Investors Move Up Risk Spectrum, though Gateway Cities Growth Present Compelling Case

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By Dennis Kaiser | Connect Media

Connect Los Angeles is the event that helped launch Connect Media five years ago. The standing-room-only crowd of more than 500 at this year’s Connect LA conference heard a wide-ranging conversation among commercial real estate’s leaders. In addition to five deep- dive panel discussions, there were three special presentations, capped by a salute over cocktails to the latest winners of Connect Media’s Top Broker and Women in Real Estate Awards.

The Buy, Build, Sell, or Hold: Investment & Development Insights panel, moderated by Cushman & Wakefield’s Morgan Jackson, featured a regional view on SoCal investment, development, and asset performance from the most active players. Panelists shared their insights into the market, the factors driving redevelopment and new development opportunities, and how they are shaping their deals.

Greenoak Real Estate’s Jonathan Epstein launched the discussion by explaining what is behind a shift in asset classes for investors to a higher risk profile of value add core plus from core. “There is a consistent need for return in the world. I think as interest rates have been relatively low for a long time and will to continue to be low, I think something like two thirds of sovereign debt is still in negative yield territory, that’s been that continued push for huge amounts of capital to continuously seek higher returns.”

He pointed out that the high volume of capital coming into the system is creating an environment where the need to place capital is helping to drive up prices. Though Epstein notes, the U.S. is viewed as a market that has the capacity to absorb the volume of those capital flows.

Epstein indicated they are finding value add deals interesting, while also pursuing core plus assets, as they work to balance the risk-return of their investment portfolio. The U.S. market, as a whole, represents trillions of real estate value that presents sufficient opportunities if investors pay attention to emerging trends or areas of growth. “We can find the right spaces to invest that capital,” said Epstein.

Given that core is largely considered a fixed income alternative and in an environment of interest rate normalization, most core investors saw a continuous rise in the curve. So, for investors seeking yield, core assets have provided significant returns from appreciation, though not income. Epstein notes, now that it has stabilized, there’s little leverage remaining, thus it is pushing institutional investors with 7% to 7.75% IRR expectations up the risk spectrum. He says, “We’ve seen money move out of core, but for the most part we’ve seen new entrants coming into the market the last two years that have really looked at the value add space and less so on core plus, which we see as an opportunity because there’s been less capital raised in that space.” And when projected five years forward, the value add will be a core plus or core deal.

Rising Realty Partners’ Chris Rising notes his fundamental view is that while location is important, each building is its own micromarket and they essentially compete against two to four buildings. Knowing a building inside and out and delivering different characteristics is actually what wins lease deals, he says. Though he doesn’t believe office location decisions are “pre-baked,” in his experience as a tenant representative broker it typically comes down to a few buildings. That means landlords must focus on location to know where the “puck is going to be,” but more importantly create an office environment with unique amenities and experiences to “beat the two to three buildings we think we compete against,” says Rising.

That means adopting an approach that is centered on “impact as alpha.” Rising notes that more often today that involves tracking a buildings’ carbon footprint and working to reduce what’s produced, taking a building to LEED Platinum and creating a workplace experience where tenants feel healthy because that’s what people think about now. That is challenging when taking on a historic redevelopment, notes Rising, because they’ve had to relearn lessons with each project and there’s hurdles with the permit process this cycle.

The end result, Rising believes, is worth it because the final office product they deliver tells a story in an authentic way that appeals to the people who ultimately work in the building. “What we are able to do with these historic buildings is give someone that sense of history, that sense of place within a 21st century infrastructure,” says Rising. “I think that’s really appealing to tenants today.”