A full house gathered via Zoom on February 18, 2021, to listen in on a panel discussion hosted by Danny Kaufman, CFA, Senior Managing Director and Co-Head of the JLL Chicago office. Featured in the discussion was Emi Adachi, Senior Vice President and Deputy Director of North American Investment Research at Heitman; Brad Gries, Americas Co-CIO & Head of US Transactions for LaSalle Investment Management; and Michael J. Nigro, Managing Director and Head of Real Estate Value Add and Development for Americas at RREEF. The discussion covered real analysis of the current real estate investment market, hypotheticals of real estate investment strategy, and a brief Q&A session. The discussion began with panelists sharing their current focus areas within the real-estate investment landscape.
Gries kicked off the discussion by stating that his advice to clients depends largely on the client’s risk appetite. He went on to explain that he is advising his clients that are invested in only core real-estate allocations that they should expand their real estate portfolio and increase leverage to take advantage of the low interest-rate environment. Further, they should focus on investing in the industrial and residential sectors, as they show the most promise coming out of the pandemic and be wary of the office and retail sectors. Adachi followed up by stating that now is a great time to invest because she believes we are at or near the bottom of this economic recession. Further, she and her team have a high conviction in self-storage and medical offices, even though a lot of capital is already flowing to these sectors. Adachi also pointed out that there has been growing investor interest in life-sciences assets and data centers, but she and her team hold a lower conviction on these investments due to their newness. She too offered caution for retail and office space at the moment but believes they will make a rebound. Nigro rounded out the responses by pointing out the dispersion of volatility and returns across real-estate investments landscape. Specifically, public REITs showed a lot of volatility at the beginning of the pandemic while private investments were more stable, and certain sectors, like hospitality, took big hits to their returns while others, like industrials, showed strong returns throughout the pandemic.
Kaufman then asked the panelists what trends are being hyperbolized in the market today? Nigro started the response by saying that many overhyped trends have only been buffeted by the pandemic. Gries followed up offering specific examples saying that the trends such as “the death of the mall,” “the death of the office building,” and the “death of the city” have been hyperbolized trends. He and Nigro both agreed that malls are in decline, but the other two trends—office buildings and cities—are simply reactions to the changing working conditions stemming from the pandemic. Adachi offered an alternative view saying that many of these trends have been in progress since long before the pandemic. She stated that population growth in urban areas has been slowing for years while suburban population growth has been accelerating. While these trends are largely cyclical and align with the aging of generations in America, she offered a more tempered perspective on the “death of the office building” and “death of the city” trends.
Kaufman’s next question was how real estate investors are moving their assets. Again, Nigro kicked off the response, explaining that real-estate assets are inherently illiquid—for the most part. Their illiquid nature thus makes any movement into or out of these assets very slow. As far as weightings within a real-estate portfolio are concerned, Nigro explained that RREEF still recommends being overweight in industrials and has confidence in retail going forward. Gries followed up by reiterating many of Nigro’s points and stating that many of his investors are opportunistically shifting to more healthcare-focused investments. Adachi also echoed many of the same points as Nigro and Gries, and also explained for listeners how difficult making a meaningful shift is. Going back to Nigro’s point about illiquidity, this feature of real estate investments is amplified by attractiveness of assets—if an asset is attractive, the owner of that asset is more unlikely to sell it because of its strong performance. Similarly, unattractive assets are also difficult to sell because nobody is willing to buy them. Kaufman elaborated on Adachi’s point and stated that these frictions have been amplified by the pandemic.
Kaufman continued by asking the panelists a hypothetical question, “if you were a CEO or COO of a Fortune 500 company, what are the 3 MSA’s you would target for a new corporate office?” Nigro stated that he would play to the southern migration trend in America and target cities like Phoenix or Denver out west, Dallas or Austin in the south-central US, and Atlanta, Miami, or Tampa for the southeast. Adachi offered a very different strategy, playing to the educated millennial workforce. She recommended offices in some of the more offbeat urban cities—like Los Angeles, Chicago, and Boston—where cost of living is lower than major cities like New York and San Francisco. Gries said his strategy would be company dependent. For a tech company, he would recommend cities that are more attractive to the younger, tech-savvy workforce, like Austin or Denver. However, for companies with a large workforce that requires a lot of travel, he would target major airports, like Dallas or Atlanta. Kaufman then asked a follow-up question, “would you recommend an urban tower or suburban hub?” All three panelists agreed that the suburban hub will have to compete with the growing work-from-home trend, so they would most likely invest in an urban tower.
