Archives for March 2022

Also, the share of capital flowing into secondary and tertiary markets has widened considerably.

Deal flow for the multifamily asset class has officially hit record levels, as increased competition for assets is pushing investors into smaller markets.

New research from Marcus & Millichap notes a “historic level of trading activity” in 2021 after a 22% contraction the year before. Deal velocity for apartments at $1 million and above rocketed up 50% in 2021, while rents grew by double digits.

Deal flow was also influenced by investor concerns over possible changes to the capital gains tax, according to Marcus & Millichap analysts. And “abundant investor demand has translated into higher sales prices as a result,” they note. “The U.S. average price per unit rose nearly 9 percent in 2021 to over $180,000. Cap rates have compressed as a result, with the national mean dropping to 5 percent.”

Initial yields for trophy assets in desirable markets traded in the mid-2% range last year, helped along by historically low interest rates. Rates are expected to continue rising this year, however, which will temper yields: “Paired with competition from other parties, this trend will likely drive investors to widen criteria this year, bolstered by a generally recovered economy,” the report predicts.

That means investors are likely to look at more markets than before. Over the past two decades, the share of capital flowing into secondary and tertiary markets has widened from 38 percent of trades in 2000 to 53 percent in 2019 and 57 percent in 2021.

“Beyond lower entry costs and higher yields for comparable assets, properties in non-primary markets also benefit from favorable demographics,” the report notes. “Migration out of dense city cores accelerated over the past two years and will continue moving forward due to the aging of the population. Improving apartment operations have also increased institutional investor demand, often targeting core properties in high-growth markets. After pausing in 2020, the number of trades priced over $20 million completed last year was on par with 2019. Competition from larger investors will push some smaller buyers to less active asset classes and locations.”

On the supply side, Moody’s predicts a “mild uptick” in multifamily deliveries this year, but notes that supply chain and labor issues will continue to derail projects. The firm’s current forecast calls for vacancies to remain flat.

“At this point in the cycle, demand outstrips supply in most markets, and short lease terms and non-sophisticated tenants make a strong case for the asset class being an inflation hedge,” Moody’s analysts note in a recent report. “But, if our economic forecasts come to pass about Treasuries going up by approximately 100 basis points over the next two years, and that translates to exit cap rates, the need for NOI growth on tightly priced assets gets amplified.”

Source: “Deal Flow For Multifamily Hitting Record Levels“

“How do you preserve wealth in times when the Four Horsemen are on the loose?”

Barton Biggs, the well-known former Morgan Stanley strategist, who sadly passed in 2012, asks an interesting question at the beginning of his book, Wealth, War & Wisdom: “How do you preserve wealth in times when the Four Horsemen are on the loose?” (By Four Horsemen, Biggs refers to “pestilence, war, famine and death.” See also Revelation 6:8.)

Back in 2008 (when Russia invaded Georgia – some things never change), Biggs gave Wealth Management (then still Registered Rep.) an exclusive look at his work which, given Russia’s recent invasion of Ukraine, and the financial chaos that looks to follow, is as relevant today as it was then. Here is an excerpt from Wealth, War & Wisdom.

Beware Of Investing In “Keeper” Stocks: Nothing Lasts Forever!

[One] message from history is that even in the Lucky Countries (countries on the winning side that don’t suffer catastrophic attacks), wealth invested in equities should be diversified. There are no magnificent long-term, “keeper” stocks to put away forever, and there never have been because no company has ever had a sustainable, forever competitive advantage. Excellence that lasts over multiple decades is virtually nonexistent.

Some advantages last longer than others, but all are temporary. Furthermore, there is overwhelming evidence that the duration of corporate competitive advantages has shortened, which is not surprising in a world where the rate of change is accelerating. It’s the nature of business evolution. Also bear in mind that wars, as Joseph Schumpeter might have said, are “gales of creative destruction” and in the aftermath lead to accelerated technological progress.

