CRE Analyst

Here are the trends and events that we think will define commercial real estate in 2024.

This week's megadeal started ten years ago... Two days ago, Blackstone and Equity Residential announced another big apartment sale: "Equity Residential to Acquire $1 Billion Apartment Portfolio from Blackstone Real Estate" ---- Quick highlights ---- -- $964 million for 3,572 units, 11 properties in Atlanta, Denver, and DFW. -- EQR wants to grow its sunbelt footprint. -- Buying below replacement cost was a key driver. -- The properties were sold from three different Blackstone vehicles: (i) BREIT, the non-listed REIT for retail investors with redemption queues, (ii) BPP, the core+ vehicle for institutional investors with redemption queues, and (iii) BREP, one of Blackstone's flagship closed-end opportunistic funds. -- Blackstone is selling but still likes apartments, stressing that this was a win for everyone involved. ---- Beneath the headlines ---- This week's deal deservedly got a lot of attention. Perhaps because, despite many pundits calling for 6% cap rates and doom loops, it's the third $1B+ apartment deal to be announced over the last four months. However, we think the most interesting story behind this deal started nearly ten years ago when EQR sold $6 billion of apartments to focus on "gateway" markets. The biggest move was announced in October 2015 when EQR sold a $5+ billion portfolio to Starwood. EQR's then-CEO said it was an extremely opportune time for the REIT to monetize investments in this portfolio: "Not only have we demonstrated the enormous value created for our shareholders through the realization of an unlevered internal rate of return of 11.1%, but we have also narrowed our focus, which will now be entirely directed towards our core, high-density urban markets that will fulfill our strategic vision and drive EQR performance for many years to come." CoStar reported that EQR's selloff wouldn't slow as it intended to sell another 5K units at a weighted average cap rate of 6% to 6.25%, as EQR excited South Flordia, Denver, and New England. ---- Postmortem Questions ---- Was EQR's exit from these markets ten years ago a mistake? "Yes, it was a mistake." EQR missed out on meaningful income and appreciation over the last ten years and doubled down on the markets that were hit the hardest during Covid. "No, it was a good deal for EQR." EQR executed its business plan, achieved double-digit unleveraged returns, and returned substantial capital to shareholders. Our take... As in most things related to CRE, both deals (this week's $1B sale from Blackstone's vehicles to EQR and EQR's $6B of sales to similar funds 10 years ago) follow the capital. We'll dive into our rationale for these transactions over the next week. Kudos to Eastdil Secured, RBC Capital Markets, Santander, and Sumitomo Mitsui Banking Corporation – SMBC Group for pulling the deal together in a challenging environment.

"I want to be a developer." We hear this all the time, but fewer than 1% end up in development because... 1. You often need related experience to break in. 2. Openings on experienced teams are rare. 3. Landing a role is extremely competitive. 4. Analyst/associate comp is usually lower than other paths. ...which is why we're flagging this opportunity. This feels like a needle-in-a-haystack opportunity for the right person who wants to level up on the development career path. Why we like this role: 1. Strong macro tailwinds (tenants need IOS, capital wants it) 2. Experienced team 3. Very competitive compensation package Located in Austin, Texas. Apply here: https://lnkd.in/gK9wRb2N

Rewind 36 months: Would you have invested in this fund? ---- Fund overview ---- Sponsored by TPG, one of the largest PE firms with decades of experience managing real estate investments. The third core plus fund in a series. Focused on life science and industrial property types. ---- Historical return profile ---- The prior two funds generated 20%+ returns and 1.2-1.6x multiples. ---- Special incentives ---- You'd get discounted fees and a board seat for being a 10% investor. You could also convert your interests into an open-end structure at some point in the future. ---- Your takeaways? ---- What do you think this fund's returns have been to date? We'll share updated return information in the comments. Background on this document: Hamilton Lane advised the State of New Jersey on this potential investment. This document is the summary of Hamilton Lane's recommendation.

