Investing Strategies How to identify good Proptech Opportunities PG 18
THE FAMILY OFFICE REAL ESTATE MAGAZINE
REAL ESTATE
FALL 2020
FAMILY OFFICE
MAGAZINE
How A New President May Affect Real Estate Investing for Family Offices
Even With a New Administration, Family Offices Need to Focus on the Benefits of Real Estate
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Finally, we know who will be the next President! During that time, family offices were holding off making Opportunity Zone investments and selling assets looking for 1031 exchanges. With the new administration, there is a considerable possibility that President Biden will want to raise taxes, and more precisely, capital gains taxes. There are even conversations that he may try to roll back 1031 exchanges to where if you make less than $400K a year, you cannot take advantage of the benefits 1031 exchanges provide. Even though 70% of family offices do not take advantage of 1031 exchanges (as identified in the 2020 Family Office Real Estate Study), this can play an essential role in what has been an excellent way for family offices to create and maintain generational and legacy wealth. The positive side of all of this is that the Republican Party may keep control of the Senate, which should stop some of these changes. Regardless of what may happen to taxes on the wealthy, family offices need to remember that real estate is the second area of wealth creation for family offices after the industry where their wealth came from. Real estate is a tremendous asset class for maintaining wealth as well. DJ Van Keuren Evergreen Property Partners
From The Publisher
37 I FAMILY OFFICE REAL ESTATE STATISTICS Statistics from the 2020 Family Office Real Estate Study
The Family Office Real Estate Magazine
18 I HOW FAMILY OFFICES & REAL ESTATE FIRMS CAN SOURCE GREAT PROPTECH OPPORTUNITIES Many say the future of real estate is real estate property technology or PropTech. Understanding there is an opportunity is one thing; choosing the right option is another.
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INVESTMENT STRATEGIES
12 I COMMERCIAL REAL ESTATE PERFORM WELL UNDER BOTH PARTIES The new administration has been speaking of tax changes, specifically in real estate, that could adversely affect family offices.
MARKET CYCLES
COVER STORY
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27 I THE MUELLER REAL ESTATE MARKET MONITOR The Second Quarter of 2020 Analysis The physical market cycle analysis of 5 property types in 54 metropolitan statistical areas
BY THE NUMBERS
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COMMENTS & PERSPECTIVES Family Offices Must Take Advantage of the Upcoming Real Estate Opportunities During COVID 19 An Interview with iGlobal Forum President Anna Ivanova on "What Should a Family Office Look for In a Conference during and after the Pandemic.
By DJ Van Keuren - Family Office Real Estate (FORE)
"Will your family office take advantage of the upcoming opportunity that COVID-19 will provide?" DJ Van Keuren
COMMENTS & PERSPECTIVES
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Family Offices Must Take Advantage of the Upcoming Real Estate Opportunities COVID-19 Will Provide!
ver the last few weeks, I have had the opportunity to speak with other family offices regarding what they are doing on the real estate investment front. The majority of families have been putting a stop on any of their investments. Their investments are not only in real estate, but other types of investments as well. Their primary focus has been on their stock portfolios. With the volatility of the stock market continues to garnish the emphasis of family offices and realize that there is an opportunity there yet still figuring out how they want to go about that opportunity. Rome Now is the time I believe family offices should be focusing more on hard assets and the opportunities they will provide. In the US, the hardest-hit property types have been retail assets. Everyone that I've spoken to that's had exposure to retail assets or manage those as a professional real estate investment company has been getting asked for rent relief almost immediately when the coronavirus was considered a risk. For those that have apartments, I know many people that have re stress-tested what could happen. The reality is that with everyone quarantined, everyone will note be moving. In many ways, this may be the safest real estate property type on the market. Real estate lags the stock market, and the impact it will have on apartment buildings will not be seen for at least 90 days after a notice downturn in real property. It will be 90 days after when you will start to see delinquency in payments from tenants and put stress on the building's cash flow. If the virus is in the same position in 4 months as it is today, the impact on apartments will become evident.Although not spoken about, I would imagine office buildings will be taking a hit soon with tenants asking for rent abatement. Smaller businesses that are housed in we work type environments, will be canceling their month to month obligations. And of course, there are hotels. With no one traveling, vacancies rates will continue to go up significantly, where many hotels may not be able to fulfill their loan obligations. But with there's trouble, there's also a significant opportunity. Family offices need to realize that a bad short term outlook doesn't mean the long term isn't secure. Family offices should see it as an opportunity and remain opportunistic. In my last newsletter, I mentioned that any development that starts today should be one of the safest places to invest because you won't need to worry about occupancy for another 18 months to two years. Still, because of what's happening, there will be an excellent opportunity to pick up prospective properties due to defaults. The family office's first objective is to "not lose money:" Still, they must stay the course with one of the most significant benefits their capital provides, which is being able to invest long term. The coronavirus may get worse, but this too shall pass. When that does, demographics will continue with people moving into areas where there's a high quality of life, employment opportunities, and a cheaper cost of living. Things will get back to normal. Will that be next month, or by the end of the year, no one knows right now, but when we look back on this time in history, it will be a blip on the map with one question that will have an answer. Did your family office take advantage of the opportunities the coronavirus provided?
