Archives for January 2020

New modern, luxury urban apartment buildings sometimes can have a cookie-cutter feel (at least the ones that aren’t soaring to ever-greater heights). That’s why multifamily developers continue to tackle the costs and challenges of revitalizing historic structures. Such projects can be more expensive and trickier to bring to the market, but the result is often a unique product that can generate outsized returns.
“The renters in some of these iconic buildings will pay a premium,” says Jake Reiter, president of Verde Capital, a real estate private equity firm based in Philadelphia.

However, renovating a historic landmark is often expensive and difficult—and investors do not necessarily pay more for historic buildings than new construction. A designation as a historic landmark can protect buildings that need expensive repairs from the wrecking ball. That leaves the future of these landmarks up to developers stubborn enough to unlock their potential.
“The unique history of a historic building allows you to establish a brand,” says Carl Dranoff, CEO of Dranoff Properties. “If you can mesh old and new, create something special and unique, the brand elevates your value significantly. Ask Apple, Tiffany or BMW what a brand does—the value of the product is higher. That goes to the question of whether rents are higher and building valuation can hold a premium.”

No cap rate bonus

Investors often pay high prices for landmark apartment buildings—but the prices are not consistently higher or lower than comparable new apartments.
“I have not seen evidence that historic rehab in itself drives cap rates down,” says Reiter. For example, Verde Capital recently recapitalized its interest in The Left Bank, a luxury apartment community set in a re-furbished factory next to the University of Pennsylvania in Philadelphia. Investors valued the property at a capitalization rate of 4.6 percent. That’s comparable to other apartment properties in Philadelphia with similarly strong locations—neither sharply higher or lower.
“For buildings in a similar location—I don’t think there is much of a difference in cap rates,” says Calum Weaver, executive managing director in Cushman & Wakefield’s Florida Multifamily Capital Markets Group, based in Miami. Sometimes, investors will pay even pay less for a building that has a historic designation—because they could potentially demolish an unprotected building and replace it with something larger, Weaver says.

Unique locations, irreplaceable finishes, high renovation costs

Landmark buildings often sit on some of the most desirable locations in their markets. That especially true as developers return to once-neglected downtowns and waterfronts in cities from Brooklyn, N.Y., to Nashville, Tenn. Because a historic designation typically prevents demolition, the only way that owners can tap the value of their properties is through renovation.
Buildings that are old enough to earn a designation as a historic landmark often need a few expensive repairs. “They need a lot of work to get them up to our current standards—the economics don’t necessarily work,” says Weaver.
Investors who specialize in rehabilitating historic buildings can access state and federal resources like historic rehabilitation tax credits to help pay for the extra cost of rehabbing or even transforming a historic building. Verde’s renovation of the Left Bank required changes like cutting an interior courtyard into a large, former factory building. “You are likely going to need the tax credits to equalize the costs,” says Reiter.
Investors that don’t specialize in historic rehab are not always familiar with historic tax credits or consider the program when they purchase historic buildings, says Weaver.
However, once a historic building has been fixed up, some renters will pay more, depending on the features of the property. “The buildings that have a lot of charm or uniqueness, they are always going to do well,” says Weaver, who works with many Art Deco apartments in the classic neighborhoods of Miami’s South Beach area. “They are built like bunkers—the bones are good. And the units are larger than what is built today.”
For example, Verde Capital is earning top rents at its apartments at The Franklin Residences, a renovation of the grand, Ben Franklin Hotel in Philadelphia’s Center City. “We were able to charge premium rents because of the location and the finishes,” says Reiter. “Some materials and craftsmanship can’t be replicated at any cost. Even if you had the craftsmen try, you couldn’t do it.”
Historic buildings can also leverage their history to attract residents to a new neighborhood. For example, The Victor, a renovation of the former RCA Headquarters building, has attracted residents to a new neighborhood in Camden, N.J., on the Delaware River waterfront.
“The historic DNA of the building is what made it initially successful despite all the pundits who said it was on the wrong side of the river,” says Dranoff. His firm first renovated the abandoned 650,000-sq-ft. building into 341 apartments in 2004 and is now updating the common areas and apartments. “The residents and customers, they live in a special building and are almost always going to select us over a nearby or competitive project.”
By: Bendix Anderson (NREI)
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MSCI, an American finance company, released its 2020 Emerging Real Estate Trends report today. The main themes of the report revolve around the improvement of data in the real estate investment space, and how this is playing a more vital role in investment decision-making.
NREI asked Will Robson, executive director and global head of real estate solutions research with MSCI, to discuss the report’s findings in-depths. Here are the takeaways from the discussion.