Corporate evolution seems to consist of a company developing a competitive advantage, exploiting its edge, and becoming successful. Then its share price soars, and soon it is discovered and thereafter becomes a keeper growth stock. As the company grows and gets bigger, it attracts competition and inevitably becomes less nimble and creative. Then as it ages, its growth slows and eventually it either becomes stodgy or obsolete. Studies of organizational ecology show that while there is immense innovation in the world economy as new companies create new businesses, there is far less innovation in large, mature companies. To express the same concept differently, companies don’t innovate; entrepreneurs do. IBM and Intel were once great innovating companies, but now they are corporate research laboratories. Bill Gates was the innovator, not Microsoft.

For example, back when the pace of change was much slower, there were stocks that retained a competitive advantage for a long time. Eric Beinhocker in The Origin of Wealth writes how the British East India Company in the seventeenth and eighteenth centuries had a total monopoly in four countries, possessed worldwide dominance in everything from coffee and woolens to opium, had its own army and navy, and was actually empowered by the Crown to wage war if necessary. However the world changed, it didn’t, and its “massive wall of core competencies” collapsed in the face of technological innovation. It went out of business in 1873.

In 1917, Forbes published a list of the 100 largest U.S. companies. Over the next 71 years there was the Great Depression, World War II, the inflation of the 1970s, and the spectacular postwar boom. When Forbes reviewed the original list in 1987, 61 of the companies no longer existed for one reason or another. Of the rest, 21 still were in business but no longer were in the top 100. Only 18 were, and with the exception of General Electric and Kodak, they all had underperformed the market indexes. Since then, Kodak has had serious difficulties so GE is the sole, truly successful survivor. In 1997, Foster and Kaplan checked the endurance record of the Standard & Poor’s 500 Stock Index since it was created 40 years earlier. Only 74 of the originacompanies were still in the select 500, and that group had underperformed the overall index by 20 percent.

Warren Buffett is a certified immortal, but even investment clairvoyants can misjudge individual companies. Eleven years ago, I listened to him extol Coca Cola as an impregnable franchise growth stock you could safely lock away and own forever. The shares then sold at a substantial premium valuation. He misjudged the various social, industry, and company-specific ailments that have afflicted the company and crushed its stock price. The same applies to another of his favorites: The Washington Post.

In another study cited by Beinhocker, two academics, Robert Wiggins and Tim Ruefli, created a database of the operating performance of 6,772 companies across 40 industries in the postwar era. They sorted for persistent, superior business, not stock market, performance lasting 10 years or more relative to the industry the company was in. They discovered that there was no safe industry. The pace of change was faster in the high-tech groups than in the more mundane ones, but the velocity was increasing in all industry groups over time. They also found that only five percent of the companies achieved a period of superior performance that lasted 10 years or more, and a mere half of one percent sustained competitive advantages of 20 years. Only three companies, American Home Products, Eli Lilly, and 3M reached the 50-year mark.

Diversification of wealth in equities over decades or generations means either buying index funds or somehow finding the unusual investment management firm that with wisdom and vision can construct a diversified portfolio that will at least keep up with and hopefully beat the averages — after taxes and fees. Two important advantages of an index fund are that it minimizes taxes and transaction costs because of its low turnover and charges a miniscule investment management fee. You can now buy an index fund to replicate almost any equity sector. A number of recent studies show that over time the average American investor whether he or she buys individual stocks or active mutual funds, earns a return considerably less than that of the S&P 500. It pains me to write it, but professional investors don’t do much better on a statistically significant, risk-adjusted basis.

The record indicates that public equities over the long run are (to use the infamous phrase) highly likely to earn a return well in excess of the inflation rate. If you live in a stable country and you know with a high degree of certainty you can achieve a long-term real return of 400 to 700 basis points in an index fund why fuss with anything else? Maybe if you still believe in fairies and are a skilled professional investor you can do better but don’t count on it. Above all, don’t hold your eggs in a few big baskets. The old saying: “put all your eggs in one basket and then watch the basket” is broker baloney. The risks in holding an undiversified portfolio are astronomical.

