Investors pile into real estate with hope of better returns

After a three- to six-month coronavirus-induced pause, investor interest in real estate is ramping up as a source of yield in a low-interest-rate world, which is expected to continue into 2021.

Industry insiders anticipate growing rents in niche sectors, including data centers, medical offices, cold storage and single-family homes for rent. Of the four main real estate sectors, industrial and multifamily are most prized, leaving hospitality and retail behind, industry experts say.

Overall, real estate executives project slightly higher returns for the asset class in 2021. According to the Pension Real Estate Association's fourth quarter Consensus Forecast Survey of U.S. commercial real estate market returns, respondents expect a NCREIF Property index total return of 2.8% in 2021 and 6.9% in 2022, compared with an estimated 0.1% in 2020. Respondents anticipate the NCREIF to produce a total return of 5.1% per year from 2020 through 2024.

"What we are hearing from people is that ... (they) are generally positive and optimistic" about 2021, said Peter T. Martenson, San Diego-based partner at Eaton Partners LLC. "(Real estate) fund managers are getting a COVID pass."

Investors understand that any disruption in real estate is from the COVID-19 impact because "they expect things to return to the mean in the short term," Mr. Martenson said.

"Investors are feeling good even though they have trepidation for lack of certainty in 2021," he said. "They took a three- to five-month hiatus in investing in 2020 and so have the firepower."

But there is a caveat, he said. "Everyone is walking forward knowing the world could change at any moment and they might have to revise" their investment plans, Mr. Martenson said.

Technology will be a big real estate theme in 2021, said Indraneel Karlekar, Pasadena, Calif.-based global head of research and strategy at Principal Real Estate Investors.

"Technology has never before been such a disruptor, innovator, and one of the structural drivers of long-term growth," Mr. Karlekar said.

The importance of technology has been accelerated by the pandemic, he said.

"We think technology will become a material influencer of where you want to put capital to work," Mr. Karlekar said.

Anita Lyse, Luxembourg-based global head of real estate group head of segments and Nordic desk leader at Alter Domus, an alternative investment administrator, agrees. "Data is said to be the new oil," Ms. Lyse said. "But the use of data is where the real value is. You can gather data all day long but the question is how to use it and what to use it for."

Most of Alter Domus' clients want to use data for investment management or portfolio management decisions, she said.

"Data analytics is something that is being used more and more to get a feel on how certain assets or a portfolio is performing," Ms. Lyse said. "The challenge is how to manage that data flow and update the data on a more frequent basis."

The biggest question for most real estate investors is "where to put the money to work" in 2021, Mr. Martenson said. Some investors prefer to invest in core, or core-plus real estate in cities and regions that were not dramatically affected by COVID-19 in 2020. Others are more opportunistic, investing in student housing and parking lots, sectors where there has been a clear, substantial impact by the pandemic. But these investors believe that when the world returns to normal, these areas will return to the mean, providing them opportunistic real estate returns.

Meanwhile, structural tailwinds like the accelerated shift to e-commerce are benefiting some real estate sectors such as industrial and boosting new ones such as cold storage, Mr. Karlekar said.

"Now the U.S. consumers have driven e-commerce grocery as high as it is in the U.K., which is one of the highest e-commerce grocery markets," Mr. Karlekar said.

Cold storage demand is expected to continue ramping up significantly over the next few months as people buy more groceries online, Mr. Karlekar said.

Data centers is another property type that has benefited from the pandemic as people have become more data dependent, he said.

Niche real estate sectors such as data centers and medical offices will grow to be more mainstream in 2021, Mr. Karlekar said.

Ms. Lyse agreed. "These assets will become perhaps not completely mainstream but less alternative than they used to be. The interest for life science and medical centers has clearly been spurred by the pandemic. People realize these things are important and there is now a huge interest," she said.

Eaton Partners' Mr. Martenson said a number of real estate managers have been buying and creating portfolios of car washes, especially in the Southwest U.S. where people have been moving during COVID-19. The managers see embedded value in these properties and expect to realize returns when the economy bounces back, he said.

