This article is sponsored by Calmwater Capital • CBRE Investment Management • Greenberg Traurig • Logistics Property Company • Macquarie Infrastructure & Real Assets

A new chapter of the pandemic era has begun for the US real estate sector.

Managers, by and large, are no longer fixated on stabilizing their portfolios. Investors are not fretting over existing exposures. As Larissa Belova, portfolio manager of CBRE Investment Management’s US Core Partners platform, puts it: “Investors aren’t asking about rent collections anymore.”

At PERE’s US roundtable, the panelists agree market sentiment has shifted from ‘wait and see’ to ‘buy, buy, buy.’ “Broadly speaking, transaction volume is still recovering from pre-pandemic levels across the industry,” Belova says. “But from an activity perspective, at CBRE Investment Management we definitely feel like we’re even more active than pre-covid at this point, in terms of deployment.”

The big challenge the industry must solve for now, the panelists say, is how to operate in a market in which so many interested buyers are competing for so few assets.

“There is a lot of equity capital out there, and not enough great deals for smart investors,” says Stephen Rabinowitz, co-chair of the global real estate practice at the New York law firm Greenberg Traurig.

Across the office, retail, multifamily and industrial sectors, more than $53 billion of institutional-grade transactions – valued at $2.5 million or more – were closed in the US in August, according to research firm Real Capital Analytics. This is nearly triple the activity seen in August 2020 and a 28 percent rise from August 2019. While pent up demand from an industry that spent the better part of a year on pause might have contributed to this deluge of dealmaking, a sharp rise in prices has had a more direct impact. Apartments, industrial assets and suburban offices were each up 14 percent or more, year-on-year, according to RCA’s Commercial Property Price Indices. Even retail jumped
12 percent, albeit from a much lower basis.

“The evolution of broad secular, demographic and technological trends is affecting demand dynamics and changing how we use real estate. These ‘emerging growth sectors’ will play a key role in the core portfolio of the future”

Larissa Belova
CBRE Investment Management

Rabinowitz says he fields calls daily from clients who hope he will have an inside track on a promising off-market deals, even though that is far from his remit. “We’re not in the brokerage business,” he says. “But there’s a sense that once a good deal gets to a big brokerage firm, that deal is going to go to auction and may result in someone paying a really rich price.”

Eric Wurtzebach, senior managing director and head of Americas for the Australian bank investment management platform Macquarie Infrastructure & Real Assets, has seen the same trend playing out first-hand. “Almost every high-quality core asset that’s marketed seems to be going through five, six, seven rounds of bidding,” he says. “It’s incredibly challenging to be successful in auctions today. There is definitely more demand than supply and that makes things very difficult.”

To make deals work in this hyper competitive market, Wurtzebach says some groups are operating off overly ambitious assumptions. “For industrial, you’re seeing rent growth projected above 12 percent for the next two years in coastal markets,” he says. “It’s very hard to prudently underwrite that type of rent growth.”

Larry Grantham, founder and managing principal of the Los Angeles-based lender Calmwater Capital, has seen similar trends playing out, even within second- and third-tier assets. “There’s so much capital chasing so few deals,” he says. “We just looked at a class C multifamily property in Denver, built in the late 70s, trading at 3.8 [percent capitalization rate], so future rent appreciation is already factored into the purchase price.”

Grantham questions the sustainability of broad capitalization rate compression, particularly in a macroeconomic environment where the Federal Reserve may soon raise interest rates.

Groups more focused on development, meanwhile, have had their own set of covid complications. Jim Martell, chief executive of Chicago-based Logistics Property Company, says demand for light industrial space, from investors and end users, exceeds any­thing he could have imagined in his three decades focused on the sector. While his group has a robust pipeline of projects and blue-chip tenant demand, the havoc wrought by the pandemic on supply chains has introduced new uncertainties to his business.

“If someone comes in today and says, ‘I need a million-square-foot building. When can I have it?’ – I have no idea when I can get the commodities necessary to build that building and at what price, because a lot of the major commodities are priced upon delivery, not upon contract,” he says. “So, that combination is creating a lot of pressure on us to answer that question.”

