How to Play a Real Estate Recovery
For investors, the real estate roller coaster ride continues. They made billions -- probably trillions if you add it all up -- flipping houses, leasing offices and constructing condo towers. Then the real estate market collapsed, throwing the U.S. into the 2007-2009 recession.
Now the prognosis for real estate investments is looking much better, though it's anything but simple. Some commercial real estate has rebounded, with investors craving income that real estate provides, while residential real estate -- particularly single-family homes -- may be at once-in-a-lifetime bargain prices.
Bloomberg.com asked four top experts for their take on the the opportunities and potential pitfalls facing real estate investors in the coming years. Edited excerpts of their interviews follow:
Jim Sullivan, managing director of REIT research, Green Street Advisors
Every diversified investor should have some exposure to commercial real estate, and REITs [real estate investment trusts] provide a terrific, transparent and liquid way to get that exposure. Operating fundamentals in most property types range from good to great, with good being the shopping center business and industrial business and great being the apartment business. The economy is not doing great, but the silver lining for commercial real estate is how little new supply is coming on the market. Too much new construction is typically what puts a halt to real estate recoveries. This time around, it's just not an issue.
REITs tend to be specialized by property type. You can pick and choose, depending on what your economic outlook might be. If your forecast is a little rosier, you'd want to be in property types that respond well in economic recoveries -- hotels, for example, or REITs that own shopping centers with lots of small tenants. If you wanted to be a bit more defensive, health care REITs are a terrific place to be.
The question of whether REITs are cheap or not depends on what you compare them to. If you're thinking about selling bonds and buying REITs, that looks like a good trade. If you're thinking of selling some of your S&P 500 [stock funds] to buy REITs, that's a trade that doesn't look as good today as it might have a year ago. I have to throw out a warning that there's a whole world of REITs called "non-traded REITs." Unlike publicly traded REITs, the valuations are hard to discern and there are a ton of fees for individual investors.
John Burns, chairman and president, John Burns Real Estate Consulting
The biggest opportunity is buying distressed single-family homes, because that market has been completely beat up. The next biggest opportunity is buying land because very few people have been focused on it. If you have a long-term view, you'll probably see a significant multiple return. Buying land is a complicated business, though. Mom-and-pop investors should not be buying land.
Investing in apartments has gotten very expensive in gateway cities like New York, San Francisco, Los Angeles and San Diego. I'm not going to say those are bad investments, but you're paying a premium to get in those markets. There are opportunities for B- and C-class properties in the non-gateway cities like Phoenix, Dallas, Houston and Chicago. Renters are in for a rude awakening over the next three years. They're going to get significant rent hikes, which is going to cause far more of them to start looking at home ownership.
Lauren Pressman, director of investment research at wealth management firm Aspiriant
The U.S. is in a period of sustained but very slow growth. Job reports are huge factors for real estate, because jobs create demand for housing, for offices, for travel and at retail establishments. We're wary of things like retail and office, except in very unique circumstances. Multifamily real estate (apartment buildings) arguably had all the tail winds at its back to do the best of all asset classes. However, be careful. There is so much capital chasing multifamily, and that can lift prices beyond a point where your return is commensurate with risk.
Our overriding philosophy now is to look for opportunities that don't require a strong recovery to make money. So, for example: debt. Instead of bidding on apartment buildings, funds will provide debt for a new apartment owner. They can provide it at fairly high interest rates because debt is very hard to come by these days.
We're very cautious. You need to choose the right asset with the right manager with the right business plan. If you go and buy something because you think rents are going to go back to 2007 levels, that's not a good strategy.
Jack Chandler, global head of real estate, BlackRock
We're very focused on cities we think are going to compete for jobs. As opposed to 2000 to 2006, when there was job growth everywhere, it's much trickier. There is going to be a much bigger spread between the performance of winners and the losers. So the New York, San Francisco, Washington markets are pretty fully priced. Secondary assets in secondary locations -- especially in areas that have not seen job growth resume -- have seen a very small amount of interest from the capital markets.
We like mezzanine debt [a form of debt that is riskier and thus pays higher interest rates than more senior, secured forms of debt]. In debt, as they always say, your upside is you get your money back. If you think equity is going to earn 6 to 9 percent over the next three to five years, and debt's earning 7 to 12 percent (while the debt has a more senior part in the capital structure), that's a compelling risk proposition. You give up the potential upside for the extra yield.