Archives for September 2022

Self-Storage On Track For Strong 2022, But Headwinds Remain

September 7, 2022 by CARNM

Self-storage is still enjoying a strong year despite increasing headwinds overall including normalizing social behaviors and demand drivers.

According to a new analysis from Marcus & Millichap, the average asking rent for a standard 10-by-10 unit in June was up 15% compared to year-end 2019, while vacancy contracted over the same period by 190 basis points to 6.6%.

Marcus & Millichap’s 2022 forecast sees self-storage vacancy rise on an annual basis for the first time since the onset of the pandemic to hit 7.25%, an increase of 60 basis points year over year. However, lifestyle changes wrought by the pandemic are still expected to keep unit availability “well below” pre-2020 levels, they say.

Construction is at a five-year low, thanks in large part to continuing headwinds impacting construction more generally. About 53 million square feet are expected to be completed this year, well above prior downturns when totals were beneath the 10 million sf level.

Rents also predicted to tick up in 2022 for the third straight year, led by Texas and cities in the Southeast that have seen the most in-migration during the pandemic. The mean asking rent is expected to close out the year at $1.34 per square foot.

And that’s attracting investors, who registered trades in the 12-month period ending in June 2022 that surpassed pre-pandemic numbers by more than 70%.

“While transaction activity peaked at record levels in the second half of 2021, sales velocity through the first half of this year is still well above historical averages,” the report notes. “Even as interest rates began to climb in March, increasing capital costs, transactions actually rose between the first and second quarters. While this indicates substantial investor enthusiasm, the Federal Reserve is expected to hike rates multiple times before the end of 2022, possibly dampening for deal flow.”

The buying pool is also broader, as investors are looking to self-storage as an attractive inflation hedge and wooed by the sector’s “countercyclical” renter demand: “Most self-storage units are leased on a monthly basis, allowing rents to be adjusted more frequently than in other property types. While the inconsistent rate environment is prompting some larger parties to delay acquisitions, robust fundamentals have kept private buyers energized.”

However, there are some headwinds: “significant” cap rate compression would impact investment, and segment yields nationally declined from the mid-6 zone in late 2019 to mid-5 percent as of April.

Significant cap rate compression could impact investment landscape. Segment yields have dropped notably on the national level since the onset of the pandemic, declining from the mid-6 zone in late 2019 to the mid-5 percent tranche as of April 2022. Marcus & Millichap experts say that buyers looking for higher yields to offset steeper borrowing costs might look for opportunities in outlying suburbs or tertiary markets.

“Capital costs are climbing, impacting terms. Banks, ranging from local to national in scope, continue to be the most active lenders in the space, but are likely to favor borrowers with whom they have an established relationship with,” the report notes. “The owner-user structure common in many privately owned self-storage properties may also align more with bank and credit union preferences in the event of an economic slowdown. Lenders have generally tightened underwriting criteria, with individual asset quality and location continuing to be differentiating factors.”

More funds than ever are investing in the space. In May, for example, self-storage owner and manager Storage Post announced a $500 million in capital from a fund sponsored by Almanac Realty Investors, a business unit of Neuberger Berman. Earlier this spring, Cory Sylvester, Principal at DXD Capital, told GlobeSt.com that institutional capital is entering the space “as it has shown to be an extremely recession resilient asset class, along with seeing unprecedented growth since the onset of the pandemic.”

Because the equity checks on a deal-by-deal basis tend to be much smaller than traditional real estate asset classes, these institutional players are looking for partners who can execute at scale, Sylvester said.

“We are seeing that trend in our business, and it has become evident with the recent string of announcements that institutional capital is aggressively seeking a partner in the space.”

Source: “Self-Storage On Track For Strong 2022, But Headwinds Remain“

The Heat Is Off? Recession-Related Valuation Drops Could Douse Overheated Markets

September 7, 2022 by CARNM

With a likely recession on the horizon, property owners across the U.S. are preparing for the drop in property values that tends to accompany economic downturns, but some property types can anticipate a harder hit than others.

Property types responded differently to pandemic-era market shifts, causing some to shoot up in value at a supercharged pace while others languished. But now, faced with a recession, the playing field could be leveled.

“Broadly speaking, all real estate valuations are likely to come down in the coming months, since there is little doubt that interest rates will continue to rise, perhaps substantially,” Reveille Hospitality Chief Investment Officer Marco Roca Jr. said.

But how much values drop, and what it means when they do, is not so easily generalized.

For instance, the two darling property types of recent years, industrial and multifamily, could be in for a correction that will turn down the temperature on overheated markets for those property types.