Source: Rockefeller Group
he coronavirus has caused many real estate changes, and one of them has to do with how people are attending conferences.In the past, people would get on a plane and attend a conference in person. Over the years, I've had many questions from people asking what conferences should I attend, what conferences shouldn't I attend?Today is different, amid a pandemic.Today is the era of Zoom meetings and zoom conferences. To provide a better understanding of today's conference circuit, I spoke to Anna Ivanova, Founder and Managing Director of iGlobal Forum, a conference platform that she founded in 2008, right before the recession.The big question I wanted to find out was what a Family Office should look for in a conference, how things have changed today and when we think we might get back to attending conferences in person.The following was an interview last month with Anna. Why Do People Go to Conferences? People go to conferences to look for content and to benchmark from fellow industry executives.A great example is when we launched the first event in 2008, even though we were on the brink of a major recession, it was one of our most well-attended events as people were looking, more than ever, to speak with industry professionals to understand what was going on in the market and how to approach their investment decisions.They were looking for answers.On the flip side, when times are great and when the economy is booming, people are usually busy in their offices and we find that the focus is more around networking. In these Covid times, are you starting to see many more people coming for the content than you saw before now? Yes, and people are also willing to pay for content. So, even though the format is different and is now virtual, we are continuing to do what we have been doing for 12 years, delivering reliable content. It's just in a different vehicle and it’s online now. What should a family office look for in a successful conference, especially as there are many conferences out there? I think successful conferences need to have three differential factors. 1.Conferences which are not too populated: Family Offices should look for conferences that are not too populated with vendors or where they will get lost in a big crowd. Some conference companies fill up their events with as many sponsors as possible. I believe that this approach compromises the attendee’s experience.What we have found out is thatthe optimal size for a productive networking experience is between 100-150 attendees. We want to make sure that people get the opportunity to meet the speakers. People can engage in conversations and we are able to arrange meaningful one on one meetings. This is quite difficult to replicate in a large-scale conference or tradeshow. 2. Quality of attendees.People go to conferences to connect with the end-users. They should have access to decision-making executives.That’s probably the most important advice when looking for a successful conference. Look for conferences with a handful of vendors and a high-quality list of speakers and attendees. 3. Unique Content:The last thing but equally important is to make sure the content is unique. I think many conferences replicate content or the content throughout the event is repetitive.Look for interesting content which you cannot read on the news. How can an investor that goes to one of these conferences maximize their time? As mentioned, people are there for content and networking. For the networking element, the conference organizer should be doing the heavy lifting and helping you arrange meaningful one on one meetings based on your specific needs. But try to meet as many people as possible!Don’t be shy and approach the speakers also. They are there to network as well and no one refuses an introduction at a conference. So you've been doing this for 12 years. You started in 2008. Five years ago, you began to have conferences in London. What are we going to see going forward?How is this going to change the future of conferences, and what should we look for? I think we live in very interesting times that are constantly changing so we’ve had to adapt and innovate. We just updated and launched our new website which streamlined our three brands, iGlobal Forum (events), iGlobal Live (an online library of events for people to watch at their convenience), and the ISCP Club (the first of its kind, an online networking platform connecting independent sponsors and capital providers). When I think about how iGlobal Forum is evolving during Covid, we are becoming much more of a media and events company vs. just an events business.We now live in this digital world where we can distribute content essentially around the world to be watched at people’s convenience and from their homes. I think there is going to be a point when we are all going to get on an airplane again and meet in person at a conference but it might be a while.When we come out on the other side, people will be a lot more selective about the conferences they attend. I think people will ask themselves the question - do I need to get on a plane to go to this particular event or should I watch it from home or my office?The option will be there from now on – therefore, the decision making process will change as hybrid events are here to stay.
An Interview with iGlobal Forum President Anna Ivanova on "What Should a Family Office Look for In a Conference during and after the Pandemic."
