Institutional investors investing in the US should focus more on the risk profile of their real estate investments and be willing to pursue less risky alternatives in gateway cities instead of searching for higher yields in secondary or tertiary markets, heard delegates at PERE’s Global Investor Forum held in Hong Kong today.
Panelists speaking on the real estate opportunities available in North America cautioned against branching out to second-tier cities where returns can be higher as compared to gateway cities like New York and San Francisco – a trend which increasingly is being adopted by many local and international investors.
“We are willing to invest in the major markets so that in the long period of time, our returns will hold up through the full cycle,” said Walter Schmidt, senior managing partner at Rockwood Capital, a New-York based real estate investment firm. “Investors should be careful about going to smaller economies which might not have the strength of demand for a long term.”
Schmidt spoke about a recent analysis done by Rockwood on the performance of the $28 billion worth of real estate investments the firm has done in the last two decades with the intention of determining which investments in gateway cities outperformed all other deals. “These major markets have had the deepest employment growth, highest quality of income and therefore create the best fundamentals from an operating point of view,” he said of its findings.
According to Len O'Donnell, president and chief executive officer, USAA Real Estate Company, some investors are now becoming more receptive to alternative investment strategies and are willing to modify their return expectations. For investments in certain asset classes, he said, investors are now happy with 12 percent to 15 percent returns.
“We are looking at places with lesser risk and modified returns. Some investors are okay with buying an office building in a low risk area where 60 percent of building rolls out in the next three years in Houston but rents are $5 a foot below the current market price,” he said. The panellists also spoke in favor of developing industrial, multifamily and office assets in gateway markets as viable investment routes.
“In 2011 to 2012, we did development in secondary markets. Now, we are happy with gateway markets because these markets will outperform in a downturn,” said O’Donnell. “So even though we might be doing development, which is riskier than acquisition, we are de-risking ourselves in terms of geographies.” USAA currently has around $1 billion of office space under development, and is also looking at developing multifamily assets in San Francisco as well as distribution centers in California.
Hugh Macdonnell, managing director, Clarion Partners, added further: “[In] industrial development for example, the time to zone and build is relatively short and efficient, and costs are manageable and easy to underwrite. You can underwrite risk for doing industrial development and still get good adjusted returns.”