Real estate money managers are looking beyond the four food groups of retail, multifamily, office and industrial to provide investors with returns in a challenging investment environment.
The managers are nibbling on everything from parking lots to memory-care facilities. Investors are not only investing in these areas through specialized funds, but also are finding that slices of diversified real estate funds are being invested in these niche investments.
While institutional real estate allocations have been climbing steadily over the past four years, investors are increasingly nervous, said Doug Weill, managing partner of Hodes Weill & Associates, a New York firm that advises real estate managers.
“We are seven years into the (economic) cycle,'' Mr. Weill said. “There is geopolitical unrest, risk is rising around the world and investors worry about a possible increase in interest rates.”
Institutional investors' real estate allocations are expected to reach 10.3% in 2017, up from 9.9% this year and 9.5% in 2015, according to the annual real estate survey from Cornell University's Baker Program in Real Estate and Hodes Weill.
However, investors are taking a defensive approach, concentrating on debt and niche type investments they believe will weather an economic downturn, Mr. Weill said. “Non-main food group investments are gaining much more favor in the marketplace, albeit from a very small base,” Mr. Weill said.
While niche real estate investing is more developed in the U.S., there is interest among European investors as well, said Will Rowson, managing partner in the London office of Hodes Weill. “Niche real estate strategies are not as mature (in Europe) as in the U.S. and so there are fewer opportunities for investors to get into those,” Mr. Rowson said.
What's more, there is a shift toward investor focus on higher yielding strategies. Value-added strategies are more in favor today, followed by opportunistic investments, Mr. Weill said.
While core funds stick to the four main real estate property types, value-added and opportunistic funds can stray into niches, said David Stone Phelps, a partner in the Los Angeles office of law firm Akin Gump Strauss Hauer & Feld LLP who specializes in real estate transactions, primarily representing real estate managers, capital market clients and institutional investors.
“Opportunistic and value-added funds ... can have a broader focus and investment strategy including assets to be repositioned or `out-of-favor' or specialized real estate. In the end it's all about yield and returns,” Mr. Phelps said.
Out of diversifed funds
That interest in niche investments actually applies to general partners investing “out of diversified real estate funds, too, because specialized funds are usually selling higher returns in single-sector products, though with more risk,” Mr. Phelps said. “The bottom line for all is that investors want higher yields out of real estate because they aren't getting it in their equity or fixed-income portfolios, so they are taking on more risk by engaging in varied strategies.”
In September, real estate investment firm Stockdale Capital Partners LLC, along with London-based global property company Gros-v--en-or Group and San Diego-based parking operator Ace Parking Management Inc. formed a joint venture to invest in parking lots.
The partnership will target income-producing parking garages in urban, high-traffic submarkets and garages attached to hotels and office buildings that can be acquired and managed independently, said Daniel Michaels, managing director in Stockdale Capital's Los Angeles headquarters.
There is very little institutional capital investing in parking lots now and they require a certain level of sophistication to operate, Mr. Michaels said.
“In this day and age of lower yield and lower return, we thought it was a pretty interesting niche,” he said.
What's more, the number of parking lots is shrinking as urban lots are being developed into buildings, he said, adding that new buildings these days generally provide fewer parking lots than are needed.
This is Stockdale Capital's third joint venture in niche real estate this year. In February, the firm formed a $100 million joint venture with an unidentified investor to acquire medical offices in Los Angeles and a $75 million partnership with private equity firm Siguler Guff & Co. LP to acquire value-added properties across the Southwest.
Stockdale Capital, which started out as a family office, also invests in adult-only housing.
“This is where the value is at this point in the cycle. We stopped investing in hotels, retail, office and industrial. We think medical offices will outperform because of the aging population,” Mr. Michaels said.
Barings Real Estate Advisors, a unit of MassMutual Financial Group, also is investing in niche real estate such as parking lots and self-storage facilities. The firm entered into a joint venture with LAZ Parking in 2014 to invest in parking lots, said Scott D. Brown, global head of real estate in the Hartford, Conn. The joint venture so far has invested in lots in Seattle and Chicago. The investment provides income and a good overall total return, he said.
Veteran real estate investors are more likely to be open to investing in niche strategies. Institutions with real estate investment experience are looking to diversify their holdings, said Craig Blanchard, managing director of multiasset-class investment manager Makena Capital Management LLC, Menlo Park, Calif.
“An investor's first couple of real estate investments aren't going to be manufactured housing,” said Mr. Blanchard, who oversees Makena's real estate investments and portfolio construction. But niche investments such as manufactured housing can be attractive investments for experienced real estate investors, he said.
Niche sectors have three things in common, he said: fragmented ownership; a property type requiring specialized expertise; and lack of easily attainable information compared to more core investments.
Indeed, manufactured housing is a property sector that Makena favors, in part because it is not very capital-intensive. “You buy a big plot of land and rent it to the people who put homes on it and they pay you rent,” Mr. Blanchard said. “It's a sticky investment because for people to leave they have to pick up their homes and move them. They tend to be a durable cash flow stream.”
Another niche sector for Makena is workforce rent-controlled housing in New York City. “There's a fragmented ownership base and running workforce housing in New York City ... requires specialized expertise because you are working with several governmental authorities and tenant groups,” Mr. Blanchard said.
However, the durable cash flow stream tends to stay through economic cycles “as long as you have a really good operator,” Mr. Blanchard said.
Andrew Gibbs, senior analyst in the Philadelphia office of Aberdeen Asset Management, agreed that he is seeing many more niche opportunities. There is increased interest from investors as they search for yield, he said. Aberdeen is investing in niches including student housing, medical office and senior housing. “They have performed well during economic downturns,” Mr. Gibbs said.
Aberdeen executives do still have some trepidation about student housing.
“We certainly have some concerns about supply pipelines in student housing, particularly at smaller universities,” Mr. Gibbs said.
Aberdeen prefers to partner with universities to build on-campus student housing.
“It's attractive because there is very high barriers to entry and typically it's a public-private partnership in which you get some lease guarantee” with fixed rent increases.
This article originally appeared in the October 31, 2016 print issue as, "Managers park assets in new investments".