Annual Real Estate Outlook event hosted by CFA Society New York presented views on investing in several real estate specialty asset classes including data centers, medical office buildings, parking, and senior housing. The specialty sectors are increasingly becoming institutionalized as investor search for yield and low-correlated assets. Panelists included allocators, operators, and private equity fund managers.
The panel moderator, Peter Madden, real estate portfolio consultant to SECOR Asset Management, asked each of the speakers to describe how to find value and growth at a time when the economy has been expanding moderately and new real estate supply has been creeping higher.
Given the long length of the real estate upcycle, Kevin Higgins, Real Estate Portfolio Manager for the New Jersey Division of Investment, is looking for downside protection from the inevitable downcycle and resilient cash flow. He also pointed out that that the state’s public pension plans have been overweighted in noncore assets and recently committed to a medical office club deal and expanded into infrastructure.
High barriers to entry can slow supply growth and sustain cash flow. In urban areas with high land costs parking will rank low on the list of highest and best uses for real estate. There is little economic justification of excess parking supply. Often, municipalities need to require, incentivize, or commission ample parking, noted CJ Follini, Managing Principal of Ranger Asset Management. Likewise, schools and hospitals often require dedicated parking. There are few national players which leaves opportunities for consolidation.
In contrast, healthcare and senior housing facilities require strong operations to succeed. Operators need to contend with both patients/residents and regulators to succeed. Philip Kroskin, Senior VP of Real Estate Development for Sunrise Senior Living, turns the assisted-living customer experience to a competitive advantage. Sunrise received a 2018 award from J.D. Power for “Highest in Customer Satisfaction among Senior Living Communities” as a consequence of consistent, high-quality employee training and management. There are also opportunities for consolidation as most property owners control ten or few facilities.
The medical office building (MOB) has been evolving as physician practices encompass more professionals and the use of medical imaging and other technologies have migrated from hospitals to decentralized MOBs. David Lynn, Ph.D., the Founder and CEO of Everest Medical Core Properties, pursued the medical office and healthcare space based on his research and professional experience across several major asset classes. Everest is a subsidiary of Fosun International.
He further explained how medical technology becomes an anchor for smaller medical centers because medical practioners prefer to be closer to the expensive equipment and the cost can be shared among the other affiliated doctors. In addition, patients tend to remain loyal to their medical providers.
Despite the long-term demographic trends supporting healthcare investment, Mr. Kroskin also pointed out that during the next 5-7 years the 85-year-old population, the silent generation, will decline until the baby boomers reach their 80s.
Sami Badri, a Research Analyst for Credit Suisse, highlighted several of the trends driving the data center space. Location can be as important for locating data centers as for any type of real estate. Low latency can be a competitive advantage for data centers located near the source of and demand for rapid data transmission.
For example, high frequency traders demand the low latency that comes from locating data centers near major trading exchanges, and the jump in video and other data usage by cellphone users encourage carriers to locate data centers near cell towers. Low cost power is another location driver due to cooling requirement.
Returns from these sectors are logically higher than core real estate returns. One panelist pointed to initial stabilized cash yields of at least 10% which, when compounded with growth and inflation, can provide IRRs in the mid-teens.
Following the panel presentation Dr. Lynn provided an economic overview of real estate and healthcare trends. Average capitalization rates (cap rates, which represents cash NOI divided by total property value) were flat-to-down in 2017. The decline reflected mix-shift associated with an increase in transactions outside of the most expensive gateway cities as investors searched for greater value. Likewise, there was reduced buying demand from China owing to foreign capital restrictions. Foreign investment growth in the U.S. has been coming from Canada and Singapore.
When the next recession does arrive, Dr. Lynn does not expect a major decompression in cap rates. Rather, it should occur slowly. A key warning sign to watch for is cap rates falling below borrowing costs, which is a sure way to lose money if properties are over leveraged and rents decline.
CFA Society New York wishes to thank the volunteers who organized the event: Patrick Nessenthaler (lead) and Steven Bloom, Anthony Liu, and Kevin Maxwell.