Common sense and the message of the past is that reversion to the mean is an over-powering, gravitational force in all aspects of the investment world, but particularly in equities. There are no super-return asset classes! It is written in stone that exceptional returns attract excessive capital, and size is the enemy of performance. No one should have any illusions that private equity or hedge funds will be any different.

Gold, Art, And Bonds Are Problematical

Third, the history of Europe during World War II indicates gold and jewelry work fairly well to protect a small amount of a wealth. Think of them as your “mad money.” However, as noted previously, the history of World War II warns not to keep them in a safe deposit box in-country. Conquerors demand the key, and your bank will give it to them. Have your own safe deposit box at home or secrete your valuables in a safe haven. Above all don’t tell anybody. When your neighbor’s children are starving (as so many were in the lawless winters of 1945 and 1946), they will do anything. If the barbarians come next time as a terrorist attack or a plague, you are going to want to have your mad money close at hand.

Fourth, art is not particularly good either. It is vulnerable to destruction by fire, can easily be damaged, quickly plundered, and it’s difficult to hide. At the end of the war, Warsaw alone reported 13,512 missing works of art of one kind or another. That said, some Europeans successfully removed valuable pictures from their frames and smuggled the canvases out of their home countries and transported them to safe havens. The caveat was that when they tried to sell them, they were only able to get a fraction of their true value.

Fifth, at least based on the last century, fixed-income investments are nowhere near as good as equities. Even in the Lucky countries, they provided returns far below stocks, although they did offer much lower volatility. Across the various countries, bonds had a standard deviation about half of that of equities, and bills had volatility about a quarter that of equities. In terms of liquidity, they were fine. Fixed income markets remained relatively liquid in London and New York throughout the war years.

In the Losers [Germany, Japan, Italy, et al.], fixed income had severely negative returns, and although government paper is normally considered to be relatively risk free, German bill investors lost everything in 1923, and German bonds investors lost over 92 percent in real terms after World War I. Admittedly inflation was virulent in a war-torn world, and fixed income is not the place to be in such an environment. In the chaotic, disorderly environment of the war years in the Loser nations, you can’t sell bonds or cash in bills any more that you can trade stocks. However there was a period in the 1930s when because of deflation, bonds were the best performing asset everywhere.

Source: “Investments During Wartime“

The future will still rely on highly skilled labor to operate complex systems and machinery, alongside robotics—labor that is increasingly more difficult to find.

Labor scarcity will be among the major headwinds driving industrial commercial real estate decisions in 2022 as record shortages challenge distribution channels and unemployment hits a near-historic low.

“With industrial related hiring already at all-time highs, the continued need for labor to service growing e-commerce demands, combined with an economy at nearly full employment, is exacerbating the labor shortage for distribution workers in many markets,” a new report from Colliers notes, adding that the US unemployment rate is now near a 50 year low of 3.5%.

And while so far, the industrial sector has managed to post record growth, the labor shortages span “nearly all demographic groups and affect the entire American economy,” and continuing lows will slow the rate of economic growth and slow manufacturing output, Colliers predicts.

“While automation and advanced technologies are becoming more prevalent and affecting industrial employment, the future will still rely on highly skilled labor to operate complex systems and machinery, alongside robotics—labor that is increasingly more difficult to find,” the report notes.

In addition, scarce land availability will continue to impact the sector. Prologis reports that construction starts have risen to an all time high of 120 million square feet in the sector, but the firm notes that new supply is mainly concentrated in low-barrier secondary and tertiary markets and the outlying submarkets of inland markets.

While a record level of new supply is expected by the end of 2022—including massive build-to-suit projects for e-commerce suppliers and big-box chains—land near big population centers is increasingly scarce.

“Companies seem willing to pay a premium price for land with fierce competition for developable sites,” Colliers analysts note. “This competition is also driving up industrial rents, especially for logistics space near US seaports.”