New world core-der

MIRA is far from the only firm to see its core strategy altered. In recent years, there has been a steady migration of institutional capital from office and retail to residential and industrial, which benefit from a national housing shortage and a secular shift to digital commerce, respectively.

Covid supercharged those trends. Housing and logistics have become even more critical, offices and shops less so. This year also saw niche strategies, particularly data centers, life sciences labs, student and seniors housing, and cold storage, move into the mainstream.
Belova says this embrace of alternative real estate categories is the natural progression of a changing world. “The evolution of broad secular, demographic and technological trends is affecting demand dynamics and changing how we use real estate. These ‘emerging growth sectors’ will play a key role in the core portfolio of the future.”

Wurtzebach sees the shift to alternatives through a financial lens. “There’s more capital available than ever, and the majority of that capital is being pushed into rental, industrial and smaller specialty asset classes like storage, medical office buildings and life-sciences. Because we’ve significantly reduced, in some ways, capital flows in two of the main property types – retail and office – there’s a tremendous amount of capital flowing into these three areas,” he says.

Yet, for all the conviction behind certain alternatives, opportunities for investing remain relatively limited, particularly in the private market. “Everyone believes in the data center space concept; everyone understands it and sees it growing over time, so there’s tremendous demand. But how do you access the sector?” Wurtzebach asks. “The same is true with the life sciences sector, as there aren’t a lot of really strong operators. So, from an investor perspective, they’re kind of limited in their choices.”


“There is a lot of equity capital out there, and not enough great deals for smart investors”

Stephen Rabinowitz
Greenberg Traurig

Grantham says not all investors have given up on the once-mighty office and retail sectors. He sees a viable model in retail, for example, focused on necessity stores and hybrid business models.

“One of our borrowers with pension fund capital recently mentioned their retail assets are valued at pre-covid levels, sans California and maybe Manhattan,” he says. “In particular, grocery-­anchored, Target/Walmart-anchored, have all been performing well. And you’re seeing vacant junior anchors being repositioned or snapped up by industrial users for last mile distribution. So, is this the death of retailers or the continued evolution of retail?”

CBRE IM sees continued viability for physical retail, Belova says. But it relies on getting the right occupier into its spaces and accommodating their evolving needs. “For the
clicks-to-bricks tenants that are forward thinking in the omnichannel model, the actual bricks matter for the experience. Ultimately, many consumers want to go see, feel and try out certain items, whether they’re ultimately buying online or in the store.”

ESG is not just ‘nice to have’

Along with asset allocation, environmental, social and governmental concerns have become top of mind for the industry. Belova says this is because investors are insisting it be there.

“It’s no longer just a nice-to-have,” she says. “It’s among the questions we get: ‘Are you doing climate risk analysis, when you acquire buildings? What are you doing in terms of ESG due diligence?’ These have become standard, as part of our acquisition process and ongoing asset management process.”

Tenants have also taken up the mantle of ESG advocacy, Rabinowitz says, pressuring landlords to make upgrades to their properties and practices by making them a condition of their tenancy. Larger occupiers, such as financial service groups and banks, are often the most effective: “Those groups are starting to put that in their leases: ‘You, my [building] owner have to do this if I’m going to enter into your lease.’”

“We need to get [people] to work, because there are a tremendous number of opportunities out there, and we are just not motivating people to take advantage of them”

Jim Martell
Logistics Property Company

Grantham says the push to factor sustainability into its lending practices has made its way to his firm in 2020 by way of a large European investor. Calmwater hired a consultant and, ultimately, becoming a signatory of the UN-backed Principles for Responsible Investing.

“Investors and lenders are going to continue to put more pressure on GP sponsors to be cognizant about ESG and transparent about related practices. You are already seeing it,” he says. “The trend is going in the right direction.”

Despite the broadening support for sustainability from investors, lenders and equity managers, there remain hurdles at the property level, the panelists say. Chief among these is the reluctance of certain tenants to disclose their energy consumption to their landlords, which can be a hindrance to manager reporting.

