Caisse Betting on Multi-Family Real Estate?

Arleen Jacobius of Pensions & Investments reports, Quebec pension fund invests in U.S. multifamily real estate:
Ivanhoe Cambridge — the real estate arm of the C$176 billion Caisse de Depot et Placement du Quebec — is snapping up multifamily real estate at a fast clip, and it's not done yet.

This month, Ivanhoe Cambridge bought into the $1.5 billion Equity Residential portfolio recently taken private by Goldman, Sachs & Co. and real estate manager Greystar Real Estate Partners.

Executives of Montreal-based Ivanhoe Cambridge believe the time is right to increase multifamily investments in the United States and the United Kingdom.

“Ivanhoe Cambridge believes in increasing its investment in the multiresidential segment in key markets and the U.S. is one in which we want to register growth this year,” said Sebastien Theberge, senior director, public affairs and communications at Ivanhoe Cambridge in an e-mail. “The economy is picking up and social-demographic trends are favorable, two key factors that will support the sector in the near future.”

The Equity Residential deal includes a portfolio of 27 high-quality multiresidential properties in high-performing submarkets in the U.S. Most properties in the portfolio were built in the 1990s and have strong existing cash flows. The partners will embark on a multiyear maintenance and renovation program for the properties. Mr. Theberge declined to provide terms of the transaction.

All together, Ivanhoe Cambridge has investments in 56 multiresidential properties located in major urban centers in Canada, the U.S. and the U.K.

“In the U.S., we are focusing on markets with strong, diversified employment bases, primarily New York, Boston, Washington, Los Angeles and San Francisco,” Mr. Theberge said in his e-mail. “In Europe, the focus is on Paris and London. Our London investments are through an alliance with Residential Land.”

In February 2012, Ivanhoe Cambridge — in partnership with Residential Land and Apollo Global Real Estate — bought four multiresidential buildings in prime central London. In December, Ivanhoe Cambridge acquired majority ownership interests in two multiresidential complexes in prime central London — one in South Kensington and the other in Belgravia.

Ivanhoe Cambridge's partnership gives it participation in any acquisition opportunity the partners come across that matches Ivanhoe Cambridge's investment criteria.
The Caisse has one of the best real estate teams among any institutional investor. If they're investing in this sector it's because they believe the economy and demographics are favorable going forward.

One thing that concerns me, however, is that some segments of the United States are very expensive. Bendix Anderson of National Real Estate Investor writes, Are Multifamily Prices Peaking in NYC?:
Sky-high prices for Manhattan apartment properties and rock-bottom low yields for investors may have reached the limit.

“The yield is down to the bare bones,” says Peter Schubert, managing director of capital markets for Transwestern. “I am calling the bottom.”

New York City’s clear strengths, including strong demand for rental apartments and a sharply limited supply of new apartments, are no longer enough to justify the prices paid by investors for top properties in top neighborhoods, according to Schubert, co-author of Transwestern’s “2013 Multifamily Housing Survey.”

Investors from all around the country are pouring money into New York City apartment properties. They are looking for an investment that yields more than Treasury bonds but that is still safe, even in our slow, uneven recovery. New York multifamily properties were resilient during the downturn, so they are attractive. “I’m talking to clients in Texas who say that their new mandate is to go and spend money in New York City,” says Schubert. “They have money burning a hole in their pocket.”
Low, low cap rates

Prices kept rising through the end of 2012. Average cap rates for apartment properties in Manhattan, which express their net operating income as a shrinking percentage of rising prices, fell to 3.9 percent in the fourth quarter. That’s more than a full percentage point below the year before, according to data firm Real Capital Analytics. “There is no cap rate compression left,” says Schubert.

Meanwhile, the average price per unit at apartment properties was well above $500,000, according to Real Capital Analytics. That’s high even for Manhattan.
Rent risk

Properties sold at low cap rates may have a difficult time growing their net operating incomes enough to justify their high prices. Expenses such as property taxes and utilities have been growing at three times the rate of inflation in the City.

Rent growth is also slowing. “We could endure a year or two of flat rent growth,” Schubert warns. Other market analysts see rent growth slowing already. Effective rent growth was just 0.1 percent over the first quarter of this year and actually shrank 0.2 percent in the fourth quarter of last year, according to Reis Inc. That’s in spite of a vacancy rate among institutional investment-quality apartments of just 1.9 percent in the first quarter. Usually, low vacancies mean higher rents. But rents still need to fit what residents can pay. “We may be seeing that rents are hitting the upper bound of what people can charge,” says Brad Doremus, vice president of research and economics for Reis.

Many investors are assuming rent growth will be much higher at the properties they buy in Manhattan. Even relatively conservative underwriting often assumes annual rent growth of 3 percent, Schubert says.
Big city risk

New York City real estate also carries unique risks. Nearly one-third of the City’s housing stock is restricted by rent stabilization laws. During the boom, investors bought dozens of rent-stabilized properties with plans to quickly raise the rents. Nearly all of these plans failed. Stuyvesant Town in Manhattan was just one high-profile property seized by lenders. Even if a buyer fully understands the local rent laws, those laws could always change. “It’s an evolving set of rules,” says Schubert.