At the same time, office — one of the main real estate sectors "is a pretty challenging space, if you look at value," Mr. Karlekar said. It's hard to value office properties because there have been so few transactions, he added.

Looking at real estate investment trusts as a harbinger of what might happen in the private real estate market, there have been some REITs with New York and San Francisco office properties that are trading at fairly discounted levels, he said.

In Principal Real Estate's view, 2021 will be a year of price discovery and portfolio rebalancing for the office sector, Mr. Karlekar said.

The pandemic has rekindled an argument around whether there is an exodus of people from the cities to the suburbs. Principal executives think the movement to the suburbs could be temporary and reverse should employers decide to pull their employees back to the office, he said.

"Gateway cities are having a moment of crisis, but they will always be resilient," he said. Even with Brexit, "I would be a fool to write off London and say London is finished," Mr. Karlekar said.

Managers with exposure to suburban properties say the tide is turning in their direction.

Mark Whiting, San Francisco-based CEO of real estate investment and development company Drawbridge Realty Management LLC, said as a result of the COVID-19 crisis, "the demand has moved in our direction to suburban locations" with ample parking around the buildings that are also accessible to public transportation.

Drawbridge is co-owned by alternative investment manager KKR & Co. Inc. and an investor group from real estate consultant The Townsend Group.

Drawbridge invests in offices generally leased to a single tenant, which tend to be in suburban markets, he said.

"We're still in early innings in the phenomenon" of people moving to the suburbs, Mr. Whiting said. "We began to see the shift pre-COVID" but the pandemic accelerated the move to the suburbs, he added.

Even so, "not all office is created equal," he said. "We're actively negotiating and leasing space in suburban locations where large companies can establish a larger footprint."

The firm is also buying properties. On Dec. 24, Drawbridge announced the purchase of a Class A office building on the southeastern edge of Research Triangle Park, N.C., for $89.7 million. The building is the headquarters of IQVIA Holdings Inc., a Fortune 500 company, which provides contract clinical research services to the biopharmaceutical and health sectors.

Whether it's attractive comes down to whether the tenant is able to pay rent and the "folks paying the rent today are the larger, higher-quality tenants," Mr. Whiting said.

Even so, in the short term there generally will be some downward rent pressure, he said. "There is a lot of healthy demand ... in the worst headwind in all my years of being an investor in the space," he said.

Tenants in industries such as technology, biotech and defense are doing well and are taking a longer-term view, Mr. Whiting said.

While real estate investment and fundraising was in a lull as a result of the pandemic, "since the summer, there's been enormous interest in real estate," said Nancy Lashine, New York-based founder and managing partner of Park Madison Partners LLC, a boutique real asset private equity placement firm.

"The need for yield is clear," she said.

"On the lending side, there is a huge amount of debt out there for real estate that is well-leased," although debt is hard to find for distressed sectors such as retail or senior housing, she said.

The most attractive debt is agency debt such as by Fannie Mae and Freddie Mac, which is available and cheap. Shadow credit markets including private debt funds for mezzanine debt and bridge loans, even for construction loans, are available as well for the well-leased industrial and multifamily properties, she said. And she expects this to continue throughout 2021.

The availability of debt is the reason prices have been maintained, even if rents are lower, she said. "If you buy at the same price and finance at a lower rate, you end up with higher cash flow," Ms. Lashine said.

One of the bigger changes, albeit gradual, and one which Ms. Lashine expects to continue is the desire by institutional investors to buy into a specific portfolio or asset such as in a co-investment or in a secondary market transaction, she said. Among other things, the money is invested quicker, she added.

"The days of investors writing a blank check for a blind pool are over," Ms. Lashine said.

Real estate flooded with capital and available cheap debt would appear to be a recipe for an increase in real estate managers taking real estate investment trusts private, but that did not occur in 2020, said John Worth, Washington-based executive vice president for research and investor outreach at Nareit.

"The lack of privatization activity in 2020 despite the COVID-19 crisis is the dog that didn't bark," Mr. Worth said. "Even in the most distressed sectors, well-capitalized REITs with access to equity and debt markets and seeing a brighter future post-COVID have not been willing to undervalue their properties and sell at fire sale prices."