The other challenge is getting end users to pay extra for property enhancements that make buildings more efficient and sustainable. In the industrial space, Martell expects this reluctance to dissipate over time as tenants realize the mitigating impact these features can have on future costs.

“There are plenty of partners to invest capital with, and investors are not going to commit to partners that lack a best-in-class ESG focused strategy”

Eric Wurtzebach
Macquarie Infrastructure & Real Assets

In the short-term, Martell says his firm attempts to frame conversations around “cost of occupancy” rather than cost of rent. “We don’t want to compete on just rent; we want to solve an occupancy cost,” he says. “We’re dealing with energy consumption and use, the throughput of a building and technology. So we can find economic incentives, and things that will positively impact the tenant. We can charge more base rent because their cost of occupancy in our building will be less.”

When it comes to structuring deals and platforms, Wurtzebach says investors still value risk-adjusted returns above all else: “There are plenty of partners to invest capital with, and investors are not going to commit to partners that lack a best-in-class ESG focused strategy.”

‘The Great Resignation’

In 2019, deep into the longest growth cycle on record for US real estate, many wondered what kind of ‘black swan’ event would knock it off course. The answer arrived in the form of covid-19.

Sentiments are split on the panel as to whether the brief recession in 2020 constitutes a market reset. But the sector is undoubtedly on the rise again. What threatens that growth most this time around? The consensus is nebulous: something that would cause rents to stop growing and upend the lofty expectations of the current vintage of deal underwritings.

One concern shared among participants is the state of the US labor market. Workforce participation has flatlined at 61.5 percent since June of 2020, according to the US Bureau of Labor Statistics. This is up from the 60 percent nadir of April 2020, but shy of February 2020’s 63.4 percent despite a record 10.9 million job openings nationally.

“The Great Resignation is real,” Rabinowitz says. “There’s a real labor shortage right now. That can have a real impact on things that we do, how real estate is used, where people live and so on.”

“Investors and lenders are going to continue to put more pressure on GP sponsors to be cognizant about ESG… you’re already seeing it. The trend is going in the right direction”

Larry Grantham
Calmwater Capital

Martell has seen the labor shortage in the construction sector, which has struggled to attract enough workers. He blames enhanced unemployment benefits, which were ended at the federal level in September. “We need a lot of people and there are a lot of jobs out there, so we must stop incentivizing people to stay home. We need to get them to work, because there are a tremendous number of opportunities out there, and we are just not motivating people to take advantage of them.”

Many uncertainties remain for both covid and its further impacts on the real estate industry. What life will be like once the world is clear of the pandemic evokes another set of questions entirely.

“We must be prepared for covid to still be here a year from now; masks will still exist, the hybrid work model will still be evolving. But I’m optimistic we’ll be in a better overall situation,” Grantham says.

Rabinowitz shares a similar sentiment, but with a rosier outlook: “I’m pretty optimistic that the world, at least for the medium term, is ready for people’s lives to improve. Human nature is that people are always going to strive to figure out a way to have a better life.”

Industrial revolution

While expansion of e-commerce is driving logistics growth overall, more granular trends give a better sense of where the market is going

Logistics has been the darling of the US real estate market in recent years, as investors look to participate in the growth of e-commerce.

The pandemic has ramped up that sentiment. Stuck at home, more consumers have taken to online shopping and e-commerce companies have sought to scale their footprints accordingly. These factors have led to impressive performance, including a total return of 23 percent by industrial funds in the NCREIF Property Index during the past year.

However, Eric Wurtzebach says the true scale of the opportunity in the space is not fully appreciated. “What hasn’t been talked about enough in the industrial space is the shift from one or two day delivery to delivery within one to two hours,” he says. “I believe that is going to lead to another uptick in industrial space demand.”

Another driving force behind warehouse growth in the years ahead will be inventory management, Larissa Belova says, companies making sure they have excess capacity. “Due to supply chain disruptions, tenants are now moving from ‘just-in-time’ inventory management to ‘just-in-case.’”

Jim Martell says LPC recently completed a 500,000-square-foot warehouse that will serve just that purpose for a global home furnishings retailer in the Seattle area. It is the second warehouse for the retailer in that metro serving that purpose, and both are currently empty.

