AMERICAS NEWS: Energy rush

Known for building some of the most high-profile multifamily projects in America’s cities, Related Companies now is moving into uncharted territory – the country’s shale oil markets. In those markets, particularly North Dakota’s Bakken Shale and Texas’ Permian Basin and Eagle Ford Shale, energy exploration and production activity have created soaring job, wage and population growth, leading to unprecedented levels of residential real estate demand. 
Despite the abundance of available land in these markets, building on these sites is difficult – not only because of the lack of infrastructure, including power, water and sewer, but the dearth of construction workers, many of which have opted instead for high-paying oil and gas jobs. In addition, North Dakota’s harsh winters limit its building season to a maximum of four to five months per year. Moreover, few lending institutions are willing to provide capital for projects, so most developers must build entirely with equity.
“There is tremendous demand but also high barriers to entry because it’s very hard to build even though there’s a lot of land,” said Justin Metz, Related’s managing principal of real estate fund management. “That combination makes it a very compelling opportunity for us.”
To date, Related has executed two major deals in US shale oil markets on behalf of its $825 million Related Real Estate Recovery Fund. The transactions, both of which closed this year, include the acquisition of an existing 3,000-unit apartment portfolio in Midland and Odessa, Texas, which the firm intends to upgrade, and the purchase of 60 acres in Watford City, North Dakota, where the firm plans to develop 240 residential units.
Related, which is said to soon begin marketing a successor vehicle to its Real Estate Recovery Fund, also is said to have launched one of the first property funds focusing on investing in the US energy exploration markets. Through the fund, which PERE understands is targeting $300 million in equity, the firm is expected to buy and build up to 6,000 multifamily units in North Dakota and Texas and already has identified several assets for the vehicle.
Energy exploration markets, however, require a different approach than US gateway cities. “You have to come with a very fresh perspective,” said Metz. “You can’t come and say, ‘We’ve used this model somewhere else, so it’s going to work here’.” To tackle the challenges of building in North Dakota, for example, Related plans to partner with its contractors to incentivize them to remain on the job and to use modular units, so that much of the housing can be constructed offsite. 
Because of their higher-risk nature, multifamily investments in US shale oil markets have generated 15 percent returns on cost. Such yields, virtually unheard of elsewhere in the country, are rapidly attracting new players to these areas.
“When we started looking out there about two years ago, it really was the Wild West,” said Jeffrey Baker, executive managing director at real estate services firm Savills, which has brokered a number of property deals in the Bakken region. Now, “it’s very competitive, more competitive than we’ve seen in some mainstream markets.” 
Just 18 months ago, Baker noted that investors had to be educated about the market. “They hardly knew where North Dakota was,” he quipped. “Whereas, at this point, we have 100 active major investors actually interested in investing in that region.” 
The growing interest in such markets, however, already has compressed cap rates by a fair amount over the past 12 to 18 months. Indeed, Baker expects that assets currently being marketed for sale now are likely will trade some 300 to 400 basis points lower than the current return.
Other private equity real estate players in the space include Kohlberg Kravis Roberts, which is developing a 163-acre master-planned residential community in Williston, North Dakota, and is said to be pursuing other deals in US energy markets.  And, earlier this year, Savills represented a New York family, in partnership with a major state pension plan, on the acquisition of several hundred apartment units in North Dakota that were built by a local family office.
Metz admitted that the flow of institutional capital into the US shale oil markets is a concern. “We have been working on this opportunity for two years,” he said. “When institutional investors appear, it means the opportunity is going to become more mainstream, but we’ve had enough of a head start that we can build up our portfolio for acquisition by other institutional capital.” 
That said, many still are viewing the energy boom as a sustained real estate opportunity. “Where else can you find long-term stabilized returns of any significance?” said Anthony Albanese, head of the energy facilities group at property services firm CBRE. “These energy companies are willing to commit for the long term and, because the market is rural, you can get higher returns for a longer period of time.”
Indeed, oil companies estimate that the drilling cycle for recoverable energy in North Dakota will last more than 50 years, with an even longer timeframe for Texas. “Of all the opportunities we have been looking at, this probably has the best long-term supply-demand fundamentals of anything that we see out there today,” said Metz.