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"A Family Office should look for two things when deciding to go to a conference. 1) making sure the conference is not too populated and 2) the conference needs to have Unique Content." Anna Ivanova - iGlobal Forum
Commercial Real Estate Performance Under Both Parties
Cover Story
ith the recent presidential election results and Biden becoming the President, the alternative investment and real estate industries are increasingly worried about Biden’s proposal to eliminate Section 1031 of the Internal Revenue Code and how having a Democrat in the white house will affect real estate. Per a recent Cushman & Wakefield report, which dives straight back into the late 1970s, Demonstrates that returns on investment to investors in commercial property tend to succeed under both Democratic and Republican administrations. The analysis worked off info in the National Council of Real Estate Investment Fiduciaries Property Index (NCREIF NPI), which institutional investors in the U.S. use to estimate commercial property operation. Consider it as a guide for determining what will be a fantastic investment and what will not. It ends up that the NPI does fairly well whoever's at the White House. "Property has played well under both parties," the Cushman & Wakefield report, which in-house economists Kenneth McCarthy and Kevin Thorpe authored, stated. "Since 1979, NCREIF property index yields have averaged better than 8.5 percent yearly under different Republican and Democratic administrations." In reality, when you examine the graph below, you will understand that the downturns in commercial property investment operation have come through recessions, such as the one in the onset of the 1990s (under Republican George H.W. Bush) and throughout the fiscal meltdown of 2008-2009 (under Republican George W. Bush and Democrat Barack Obama). To be clear, it might matter very much on the election of Former Vice President Joe Biden as as has stated that he would like to tweak present 1031 exchange rules. For example, he disagrees with President Donald Trump about the effectiveness of the opportunity zones program the 2017 national tax reform created. Quite a few investors have taken advantage of the Opportunity Zones to park cash in various improvements to defer particular taxes. For Family Offices the reduction in 1031 exchange opportunities based upon their annual income being greater than $400K. 1031 EXCHANGE At length, still, yet another suggestion for real estate investors will be Biden's need to expel the 1031 tax loophole. This taxation law percentage makes it possible for investors to cancel their real estate taxes from asserting reductions due to land loopholes. This loophole can usually be used even though investors have real estate admiration. The alternate investment and real estate businesses are becoming more and more concerned about Biden's proposal to get rid of Section 1031 of the Internal Revenue Code. Since 1921, investors are allowed to defer paying capital gains taxes on investment property earnings when they reinvest the proceeds to a similar investment land within a predetermined timeframe. Following an investment property is sold, investors generally have 45 days to identify the replacement property and 180 days to complete a trade. Biden's policy proposal, dubbed The Biden Plan for Mobilizing American Talent and Heart to Create a 21st Century Caregiving and Education Workforce, could remove 1031 like-kind exchanges for top-earning property investors. Joe Biden recentlyannouncedhe would seek the end of 1031 "like-kind" exchanges for investors whose annual income exceeds$400,000. While efforts to end 1031 exchanges have been made before, real estate investors get nervous every time the issue surfaces. As stated by the Biden effort, "The program will probably cost $775 billion over ten decades and will be paid for by rolling unproductive and unequal tax breaks for property investors who have incomes around $400,000 and taking measures to improve tax compliance for high-income earners." Though 1031 exchanges aren't cited by name in the program, Bloomberg declared, citing a senior Biden effort official, that"a Biden government would aim for so-and-so exchanges, allowing investors to defer paying taxes to the sale of a property when capital gains are reinvested in a different property. The official said they'd prevent investors from utilizing real-estate losses to reduce their income tax statements." The Tax and Fiscal consequences of Section 1031 Like-Kind Exchanges at Real Estate could be significant. A recent study sponsored by a coalition of advocacy groups headed by the Real Estate Research Consortium, including ADISA and the IPA, concludes that removing 1031 exchanges would interrupt many community land markets and damage both renters and owners tiny investors. The analysis, which was run by David Ling Ph.D., a professor at the University of Florida, and Milena Petrova Ph.D., an associate professor at Syracuse University, asserts that removing 1031 exchanges would probably result in a drop in commercial property prices in several markets. Also, even less reinvestment in residential and commercial property, a larger utilization of leverage to fund acquisitions, and a rise in investment holding periods that could lead to a drop in market liquidity along with a downturn in associated sectors. Included in the research, the authors examined CoStar data from about 816,000 real estate trades that happened in 880 core-based statistical regions on January 1, 2010, before June 30, 2020, using a median cost of $1.1 million and an entire trade volume of $3.4 billion. Based on Mountain Dell Consulting, the securitized 1031 (Delaware Statutory Trust (DST))market increased $1.05 billion and $410 million during the second and first quarters of 2020, respectively. WHY IS THIS SO IMPORTANT FOR FAMILY OFFICES According to the 2019 and 2020 Family Office Real Estate Investing Report, xxxx% of Family Offices had not taken advantage of the 1031 exchange.If there is a change in the 1031 tax code this could be significant for Family Offices, especially if there is a change in the capital gain laws. If the 1031 Exchange continues with no changes, and more and more Family Offices participate in these exchanges volume of 1031 exchanges can signficatly increase, providingan even greater impact on the real estate sector. So far as return on investment, even however, the election result does not matter as much as other variables --though the President can indeed play a part in how these variables unfold. "Instead of elections," that the Cushman & Wakefield report stated, "the property cycle, the market, rates of interest, COVID-19, economic events, and long-term expansion drivers (such as demographics and technological shift ) would be the areas to concentrate on in ascertaining the potential real estate investment opportunities.”
Publisher's Insight: Finally, we know who will be the next President! During that time, family offices were holding off making Opportunity Zone investments and selling assets looking for 1031 exchanges. With the new administration, there is a considerable possibility that President Biden will want to raise taxes, and more precisely, capital gains taxes. There are even conversations that he may try to roll back 1031 exchanges which could remove a 100 year tax benefit.
Commercial Real Estate Performs Well Under Both Parties
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Tax efficiency has been high on the list for family office real estate investors.However, very few family offices have not taken advantage of one of the most important tax strategies in real estate – the 1031 exchange.
Family Offices and 1031 Exchanges
By Andrew Ackerman - Dremit Ensenia Wealth, LLC.
