With the US real estate market and economy being what they currently are, which is to say stable and slowly recovering, it’s tougher to find distressed deals in the States these days. Interest rates are low, which means there is a lot less pressure for people to sell. As a result, the days of abundant distressed opportunities are becoming fewer and further between.
With a lack of distressed opportunities in the US, how does a fund manager with an opportunistic strategy achieve the 20 percent returns its investors expect? One way for such a firm to get those high returns is to get its hands dirty by digging into development and built-to-suit (BTS) projects.
In particular, multifamily development has been garnering a great deal of attention from investment firms for a few years now. That is understandable as fundamentals for the sector are strong, with pent up demand, solid job growth and declining home ownership. There’s also a tremendous amount of competition to buy Class A apartments in the US, combined with a dearth of supply. So, for a distressed specialist looking to make its mark in today’s real estate investment environment, multifamily development can make a great deal of sense.
Take AREA Property Partners, for example, which recently has been concentrating more on multifamily development deals. In the past 15 months, the New York-based firm has invested in multifamily projects totaling approximately 2,400 units and a total value of approximately $400 million. Over the next six months, it has committed to developing an additional 1,100 units with a total value of more than $450 million.
Why has AREA taken such an interest in this space? According to global chief executive officer Lee Neibart, it is because the firm “always looks at broken deals, but we just haven’t found those existing deals that fit that return criteria.”
AREA isn’t alone in seeing the advantage of moving towards development. Office investment firms such as CBRE Global Investors (which bought a controlling interest in multifamily developer Wood Partners in 2008) and Hines also have discovered the value of multifamily development as a good way to achieve those value-added and opportunistic returns in recent years. Other private real estate companies including Normandy Real Estate Partners and Clarion Partners also agreed that there are many opportunities to be found within the BTS space.
Distress investors aren’t just turning towards multifamily development. Morristown, New Jersey-based Normandy has been ramping up its redevelopment and suburban office BTS activity over the past few months. Witness its recent acquisition of the Central Square portfolio in Cambridge, Massachusetts – a quasi-development site in which the firm acquired a portfolio of older office/lab buildings and is rezoning the properties for a new mixed-use development – and its current development project in Needham, Massachusetts, where Normandy recently received approvals for more than 800,000 square feet of Class A office space. Industry sources said the firm is finalizing its first lease for more than 300,000 square feet with an as-yet-undisclosed tenant.
The industrial sector also has seen both speculative and BTS activity in markets where fundamentals are strong. Although most development in the warehouse space is BTS, ground-up development has been taking place in some regions like southern California. In the southern part of the state, for example, big-box warehouse vacancies are at less than 4 percent, which has led to such speculative development.
Of course, there’s a great deal of potentially unwanted risk inherent to such a strategy. Although a number of firms can invest in existing real estate, it bears repeating that not every firm can build. Therefore, it’s essential that the fund manager either knows what it’s doing when it comes to development or partners with a seasoned developer.
In addition, some institutional investors focused on distressed opportunities may not be so keen to switch gears and shift their attention towards development. They may not see the opportunity in building new property and, worse, may not want to hear about the opportunity. Therefore, fund managers could face the extra challenge of not only convincing investors that there are good opportunities in development but that, in some cases, rehabilitating a property could be riskier and more expensive than constructing a building from the ground up (this is particularly true when it comes to getting the building LEED certified).
Although some industry insiders told PERE that they aren’t seeing a rush towards development—there has been an uptick in multifamily construction, for example, but multifamily completions are still below long-term averages—many see it as an emerging trend that will continue to grow. Yes, development can be risky, especially for a firm that historically is known for being solely an investor. However, if the GP knows what it is doing or has a dedicated and skilled development arm (the way CBRE Global Investors has Wood Partners), the risk can pay off.