Nearly two months into the year, the economic outlook for 2019 remains clouded by uncertainty. Yet, according to real estate professionals, the future is not quite so confusing. A survey by National Real Estate Investor for its 2019 market outlook report reveals the vast majority of industry professionals are aligned on a few points:
“There is wide consensus that the most recent commercial real estate cycle and broader economic expansion have stretched on to a point where a slowdown should be expected. But no one is quite sure when it will start or what might precipitate a dip. Yet even with that backdrop, most commercial estate pros expect 2019 to be a smooth year. Some segments and markets still have room to grow. Others might have peaked, but there are few fears of a hard landing coming to pass.”
Real estate pros are in broad agreement that a slowdown is coming, with many also anticipating a downturn in the not-too-distant future. Yet, while they agree the current cycle is long in the tooth, there is considerable diversity of opinion on how best to play it as investors. NREI’s latest market outlook includes ideas from a number of seasoned real estate investors and managers, three stuck out as deserving further discussion - as well as serious consideration by investors.
Invest in multifamily value-adds for long-term payoff
Multifamily housing has long been a staple of real estate investing, but the asset class has been experiencing some headwinds of late. One issue is rent growth, which peaked in 2015. Rents have continued to climb, though at a more modest clip. At the same time, Federal Reserve rate tightening is also having an impact. According to Precilla Torres of Hunt Real Estate Capital, investing in value-adds is the best strategy for unlocking value in both the short term and the long term:
“The value-add strategy creates attractive returns for investors in the medium term by boosting NOI through physical and/or operational overhauls. Furthermore, returns are enhanced because this strategy pairs with attractive financing options through the bridge loan market, where spreads on transitional floating-rate loans remain low.”
Well-executed value-add strategies increase the value of properties and boost income in short order, but the really important point here is the financing component. With financing still incredibly cheap by historical standards, investing in elevating the quality of existing properties now will help support their value when the cycle turns, as well as providing superior income payoffs over the long run.
Investors with exposure to real properties should consider executing on value-add strategies themselves. Those with exposure to multifamily - other commercial real estate - assets via real estate investment trusts should be thorough in their due diligence. REITs with strong balance sheets and the willingness to invest in the future could prove to be the real gems of the next growth cycle.
Recession-proof your portfolio with student housing
Michael Orsak of Campus Advantage, a private real estate firm specializing in developing, acquiring and managing student housing properties, thinks everyone should get in on his firm’s line. Specifically, he argues student housing is more resilient to the impacts of economic downturns than are other types commercial real estate:
“Smart investors will seek downside protection, and a strategic allocation to student housing provides portfolio diversification with downside protection for institutional real estate investors. Unlike multifamily, retail, industrial or commercial real estate, demand for student housing is demographically-driven, offering recession resilience.”
Orsak’s case for student housing as a late-cycle winner is compelling. There are more college students every year; even more when the job market goes sour and staying in (or returning to) higher education becomes an attractive alternative to unemployment.. Evidence from the last downturn supports the case. Based on data from publicly traded REITs, net operating income from student housing rose 11.9% between 2007 and 2010. Over the same period, apartment properties saw their net operating income fall by 3.4%.
While the public options have been limited in recent years thanks to the buyout of a number of student housing REITs, there are a few still out there, such as American Campus Communities (ACC, Financial), that can offer investors exposure to the segment.
Sell your self-storage assets before the music stops
Self-storage has been one of the top performers among niche real estate classes over the last several years. But, according to Tom de Jong of Colliers International (CIGI, Financial), the fun may soon be over as owners flood the market:
“Entering 2019 we will see more self-storage properties coming to market as sellers are coming to the realization that we are nearing the end of this cycle and the downside risks are considerably higher for those that wait too long!”
While the growth cycle started earlier for most other commercial property types, the self-storage boom only really got started in 2015. Since then, capital has flooded in from a multitude of sources. In de Long’s view, historically low cap rates will soon begin to climb, which will inevitably push down asset prices. The deluge of capital has led to prices being bid up. As owners realize their predicament, they will flood the market.
For investors currently with exposure to self-storage real estate, de Long’s warning should not be taken lightly. For those who have been sitting on the sidelines, now is definitely not the time to get into the asset class.
Disclosure: No positions.
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