Investment Strategies
Publisher's Insight: For years now, I have been a big supporter of property technology or "proptech." It is an area that will change and disrupt the industry, mainly because the industry is so fragmented and because it is one of the sectors that typically lag other sectors due to the nature of the business. This article is insightful and helpful in identifying some of these opportunities, primarily because this is the future of real estate.
How Family Offices & Real Estate Firms can Source Great Proptech Opportunities
PropTech
any family offices that invest in real estate property startups (Proptech) are real estate operators with reasons for investing from strategic insights to benefit their assets. For the family office that is heavily invested in real estate, the case for investing in proptech startups or Venture Capital funds is doubly strong. But it is much easier said than done. This scenario is quite typical: A family office with real estate roots decides to find great startups to invest in or partner with. Someone, usually from the younger generation of the family, with a fair amount of real estate knowledge, but virtually no startup experience is tapped to lead the charge. Once the word gets out of the interest n investing in proptech companies, they are bombarded with startup and fund pitches, not to mention a host of “investment advisors. Many of these investments are not even proptech, but enough are that he or she spends tons of time wading through pitch decks. A few of these startups look pretty good, so the family office decides to invest and/or set up pilot projects with the operating company. These fail miserably. The family office decides that engaging with startups is a waste of time. There is, however, a better way to go about this. HOW TO IDENTIFY GREAT STARTUPS TO PARTNER WITH AND/OR INVEST IN As the Cheshire Cat told Alice, “If you don't know where you are going, any road can take you there.” If the goal is to partner with a proptech startup to get a leg up competitively or even if the operating company vets the startup’s solution, you need to be looking at startups at the right level of maturity. This means looking for startups raising Seed ($1M-$2M) or, to be safer, Series A ($4M- $8M+) rounds.** Earlier stage startups are still cocktail napkins and science projects; the later stage isn't cutting edge. The founders are also less experienced, and the product is still a bit raw, so while it’s tempting to want to get in earlier (and you can write smaller checks and always be a player), you probably want to start with the slightly more mature guys. This filter, by itself, will weed out many startups and save tons of time. ** Important note: you would not be investing this amount in the startups. The lead investor will generally fund half or more of the total investment round. A family office participating in the round would likely invest 10-25% of the whole round.An investment of this size would equal roughly $100K-$500K+, depending on the round's size. MAKE SURE YOU PICK THE RIGHT PARTNER In-depth domain knowledge isn’t enough. You wouldn’t let someone with no development experience pick real estate assets to invest in, so why would you let someone with no startup investment experience pick startups? You need to pair up the industry experience with the VC skills. Fortunately, it’s possible to find people with 5+ years of venture experience and at least some proptech investment experience. It is those investors who will ultimately want to raise their venture funds.If approached with this kind of opportunity, they will look to invest in 10-20 startups over the next year or two with the expectation that, if all goes well, you would jointly look to bring in outside money to turn this into a formal VC fund. To give you a sense of what this translates into financially, assume that you are focusing on (relatively) more mature startups raising Series A rounds (avg $5M) where you are committing to 10% of the round (avg $500K check size), so for 10-20 investments, this comes to a $5M-$10M commitment. As an alternative, some family offices invest in a proptech VC fund to get early access to a range of portfolio companies. Depending on the size of the fund.It will generally want a $1M-$5M investment (technically, a “commitment”) to be called over 4-6 years. With a smaller investment, an investor would not necessarily have access to as many proptech startups.The exception would be if an investment were made into multiple funds.) A downside would be you would most likely not receive the same insights into the rapidly evolving real estate world you would otherwise get from investing directly. Often you need someone with more than just a proptech VC experience. Many investors with real estate operating companies use the business line to help assess how well a startup’s product or service fits the market; in some cases, their entire purpose of investing in proptech startups is to find innovation for their own real estate business. If piloting with the parent company is vital to your strategy, then having your business units work with the startup for some time (viz., a "pilot" or trial project) is critical. It would help if you had someone who can work internal politics. You can’t pilot with startups if you don’t know who in the line is genuinely interested in innovation instead of just paying lip service to it: you need someone who can work internal politics. This is not part of the typical VC experience, so you have to look at the candidates’ backgrounds for other indications. Prior experience at large companies (including consulting), business development work, a stint at an accelerator, etc. are all some clues that a candidate might have the right political antenna. THE TRUTH ABOUT INVESTMENT ADVISORS Having third parties bring you deals in exchange for a commission is entirely normal in the real estate world. This could translate into a kiss of death in the venture world;the best startups are never represented by an investment advisor. VCs are the most networked people on the face of the earth. VC professionals present at panels or judge pitch events all the time. They meet dozens of entrepreneurs every week and know – and have often co-invested with – virtually every other VC in the same space. If a founder can’t network into a warm introduction to a VC, how will he find customers? Plus, the very fact that the founder thinks he can wave his hand and have someone else take on something this crucial to his business for him is a huge red flag. Those startups are invariably hairy, old, over-shopped deals that every halfway serious investor has already turned down. BEING SURE NOT TO GO TOO DEEP INTO TOO MANY STARTUPS When you get a startup’s pitch deck, the temptation is to read it all, think about the business as a whole, and come to a holistic, well-reasoned thesis. That kind of deep-dive takes much time, and there are many startups to review. The startup needs to earn that much of your time. Your first pass review should be much quicker, just a few minutes, to filter out startups that can’t cut. It takes time, domain expertise, and much deal flow to build the kind of pattern recognition that lets you immediately filter out the proptech startups that are too early or too fatally flawed to be worth the extra time. MAKING SURE TO SET UP ANY PILOTS SUCCESSFULLY There’s a saying in business: You get what you measure. Do you measure the number of startup pilots a division undertakes? Is this a factor in whether a manager gets promoted? If you do track pilots,howdo you track them? One of the more subtle mistakes companies makes a focus on success. In most cases, a failed project is a black mark that can cost a manager their bonus and promotions. If a project isn’t performing, the manager will often throw more resources at it until they can claim some victory, delaying resolution, and wasting time and money. Instead, the focus needs to be onlearning quickly.Pilots should explicitly be for 3-6 months, and the questions should telegraph that even negative results are a win, as long as they get there quickly, and the results are actionable. To make this a bit more concrete, here are a few examples: portal, and the software seamlessly coordinates access for the dog walkers, fitness pros, cleaners, etc. with the front desk. Plus, the founders are a pleasure to work with.” (Stop the pilot and roll out more broadly.) SUMMARY For the family office with significant real estate assets, investing in proptech startups is not just a financial opportunity; it is also a strategic opportunity in many cases. But it is much easier said than done, and how you do it and whom you pick to do it for you to make a huge difference.
