From acquiring distressed loans to providing capital as a shadow lender, here are seven CRE asset types that will pay off this year.
Below are my seven strategies to make big profits in CRE in 2021.
Acquire Distressed Hotel Assets
The hotel market in 2020 was decimated by Covid and state lockdowns with falling demand, occupancy, and RevPAR. Per CBRE through Q3-20, room demand was down 36.8%, national occupancy was down 37.9% and RevPAR down 54.5%. These are horrible statistics, however, where there is great distress in CRE, there is also a great opportunity. The economy is expected to recover substantially in 2021 with increased business and leisure travel. This will be exceptionally good for the hotel industry and many hotels today can be purchased at exceptionally low values or the debt can be acquired at a substantial discount to eventually obtain the hotel asset or get repaid at par value.
Acquire Distressed Retail Assets
Many shopping center and mall real estate assets are selling at 8.0% to 10.0%+ cap rates and some of these assets should be bought. Retail assets have been out of favor for the last few years and Covid has accelerated the demise of the weaker retail chains in the industry. Although there are still tenant risks, with bankruptcies and store closures, they can still provide higher risk-adjusted returns than other CRE assets. A number of the public retail mall REITs are also selling at deep 50%+ discounts to net asset value and are also ripe for a buyout or being taken private. Some of these distressed retail deals are opportunistic investments and need significant renovation, releasing or a change in highest and best use.
Invest in Data Analytics Businesses
One of the key growth areas of CRE is in data analytics. Data analytics encompasses all aspects of big data for CRE including demographics, ownership data, property data, historical value information, sales/lease data and financial analysis. The data analytics space is very fragmented with a few large companies like CoStar, RealPage, REIS (a unit of Moody’s) and Real Capital Analytics and many smaller local and start-up companies. These larger firms have been acquiring smaller competitors to expand their service offerings and customer base. As the industry grows, there will be more consolidation and an opportunity to acquire these smaller private firms and even establish a platform to consolidate these entities or sell them to the larger firms. The large CRE software firms are also prime buyers for data analytics companies as they seek to diversify their software business and cross-sell the data analytics products.
Sell Overpriced Core Assets and Reinvest in Opportunistic/Distressed Assets
A chart on institutional CRE investment strategies show the risk and return for various strategies from the lowest risk, core investments, which are typically fully leased, institutional quality, Class A properties with little or no leverage, to value-added strategies which are higher risk strategies that involve some property redevelopment, tenant adjustment or leasing or with operational problems to opportunistic strategies, which are the highest risk category that involve a high degree of redevelopment, leasing, tenant relocation or change or are in financial distress. Many core properties are still trading at 3.0% to 4.5% cap rates and should be sold, especially in blue cities. The proceeds should be reinvested in higher return opportunistic strategies, as discussed in #1 and #2 above.
Provide CRE Loans as a Shadow Lender
Although the regulated lending market for CRE assets saw loan volumes decline by 50% in 2020, the health of the industry has held up very well. Due to a booming economy and pent-up demand in 2021, the lending market will see increased loan activity from banks, insurance companies, the GSEs and savings institutions. There will also be an insatiable demand for loans that do not fit into the loan box from these regulated lenders and the shadow lenders will be available to meet this demand. 2021 will be a great market to start a debt fund to service this untapped loan market niche.
Acquire Public REIT Stocks
The FTSE-NAREIT All Equity REIT Index will be down in 2020 by about -12%, with many sectors down by double digits. Through October 2020, these REIT sectors were down as follows; office -35.97%, retail -42.12%, apartments -28.08% and hotels -50.33%. These large stock price declines will turn around substantially in 2021 and I am predicting that the FTSE-NAREIT All Equity Index will be up by 10%. Many REIT stocks are trading at historically low values and should be purchased. I have stated many times that individual investors should allocate 15%-20% of their total portfolio into a diversified equity REIT fund. During the Financial Crash that lasted from 2007 to 2012, the average REIT stock was down about 50% and they came roaring back after 2012 with double-digit annual returns through 2019.
15 CRE Risks to Watch For
As always when investing it is crucial to understand the accompanying risks. Here are 15 that investors should watch in particular.
- Cash Flow Risk-volatility in the property’s net operating income or cash flow.
- Property Value Risk-a reduction in a property’s value.
- Tenant Risk-loss or bankruptcy of a major tenant.
- Market Risk-negative changes in the local real estate market or metropolitan statistical area.
- Economic Risk-negative changes in the macroeconomy.
- Interest Rate Risk-an increase in interest rates.
- Inflation Risk-an increase in inflation.
- Leasing Risk-inability to lease vacant space or a drop in lease rates.
- Management Risk-poor management policy and operations.
- Ownership Risk-loss of critical personnel of owner or sponsor.
- Legal, Title, Tax and Political Risk-averse legal, tax and political issues and claims on title.
- Construction Risk-development delays, cessation of construction, financial distress of general contractor or sub-contractors and payment defaults.
- Entitlement Risk-inability or delay in obtaining project entitlements.
- Liquidity Risk-inability to sell the property or convert equity value into cash.
- Refinancing Risk-inability to refinance the property.
Joseph J. Ori is executive managing director of Paramount Capital Corp., a Commercial Real Estate Advisory Firm
Source: “Six CRE Assets to Buy This Year“