Demographics, climate change and regulatory issues are factors determining where companies invest in U.S. real estate, according to panelists at the Global Property Market conference at the Metro Toronto Convention Centre on Dec. 3.
In addition to the country’s largest gateway markets, the four panelists identified the key non-primary cities they’ve invested in, or are considering.
Rockwood Capital, LLC managing partner Tyson Skillings said Rockwood has identified Austin, Texas as well as Portland, Denver and San Diego as having similar dynamics as gateway markets, including a highly educated workforce, innovation clusters, well-funded research institutes, some constraint on supply and a high quality of life.
“They have a disproportionate share of the employment growth that we’ve been seeing. That intrigues us and that’s why we’re studying them.”
Rockwood has offices in San Francisco, New York City and Los Angeles and manages $8.8 billion US of equity commitments from investors.
The real estate investment management firm was founded in 1995 and provides equity capital and operating expertise for repositioning, recapitalization, development and redevelopment of retail, hotel, residential, office, and research and development space in markets throughout the U.S.
Skillings noted that, while the San Francisco Bay Area will remain a “nucleus of innovation,” he’s seen quality jobs leaving for some of the aforementioned markets.
Demographics key to U.S. investments
BentallGreenOak, with head offices in New York City, Toronto, London and Tokyo and US$48 billion of assets under management, has an established multifamily portfolio in gateway markets.
It has made a major push over the last few years into secondary cities where young professionals are going to want to live, including Raleigh, N.C., Salt Lake City and those mentioned by Skillings.
Amy Price, the managing partner and co-head of the U.S. for BentallGreenOak, said the company is also looking at emerging locations in close proximity to primary markets, including Hoboken, N.J. and Oakland.
A bigger focus is being placed on affordable housing and Price said rent-to-income levels are very high in the largest markets, so it’s a challenge to grow net operating income because it’s harder to increase rents.
BentallGreenOak wants to find markets with lower rent-to-income ratios that have greater potential to grow rents over time.
The Seattle-based company provides independent advice and tailored services to private and institutional clients investing in North American real estate.
Metzler has bought in Seattle, Denver, San Diego, Atlanta, Dallas and Austin, which chief investment officer Zeb Bradford said have younger populations, universities and high growth, and which are benefiting from migration from the northeastern U.S., Silicon Valley and the San Francisco Bay Area.
It’s looking into, but hasn’t yet purchased in, Nashville and Orlando.
Metzler worked with Germany’s Union Investment on its June 2014 acquisition of the 12-storey, 498,768-square-foot Target Plaza III mixed-use office building in Minneapolis. It was purchased for $164.5 million and sold a year ago for $171 million to Menlo Park, Calif.-based Menlo Equities.
While Bradford said Minneapolis has a large number of Fortune 500 companies, a highly educated workforce and a concentrated central business district, he’s doubtful Metzler would invest there again because it isn’t large enough and that there was a thin buyer pool for Target Plaza III due to a lack of institutional investors.
NREA and data centres
Washington, D.C.-based National Real Estate Advisors has US$5.6 billion in gross assets under management through 43 investments in mixed-use, apartments, office, retail, industrial, hotels and data centres in leading U.S. markets.
President and chief executive officer Jeffrey Kanne said National plans to enter the downtown Detroit apartment market next year because he believes the long-beleaguered city’s comeback and growth are real.
Kanne said National has fossil fuel-powered data centres in northern Virginia and Manhattan, but is higher on those it owns in the state of Washington because of their hydroelectric power source, the cheapest type available.
This is an important factor since electricity is the biggest cost for data centre tenants. National’s data centre expansion plans revolve around locations with readily available hydro sources because Kanne believes a carbon tax will eventually be introduced in the U.S.
“Data centres have made possible the radical changes in our economy,” said Kanne. “We like the data centre space because the drivers are multiplying and the drivers that exist are increasing their demand.
“There’s more money coming into the space and costs aren’t what they used to be for data centres, I’m sorry to say, but it’s very hard to get into data centres.
“There’s a very high barrier to entry because they cost a lot.”
Impact of climate change
Kanne has seen the effects of climate change where he lives in Maryland. His firm looks at such risks within its existing portfolio and when considering acquisitions and developments.
It does a resilience analysis of markets and the potential effects of threats such as hurricanes, tornadoes, hail and flooding.
National is selling its Houston portfolio due to its susceptibility to these threats, and Kanne said it won’t invest in Florida because of flooding concerns.
“There are plenty of places to invest, so why invest in an environment you know faces extraordinary difficulties, even in the best projections, and has virtually no plans to deal with them?”
Price said climate change is a topic at every BentallGreenOak investment committee meeting. It is also wary of Florida.
It was considering acquiring an inland industrial building in Florida, but its viability was based on access to a freeway at risk of flooding. BentallGreenOak decided against the purchase.
“When you think about your exit, you can’t be investing in Miami without assuming that in five to seven years the capital markets will have a different view of risk than they have today because the risk will be better understood,” said Price.
Impact of regulatory issues
Rent controls are a concern for apartment building owners in cities experiencing a housing affordability crisis, with New York City and San Francisco leading the way.
“You’re looking at the next layer of cities where there’s a struggle with affordability, and you have a more liberal approach to politics,” said Price, citing Seattle and Portland as being in that boat.
“You have to think about rent controls if you’re investing in major urban markets in particular.
“I think affordability is a major issue, and that creates opportunities and challenges for investing in the multifamily space. You’ve got to be very local in terms of how you assess that risk.”
Price said rent controls aren’t always as restrictive as they may initially seem to a landlord’s ability to raise rents, but there’s a risk in where future legislation could lead.
Kanne doesn’t believe any major new apartment buildings will be constructed in San Francisco in the next 10 years if something doesn’t change with rent control legislation; companies can’t afford to build them in the current economic climate.
One challenge is that 25 per cent of the units in a new apartment have to be classified as affordable housing.
“We’re very long-term investors, so in the end I believe that, although rent controls may be around for a while, the folly of it will become apparent eventually and they’ll go away,” said Kanne.
Skillings said rent regulations feel like a “short-term fix” and a “political ploy.”
He said Los Angeles has “great runway ahead of it” for its office market. Rockwood has been investing in creating value in office properties in submarkets including Culver City and North Hollywood, but there are still issues.
Los Angeles will host the 2028 Summer Olympics, which is driving a number of major infrastructure projects. While new transit rail lines will help ease mobility problems, Skillings said not enough residential density is planned along them.
“They can’t get the entitlements through, or it takes forever to actually add the amount of housing that they need that will also help with the continued urbanization of that city.
“The layover of rent regulations doesn’t solve that.”