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Public Reit's
WHAT IS PROPTECH? While there are many ways to define PropTech, the most common and straight forward definition is "a collective term used to define startups offering technologically innovative products or new business models for real estate markets"
RIGHT QUESTIONS TO ASK: "Its been three months; what have we learned so far? What actions should we take?" "Have we learned enough, or do we need another three months?" What specifically would we learn if we extended?" What would teach us more and generate more actionalble results: extending this pilot or moving on to the next one. RIGHT ANSWERS TO HEAR "We've tried syndicating XYZ deal on a real estate blockchain exchange but didn't get any qualified investors" (Closes this pilot and try something new.) "We provided that we could charge an $$$ per month premium for smart apartments, but the product itself was buggy" (is it fixable, or should we ditch this startup and pilot with a competitor?) Our tenants love the amenity
Property Types
By DJ Van Keuren - Evergreen Property Partners
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Workforce Housing
Publisher's Insight: This time around Family Offices are waiting for opportunities to invest, and many have already started buying hospitality assets. Multifamily is still the property type of choice for family offices, however although fundamentals are remaining the same and will be once we come out of the pandemic, family offices still need to be careful when it comes to buying new workforce housing assets.
o with the pandemic, where are family offices investing in real estate? Pre-COVID, according to the 2020 Family Office Real Estate Study, going into the year, Families had a focus on investing in multifamily (75%) followed by Industrial (53.6%) and then office (32%) and retail (25%) With family offices finally starting to reinvest into real estate, the central area of focus has been industrial, followed by distressed hospitality. However, multifamily still seems to be the property type of choice, even during this pandemic. If family offices continue to want to stay the course, what do family offices need to know if they will continue to invest in multifamily properties? FAMILY OFFICE INVESTORS NEED TO UNDERSTAND: WORKFORCE HOUSING'S OCCUPANCY HAS BEEN ARTIFICIALLY INFLATED! Why? Because of the government's stimulus,which will be happening again very soon. Workforce housing is commonly targeted at "essential workers" in a community like police officers, firemen, teachers, nurses, and medical personnel, but it also includes small business owners and those that work in the retail sector, both areas that has been hit the hardest by the pandemic and many of these jobs may never return. Among the companies that have either closed locations or filed for bankruptcy include Neiman Marcus, New York & Co., The Paper Store,Pier 1, Stein Mart, Tailored Brands (Men's Wearhouse, Jos. A. Bank, Moores Clothing for Men, and K&G), Tuesday Morning, Victoria's Secret, 24 Hour Fitness, A.C. Moore, American Eagle Outfitters, Ascena Retail Group (Ann Taylor, Loft, Lane Bryant, Lou & Grey), AT&T, Bath & Body Works, Bed, Bath & Beyond, Bose, Brooks Brothers, Century 21, The Children's Place, Christopher & Banks, Estée Lauder, GameStop, Gap, GNC, H&M, Heritage Brands Outlet Stores, Hertz, J.Crew, JCPenney, Lord & Taylor, Lucky Brand Dungarees, Lucky's Market, Macy's, Microsoft Store, Modell's Sporting Goods. Having a roof over your family's head is the most critical area to put any cash you may have for you and your family. That means that when stimulus money comes in, a priority is to use it to pay rent. The stimulus money that has caused occupancy and rent payments to remain intact will not last. I believe that over the next 3 to 6 months, there will be opportunities to purchase workforce properties at a discount. In addition to stimulus payments, the other variables that family office investors need to consider would be the balance sheet of its operators, how states will work with renters and owners, and how lenders will work with its borrowers on these properties. Family offices need to understand that stimulus money has had a significant impact on workforce housing. Now is the time to sit on the sidelines for a while to see where multifamily housing opportunities may go. If the effect isn't as substantial as I imagine it to be, there will still be opportunities to still invest in many markets due to the fundamentals remaining the same when the pandemic starts to fade. Until the epidemic begins to stabilize, and people can go back to work that lives in these types of properties, it would be best to wait to invest into workforce housing.........at least for the time being.
