Place Your Bets – Dec. 2, 2024
In his pre-Thanksgiving edition of The Chief Economist on LinkedIn, titled “Off to the Races,” BGO’s Ryan Severino assessed the current and future state of the major property types as well as the fourth-quarter outlook for commercial real estate investing overall. “Increasingly, investors are showing a renewed interest in CRE as a competitive asset class,” he wrote. “It stands on its own merits, but with equity markets hitting record highs, the denominator effect is incentivizing investors to think more seriously about increasing their CRE allocation.”
The question is, how does one invest? Among the major property sectors, industrial and multifamily remain favorable, wrote Severino, chief economist and head of research at BGO. “But at this juncture, with both sectors still heading toward stabilization, market selection takes on outsized importance.”
Severino pointed out that the difference in future performance between good and bad markets “widens significantly at times like this, even as the overall sectors remain favorable.” For example, retail is increasingly drawing the attention of investors due to its strong fundamentals.
However, many investors are facing the hurdle of investability. “Many quality assets are being held for prolonged periods,” Severino wrote. “That’s not to say there will be no attractive assets for investment. But retail requires special management expertise, relationships, and a keen understanding of a property’s trade area. That puts relatively more emphasis on idiosyncratic factors for retail.”
In contrast, there’s office, which remains “broadly out of favor” at present. Nonetheless, some investors have begun to tentatively kick the tires. “Valuations will take on outsized importance in a sector that still has many questions to answer. The market will not bail out investors that make a mistake,” wrote Severino.
Increasingly, secondary property types have begun filling a void for investors, especially those that find office and retail un-investable, or at least very challenging. Some of these property types, such as data centers, cold storage and medical office, require particular expertise along with management skill. Meanwhile, other secondary categories, such as self-storage and build-to-rent communities, can require relationships and partnerships. “While all of these property types offer opportunities for attractive returns and diversification benefits, that does not mean investment selection should get discounted.”
Severino closed the discussion by noting that “many investors have been waiting with bated breath for distressed assets to hit the market. While ‘distress’ is not a strategy per se, dislocations can offer attractive opportunities for investors across the capital stack and even the risk-reward spectrum.
“While market expectations usually exceed actual levels of distress (and we have no reason to think this time is any different), shifting capital markets could finally force the hand of many investors and borrowers who are struggling with distressed assets over the coming quarters.”
At this point, Severino wrote, the key risk facing the CRE market is not monetary policy. “With the Fed cutting rates and investor sentiment improving, the focus now turns to two other potential risks.” One is a black swan event, while the other is the impact of government policies other than monetary ones.
That being said, he concluded, “If the economy and market can avoid the more dire scenarios, the CRE market could produce its best sustained performance in decades.”