“They can’t build inventory,” Martell says. “It comes in, goes on a truck and goes out to their stores. But they know that a surge is coming and a change in inventory management is coming. So, they have a million square feet of extra space just to manage the surge.”
Both last-mile logistics sites and inventory management facilities have very specific needs. Generic industrial space often is not equipped to handle the high levels of throughput that takes place within these properties.

Stephen Rabinowitz, co-head of the real estate practice at the New York-based law firm Greenberg Traurig, says obsolescence is an overarching theme driving the demand for new logistics space. He adds that while the industrial sector may be getting the most scrutiny for its out-of-date properties, it is an issue that permeates the entire real estate industry.

“What we’re seeing in industrial is probably a little bit of a precursor to what you’re going to see in other sectors in real estate as well,” Rabinowitz says. “You’re going to have obsolescence in hospitality in terms of current assets, you’re going to have obsolescence in office in terms of current capacity. When I talk to our clients, I hear those are going to start being bigger and bigger drivers in the next few years.”

Hindsight on 2020

The covid-19 pandemic has been a singular market disruptor that has played out much differently than many expected at the outset. This is what some of our panelists would do differently with a do-over

Larry Grantham: “In April of last year, we saw an industrial deal in a secondary Sunbelt market: stabilized asset with minor roll risk, B location, B building, approximately a third of the rent roll with one of the larger companies in the world and a strong sponsor. But at the end of the day, given all the uncertainty around covid and early signs of the recession, we were uncomfortable deploying capital.”

Jim Martell: “Our view is that volatility is driven by the land price, so we backed away from the Inland Empire at $25 or $30 per square foot. Of course, that land is now $50 per square foot. And another 40 million square feet was built on top of it in the past two years. We shifted our effort to Seattle and that paid off in spades, so we came out okay. But we just didn’t focus on the Inland Empire as much as we should have.”

Eric Wurtzebach: “We should have been more aggressive in 2019 and during the early months of covid. While it is more of a generic answer, I would have bought anything in the industrial space in 2019 and 2020. The industrial market during that time was never better.”

Larissa Belova: “I don’t think anybody predicted the kind of rent growth that would ultimately happen in industrial. Last year, the general projections were that vacancy would increase and demand would soften in the sector and it did just the opposite, so I think we all wish we did more industrial deals last year.”

Meet the roundtable

US roundtable 2021Stephen Rabinowitz
Co-head of global real estate, Greenberg Traurig

Rabinowitz advises private equity funds, asset managers, developers and institutional investors on real estate transactions across a variety of property types. He also
advises on capital formation and financing, and chairs the law firm’s New York real estate practice.

Eric Wurtzebach
Senior managing director, head of Americas, Macquarie Infrastructure & Real Assets

Wurtzebach leads the Americas real estate division of the Sydney-based alternatives manager. It has $17 billion of real estate globally, of which $8 billion are in the US. His team handles asset management, merchant banking, an advisory business and investing from the firm’s balance sheet.

Larry Grantham
Founder, chief executive, Calmwater Capital

Grantham co-founded Los Angeles-based Calmwater Capital in 2010, initially to invest in real estate debt on behalf of Karlin Asset Management. Calmwater has raised capital from other investors since 2015 and recently held a first close on its fourth fund. The firm makes short-term, high-yield loans to institutional borrowers.

Larissa Belova
Portfolio manager, US Core Partners, CBRE Investment Management

Belova joined the $129 billion firm – then CBRE Global Investors – in 2019 as deputy portfolio manager for its US Core Partners fund. She became portfolio manager in August and is in charge of the core vehicle’s performance, asset management, expansion into new property types and ESG initiatives.

Jim Martell
Chief executive, Logistics Property Company

A 43-year industry veteran, Martell formed LPC in 2018 as a partnership with MIRA Real Estate focused on core industrial assets in the US. The firm is most active as a developer of big box warehouses and small distribution centers. Before launching LPC, Martell was founder and president of Ridge Development Group.