Source: 2020 Family Office Real Estate Study
Figure 1:
he cycle monitor analyzes occupancy movements in five property types in 54 MSAs. Market cycle analysis should enhance investment-decision capabilities for investors and operators. The five property type cycle charts summarize almost 300 individual models that analyze occupancy levels and rental growth rates to provide the foundation for long-term investment success. Commercial real estate markets are cyclical due to the lagged relationship between demand and supply for physical space. The long-term occupancy average is different for each market and each property type. Long-term occupancy average is a key factor in determining rental growth rates — a key factor that affects commercial real estate income and thus returns. Rental growth rates can be characterized in different parts of the market cycle , as shown in Figure 2.
Figure 2:
2nd Quarter 2020
Mueller Real Estate Market Cycle Monitor
Mueller Real Estate Market Cycle Monitor Second Quarter 2020 Analysis
Market Cycles
The Physical Market Cycle Analysis of 5 Property Types in 54 Metropolitan Statistical Areas (MSAs) By Glenn Mueller - Professor in the Burns School of Real Estate & Construction Management at the University of Denver.
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Overview
The Physical Market Cycle Analysis of 4 Property Types in 54 Metropolitan Statistical Areas (MSAs). The fastest economic crash in history with a 33% GDP drop in the second quarter is being followed by the most unique recovery ever seen. COVID-19 has created a group of haves and have nots for both the economy and real estate property types. Jobs are the key. May June & July saw a monthly average US job growth of 3.1 million including 213,000 in construction, 230,000 in industrial, 237,000 in office, and 1.6 million in retail. Hospitality has fared the worst, as most business travel has not resumed, and leisure demand is focused on auto access destinations. Real Estates reactions and effects are discussed below. Office occupancy declined 0.1% in 2Q20, and rents grew 0.3% for the quarter and 1.4% annually. Industrial occupancy declined 0.2% in 2Q20, and rents grew 1.0% for the quarter and 4.0% annually. Apartment occupancy declined 0.2% in 2Q20, and rents declined 0.3% for the quarter, but were up 0.2% annually. Retail occupancy declined 0.1% in 2Q20, and rents grew 0.4% for the quarter and 1.7% annually.
The national office market occupancy level declined 0.1% in 2Q20 and was flat year-over-year. Net absorption was negative by over 10 million square feet for the quarter, even though over 700,000 office using jobs were regained in the last three months. Many offices have re-opened with split teams (one at home and one in office) to maintain social distancing. If distancing becomes the norm – twice as much office space may be needed for the same number of people. And while some firms are moving to more work at home plans, others are expanding at work space. Average national rents increased 0.3% in 2Q20 and produced a 1.4% rent increase year-over-year.
Note: The 11-largest office markets make up 50% of the total square footage of office space we monitor. Thus, the 11-largest office markets are in bold italic type to help distinguish how the weighted national average is affected. Markets that have moved since the previous quarter are now shown with a + or - symbol next to the market name and the number of positions the market has moved is also shown, i.e., +1, +2 or -1, -2. Markets do not always go through smooth forward-cycle movements and can regress or move backward in their cycle position when occupancy levels reverse their usual direction. This can happen when the marginal rate of change in demand increases (or declines) faster than originally estimated or if supply growth is stronger (or weaker) than originally estimated.
Office
Industrial
Note: The 12-largest Industrial markets make up 50% of the total square footage of office space we monitor. Thus, the 12-largest Industrial markets are in bold italic type to help distinguish how the weighted national average is affected. Markets that have moved since the previous quarter are now shown with a + or - symbol next to the market name and the number of positions the market has moved is also shown, i.e., +1, +2 or -1, -2. Markets do not always go through smooth forward-cycle movements and can regress or move backward in their cycle position when occupancy levels reverse their usual direction. This can happen when the marginal rate of change in demand increases (or declines) faster than originally estimated or if supply growth is stronger (or weaker) than originally estimated.
Industrial occupancies declined 0.2% in 2Q20 and were down 0.5% year-over-year. Slower retail sales caused absorption to decline by over 10% in each of the last two quarters. Seven more markets moved further down in occupancy in the hyper supply phase of the cycle. Even though long-term sales demand growth is expected, many retailers have hit the pause button on adding warehouse space to wait for a stronger and sustained sales recovery to emerge. Industrial national average rents increased 1.0% in 2Q20 and increased 4.0% year-over-year. Expect to see even better results in the next few quarters.
Apartment
The national apartment occupancy average declined 0.2% in 2Q20 and was down 1.3% year-over-year. Second quarter net absorption was only 40% of its level in 2Q 2019. The millennial trend of living downtown is shifting – many have decided to opt for more space in the suburbs, either in larger apartments or by purchasing a home. For those who can afford it, the home ownership options is attractive with the lowest interest rates in a century. The other major trend is that the major gateway markets like Boston and San Francisco are seeing an out-migration by those that can work at home. People are heading to lower cost second tier markets and resort communities. Any market that cannot offer a car friendly and reasonable cost auto commune is facing a challenge in this new social distancing world. Average national apartment rent growth declined -0.3% in 2Q20, and but was up 0.2% year-over-year.
