It’s tough being ahead of the curve. Most investors are trend followers, not anticipators. They would rather follow the pack than lead it.
In 2022 we advised our commercial real estate (CRE) investors that a top was in for multifamily and it was a good time to head for the exits. Acquisition cap rates in many markets hit 3-3.5%. At these levels, there isn’t much ‘juice left in the squeeze’ in terms of appreciation.
Furthermore, post pandemic increases had driven rents to unsustainable levels. It was just a matter of time before rents began trending down and values followed.
We feared this would be exacerbated by all the new inventory coming online, particularly in Sunbelt States. A sampling of recent headlines from globest.com bears this out:
- U.S. Rents Dropped for Third Straight Month (Kathy Rembiz – 01/09/2024).
- Multifamily Deliveries Will Top Last Year’s Levels by 50% (Erik Sherman – 01/17/2024).
- Fed Stays Steady but Multifamily Cap Rates Keep Climbing (Erik Sherman – 01/22/2024).
Erik Sherman put it succinctly in a December 27, 2023, article stating, “Under a basic understanding of economics and the relationship between supply and demand, there comes a time when more inventory means less money. Customers can have their pick; competitors come to a point where they start lowering prices. Pricing power gets harder to come by in general. That’s been happening increasingly in multifamily markets, especially those in the South and West… And it will only get worse this year.”
Fortunately, most of our investors heeded our warning and dodged this bullet by diversifying into other, less fully priced CRE types like self-storage and senior living.
The risk incumbent in this switch may be minimal given storage and senior living’s status as the number 1 and 2 CRE Types in terms of 20-year average annualized total returns at 16.45% and 14.60% respectively. (NCREIF National Commercial Real Estate Investment Fiduciaries) and NAREIT (National Association of Real Estate Investments Trusts)
We think an even stronger case can be made for their desirability long term, given the hole left in institutional CRE portfolios with the implosion of office and retail.
Institutional investors have been wary of retail for some time due to the steady march of e-commerce. Wariness morphs into antipathy where office is concerned. It’s like a Dutch Auction, prices just keep falling until someone steps in and buys. Catching a falling knife can be bloody. Our sense is, there is more to come.
Heretofore, most institutional CRE portfolios consisted of multifamily, office, retail and industrial. The demise of office and retail has created a lacuna, or unfilled space. Nature hates a vacuum so this won’t last.
In time, we believe this will be filled with alternative property types such as storage, senior living, and medical office buildings.
Our views are shared by BlackRock, the world’s largest investment company with AUM of $9.101 Trillion. A report from BlackRock Real Estate Research says, “investors will have to build portfolios for developing demographics. A growing aging population means more demand for healthcare (including medical office) social services, and age-restricted housing. Older people may move from high-tax areas to lower-tax ones.”
Downsizing comes with growing older. This means more of mom and dad’s stuff may end up in storage. Transition to some kind of senior living facility is not far behind. And greater need for medical care outside or independent of a hospital is consistent with this transition. So try getting ahead of the curve with DSTs and Peregrine Private Capital.