Is Wall Street coming for core funds? A few dozen core funds have dominated income-oriented capital for decades. Their business model in a nutshell... -- Focus on allocations over property-specific execution -- Generate 6-9% returns, primarily through stable income -- Avoid leverage and volatility -- Don't blow up -- Low margin fees on a large base of sticky capital -- Print money after $10B in AUM since most costs are fixed ---- A bug or a feature? ---- Liquidation value is the biggest challenge with these funds, as with any perpetual fund of private assets. Since you can't sell an entire portfolio to determine market pricing, what do you pay an investor who wants out? Next best alternative to third-party sale values: Appraised values. Problem with appraised values: They lag. Problem with appraised values in a falling market: Fund investors are incentivized to redeem before values catch up to reality. Problem for fund managers in a falling market: Redemptions mount, requiring sales or borrowings, which aren't in the best interest of remaining investors. Redemption queues aren't new, but there may be an existential threat hiding beneath the surface for core funds. ---- A new model? ---- The average ODCE fund is about 30 years old. Funds have come in gone over the last 30 years, but they all play by NCREIF's rules. Income-oriented, low leverage, etc. But over the last ten years, an ODCE alternative has emerged as a potential home for income-oriented institutional real estate capital: Private equity-sponsored evergreen funds. ---- A common refrain ---- Blackstone, KKR, Apollo, Carlyle, and Ares have all hosted earnings calls over the last few weeks, and TPG and Brookfield will announce shortly. They represent $4+ trillion in AUM and nearly $900 billion of real estate AUM. Every earnings call: 'We are building a stockpile of perpetual capital.' These private equity firms control about $1.6 trillion of perpetual capital, which is up by $230 billion over the last year (13%). In other words, PE funds added 110% of the entire ODCE index to their perpetual capital stockpile over the last 12 months. They also have about $600B in dry powder compared to ODCE's $30B redemption queue. Admittedly, this is an apples-to-oranges comparison since the PE firms' perpetual capital covers all alternative asset classes, not just real estate. However, the scale of this comparison could foreshadow meaningful changes for the core real estate space. ---- Key questions ---- 1. Are PE-sponsored, income-oriented vehicles competing with core funds for institutional capital? 2. Will these PE firms' open-end vehicles outperform? Blackstone's BPP has about a 6% historical return. 3. Is any capital truly "perpetual" or sticky?

Sorry, low rates can be bad for real estate... Just about everyone reacted negatively to Friday's job report. ...except for some high-profile real estate pundits, who are very excited about sub-4% interest rates. On one hand, it's hard to blame them. After staring down a 5% 10-year Treasury less than a year ago, a 3.75% Treasury seems golden. ...because higher rates made loan payments much more expensive. ...because higher rates have crushed real estate values. ...because higher rates have pushed lenders to the sidelines. But these sub-4 rates may be fool's gold. Mark Zandi, Chief Economist at Moody's: "The clear message in today’s soft jobs report is the Federal Reserve needs to cut interest rates. They should have begun cutting rates months ago. Job growth is decidedly throttling back, unemployment is rising quickly, hours worked per week are low and falling, and temporary help jobs continue to evaporate." Campbell Harvey, founder of the yield curve recession signal: "My yield curve indicator has been inverted for 20 months. It is 8 of 8 with no false signals since the 1960s. The maximum historic lead time has been 23 months (before the great recession). Ignore it at your own risk." Claudia Sahm, founder of the Sahm Rule: "The Sahm rule is currently sending the right cautionary message about the labor market cooling, but the volume is too loud. The swing from labor shortages caused by the pandemic to a burst in immigration is magnifying the increase in the unemployment rate. At the same time, the demand for workers is softening. A recession is not imminent, but the risks of a recession have risen." Our take... The job market is slowing, pushing the national economy closer to contraction, and a contraction would be bad for real estate performance. Recessions lead to less capital, wider spreads, falling NOIs, lower values, and more credit challenges. We all may be addicted to low rates since the Government spent much of the last 15 years manufacturing rates, which put significant upward pressure on real estate values. Those were the days, but those days are done. And, unfortunately, there's another driver of falling rates: fear. ...which isn't good for a risky, leveraged asset class like real estate.

We’re wrapping up a summer fellowship with college and graduate students from all over the country, and their capstone project is to research and write about the largest CRE investment managers. This fellowship had a 5% acceptance rate and received hundreds of applications. These kids are incredible. Very impressive personally, academically, professionally. All have very bright futures. However, we think writing skills (even among the best and brightest young real estate professionals) are lacking. …good enough to get an A on an MBA paper but not good enough to send to a CEO or key client. We think it’s important to end the project with a writing sample they can be proud of and can share with potential employers. But good writing takes a lot of work and requires brutally candid feedback. Are we overvaluing writing skills?

Sometimes boring is sexy. This pitch deck --> largest REIT IPO (ever) & largest IPO of 2024 Never heard of Lineage? You're not alone. ---- Early July 2024 ---- About a month ago... Bill Ackman, the billionaire hedge fund manager with 1.3 million Twitter followers, announced he wanted to raise $25 billion by IPO'ing a hedge fund-like equity vehicle. Earlier this week, he dropped the expected raise to $2 billion. Also about a month ago... Two ex-investment bankers and a logistics management team launched the roadshow for their cold storage company's IPO. They were targeting the largest REIT IPO of all time and would use proceeds to pay down debt. Fast forward a few weeks... Ackman pulled his hedge fund-ish IPO a few days ago, while those boring cold storage guys leap-frogged the next largest cold storage operator, re-capitalized their $25 billion portfolio at a sub-6% cap rate, and raised nearly $1.5 billion more than expected. Again, sometimes boring is sexy. ---- About Lineage ---- -- Owns temp-controlled warehouses all over the world -- Seed portfolio: 84 million square feet, 3 billion cubic feet -- 13K+ customers -- Started in 2007 with one Seattle warehouse -- Largest client relationships in 7 countries ---- Investor interest ---- -- $3.6 billion targeted raise -- $5.0 billion actual raise ---- Valuation ---- -- $30 billion enterprise value -- Positioned to grow NOI by 5% to 10% per year -- 5.5% to 6.0% cap rate -- Continues to pay down heavy debt load -- May try to tap REIT bond market later in 2024 ---- Leadership ---- -- Co-exec chairmen founded the sponsor in 2008 -- Previously Morgan Stanley i-bankers -- CEO has led LINE since 2015 -- Deep logistics experience -- Insiders control 70-80% of total shares -- Locked up for six months You buying? Ps -- As always, we don't offer investment advice.