Note: The 10-largest apartment markets make up 50% of the total square footage of multifamily space we monitor. Thus, the 10-largest apartment markets are in bold italic type to help distinguish how the weighted national average is affected. Markets that have moved since the previous quarter are now shown with a + or - symbol next to the market name and the number of positions the market has moved is also shown, i.e., +1, +2 or -1, -2. Markets do not always go through smooth forward-cycle movements and can regress or move backward in their cycle position when occupancy levels reverse their usual direction. This can happen when the marginal rate of change in demand increases (or declines) faster than originally estimated or if supply growth is stronger (or weaker) than originally estimated.
Hotel Occupancy dropped substantially in mid- March 2020, with many hotels closing all together. This drop would put all hotel markets at the bottom of their cycle point #1 on the cycle chart. Business and Convention Travel has not resumed in any major way and leisure travel has only returned in a major way to auto accessible locations. It may easily be a few years before the leisure industry returns to normal. Data is no longer available from the normal source – Hotel coverage is suspended until further notice thus Hotel coverage is suspended till further notice.
Note: The 14-largest hotel markets make up 50% of the total square footage of hotel space that we monitor. Thus, the 14- largest hotel markets are in bold italic type to help distinguish how the weighted national average is affected. Markets that have moved since the previous quarter are now shown with a + or - symbol next to the market name and the number of positions the market has moved is also shown, i.e., +1, +2 or -1, -2. Markets do not always go through smooth forward-cycle movements and can regress or move backward in their cycle position when occupancy levels reverse their usual direction. This can happen when the marginal rate of change in demand increases (or declines) faster than originally estimated or if supply growth is stronger (or weaker) than originally estimated.
Hotel
Note: The 14-largest retail markets make up 50% of the total square footage of retail space we monitor. Thus, the 14-largest retail markets are in bold italic type to help distinguish how the weighted national average is affected. Markets that have moved since the previous quarter are now shown with a + or - symbol next to the market name and the number of positions the market has moved is also shown, i.e., +1, +2 or -1, -2. Markets do not always go through smooth forward-cycle movements and can regress or move backward in their cycle position when occupancy levels reverse their usual direction. This can happen when the marginal rate of change in demand increases (or declines) faster than originally estimated or if supply growth is stronger (or weaker) than originally estimated.
Retail occupancies were down 0.2% in 2Q20 and were down 1.3% year-over-year. This seems like a small decline as it does not recognize temporary closures that may reopen. Department stores, apparel and home goods have been the hardest hit by COVID 19 and as bankruptcies and closures grow these statistics should come through in the occupancy numbers. Clothing sales were down almost 30% in 2Q20. The other categories hit less include healthcare and personal care product retailers which represent over 10% of retail sales. Malls, strip centers and outlet centers have been the most affected property types and pain may continue. Leases are being signed but at half the pace of a year ago. National average retail rents increased 0.4% for the quarter based upon newly signed leases and were up 1.7% year-over-year. The new metric being watched is rents collected and that is still under 50%in retail. There are many challenges ahead for retail.
Retail
Glenn R. Mueller – Professor - University of Denver - Burns School of Real Estate & Construction Management glenn.mueller@du.edu
Supply and demand interaction is important to understand. Starting in Recovery Phase I at the bottom of a cycle (see chart below), the marketplace is in a state of oversupply from either previous new construction or negative demand growth. At this bottom point, occupancy is at its trough. Typically, the market bottom occurs when the excess construction from the previous cycle stops. As the cycle bottom is passed, demand growth begins to slowly absorb the existing oversupply and supply growth is nonexistent or very low. As excess space is absorbed, vacancy rates fall, allowing rental rates in the market to stabilize and even begin to increase. As this recovery phase continues, positive expectations about the market allow landlords to increase rents at a slow pace (typically at or below inflation). Eventually, each local market reaches its long-term occupancy average, whereby rental growth is equal to inflation. expectations about the market allow landlords to increase rents at a slow pace (typically at or below inflation). Eventually, each local market reaches its long-term occupancy average, whereby rental growth is equal to inflation.
Recession Phase IV begins as the market moves past the long-term occupancy average with high supply growth and low or negative demand growth. The extent of the market down-cycle will be determined by the difference (excess) between the market supply growth and demand growth. Massive oversupply, coupled with negative demand growth (that started when the market passed through long-term occupancy average in 1984), sent most U.S. office markets into the largest down-cycle ever experienced. During Phase IV, landlords realize that they will quickly lose market share if their rental rates are not competitive. As a result, they then lower rents to capture tenants, even if only to cover their buildings’ fixed expenses. Market liquidity is also low or nonexistent in this phase, as the bid–ask spread in property prices is too wide. The cycle eventually reaches bottom as new construction and completions cease, or as demand growth turns up and begins to grow at rates higher than that of new supply added to the marketplace
In Expansion Phase II, demand growth continues at increasing levels, creating a need for additional space. As vacancy rates fall below the long-term occupancy average, signaling that supply is tightening in the marketplace, rents begin to rise rapidly until they reach a costfeasible level that allows new construction to commence. In this period of tight supply, rapid rental growth can be experienced, which some observers call “rent spikes.” (Some developers may also begin speculative construction in anticipation of cost-feasible rents if they are able to obtain financing). Once cost-feasible rents are achieved in the marketplace, demand growth is still ahead of supply growth — a lag in providing new space due to the time to construct. Long expansionary periods are possible and many historical real estate cycles show that the overall up-cycle is a slow, long-term uphill climb. As long as demand growth rates are higher than supply growth rates, vacancy rates will continue to fall. The cycle peak point is where demand and supply are growing at the same rate or equilibrium. Before equilibrium, demand grows faster than supply; after equilibrium, supply grows faster than demand.
