FEATURE: Healthy alternatives

There is some evidence that investors are clamoring for alternative property investments, so long as the fund sponsor has the trust of limited partners and a track record to back up its thesis.

For example, Kayne Anderson Real Estate Advisors enjoyed a quick fundraising for its third offering targeting student housing, Kayne Anderson Real Estate Partners III. In fact, sources confirm with PERE that the Armonk, New York-based firm – the real estate arm of private equity firm Kayne Anderson Capital Advisors – had to turn away potential investors in order to stick to its $750 million hard cap.

Other firms are managing to attract dollars as well. Chicago-based Harrison Street Real Estate Capital’s fourth fund targeting student housing, as well as senior housing, medical office buildings and storage properties, raised $465 million by its first close in March and is targeting a total equity haul of $600 million.

Meanwhile, the industry has witnessed private equity heavyhitters such as TPG Capital and Kohlberg Kravis Roberts (KKR) target senior living and healthcare investments this year. TPG bought Wisconsin-based Assisted Living Concepts for about $278 million, while KKR provided $150 million of convertible preferred equity for a stake in Orlando-based Sentio Healthcare Properties. 

Getting defensive 

It seems that, along with potential returns, part of the attraction of alternative property types is their accessibility and defensive nature.

“Investor appetite has grown, as these assets held up very well in the downturn,” says Harrison Street co-founder and chief executive officer Christopher Merrill.  He notes that US medical office properties as a whole performed better than office properties during the downturn, while senior and student housing ultimately outperformed traditional multifamily. Self-storage properties performed better than industrial. 

Not surprisingly, one of the main reasons why these property types fared so well is because of demographics. In the US, people are living longer and more people are going to college, so those demographics help contribute to a growing need for senior and student housing and, by proxy, medical office). Also, following the housing crisis in 2008, a number of people were downsizing their living space by moving out of homes and into apartments, which led to an increased demand for self-storage space.

Since 2008, the demand for such alternative properties certainly has grown – and it appears to be growing. In June, it was revealed that the Los Angeles County Employees Retirement Association expects to allocate up to $350 million to niche opportunities in student housing, senior housing and medical office in the US, with about $75 million of that amount projected to be deployed during fiscal year 2013-2014.

Fortunately for investors, a number of fund managers, including Kayne Anderson, Harrison Street, GI Partners and Virtus Real Estate Capital, are there to accommodate their growing appetites for such niche investments. In time, these investments may evolve from being niche property types into more mainstream ones.

Seeking yield, avoiding risk

As PERE previously reported in its February issue, student housing is showing strong and steady growth due to a growing student population and lack of on-campus accommodations at universities. A November 2012 report by Jones Lang LaSalle also points out that the US is one of the most attractive markets for the space, with investments in 2012 reaching roughly $2 billion. 

The US Department of Education reveals that the demand for student housing is steadily outstripping supply in a large number of markets, with many public universities experiencing 2 percent to 5 percent annual enrollment growth. While enrollment at public universities has grown, the existing supply of on-campus housing has failed to keep up. All of these fundamentals lead to increased interest from LPs. 

“Investors are yield starved,” says Al Rabil, chief executive officer of Kayne Anderson Real Estate Advisors. “They’re looking for a place to find yield where they’re not getting into too much risk.” Many nontraditional real estate assets fit that bill. 

While student housing properties can generate high returns due to a favorable supply-demand dynamic, advancements in technology, combined with a growing aging population requiring frequent visits to the doctor, has resulted in an increased demand for medical office, senior housing and memory care facilities.

In the self-storage sector, a February report by the Wall Street Journal noted the rise in popularity among private real estate investors. “Self-storage had long been a market mostly operated by mom-and-pop landlords,” the report stated. “The sector became more popular over the past few years after catching the eye of a growing number of private equity investors armed with cheap financing and dwindling options for high-yielding investments.” 

In fact, the more that fundamentals push up the demand for these property types across the board, the more that GPs begin to focus on and specialize in such previously underplayed sectors. 

Price and access points

Alternative property types also are gaining interest from institutional investors primarily because of pricing. Anthony Frammartino, a partner at real estate consultant The Townsend Group, tells PERE, LPs are becoming more interested because the price of many of these assets is right.

“They’re somewhat alternative in name only,” says Frammartino. “If you look at the public markets, they’re not being priced as if they’re at all that alternative.” 

Rabil adds: “You’re looking at alternative properties trade a little wider than core assets. When you buy student housing at a 5.5 percent cap rate, multifamily typically is 200 basis points south of that.” 

Besides price, another access point for investors to such alternative properties is the emergence of niche players. “There was no real way to access these deals before,” says Merrill on why Harrison Street set up its business model the way it did. “These are small, fragmented deals.”

Adds Frammartino: “A lot of these areas are still pretty small. It requires a specialist approach.”

More mainstream

Going forward, it’s likely that alternative properties will continue to increase in interest and importance for investors, regardless of how the economy winds up. In fact, some firms refer to these properties as ‘recession-proof.’ 

Take Virtus, for example. Last year, the firm launched the Virtus Real Estate Capital Fund, a diversified fund to target multiple recession-proof property types throughout the US, including student housing, self-storage, medical offices and senior living projects, the latter of which is a new addition to the firm’s investment strategy. 

According to Virtus’ website, the firm “focuses on investment opportunities whose success does not require a particular economic environment. Instead, Virtus seeks to capitalize on opportunities arising out of increasing demand that can be sustained even in the face of a recession or a decline in general real estate values.” 

Ultimately, it is likely that such property types will not be seen as alternative, as they’ll all be a part of most institutional investors’ portfolios. This is especially true if more LPs restructure their real estate portfolios to focus on real assets, like the way that the San Francisco Employees Retirement System currently is doing and the way that JPMorgan Asset Management believes investors will in the next decade or so. 

“I think they’ll become more mainstream,” says Frammartino of alternative real estate. “It all comes down to how they are priced.” 

Indeed, the acceptance of these property types has been steadily growing, with some types having been accepted a little longer. In terms of pricing and returns, the senior living and self-storage sectors have drawn a number of parallels to the themes that investors see with multifamily—a property type that would have been classified as alternative 20 years ago.

Despite the strong possibility that many of these property types ultimately will be seen as mainstream, it’s not guaranteed that every alternative sector will see massive growth. It still depends on the savvy of the operator and making the right moves.

As Merrill tells PERE: “The strong will survive. From a big picture standpoint, there is going to be a need for these assets in this country for a long time.”