Now we know: KKR acquired a $2B multifamily portfolio last month at a "low 4%" cap rate. When deals like this are announced we attempt to triangulate the buyer's perspective. How did they underwrite income? Capital source? Targeted returns? We post our analysis to share our perspective on market pricing/yields. These posts often spark great discussions between market participants, but they can be inherently frustrating because buyers rarely pull back the curtain on their assumptions. ...but KKR just did something that buyers rarely do. They publicly confirmed their underwriting assumptions on their big Quarterra acquisition. ---- Flashback ---- Here's what we said last month about KKR's acquisition of Quarterra: "Yesterday, KKR announced it has agreed to buy $2 billion of apartments from Lennar. Two months ago, Blackstone agreed to pay $10 billion for AIRC. We think these trades suggest a new watermark for higher-quality apartments between 5% and 5.5%." "Those who weren't loading up on class B and C apartments with excess floating rate debt are back in the game and aren't as distracted by interest near-term maturities, loan paydowns, and rate cap renewals." "The fix-and-flip hangover is just beginning, as are the opportunities for well-capitalized buyers." "...clarity and increased activity represent a meaningful step toward the industry's new normal." ---- KKR's commentary ---- KKR announced 2Q24 earnings yesterday. Real estate, infrastructure, and a growing RIA network stole the show. ...and KKR specifically commented on the Lennar/Quarterra acquisition, which it purchased in an insurance subsidiary. [Sidenote: Investment managers are increasingly leaning on insurance subsidiaries to bring in steady investible cash flow. More to come on this.] Key takeaways from KKR: -- Lack of core capital is creating strong acquisition opportunities. -- The pricing equated to a low 4% cap rate and an 8% unlev IRR. -- This was clearly a bet on growth. ---- Our perspective ---- The Blackstone/AIRC trade (April 2024) suggested that apartment cap rates are in the low/mid 5s. The KKR/Quarterra transaction suggests this range may be conservative. Here's why... 1. Falling supply pipelines = clear path to income growth 2. More constructive debt markets (more debt, falling spreads) 3. More constructive equity markets (REITs, ins co's, sovereigns) 4. Positive leverage can exist when interest rates > cap rates. ---- On the road to clarity ---- Kudos to JLL for making a market for this deal, despite the challenging environment. You can bet they (and their peer brokers) have been feeding multifamily owners with the "its-not-that-bad" perspective. Given the line of jaded borrowers looking to close out their Covid purchases, we wouldn't be surprised to see a meaningful pick up in deals coming to market. ...which means we'll likely have much more clarity (for better or worse) in the second half of 2024.

Takeaways from Ackman's road show and IPO filing... Background: Bill Acman's Pershing Square is launching a publicly traded, open-end fund designed to mimic (ish) the firm's hedge fund strategy. "Companies" (211 mentions): The fund will invest in large-cap, publicly traded companies in North America. "Pershing Square" (126 mentions): Managed by Pershing Square Capital Management, founded by Bill Ackman in 2003, with a 19% average return. "Leverage" (113 mentions): Plans to use leverage to boost returns but acknowledges the increased volatility and risk. "Fees" (107 mentions): 2.0% annual management fee, no performance fees. "Ackman" (86 mentions): Bill Ackman, the CEO and Chairman, has over 32 years in the hedge fund and asset management industry. "Conflict" (59 mentions): Pershing Square will continue to manage other funds with more favorable fee structures, which could create allocation conflicts. "Valuation" (41 mentions): Unlike other open-end funds with opaque quarterly or annual valuations, this fund will issue weekly NAVs based on public company values. "Favorable" (35 mentions): No management fees for the first 12 months. "Concentration" (16 mentions): Bets are concentrated in a few companies, which could lead to higher returns but come with more exposure to any single company's problems. Ps - Ackman originally targeted a $25 billion IPO but has since managed down expectations to $2 billion. Pps - What's more attractive: a billionaire hedge fund manager with 1.3 million Twitter followers OR a cold storage REIT? Hint: one is at the top of the 2024 IPO league tables; we'll post more on a big recent cold storage IPO later this week.