This research currently monitors five property types in 54 major markets. We gather data from numerous sources to evaluate and forecast market movements. The market cycle model we developed looks at the interaction of supply and demand to estimate future vacancy and rental rates. Our individual market models are combined to create a national average model for all U.S. markets. This model examines the current cycle locations for each property type and can be used for asset allocation and acquisition decisions.
Hypersupply Phase III of the real estate cycle commences after the peak / equilibrium point #11 — where demand growth equals supply growth. Most real estate participants do not recognize this peak / equilibrium’s passing, as occupancy rates are at their highest and well above long-term averages, a strong and tight market. During Phase III, supply growth is higher than demand growth (hypersupply), causing vacancy rates to rise back toward the long-term occupancy average. While there is no painful oversupply during this period, new supply completions compete for tenants in the marketplace. As more space is delivered to the market, rental growth slows. Eventually, market participants realize that the market has turned down and commitments to new construction should slow or stop. If new supply grows faster than demand once the long-term occupancy average is passed, the market falls into Phase IV
Market Cycle Analysis - Explanation
2020
Data
The Family Office Real Estate Study 2019/2020
2019
By the Numbers
The Type of Properties Family Offices Invest Into
Primary Investment Strategy for Family Offices
The Real Estate Property Types Family Offices Like to Invest Into
Contributors
Dr. Mueller has 43 years of real estate industry experience, including 36 years of research. Mueller is internationally known for his market cycle research on income producing real estate, his real estate securities analysis (REITs) research and his public and private market investment strategies and capital markets analysis. He is a Professor at University of Denver’s, F.L Burns School of Real Estate & Construction Management, teaching and doing research in real estate market cycles, development, feasibility, investments and real estate capital markets (REITs & CMBS). The academic program started in 1938 and offers undergraduate (BS) and graduate (MS & MBA) degrees in business RECM, as well as executive and distance learning programs. He has published 100+ research articles and 100 quarterly issues of his Real Estate Market Cycle Report. He is also the Real Estate Investment Strategist at Black Creek Group where he provides Real Estate Market Cycle Research and Investment Strategy for Black Creek’s Institutional Real Estate Investment Groups, Non-Traded and Public REIT groups. He holds a B.S.B.A. Finance major from the University of Denver, MBA from Babson College, and Ph.D. in Real Estate from Georgia State University. Former research positions at Legg Mason Inc., PriceWaterhouseCoopers, ABKB/ LaSalle Real Estate Investors, and Prudential Real Estate Investors. Visiting Professor - Harvard University - 2002 to present & summer executive education semesters. Advisory Board Member – Arden Real Estate Group – Institutional Opportunistic Real Estate Fund, 2014 to present Chairman - Board of Directors – European Investors Inc. – Global, International & US REIT Funds, 2014 to 2017 Email: gmuelle3@du.edu | https://daniels.du.edu/burns-school
COVID-19 I Andrew Ackerman - Dremit
Andrew is recovering consultant turned serial entrepreneur, startup mentor and angel investor. He is the Managing Director at Dreamit, currently in charge of the UrbanTech accelerator program. Andrew has also written for Fortune, Forbes, Propmodo, CREtech, Builders Online, Architect Magazine, Multifamily Executive, AlleyWatch, Edsurge, The 74 Million, et. al. Andrew has founded two companies and has a keen appreciation for how hard it is to build a successful startup, even under the best of circumstances. He speaks Hebrew fluently as well as some Spanish, French, Japanese and JavaScript. LinkedIn:http://www.linkedin.com/in/andrewbackerman Twitter@AndrewAckerman Blog:http://www.AsAngelsSeeIt.com Emaik: andrew@dreamit.com I www.dreamit.com
Fall 2020 Contributors
Market Cycles | Glenn R. Mueller, Ph.D.
Announcing the Partnership between The Burns School of Real Estate & Construction Management and The Family Office Real Estate Institute
CERTIFICATE PROGRAMS I EXECUTIVE EDUCATION PROGRAMS INDIVIDUAL REAL ESTATE PROGRAMS FOR FAMILIES PROGRAMS CREATED SPECIFICALLY FOR FAMILY OFFICES
COMING SOON!
The Family Office Real Estate Institute and the Burns School of Real Estate & Construction Management at the University of Denver will be jointly developing educational programs specifically designed for Family Offices.