more important to invest in assets with business plans you can execute.

How can value creation strategies be pursued in real estate investing without necessarily increasing risk?

There is a common perception that when you are creating value you are taking on greater risk. In many business plans that is the case, but there are various risks we are willing to tolerate. You want to take on the risk you are in the best position to manage and execute against. You can buy a building with an opportunity to create value that leans heavily into your expertise in asset management or leasing, creating an advantage for you to bring a product to the market that you believe is going to get leased. Being more thoughtful around the product you are providing and leaning into your expertise to create value can greatly reduce the risk.

What is the significance of operational expertise in realizing value creation potential across various aspects of real estate?

There are a couple of different models in our industry. Under a traditional model, capital partners and operators form JVs that depend on the operator’s expertise. In many cases, third parties who are experts in individual functions are engaged or relied on to deliver the value creation.

“Being more thoughtful around the product you are providing and leaning into your expertise to create value can greatly reduce risk”

Conversely, there is a fully vertically integrated model where all those functions are handled in-house. There are benefits to having that model in place. First, you have a tremendous alignment of interest. Typically, when dealing with an outside third party, their interest may not always align with your own, which could lead to different outcomes. In having that alignment in-house, from day one we can staff property management, leasing, development, construction and asset management on a deal – using the same team to underwrite a new investment and execute the business plan all the way through disposition without a handoff.

The other benefit of vertical integration is deep expertise across each of these functions, which helps develop confidence in the viability of business plans. Handling execution in-house we believe will get the best outcome and allow our teams to leverage experiences across our entire platform of investments. The challenge is it is hard for an asset manager to build a deep level of expertise across a broad set of services, geographies and across property sectors. It takes significant time and investment to build these capabilities.

Typically, you think of value creation as focused more within higher risk investments. I work on the core side, and we tap into our firm’s expertise in construction and development on lower risk business plans like lobby improvements and multifamily unit renovations because we think it allows us to better execute on these strategies.

How do you balance the objectives of delivering returns to investors with creating value for tenants, especially considering the evolving demands of tenants?

They are so interrelated: we believe creating value for tenants is what drives value for investors. Our job needs to be tenant-centric. We need to think about our real estate and the space we own and operate from a tenant perspective. They are the ones leasing, occupying and running businesses out of our space. We need to think about how we can position our space to be as desirable and usable for the end user, so they are more likely to lease and renew space with us. And, of course, we can retain tenants or charge higher rents if they have more functional, higher quality space.

“A distinct and understandable business plan that managers can execute can lead to NOI growth and more confidence to deliver performance going forward”

Knowing our tenants and knowing the market all translates into returns for investors. On the office side, we build out spec suites for smaller tenants who cannot or do not want to invest the time and energy to build out their space themselves. Providing move-in ready space is an area where we can remove friction in the leasing process by investing capital to create unique, high-quality functional space that we can lease quickly in the face of a challenging office environment. We believe it is all about leaning into the things where you can be differentiated and are valued by tenants.

With the market stabilizing and interest rate shifts on the horizon, how will value creation initiatives serve as a differentiator for real estate investment performance in the future?

We believe we are nearing the tail end of valuation adjustments, and we are beginning to see the market stabilize. The Fed had indicated they are pivoting on interest rates, and there is varying data that will drive how quickly that happens. We anticipate it to be a benefit to real estate in the coming quarters. The main factor that should deliver returns is NOI growth, the area we have the most influence and control over, so that is where we want to lean in and create incremental NOI.

Investors should seek a clear strategy. A distinct and understandable business plan that managers can execute can lead to NOI growth and more confidence to deliver performance going forward.

Most outsiders assume owners buy a building, improve it and trade on the added value, but it seems that strategy is no longer prevalent. What happened?

If you step back and look at the last four to five years, various sectors saw either tremendous returns or negative outcomes. The high-level sector was the driving return differentiator amongst managers. Returns were driven less by what managers were doing at the asset level and more by how they allocated at the sector level. The divergence of return between sectors has started to narrow, with the exception of office. Going forward, we believe return performance will not be driven simply by picking sectors to invest in or to avoid. Within each broader sector, we expect performance will vary significantly across geography and subsector.

“In addition to subsector and geographic selection, asset-level value creation will become a greater differentiator in performance. You have to be more careful about what and where you are buying”

For example, the industrial sector has benefited greatly from tailwinds related to e-commerce that have benefited all subsectors and geographies. Today, however, there are very different supply-demand characteristics across geographic markets within bulk industrial versus smaller infill warehouses. In addition to subsector and geographic selection, asset-level value creation will become a greater differentiator in performance. You have to be more careful about what and where you are buying.

Gone are the days where you can buy a building that had long-term leases, and because the sector was improving you were making tremendous returns from that investment. That was a great investment at that point in time, but because there were no levers to grow NOI, there is nothing you can do to create value at the asset level to offset new supply or rising interest rates. That is why today it is important to lean back into the levers you can pull to create value at the asset level to drive investor return.

How should asset managers strategically leverage value creation initiatives across different risk/return profiles and asset classes?

That is the fundamental question. Our job should be to deliver greater returns relative to the risk we are taking. If all you are doing is delivering commensurate returns for the risk, you may not be generating alpha. We believe understanding the customer, the product and your expertise is key. The last thing you want to do is buy an asset where you have no unique value proposition. That is why we select assets where we can leverage our in-house expertise to improve and create a better product that aligns with where the depth of demand is in the market. It starts with the right thought process on the front end and follows with execution on the back end.