Industrial will drop from its pre-recession valuation highs by 14.1% and multifamily will be down 12.2% next year, Cushman & Wakefield predicted in its latest economic forecast.

For industrial, a drop in valuation is a strong possibility because the market has been so hot for so long that some kind of correction is in order.

“Industrial has been red-hot now for years, with record cap rates and record values,” Partner Valuation Advisors Senior Managing Director Eric Enloe said. “Now I’m seeing a bit of a flight to quality for industrial. There are still big numbers being paid, but buyers are really looking hard at those cap rates, especially since borrowing costs have increased.”

How a recession impacts individual space users could also be a factor in driving industrial valuations down, Enloe said.

“For industrial, valuation really depends where and how companies will continue to grow their logistics networks — do they still want to expand?” Enloe said. “A recession would definitely not be a good thing when it comes to expansion.”

Meanwhile, retail — the values of which have already taken a beating — will lose only 1.8%, according to Cushman.

Perhaps the least predictable is what awaits office properties. Cushman & Wakefield projects office values will drop 12.1% next year, while other reports note that the slide in valuation is already well under way.

An analysis by the Business Journals found a net total of nearly $6.9B in property value has evaporated across 460 office properties that secure debt in CMBS loan portfolios since August 2021. Reaching back to the pandemic’s beginning raises that figure to $8.5B in property value lost among 652 offices in CMBS portfolios.

Until there’s clarity on how much space companies need, there will continue to be a spread between what buyers think a large multi-tenant office building is worth and what sellers think they’re worth, Enloe said.

Other experts are more sanguine about the strength of office as an asset class.

“In the U.S., the worst really seems to be behind us,” CBRE Head of Office Research, Americas Jessica Morin said during a recent CBRE podcast. “Over the past three quarters, we have seen that move-ins have actually exceeded move-outs. Vacancies are starting to stabilize, although they reached that nearly 30-year high, and asking rents are starting to moderately rise.”

As for multifamily, Apartment List Senior Research Associate Rob Warnock said there isn’t much hard evidence yet to predict what is going to happen to multifamily property values in a recession.

“The multifamily apartment market is still looking strong,” Warnock said. “Although rent growth is slowing, rents are continuing to rise, suggesting that near-term revenue streams are solid.”

While rising interest rates have tempered construction in the single-family sector, multifamily construction hasn’t slumped, signaling longer-term optimism within the industry that apartments are still a good investment, Warnock said.

“Rising interest rates and inflationary price increases will spark a recalibration over the next six to 12 months,” Kaplan Residential President Morris Kaplan said, but added that there are still deep pockets in CRE and deals are still being aggressively pursued, so a correction — at least for multifamily — might actually bring a sense of normalcy to the industry.

For multifamily developers, he said, construction prices are beginning to stabilize, which will also be a positive for the industry going forward.

“This cycle restart will put us in better-controlled conditions for the future,” Kaplan said.

Cushman’s forecast predicts there is a 50% chance the U.S. economy will enter a mild recession during Q4 2022, or perhaps the first quarter of next year. A mild recession, in this context, means no GDP growth in 2023, a loss of 1.4 million jobs during that year, and relatively high inflation (3.9% for the year) cutting into consumer and corporate spending power, according to the firm.

In a mild recession, the company predicts, all U.S. commercial property values will drop an average 11.2%, but will resume modest growth (2.6%) the next year.

A relatively short dip, in other words.

The report also predicts a 30% chance of a “soft landing,” which is a slowdown without a recession. Much less likely (5% each), according to Cushman & Wakefield, is no slowdown at all, or a period of 1970s-style stagflation.

Other economists are predicting a recession as well. The Conference Board, for example, forecasts that economic weakness will intensify throughout the U.S. economy in the second half of 2022, while Fannie Mae now expects a modest recession to begin in Q1 2023 as opposed to its previous expectation of the latter half of 2023.

Although valuation changes will vary by property type, the likely drops across the board will create ripple effects for other segments of the CRE market, such as REITs and capital markets.

In the periods leading up to previous recessions (with one exception), REITs have experienced significant losses in returns, according to Cushman.

In 1973, for example, the drop in total returns was 34.5% peak-to-trough, and in 1990, the drop was 23.9%. The big kahuna among lost returns, however, was the Great Financial Crisis of 2008, with a decline of 68.3%, while the dot-com recession was the exception, according to Cushman & Wakefield.

That year, returns rose 17.8%, since that recession was short-lived, and at the time the REIT market was recovering from a contraction that began in 1997.

