High-net-worth investors are expected to continue pouring capital into U.S. commercial real estate in 2016, experts say, but they are fine-tuning their strategies to enter markets in which institutional investors are too risk-averse to play.
As 2016 wraps, it is expected that transaction data for private investors will show an increase in investment volume but that it will be more spread out into secondary and tertiary markets, according to Richard Putnam, managing director of the Western region capital markets group at real estate services firm Colliers International. Putnam defines private investors as individual investors and family offices.
“Private investors have been more crowded out the last couple of years and are looking at second-tier cities globally. The story in North America for private investors has been the growth of interest in smaller cities,” says Yolande Barnes, director of world research for Savills.
High-net-worth investors made approximately $3.2 billion in acquisitions in the first half of 2016, compared to about $4.2 billion in the first half of 2015 and about $2.8 billion in the first half of 2014, according to data provided by New York City-based research firm Real Capital Analytics (RCA).
These investors are focusing not on preservation of capital but on income production.
Commercial real estate has come to the forefront as a vehicle for yield that other investment tools, such as bonds, have not been able to deliver.
“As we move year into year, secondary markets can become increasingly sensitive. Institutional capital is retreating slightly from these markets as they look to reach for capital preservation, while private investors are willing to take more risk for a greater return. Institutional investors are more skittish and concerned over a possible future pause or downturn,” Putnam says.
“We continue to predict real estate is starting to be much more about income. Part of this is a function of the difficulty getting yield from other investments like bonds. Most high-net-worth investors have already invested into store of wealth asset investment. Now they are paying much more attention to income-producing properties,” Barnes says.
Sixty-three percent of U.S. investors expect investment volumes in the U.S. to rise, with industrial and logistics the most preferred investment sector, following by CBD offices and shopping centers, according to Colliers’ 2016 global investor outlook found.
High-net-worth investors are now increasing real estate investment, concentrating in alternative sectors such as student housing and nursing homes in secondary cities, according to Barnes. For investment in gateway cities, they are concentrating mostly on hotels.
“More high-net-worth investors are putting capital into assets and markets where spreads are wider. In Southern California, for instance, private investors are looking to flex R&D properties for higher yield. In secondary and tertiary markets they are looking to suburban offices,” Putnam says.
According to a Savills report “Where is smart money going,” ultra-high-net worth investors will be concentrating in the Pacific Northwest, California, Texas and certain southwest and northeast markets between now and 2020. “Cities in these regions are driven by the knowledge economy, fast-growing local populations and, in many cases, a burgeoning tech industry,” the report reads. Markets identified as net buys for high-net-worth investors include Seattle, Portland, Ore., San Francisco, Chicago, Houston and Boston. Net hold properties include Los Angeles, San Diego, New York, Washington D.C., Tampa Bay and Miami.
Don MacLallen, senior managing partner at Faris Lee Investments, represents high-net-worth investors when they search for retail properties. He cites below- or at-market rents, strong long-term occupancy, well-performing sales, and the right tenant mix to weather economic downturns as criteria that high-net-worth investors are seeking in retail properties.
“There is still quite a demand from private capital, whether from family office, high-net-worth, overseas or 1031. The issue is more of the product meeting their specific investment criteria and risk tolerance,” MacLallen says, noting they are a class of investors placing increased emphasis on risk aversion.
“One profile of investors prefers single-tenant properties with long term credit leases and/or multi tenant legacy infill product in dense locations, such as in West L.A., to hold long-term. These investors know returns are low on these types of assets, but are pursuing a generational strategy for preservation of capital,” MacLellan says. “Another profile of investors is looking at higher cash flow properties with intrinsic low rent from low price per square foot. [They] want to get higher yield by taking advantage of low interest rates. These cash flow investors are looking into secondary locations.”