The economic expansion we have experienced nationally since the recession has been long and slow — 9.5 years, to be exact — but San Diego’s real estate fundamentals have been in check, which bodes well for the region, said Brian Russell, SVP at Eastdil Secured, during yesterday’s NAIOP San Diego’s lunch event, “Capital Markets and How San Diego Will Be Impacted.” The event presented national trends and predictions and how they impact our local region.
Russell said supply is under control, and the cycle still has legs, with room for both pricing and rent growth. Moderator Dennis Cruzan, founding partner of locally based developer Cruzan, asked if companies are still growing in the area enough to make a difference in the real estate market, and Aldon Cole, senior managing director of HFF LP, said the growth has been disciplined and companies are not overstaffed.
Russell said what makes this cycle different from other cycles is that overseas investment money from markets like Hong Kong and Singapore is finding gateway cities like L.A. and San Francisco to be saturated and offering lower yields, so money from those investors is trickling down to the secondary markets like San Diego. He added that the yield environment has pushed values for all general investment asset classes, just less for CRE.
Cole added that CRE as an asset class has continued to be sought by investors who want better yield than other asset types have provided, validating both the asset class and the private real estate investment market.
Moving on to discuss interest rates, Cole said the availability of capital is more meaningful to the real estate industry than where interest rates are at any given time. He said there is some headroom for growth in this area despite where we are on values. Russell added that where lenders believe we are in meaningful rent growth will determine their willingness to underwrite and at what level.
In discussing cap rates, Cole said his firm has seen that “to maintain value, NOI growth needs to be between 15 percent and 17 percent, which is an interesting dynamic.” He added, “The interest-rate conversation is front and center for the first time in a while,” and he said interest rates are impacting investment behavior.
Cruzan asked the panel and attendees if a 50- to 75-bps bump in interest rates would show a cap-rate increase, and while the audience didn’t bite, Cole said, “I do.” He added that if owners are thinking of doing anything finance-wise, refinancing would be a wise thing to do now.
Russell noted that as of Q1 2018, there was $266 billion in closed-end private real estate dry powder looking for deals — the highest amount in record — which indicates just how ready the market is to pounce on available properties and real estate investment opportunities.
Cruzan asked the panel if investment advisors could be eliminated because yields are so low, and Russell admitted that he is seeing more direct investment, while Cole said dollars will continue to be concentrated on core assets. He added that we may not see much growth, but slightly higher rates, and since we have shown good discipline and there is no oversupply, “I feel as though we’re in a pretty good place from an industry standpoint. We haven’t gotten ahead of our skis.” Institutional allocations are increasing, further validating real estate as an asset class, he said.
This year, everyone is anticipating higher interest rates, but they may not be as prolific or profound as we had thought, Cole pointed out. In addition, real estate continues to be underallocated. Russell said the benchmark is 10 percent, whereas in the past it was 9.5 percent.
Cole also pointed out that the pace of fundraising has slowed significantly, mostly due to investors’ lack ability to invest. “Funds with a Roman numeral eight or in the double digits are getting the funds, but there are not a lot of new funds coming into the market.”
Total originations increased through 2017, and HFF’s debt business was up 30 percent last year, Cole said. CMBS market share was up in 2017, and agency participation is even after the post-recession bailout.
Russell summed up what the market wants: industrial of all types, “bite-sized” core assets of smaller size but in good markets, core assets with “personality” (Main & Main, but a little hairy, a core product with the risk of core-plus), value-add multifamily, value-add office in strong markets, and homogeneous platforms and portfolios. What’s not pricing efficiently? Retail, except for premier product; most suburban office; and very large commodity assets, particularly in East Coast and Midwest markets.