For all these reasons, Schubert is urging his clients to look further afield from the core neighborhoods of Manhattan and risky “value-added” acquisitions of rent stabilized properties. Investors could look to other neighborhoods of New York City where values still have room to increase. “The best way to add value is to be ahead of the curve,” he says. “There will be more appreciation in these frontier neighborhoods.”
Some real estate investors who were burned badly during the downturn are now focusing elsewhere. The NYT reports of one investor who instead of buying prominent buildings in places like New York and Boston, is now buying residential complexes in secondary and tertiary markets like Greenville, S.C. and Maryville, Tenn.

But large institutions typically focus on primary markets, not tertiary markets. And while multi-family may be the place to invest, other sectors are much more vulnerable to structural changes taking place in our economy.

Dave Maney wrote an insightful comment on commercial real estate's fearsome future:
I wouldn't want to own most kinds of commercial real estate at today's valuations. Given the causes and direction of the radical restructuring that continues to grind through our economy, there's almost nowhere for demand for office and retail space to go but down.

Why? Because we don't have the same need to be near to each other to get things accomplished anymore.

Since the Industrial Revolution took hold 200-plus years ago, to make a product or perform a complex service, we had to gather in factories and office buildings. The need to be close to fellow workers was so critical and so vital that we literally started stacking them on top of each other in big cities, building skyscrapers that allowed thousands of employees to work together under the same very tall roof.

And in the world of retailing, we bought selections we made from what was on display on the shelves of a department store or big-box retailer.

But the Internet has begun to change the rules of proximity in significant ways. While many of us still gather in offices (fewer and fewer all the time in factories), the very nature of what it's like to work in those offices is different. Stop and think: Fifteen years ago, a typical office was an active, noisy place, with people walking purposefully about to converse with a co-worker, phones ringing with inquiries and orders, and lobbies full of visitors coming and going.

Now think about your most recent day in the office (or your attorney's or banker's office). What did you hear? Chances are ... nothing. Collaboration now happens largely in the digital world. Files are shared.

Multiple co-workers interact and move projects forward in virtual space. The phones are quiet because a company's information is online, so live inquiries are rarer. Orders get placed and paid for through the cloud.

The idea of "Putting a face to a name" used to be a huge reason for business travel. Now putting a face to a name involves pointing your browser to LinkedIn.

In short, the search box is becoming the human race's most fundamental organizing principle. We can find exactly what we want when we want it.

And unless we're trying to get served a stack of pancakes, we generally don't care where it's currently located. When collaboration is called for, we can find the very best collaborators on the planet offering us the lowest price for the services we need, and we can see them and talk with them and monitor their progress real-time all without ever once coming anywhere physically near them.

So here's your problem if you're a company owner or executive: You have lots of ways of getting things done. You can outsource, crowdsource, offshore, subcontract, use freelancing platforms — or you can hire employees and put them in your space.

But that will likely be both the most expensive and inflexible choice that your company can make.

Creating a physical space for a person to work in costs a lot of money — you can guesstimate $5,000 to $7,000 a year for a standard-sized manager's office in Class A space in downtown Denver. Because of the way most commercial real estate leases are structured, if you want office space, you're going to commit to paying for it for a very long time. You're locked in.

Now consider that we live in the most unpredictable and volatile economic climate we've seen in generations. Put yourself in the business owner's shoes: Do you want to stay lean and fast, or would you like to predict what you'll be needing and wanting four years from now?

Thinkers and investors much smarter than I (like Jeff Jordan from Silicon Valley's elite venture-capital firm Andreesen Horowitz) have written extensively about the coming destruction of the big-box retail and shopping mall business models courtesy of nimbly aggressive online retailers. Not just behemoths like, either.

Jordan cites specialty retailers that sell everything from tailored clothing to eyeglasses online and doesn't see a single skilled entrepreneur choosing to create a new retail brand exclusively in physical locations. He points out that the inherent financial leverage in real estate-based retailing models is devastating when sales and margins turn south, which is exactly what's happening to huge retailers such as Best Buy and J.C. Penney.

It's ultimately the same forces - search vs. proximity. Do I want what's handy, or do I want exactly what I want for the fewest dollars I can spend?

Am I right?

You don't have to take this argument to its extremes — that everyone will work out of their house or that all retailing will be done online — to know that the bloom is way off the rose in the commercial real estate world. Less demand means soft or weakening lease rates and increasingly squishy terms for tenants. Vacant retail space hurts remaining tenants and again puts downward pressure on both rates and terms.

No one said commercial real estate is going away. But I bet you can't create a long-term scenario where demand outstrips supply and investors win big.
As investors grapple with where to put their money to work in various geographies and real estate sectors, it's important to understand the risks in each market. The biggest risk of all for commercial real estate (and other asset classes) is a prolonged period of debt deflation.

Below, the world's best real estate investor, Tom Barrack of Colony Capital, discusses foreclosed housing and investment opportunities on CNBC. Listen carefully to his comments, very interesting.