Fewer good real estate deals seen for otherwise OK new year

Real estate is expected to remain in favor with investors in 2013, but good deals and managers with attractive investment opportunities will be harder to come by, industry insiders say.

In 2012 there were two types of real estate: core properties mainly in coastal cities that everyone wanted — and everything else.

“Real estate is in favor because everybody is looking for yield and stability, and that is hard to find in the bond world,” said Nancy Lashine, managing partner and co-founder of New York-based placement agent firm Park Madison Partners. “We assume some of those values will start to converge,” meaning prices of higher-valued properties will fall while prices of more common properties will rise.

The reason is that some of the less desirable cities such as Dallas and Phoenix are growing, but that growth is not being reflected in property values of those cities, she said.

Austin Khan, chief investment officer of Los Angeles-based real estate investment manager Ethika Investments LLC, said he has seen prices in the most desirable cities surpass pre-crisis levels.

This is why in 2013, Mr. Khan said he expects value-added and opportunistic real estate to become more attractive, especially in places like Minneapolis and San Antonio, where there is strong employment growth and quality properties at lower prices.

Mr. Khan also said some investors are taking the opportunity to sell properties while values are high.

“We are seeing a lot of people finding opportunities to sell to the market. They sell because the recovery is solid and also because of foreign capital coming in that wants to acquire trophy assets at prices that are ever escalating,” he added.

A recent UBS Global Asset Management report contends that while the values of core real estate in gateway cities — New York and San Francisco, for example — are being pushed ever higher, the asset class should continue to perform well compared with fixed income. “Core real estate yields relative to government bond yields are above their long-term averages,” the report noted. “We expect core real estate investments will continue to perform strongly.”

However, buying so-called quality properties “is not necessarily cheap these days,” the report stated. The difference between real estate and bond returns as well as the income produced by real estate “should appeal to real estate investors starved of current income as well as the more traditional buy-and-hold real estate investor,” the UBS report said.

Ms. Lashine noted that real estate's popularity with investors is tied to interest rates on debt. “If we get QE (quantitative easing) to infinity, yeah,” investors will continue to invest in real estate, she said. Low interest rates make it tough for managers to pass up transactions because the low financing costs make up for higher prices, she added.

Managers should not expect deal terms to return to pre-financial crisis levels, and many real estate managers still might have to give concessions to investors, real estate industry professionals say.

Current and potential investors are pressuring managers to reduce management fees, according to a recent outlook report on private equity real estate by consulting firm Ernst & Young LLP, New York.

Managers will need to grow, leading to consolidation as larger firms acquire smaller, niche real estate managers, Ernst & Young projected.

Fundraising is expected to remain a challenge. “Institutional investors don't make a decision unless they have to and this environment is an ideal environment because there is so much uncertainty. There are a lot of good reasons to do nothing,” Ms. Lashine said.

Dave Gilbert, CIO at New York-based real estate investment manager Clarion Partners, said certain sectors such as defense already have slowed down because of economic and political uncertainties. Other factors not bound up in politics also will have an impact on real estate, he said.

“Notwithstanding steady demographic growth and the fact that homes are more affordable now than in decades, fewer young people are buying houses today, “ Mr. Gilbert said.

“Many of them have doubled up, are renting, or have moved home given the weak job market. Many also believe that buying a house is a poor investment, and could hinder their mobility in a job market that rewards mobility. Buying a house, therefore, can be low on their priority list.”

This has a huge impact on the real estate industry, Mr. Gilbert said.

“With every point drop of homeownership — already down from a high of 69% to its long-term historic average of roughly 65% — we believe will result in 1.2 million new renters,” he said. If the trend does continue, it will be a good time to invest in the multifamily sector.