Colliers also notes that facilities in excess of 2 million square feet are increasingly popular in dense markets as retailers attempt to establish footholds closer to consumers and shorten delivery times. The firm is tracking 12 such big-box multi-story industrial mega centers currently under construction, and notes that a vast majority are for Amazon.

Source: “Labor Shortages, Land Availability Will Pressure Industrial in 2022“

VC funding is turbocharging a building boom of new lab space, with 31M SF under development in emerging and established markets.

A flood of venture capital is turbocharging a building boom for new life-sciences lab space as biotech and pharma players race to develop new life-saving treatments using the genomics breakthrough that produced the leading Covid-19 vaccines.

A record 31 million SF of life-science space was under development during the fourth quarter of 2021, nearly doubling the 19 million SF reported during the first quarter of last year, according to CBRE. The Q4 total includes new construction and conversions of offices into lab space.

During the first two months of the new year there has been a steady drumbeat of new mega-projects to develop lab space, including this week’s announcement that Ensemble/Mosaic and Oxford Properties Group are joining forces in a $1.5-billion deal to develop up to 3 million SF of life science properties at the Navy Yard in Philadelphia.

On Feb. 22, Eli Lilly announced plans to develop a $700-million Lilly Institute for Genetic Medicine in Boston’s Seaport District. Eli Lilly will lease 334,000 SF of a new 12-story building to be co-developed and operated by Alexandria Real Estate Equities, which primarily owns and develops life-sciences properties.

A tidal wave of venture capital has been flowing into Boston, which has long been the leading global hub for life sciences.

Colliers International estimates that life-sciences projects under development or in planning will expand the sector in greater Boston to more than 60 million SF by the end of this decade.

Boston has attracted nearly $20 billion in VC investments for life sciences projects in the past two years, according to Crunchbase.

Overall, VC funding of life sciences R&D has tripled over the past five years, with more than $8 billion in new VC funding for life sciences in Q4 2021, according to CBRE. Boston-based RA Capital Management heads the national list of VC investors in life sciences, pouring $6.1B into the sector in 2021.

While Boston’s traditional hegemony in life sciences is shared with San Francisco and San Diego—California is known as “the birthplace of biotech”—these biotech powerhouses are facing strong competition from established life sciences sectors in Philadelphia, Raleigh-Durham, Northern NJ and Bethesda, MD as well as rising life-sciences hubs in Los Angeles, Houston, Denver-Boulder, Seattle-Bellevue, Chicago and Minneapolis-St. Paul.

Houston-based developer Hines recently announced that it would invest “billions of dollars” in life sciences projects in the next 24 months, focusing on non-traditional markets including Houston, Washington, DC and Nashville.

A spate of adaptive reuse projects involving the conversion of office buildings into lab space is an indicator of the burgeoning demand for life sciences facilities. Converting an office building into a life sciences lab is more expensive than other reuse projects due to the special systems needed for ventilation, cooling and moving equipment.

Longfellow Real Estate Partners, the largest privately owned commercial developer of life sciences projects in the US, last month announced the purchase of a seven-story office building in Long Island City, NY that Longfellow will convert into a 208,000 SF life sciences lab.

The $155-million transaction was Longfellow’s first acquisition in the New York City market.

Genomics research was driving life-sciences growth before the pandemic struck, but the successful development of mRNA vaccines is generating huge investments in R&D for new genetically engineered treatments for cancer, diabetes and other life-threatening ailments.

The Pfizer/BioNTech and Moderna vaccines were created using “messenger” RNA (mRNA), nucleic acid containing genetically engineered nanoparticles of the virus that “instruct” human cells to manufacture antibodies that fight off COVID-19.

This technology has created a platform for the rapid development of new molecular-level treatments that are expected to revolutionize the development of drugs.

Source: “Race to Build Labs Spurs Exponential Growth in Life Sciences“