Cushman & Wakefield also predicts that in a mild recession, cap rates will increase across property types, most acutely this year and during all of 2023. Industrial and multifamily are forecast to see the largest increase in cap rates, something of a mirror to the significant compression they experienced during 2020 and 2021.

Higher interest rates and tighter lending will likely slow transaction volume and depress prices, but Location Ventures CEO Rishi Kapoor posits that any such correction will be healthy for long-term growth of the industry. His company holds a $3.5B residential and commercial portfolio.

“Both factors work toward stabilizing what has been record-breaking and rather unsustainable transaction volume and pricing,” Kapoor said. “We enjoyed it, but always knew the tide would recede, meaning a re-evaluation of deals, and whether placing more equity on the table to close a transaction is worthwhile.”

Lower prices will also represent a fresh jumping-in point for opportunistic investors ahead of the next phase of growth, Kapoor said.

“While not fully insulated from the recent macro headwinds adding downward pressure to valuations, as an asset class commercial real estate still has sound fundamentals and healthy performance,” Altus Group President, Analytics Americas Rick Kalvoda said. “That should provide some valuation support.”

Commercial real estate asset values continue to be driven by local market economic activity, property sector trends and property-level performance, Kalvoda added.

“That said, if the current macroeconomic concerns do materialize and negatively affect local markets, then we might see more downward pressure on commercial real estate values,” he said.

Among the macroeconomic trends to watch is the rising cost of capital, which will factor into property values. While capital is more expensive than it has been for many years, and probably won’t get cheaper any time soon, the impact of rising interest rates on CRE values isn’t necessarily straightforward, Enloe said.

“The cost of borrowing has gone up, and so the returns necessary to make the investment work have also gone up,” Enloe said. “That means there’s pressure on cap rates.”

On the other hand, he said, the market is still flush with capital — the same capital funneled into CRE in recent years, driving prices upward.

“That kind of negates some of the interest rate pressure,” Enloe said.

Even so, a lot of CRE is sensitive to interest rate hikes, which will be a headwind to the market in the post-pandemic era, DGIM Law founding partner Daniel Gielchinsky said.

Certain areas of the country and sectors will be more insulated than others, so evidence of a sweeping correction is hard to find, said Gielchinsky, whose specialty is real estate.

“I see an uptick in certain classes feeling the heat from lowering investment volume, reduced lending activity, higher interest rates and souring deals,” he said.

Source: “The Heat Is Off? Recession-Related Valuation Drops Could Douse Overheated Markets”

Advisors Take on Alternatives

September 6, 2022 by CARNM

Asset managers and technology firms are luring retail advisors into alts with easier access and promises of diversification and enhanced returns. Here’s what advisors themselves think about broadening their client portfolios.

Alternative assets have long been the domain of ultra-wealthy and institutional investors, guarded as they were by astronomical investment minimums, hefty fee structures and lack of liquidity. A wide swath of personal investment advisors could be forgiven for never bothering to gain more than a vague understanding of this wide-ranging asset class in all its varied complexity.

But new investment wrappers, sleek advisor technology platforms and business partnerships have made alternatives considerably more accessible, just in time for world events, heightened inflation, rising interest rates and volatile markets to lay bare the vulnerabilities inherent in the traditional 60/40 portfolio.

As alternative asset managers clamor to corner the merely high-net-worth market and wealthtech providers continue to innovate in the space, financial advisors are faced with a growing menu of potential products to offer their clients in the name of risk management, protected income and alpha.

WealthManagement.com reached out to advisors around the country to learn how they’re incorporating alternatives into their own practices and found that, while many remain wary, the majority who have accessed the investments for clients are happy with the results so far.

Most reported similar challenges around the client education, research and due diligence efforts needed to invest successfully in the space, as well as the additional paperwork required by most private investments—an onerous task that has been at least partially solved by large, tech-driven alternative platform providers and new investment vehicles.

“Alternatives are a very broad category and can be confusing and intimidating to most advisors, let alone the investing public,” said Jason Siperstein, president of Eliot Rose Wealth Management in West Warwick, R.I. An RIA catering to individuals nearing retirement, the firm manages around $116 million in client assets.

Eliot Rose, a 20-year-old firm, only recently began offering alternative investments to clients for the first time, as a substitute for a portion of its bond exposure. All alternative investments are accessed through custodian Charles Schwab, adding an extra layer of diligence while limiting the scope of potential investment opportunities. (Siperstein said that Schwab offers “more than enough options.”)

His firm considers only liquid and semiliquid alternatives with risk profiles similar to the bonds they’re replacing, with different yield drivers and low correlation to the rest of the portfolio, he said.