Steering back to investment portfolios, Kaufman asked the panelists how ESG issues have been impacting their investment decisions. Gries responded by saying that ESG is not a primary driver, but it is an important factor that is considered in every investment decision. He elaborated by saying that LaSalle assigns a different climate risk weighting to real estate assets based on the geographic location of the asset. However, LaSalle completes an extensive ESG checklist and assigns a climate risk score to every deal, regardless of the geography. Nigro offered a slightly different perspective based on RREEF’s focus on the development market. He said his clients find ESG to be incredibly important, with some not even considering an investment in a development that doesn’t meet certain requirements for certifications such as LEED. Adachi finished up the response by saying that the ESG assessment differs based on the risks posed by the asset’s geography. For example, and asset in Louisiana would be assessed for sea-level risk while an asset in California would be assessed for wildfire risk.
Kaufman then asked the panelists if they are steering their clients to higher risk investments like structured finance vehicles or opportunistic properties. Gries shared that many of his clients have stated where they want to play in the market from the beginning, and that hasn’t really changed with the pandemic. He continued to say that while a lot of money has flowed into structured deals and high-risk opportunistic debt deals, the recent investment focus has been on core and core plus assets. Nigro chimed in by stating that he has directed some of his clients to higher debt investments as true core assets have been hard to sell. Such advisory has been growing at a significant clip recently. Kaufman echoed Nigro’s point that advisory in the higher-debt space for real-estate investments has been growing significantly, and with more advisory has come greater investment in more sophisticated assets.
Next, Kaufman asked how the low interest-rate environment has been affecting real estate. Gries started by saying that the low interest-rates have made leveraged investments more attractive. Nigro elaborated on this point saying that leveraged investments in the Pacific Northwest, Northeast, and Florida have presented the most attractive returns. These geographies have offered an average return on cost spread of ~75 basis points. Greis followed up by saying that demand in the secondary market has been increasing substantially.
The discussion was rounded out with the panelists offering their market projections from what many believe is the bottom of a recessionary cycle. Adachi stated that revenue and rent growth broadly are expected to increase, especially for industrials. She and her team have actually been surprised at the optimism of forecasts with some projecting high single digit growth in the secondary and tertiary markets; however, they are incredibly varied by investment type and geography. For example, return projections aren’t quite as optimistic in the sunbelt due to a supply boon in that region. Nigro echoed Adachi’s point about a supply deluge, pointing out that it will lead to a significant impact on development projects in those areas. Gries concurred with both Adachi and Nigro’s points and reiterated how varied return projections are based on property type and region. The event ended with Q&A.
Q&A
How have Chicago real-estate investment portfolios held up during the pandemic?
Nigro pointed out that properties nationwide have put an increased focus on collections during the pandemic, and Chicago investments have done a relatively good job of collecting rents, that said, rent growth prospects aren’t great due to the significant supply of investments. Greis reiterated the importance of collections during the pandemic and elaborated by pointing out that investors have experienced some challenges with Chicago residential and office space due to vacancies stemming from COVID. Chicago is not alone with these problems, many other urban areas are experiencing the same issue, but Chicago is projected to lag in any rent growth due to the fiscal concerns for city. Adachi agreed with both Nigro’s and Greis’s points and Kaufman pointed out that collections may have shown relative outperformance due to Chicago’s relative affordability compared to other urban areas.
What is your ESG Research process?
Nigro said ESG is in RREEF’s DNA. He reiterated that ESG is more important in the real estate development markets because many investors won’t even consider investing in a property that doesn’t meet certain ESG standards. Gries shared that LaSalle has a dedicated head of ESG and Sustainability and several regional reps across the US. On an operational level, they have an ESG checklist that is required to be completed for every investment, and they perform regular ESG benchmarking. Adachi stated that Heitman has partnered with Four Twenty Seven Inc. to source climate risk data for all their investments. Further, Heitman also evaluates all their investments for various ESG risks.
How has the popularity of retail investment platforms, like Robinhood, affected Real-Estate investment?
Both Nigro and Gries pointed out that the transformations required for private real estate investments to be accessible to the broader public are still in their infancy. There have been some recent developments in new REIT models, but the options available on retail investment platforms are limited.