This article is sponsored by CIM Group.
Jolly Singh is a principal, portfolio oversight at CIM Group, responsible for the firm’s core investment strategy. He was previously on the firm’s investments team, sourcing acquisitions and implementing business plans – which can encompass anything the firm is doing to improve the quality or value of an asset, including how to run the building more efficiently or how to lease up and stabilize the asset.
Expertise in each function of property management, leasing and construction, as well as deep knowledge of asset classes are necessary to identify opportunities and create the right spaces at all levels of risk, Singh says.
What has driven returns most recently, and what do you expect will do so going forward?
Recent performance within real estate has been exceptional, in part due to a very low interest rate environment. This includes as wide a dispersion of returns among sectors as we have had in history, with industrial on the far side of outperformance, multifamily a close second, and then office and retail lagging behind. There has also been a divergence between geographic markets, with significant growth in the US Sun Belt post-covid relative to traditional gateway cities. But, by and large, the biggest driver of returns has been sector allocation, driven mostly by high levels of rent growth in industrial and multifamily.
Sector and geography are always important factors in an investment decision, but I do not think they are going to drive returns to the same degree going forward. Asset selection and value creation are going to become much more important. It is incredibly important to find assets where you can grow NOI, especially in an inflationary and rising interest rate environment. Driving NOI growth in excess of inflation comes not just by picking a growing sector, but by picking the right assets that are well-positioned within that sector, and having a business plan that will grow NOI and ultimately lead to value creation and outperformance.
In order to drive landlord pricing power, it all comes back to supply and demand. Even within a desirable sector or geography, location matters, and by that I mean micro location. It is not just about picking the right metropolitan statistical area or even the right submarket; it is picking the right asset on the right block. We need to ask ourselves, “What tenant are we trying to attract, and how will we provide a more appealing product to that target demographic than our competitors?” Rather than just making broad, high-level sector or geographic bets, it is important to be micro market-focused, leaning into the specifics of each property and how it aligns with tenant needs to outperform in terms of leasing and rates.
What is the relation between risk and value creation?
There is a general misconception that value creation is only associated with highly risky strategies, such as opportunistic and value-add investments. Historically, the expectation has been that at the low-risk end of the risk spectrum you should only expect to achieve beta. It is possible to generate alpha through value creation across the entire risk-return spectrum.
In fact, my view is that the biggest risk in an investment is not having any levers to create value. If you are completely dependent on the direction of the capital markets, you do not have any control over your destiny. Even within a core risk strategy, we like to drive NOI growth in our investments, because we believe that will result in higher income and appreciation. It allows us to have more influence on the performance of our investment. If we can grow profitability, it helps drive value, and that is completely independent of what is happening in the capital markets.
How can value be created across the risk/return spectrum?
Value creation is more than just investing capital to reposition or build something new. There is a component of capital deployment that is needed, but there are several other value-enhancing strategies that do not require capital outlays.
For example, merchandising your property to have the right tenant mix, with retailers that can drive demand for your adjacent office or residential space, or place-making to invite and encourage people to gather. The right mix of tenants and inviting spaces can make all of those uses synergistic and more valuable to each other. Whether it is enabling tenants to be more productive and achieve higher sales to run their businesses more efficiently, or just to help tenants enjoy their spaces, it involves having a deep operational expertise across asset classes and thinking about the end user; what they want, need and value, and then figuring out how to deliver that. This can be done across the entire risk spectrum, it does not have to be associated only with higher-risk strategies.
“It is possible to generate alpha through value creation across the entire risk-return spectrum”
What is the importance of operational expertise in real estate?
Understanding what a tenant wants, and what you need to deliver from a product standpoint, is essential. You need to know how a retailer is going to use their space and what their business needs are in order to identify investment opportunities where you can make and implement business plans that will appeal to them.
This requires expertise in all functions of real estate – property management, leasing, construction – as well as a deep understanding of each asset class. This is one area where I believe we have developed a real competitive advantage. CIM is vertically integrated, with almost a thousand people on our staff spanning all those functions. We have deep expertise within each individual asset class, which helps us create a better, more valuable product for tenants and deliver better returns.
How should asset managers adjust for the effects of changing capital markets and declining valuations? What is the right strategy in the current environment?
The only real offsetting factor to the movement in cap rates and the repricing of assets is the ability to grow NOI. It acts as a counterbalance to rising discount rates and cap rates. Our view is that the right strategy in any environment is one focused on NOI growth, but especially in the current environment.
At our core, we have always been focused on creating NOI growth in each of our investments across the risk-return spectrum. That puts us in a better position to navigate these changing market conditions, because we continue to unlock value through these various value-creation strategies.
Our focus when we invest is to identify where we can create value. We look across all the components of an asset to see if it is operating optimally. If not, we identify the various levers we have that align with CIM’s core competencies and capabilities. These include executing capital improvement programs, taking a view on market rents and implementing leasing plans to achieve higher rates, and identifying ways to operate buildings more efficiently, all of which is designed to drive profitability and make our buildings more attractive to our target tenants. There is no single formula that works for every asset and every market.
If CIM cannot bring any value to the table, then we are not the buyer for that particular investment. Conversely, if we think that we can execute a business plan to add value with our operational expertise, then it becomes a candidate for us to invest in.
How do you create something of value for today’s tenants?
Most tenants are looking for high-quality, functional – ideally move-in-ready – spaces that meet all of their needs. It is very important to understand who that audience is and what exactly they are looking for so that we can then deliver that product, which can be done across all asset classes.
For example, office is a sector with a number of headwinds. We have successfully built out spec suites for smaller tenants that are functional and essentially move-in-ready, with high-end finishes. This eliminates the burden that was previously placed on these tenants and has helped drive leasing velocity across our portfolio. Previously, office landlords would expect tenants to design a space, hire a contractor, and oversee the buildout. Only after completion would they be entitled to a tenant improvement allowance reimbursement, and they would be on the hook for any overage.
Tenants of this size do not typically have in-house real estate groups or the expertise to build out their space. At CIM, for smaller tenant spaces we have tried to take on the design and construction responsibilities for spec suite buildouts because it better aligns with our expertise. Taking this approach helps eliminate much of the friction associated with a traditional lease structure for these tenants, decreasing the time to move-in from 9-12 months to more immediate.
Likewise, much of the industrial space that we have today can be occupied almost immediately, with very little adjustment needed.
Across our residential portfolio, we have been renovating multifamily units to a standard that people are looking for, with outdoor amenities that are in-demand. Creating a sense of community within our properties, whether it is through events or other levels of engagement, allows us to retain more tenants and charge higher rents.