“Sure, you give up a little potential return, but the flexibility for our client base was worth it,” he said. “In addition, we wanted to make sure our alternatives investments were not only uncorrelated to the rest of the portfolio, but also uncorrelated among themselves. I think a common mistake a lot of advisors make is choosing only one alternative strategy with a high correlation to the rest of the portfolio. To really make this work, you need to carve off a whole alternative sleeve of your portfolio and ensure this piece moves independently.”

Research and client communication have presented the biggest challenges to adopting alternatives, said Siperstein. Practice, and visual aids, can ease the client communication part, he said, but there is no getting around the additional due diligence.

“You want to make sure you choose the right manager for your alternative sleeve,” he said. “The dispersion in returns between good managers and bad managers is massive!”

Year to date, said Siperstein, the alternatives sleeve in his firm’s portfolio has been its best performer. “We, for one, are glad we did it. … Just be aware that it takes a lot more research and due diligence to enter this space,” he said. “However, with proper effort, it can add meaningful performance to your portfolio at large.”

Jeff Nauta is a principal at Henrickson Nauta, a Belmont, Mich.–based RIA with more than $400 million in assets under management. His firm is developing its own inhouse alternative access funds and funds of funds, with administrative and logistical support from Fund Formation Group.

Nauta said his firm approaches alternatives as they would any other asset class in a portfolio—as a tool to improve its risk/reward profile.

“We see a lot of investors and advisors chasing the strong returns of alternatives this year,” he said. “We are strong believers that traditional alpha is fleeting at best, so we look for alternatives that provide returns as compensation for identifiable risks or structural reasons for a lack of capital in the asset class.”

An investment isn’t an alternative, Nauta explained, unless the risks differ from those seen in equity and fixed income markets such as liquidity, complexity and headline risk.

“With that in mind, we exclude a lot of things like traditional private equity funds or long/short hedge funds given the heavy reliance on equity risk premiums in one form or another,” he said. “Instead, we invest in more niche opportunities like reinsurance and life settlements, both of which have their futures.

In addition to the extensive due diligence involved, Nauta also said considerable effort and time are required to educate clients and manage expectations. He pointed out, too, that these investments can cause more work for advisors on the administrative side, depending on the vehicle and how an advisor manages portfolios.

“For purchases, interval funds look and feel a lot like a mutual fund, so it’s very easy to incorporate them into model portfolios and allocate across clients,” he said. “For private funds, clients will need to sign subdocs, which can be time-consuming. The CAIS, iCapital and Prometheuses of the world are trying to make the process more efficient, but it’s still labor-intensive.”

Commingled private funds, said Nauta, provide diversity within a single fund while minimizing paperwork and providing access to lower minimums.

“We think custom funds like these will be the next evolution in RIAs allocating to the space,” he said. “It certainly puts more onus on the RIA to source and diligence the investments, but for RIAs with the ability to do so, it provides greater flexibility, access to more niche funds, lower costs and the panache of having the firm’s name on the fund. As an example, we’re able to access a smaller litigation finance fund that simply wouldn’t have the capacity to make it worth iCapital’s or CAIS’ time.

“The setup and ongoing administration definitely require more time,” he added, “but we think the benefits outweigh the costs.”

Some firms prefer to take advantage of one or more of the alternative platforms—such as iCapital or CAIS—that have been instrumental in making these products more widely accessible, whether on a turnkey basis or as part of a full-service platform.

Kostya Etus is head of investment strategy for Dynamic Advisor Solutions, a Phoenix-based asset management firm and RIA with around $3.3 billion in assets under management. Last month, Etus and Dynamic announced a partnership with CAIS to provide end-to-end alternative investment solutions to Dynamic advisors.

For advisors with the scale and resources, Etus believes the platform solution is the easiest route for advisors to swiftly and safely access private alternative investments that can return considerably higher yields than publicly traded mutual funds or ETFs.

“Private investments require complex paperwork and subscription documents, and it’s sometimes tough to understand how to complete or get access to some of these things,” he said. “And the CAIS platform is just a really seamless digital experience.”

Comparing it to an online marketplace, Etus said the platform not only makes it easy to complete transactions, but also provides a comprehensive, customizable and searchable menu of investment options.

“You can filter the list by private investments, private equity, private real estate, private credit, hedge funds, structured notes, and everything is consistent. You can see all their limitations or restrictions, the holding period, the minimum investment. Everything’s easy to understand, and they have the education right there; they have the Mercer research reports.”

Independent vetting of all CAIS investments by industry giant Mercer is his favorite perquisite, but Etus also appreciates that Dynamic advisors in need of extra help now have access to CAIS experts and portfolio managers. “I think that’s really great,” he said, “because oftentimes you don’t really know who to call or how to get more information.”