1. Climate risks

Robson says climate change awareness is increasing across all markets globally, though some markets are more advanced than others. For many years and to many investment professionals, climate risk seemed like an abstract problem for the future. Over the last couple of years, Robson argues society has become more aware of the urgency of the problem.
The obvious climate risks for commercial real estate investors include damage to property, but the report also mentions “slow burn risks.” These include, for example, potential changes in warming cycles and the gradual impact on the costs associated with keeping buildings cool. Balancing the costs of retrofitting cooling systems against potential impacts on building values will likely become a concern for investors over the coming years.

“Beyond physical risks, you also have transitional risks,” says Robson. “So, the transitional risks include the need for de-carbonization. Obviously, achieving that decarbonization comes with a cost. So, trying to understand what the costs are of de-carbonizing, either through choosing to reduce carbon emissions or through regulations where they force you to reduce carbon emissions.”

2. The human capital angle

Improving the characteristics of a local area or city may bring longer-term benefits for a commercial assets. Factors such as housing affordability, diversity, quality of human capital and employment opportunities are increasingly being addressed in the assessment of attractive cities for investment. Environmental, social and governance (ESG) concerns are becoming systematically integrated into investors’ strategies across asset classes. Today’s real estate investors need to consider how ESG issues may impact the risk-return characteristics of their portfolios.

3. The many dimensions of real estate risk

Top-down macro risk analysis and bottom-up specific risk analysis at the asset level have generally been separate functions, performed by separate teams. But investors are increasingly realizing the link between the two. As allocations to commercial real estate have increased, investors are aiming to model specific risks in a consistent, quantitative and integrated way, Robson notes. Addressing these analytical challenges has become a greater focus.
“There’s a systematic element to it. I think there’s a lot of dimensions of risk, whether it’s lease length, tenant strength, vacancy, micro-location, walk score, these kinds of things are all asset- specific things,” says Robson. “But there’s likely a systematic element to it. There’s a lot more potential to applying data and quantitative analysis to explain that performance in greater detail.”

4. Looking beyond ‘location, location, location’

A huge amount of strategic analysis is still focused on property sector and geography, but real estate investors are beginning to be more aware that risk, return and value are driven by a broader range of factors. Continual improvements in technology mean more data can be generated, collected and processed more efficiently to help understand these drivers.
“Typically, in the past, data has been an issue for real estate investment. That has improved over time,” says Robson. “But in a world of AI, people are getting used to having more and more data in their decision making.”
In the past, many of these non-market drivers of value were hard to quantify in any systematic way. However, many of these drivers could well have systematic elements to them that affect value across a broad range of assets and throughout the real estate cycle. In the same way that factor analysis has gradually chipped away at specific risk in the equities market, a similar analysis might be possible for real estate assets.

5. CRE’s role within broader investment portfolios

Broad economic forces have been shown to impact individual property investments, but asset-specific characteristics may lead to widely different results for assets within the same property sector and geographic market. Opportunistic developments, for example, can carry extremely high levels of project-specific risk, whether it’s the level of market rents at the time of completion or the pricing environment when an investor seeks to sell a property.
Asset allocators have increasingly expressed interest in the risk-return correlation characteristics of the investments they make and what they may bring to the broader portfolio. Investment managers may wish to demonstrate what specific assets will contribute in terms of the return and risks specific to an investor’s portfolio. That effort may require a new level of data and analytics.
By: Sebastian Obando (NREI)
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