Real estate debt investors focus on building diversified portfolios to spread risk. That is particularly the case with commercial real estate, where investors will typically seek some exposure to offices, retail and industrial assets, while, when it comes to residential, the development aspect often attracts specialist investors.
Real estate debt investors keep a close eye on every sector of the market, form clear views on the pros and cons of each, and seek to commit to the more attractive areas.
Here’s what a group of experts told us about their current views on the challenges and opportunities of four key sectors.
Office: Double down on Dutch
The health of the office sector is tied to a significant degree to the health of the economy, and in the UK the uncertainty around Brexit means investors are worried about the extent to which the financial services and technology industries will remain such big users of space in London. Meanwhile, continental markets would struggle to absorb much of London’s movement if there were to be a relocation, because of limited space.
Dale Lattanzio, managing partner of DRC Capital, has decades of experience in real estate debt. He says: “In office, we have seen a lot of value-added opportunities; some repositioning and refurbishment, because that’s where we are in the cycle. Sponsors are really having to carry out asset management initiatives to make the returns they are seeking.”
He sees a particular opportunity in office space in The Netherlands. “The office market there continues to recover and we see interest from sponsors looking for attractive pricing in terms of entering that market,” he says. “There is more of that opportunity in other places that are similarly further behind in the cycle, with offices having been built quite prolifically, and now a consolidation of that market is occurring.”
In the US, Paige Hood, CIO at PGIM Real Estate Finance, says: “We target our office lending in the largest markets of New York, Washington DC and Los Angeles, and I would say we are probably underweight relative to our peers in that property type. The outlook is pretty stable; construction is relatively moderate and demand is reasonably strong. As long as we continue to see job growth, overall we feel pretty positive about that segment.”
Retail: Reinvention required
Martin Wheeler, co-founder and co-head of real estate UK at ICG-Longbow, says: “You have got to be much more careful investing in retail right now, just because of the structural change in the market. Retailers are finding it difficult to make a profit, in areas like mid-range shopping centres, while high value, super high-end retail is witnessing much more robust underlying demand, as is the value end of the market.”
Several investors point to opportunities in the retail space, particularly in turnaround plays where ailing shopping centres are transformed with new entertainment and restaurant facilities.
“A lot of retail centres will need to be reinvented,” says Jim Blakemore, a partner with GreenOak Real Estate in London. “As a lender, I’m not sure I want to lend against something that seems stable but ends up needing reinvention, but if you can make the loan on the basis of reinvention, it can make a great loan.”
In the US, Ted Norman, head of commercial mortgage origination for TH Real Estate, says many of the firm’s clients continue to seek exposure to retail despite some of the stress in the sector: “When we look at retail, in addition to the top-tier malls we invest in, we really like the needs-based angle, anchored with top-tier grocers in metropolitan areas. We still think that’s a strong sector within retail.”
Residential: Home run for PRS
When it comes to residential, there is a clear division between the for-rent and for-sale sectors, with the latter currently holding little interest for debt investors. What is capturing attention in the UK is the private rented sector, which has seen substantial growth over the past five years, and is the country’s equivalent of the multi-family real estate asset class in the US.
Blakemore says: “You’re lending on an entire building of flats where one landlord is leasing units to tenants, rather than having numerous buy-to-let landlords, which is efficient and increasingly popular in the UK.”
A recent report by Savills, the estate agent, shows the private rented sector to be worth £1.29 trillion ($1.65 trillion; €1.46 trillion), up 55 percent in the total value of its assets over the past five years, and now more valuable than mortgage-owned occupier stock for the first time.
In the US, where attitudes to home ownership mean private rental is not such a new phenomenon, the sector is also buoyant. Norman says: “In residential, we like what we call the A-minus/B-plus apartment sector, where we are able to get in and finance a project acquisition with a value-add strategy. We might have a sponsor doing some capital improvements and maybe bringing a well-located B project up to an A-minus quality in a good location, and just because of rent disparity between that property and new projects you think there’s good upside potential in the ability to raise rents.”
Logistics: Leaves you wanting more
The logistics and industrial sector is currently popular with debt investors thanks to its position as a beneficiary of the trends causing retailers such problems; namely the move online and the drive towards faster and more efficient distribution.
Wheeler says: “Industrial is the sector that’s performed very well in the last 12-18 months, with increasing capital value and growing occupier demand for the underlying real estate. Both warehouses and light manufacturing are performing well and with high capital values relative to history, so we are maintaining a cautious stance.”
It is a view shared by Lattanzio. “The logistics market, particularly in the UK, has been pretty robust recently, being slightly under-supplied and with a few sponsors targeting that as interesting to develop,” he says. “We find that interesting to the extent that they own the right sites – it’s fairly straightforward to build with a supply-demand situation that you can readily see in the market is favourable. We certainly see that trend emerging.”
The same is true in the US, where Hood says: “Logistics is maybe the top property type, in that the e-commerce phenomena is really driving demand, and we see a lot of positive fundamentals. It is just a challenge to find enough industrial opportunities to lend on – we would like to do more if we could.”