Even with all the new options, support and interest, Dynamic recommends that traditional investors allocate no more than 20% of their portfolio to alternatives, said Etus. “And that’s for more of a diversified basket of alternatives. Depending on the risk and client situation, perhaps closer to 10%.”

“I think if advisors want to compete for high-net-worth clients with some of the larger, more traditional users of these funds like the wirehouses or the institutional banks, they really need to have solutions for alternative investments.

Source: “Advisors Take on Alternatives”

Will “Just-in-Case” Inventory Storage Survive the Current Moment?

September 6, 2022 by CARNM

“Just-in-case” inventory storage is leaving retailers with excess inventory and little space to store it. But it’s not likely to go away, industry insiders say.

During the pandemic, many retailers shifted their inventory strategy from “just-in-time” to “just-in-case,” stockpiling popular goods to ensure timely fulfillment of orders amid a breakdown in the supply chain. In recent months, however, a decline in consume spending left retailers with excess inventories that have added to the strain on their storage capacity, especially at a time when industrial space is already at a premium.

A recent Wall Street Journal article reported that U.S. retailers lack room for new inventory and have started using containers and trailers for overflow storage because of their mobility. This, in turn, is creating a shortage of containers and trailers needed by the logistics sector to move goods from producers to markets.

“Currently, retailers are navigating the bullwhip effect, a supply-chain phenomenon where small fluctuations result in ever-increasing disruptions along the supply chain,” says Thomas Galvin, research manager in the Los Angeles office of real estate services firm Transwestern. That is why big national retailers, such as Target and Walmart, continue to grapple with an inventory glut of off-season merchandise such as pools, bicycles and tents—items that were in short supply at the start of the pandemic and had been on backorder for many months, Galvin notes.

At the same time, shoppers are now putting the brakes on purchases of durable goods, such as cars and items needed for home improvement projects, and focusing more on everyday goods, such as food and clothing. That’s causing further challenges to retailers seeking to forecast demand, Galvin adds.

But the “just-in-case” model of inventory management “is not going away,” says James Breeze, global head of industrial and logistics research with commercial real estate services firm CBRE. “Occupiers do not want a repeat of 2020/2021 inventory shortages,” he says, adding that merchandise shortages significantly impact retail sales in a highly competitive market. “Whoever has an item in stock will get the customer; I don’t see many companies shifting back to ‘just-in-time’ and risking sales.”

Meanwhile, issues further up the supply chain, including water and power problems in China that have shut down factories, port strikes in the U.K. and energy issues in Europe caused by the war in Ukraine mean higher prices on exported goods, if those goods even get produced, notes Galvin.

“If retailers cut prices to liquidate goods, they will take an immediate loss and restocking those depleted inventories will be even more challenging in the future,” he says. The alternative might mean getting stuck warehousing goods that have gone out of fashion and continue to depreciate in value.

“How retailers balance shifting consumer priorities with longer-term supply disruptions will determine which survive and which do not, as well as what supply-chain model proves the most flexible in an increasingly uncertain world,” Galvin notes.

Impact on industrial demand

Current excess inventory needs to work its way through the system, but this will take some time, according to Matthew Dolly, leader of national industrial research at Transwestern. Total import volume for the top 10 U.S. ports rose by 5.5 percent at mid-year 2022 compared with the same period last year and is up 23.6 percent compared to 2019, Dolly notes. Seven of the top ports reported higher cargo volumes in the first half of this year than in 2021.

As a result, retailers’ need for inventory storage and control has been among the top drivers for industrial real estate demand, according to Breeze. It’s one of the major reasons why vacancy rates are currently at a record low of 2.9 percent.

Industrial developers are attempting to provide the extra space needed, with warehouse construction at a record high with 626 million sq. ft. in the pipeline. But supply-chain issues are also delaying delivery of construction materials and, therefore, project completions, causing retailers to use alternative means of product storage. They are storing inventory in containers at outside storage site, Breeze says, noting that outsourcing of warehousing and distribution to third-party logistics providers is also increasing at a rapid pace.

And while some retailers, including Amazon, have paused their real estate decisions recently, there have been plenty of others who have made commitments to large warehouses in 2022, notes Dolly. Even if the issue of excess retail inventory is eventually alleviated, there is still plenty of demand in the pipeline to fill those warehouses, he says. In fact, Dolly notes that some retailers and logistics firms may consider vacant space as an opportunity to make asset upgrades that are impossible under current constrained market conditions.

Source: “Will “Just-in-Case” Inventory Storage Survive the Current Moment?“