As the commercial real estate (CRE) market continues to draw attention as a desired asset class for investors, we take a look at some of the top concerns investors have when deploying their capital with their partners.
Navigating Market Uncertainty
With the commercial real estate market deep into its recovery period and capital continuing to flow into the sector from around the globe, questions continue to arise on what the best investment strategy will be for the short to medium term. This is evident as fund closing levels are at their lowest in 8 years, large amounts of dry powder are sitting on the sidelines waiting to enter the market, and opportunistic funds are growing in popularity as a key strategy—all signs of increasing uncertainty ahead. Additionally, a recent survey by NREI stated that over 50% of CRE professionals believed that the CRE industry is in its peak phase . Subsequently, investors are beginning to question how they will best manage these risks as interest rates increase and cap rates decompress.1,2
52% of CRE professionals believed that the CRE industry is in its peak phase.
While this has led to additional scrutiny over investment strategies, it has also kicked off assessments of current partner performance, as investors must choose who they will want by their side to navigate this change. This will put added pressure on all partners, but especially those whose results have been subpar, as investors question how they will rebound and do so in a more volatile market where speed and operational excellence will be needed even more.
In the first installment of our series, we will address the first concern investors have on whether their partners have the capacity to identify and quickly secure properties on the market.
Positioning Your Business with Investors
As many global investors continue to grow their positions in an already saturated real estate market, finding promising assets with many of the best properties already locked up continues to be a challenge. This has led investors to build strategic plans with strict criteria for who their partners should be. Firms who have underperformed are quickly eliminated along with those who are in the wrong property type or region. This may seem like it narrows the field for potential candidates, however, it may also lead to more specialized firms being considered – those who have performed exceptionally well for other investors and are looking to grow their book.
This jockeying for position leads to investor’s first major concern:
Concern 1: Can your asset management firm efficiently deploy their capital and be competitive enough to secure promising assets?
For many companies, the answer is yes. Most will say they are well positioned in the transaction community, receive deals as soon as they hit the market, and are always monitoring the back channels for off-market opportunities. If everyone is well positioned, how else can you be evaluated? To put it simply, on your ability to vet and recommend deals faster than your competitors – that is, to close. This raises the question of whether necessary investments into optimizing business processes have been made to ensure you are operating at or ahead of the pace of your competitors. Essentially the key question becomes: are you moving fast enough for your investors?
Filtering Through Volume: Finding the Best Assets
The short answer is never fast enough; every day with capital sitting on the sidelines is another day it is not earning returns and this is how investors are measured, on their returns. So in a market where many of the best assets are already spoken for, the search for promising assets can leave managers sifting through once overlooked properties that now seem more attractive. Additionally, it will often mean having to vet higher volumes of deals in less time. Deals which may be inherently carrying more risk and are attempting to be offloaded at the peak of the CRE cycle. This means that more time and due-diligence must be spent identifying and pulling safe and promising opportunities from the deck.
So as your team begins to sift through opportunities looking for potential acquisitions, staying close to the street for in-market and off-market deals is essential and how fast you can move on a deal to close is critical.
Speed Wins: Assessing Prospective Returns
Since deals rely on detailed analytics and cash flow assessments rather than initial yield, having the ability to decipher and build detailed cash flow models quickly is of the utmost importance.
If deals are in-market, building the first cash flow model is somewhat easier as they will come with enough information to get started. To build an effective model, it is essential to break down tenant agreements for existing rents and operating costs and to flesh out assumptions around market rents and rollovers that may create vacancies. However, if deals present themselves in off-market scenarios then building these models from scratch will be challenging and time consuming due to the lack of information provided. Assumptions around tenant lease agreements, rollover, the current state of market rents, and operating expenses are all hypothesized and will require multiple versions and approximations of value. In the case where these properties do come back as high-potential properties, additional comparisons of the prospective acquisition against the existing portfolio of your investors will have to be done. What they are looking for in returns, as well as major events that will cause risks to the portfolio must be considered.
Time is rarely on your side and your investors know this. But that is just the beginning. Small inefficiencies in a single deal can be quickly compounded, creating extra work only to find out that the deal in hand may not work for your investors. When you multiply this over dozens or hundreds of deals, what can often be justified as slight workarounds become events that put your team farther away from your goal of closing on the right property. Additionally, as time goes by, it is easy to start seeing less attractive properties as potential candidates and thus brings increased risk into the buying process for investors.
The Struggle to Compete
Firms who have the freedom to reallocate resources and bodies towards this process may not feel the burden of these inefficiencies as much, but mid-market firms with tighter budgets will struggle because they do not have those additional resources on hand. Staff are often stretched thin and time is rarely on your side, so ramping up to get through prospective properties becomes a game that cannot be won by simply logging more hours. It is for these reasons that larger institutional investors gravitate towards partnerships with larger firms who can move faster, stay ahead of the competition, and secure the best properties.
So how can firms win and remain competitive? By investing in solutions specifically designed for asset and portfolio management that increase capacity, reduce second-guessing of model accuracy and improve the overall operational efficiency of existing business practices. These asset and portfolio management solutions are designed to get to decisions faster for a number of reasons. They help dissect market assumptions faster across groups of tenants at once, meaning you no longer have to change every single line item one-by-one. These asset and portfolio management products also help you build models quicker because you can leverage past models easily and take existing rates and build them out across prospective tenants to get a complete picture of a property’s prospective operating income. Finally, where these solutions often save the most time is by running scenario analysis. With the click of a few buttons and quick changes to input values at the individual asset and portfolio level you get to best, base and worst case returns faster with greater accuracy.
Evolving Your Business to Win
Building investor trust is highly dependent on delivering results, so investing into your operations and specifically into asset and portfolio management solutions will increase your competitive positioning in the eyes of your investors. These investments also give you the ability to exchange data across your team with ease, integrate and re-structure data and quickly build models to understand the value proposition of an asset. To that end, firms who neglect scalable solutions that can help them secure the best properties and get ahead of their competition will continue to struggle, especially in increasingly uncertain market conditions where losses can quickly escalate. It is this reason why firms must take every opportunity to move quickly to secure prized assets and in doing so will alleviate one of the first major investor concerns.
1 Source: PERE: Fundraising Volume Fell By 50% in Q3, Meghan Morris, www.perenews.com , October 2017 2 Source: Is CRE Past the Market Peak?, NREI Staff, National Real Estate Investor, December 2016