Topic Tags: Real Estate

The State of Real Estate: Is the Run Over?

April 2015 Investment Perspectives

Core real estate investments have done well over the past several years, with the benchmark NFI-ODCE returning 12.5% in 2014, its fifth consecutive yearly gain since the real estate recovery began in 2010. Investors may be wondering if this run can continue, or if it is time to pull back on their allocations to real estate. In this newsletter, we address these questions by examining critical drivers of the real estate market, such as performance, valuation, leverage, debt profiles, income, and capital flows.

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2015 Market Preview

January 2015

Similar to previous years, we offer our annual market preview newsletter. Each year presents new challenges to our clients, and 2015 is no different: U.S. equities are at all-time highs, uncertainty reigns for international equities, and to everyone’s surprise, interest rates fell dramatically in 2014…but are poised to rise from historic lows over the next year. In the alternative space, real estate remains a solid contributor to portfolio returns, and private equity delivered on return expectations, though dry powder is on the rise. Hedge fund results were mixed, but have shown to add value in past rising interest rate environments. Further macroeconomic items that bear watching for their potential impact on capital markets include the precipitous fall in oil prices, the strengthening U.S. dollar, job growth, and international conflicts.

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Real Estate: The Income/Appreciation Story

Income and appreciation are the two main components of returns to any investment, including real estate. Core real estate returns, as measured by the NCREIF Property Index (NPI), have been driven by the appreciation component over the past several years…

Income and appreciation are the two main components of returns to any investment, including real estate. Core real estate returns, as measured by the NCREIF Property Index (NPI), have been driven by the appreciation component over the past several years, and this has naturally been accompanied by a compression in capitalization rates.

In this week’s Chart of the Week, we look at the income and appreciation components of core real estate returns and how they have contributed to total returns over the past twenty years. We can see that income has historically contributed approximately 60% to the total returns of core real estate.

The income component has been below this long-term average for most of the quarterly periods since real estate’s performance returned to positive territory in 2010, as appreciation and cap-rate compression have been the main stories since the rebound from the financial crisis. However, with the expectation for a rising-rate environment on the horizon and an end to cap rate compression looming near, we anticipate that income will start to represent a larger fraction of total returns over the medium term. This should provide comfort to investors with allocations to core real estate funds and even core-plus and value-add real estate funds that have meaningful exposure to healthy, stabilized, income-generating properties.

Drop in Shadow Inventory of U.S. Housing

In this week’s chart we examine the improving housing market and its outlook in terms of pricing stability as it relates to the number of homes in shadow inventory. To be brief, shadow inventory (courtesy of CoreLogic) represents the number of properties that are seriously delinquent, in foreclosure, and/or held by mortgage servicers that are expected to come to market in the future.

In this week’s chart, we examine the improving housing market and its outlook in terms of pricing stability as it relates to the number of homes in shadow inventory. To be brief, shadow inventory (courtesy of CoreLogic) represents the number of properties that are seriously delinquent, in foreclosure, and/or held by mortgage servicers that are expected to come to market in the future. During the recession, experts feared a second major dip in home prices would result from banks unloading the historically high number of distressed homes on their balance sheets.

Since 2009, the number of houses that comprise the shadow inventory has declined from roughly 3M to around 1.7M, thus approaching pre-recession levels. Homes prices, illustrated by the Case-Shiller Index, have continued to rebound from their 2011 lows. This represents a significant improvement in the housing market and as the shadow inventory continues to decrease the chances of a secondary dip in home prices becomes less likely.

Growth of Liquid Alternatives

This week’s chart looks at the recent fund flows and the trailing twelve month (“TTM”) percentage growth rate of liquid alternatives as of March 31, 2014. Over the past decade, private investment managers, traditionally associated with less liquid investments such as hedge funds, private equity, and real estate, have expanded their investment focus towards the creation of liquid alternative products that comply with the 1940 Investment Company Act in order to meet the demands of the rapidly growing defined contribution market.

This week’s chart looks at the recent fund flows and the trailing twelve-month (“TTM”) percentage growth rate of liquid alternatives as of March 31, 2014. Over the past decade, private investment managers, traditionally associated with less liquid investments such as hedge funds, private equity, and real estate, have expanded their investment focus towards the creation of liquid alternative products that comply with the 1940 Investment Company Act in order to meet the demands of the rapidly growing defined contribution market.

Within the open-ended mutual fund universe, liquid alternatives have once again topped all other asset classes with the highest organic growth rate over the TTM period, up 39.5% as of March 31, 2014. Although this growth rate is impressive, liquid alternative assets only represent 1.3% ($149B) of the U.S. mutual fund universe, which has over $11 trillion in assets.

As the trend toward liquid alternatives continues to grow, investors should consider the potential implications and effectiveness of the newly designed strategies. ’40 Act funds must comply with restrictions not required by traditional hedge funds such as leverage limits, short-selling, and liquidity. In addition, the standard 1.5% and 20% hedge fund fee structure has to be adjusted within the ’40 Act universe; currently, the average management fee for liquid alternative funds is around 1.5%. Since the significant rise in the formation of liquid alternative products has taken off within the past few years, investors should be cautious before diving into the space as the next decade will be a testing ground for these strategies as to whether or not they deliver on their performance expectations, in terms of both return and diversification.

2014 Market Preview

January 2014

Similar to previous years, we present our annual market preview newsletter. Each year presents new challenges to our clients, and 2014 is no different: We are coming off a banner year for U.S. equities, low interest rates continue to stymie fixed income investors, and while developed market equities enjoyed a strong 2013, emerging market stocks sputtered. In the alternative space, real estate and hedge funds proved accretive to portfolio returns, while growing dry powder in the private equity space is starting to raise a few eyebrows.

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Home Prices Rise But Are Still Below 2006 Peak

Our Chart of the Week looks at the S&P Case-Schiller 10-City Composite Index which is one of the best broad measures of housing prices in the U.S. This is a “drawdown” chart that looks at prices as a percentage of their prior peaks. When the lines on the chart are at 100%, prices are at a new all-time high.

Our Chart of the Week looks at the S&P Case-Schiller 10-City Composite Index which is one of the best broad measures of housing prices in the U.S. This is a “drawdown” chart that looks at prices as a percentage of their prior peaks. When the lines on the chart are at 100%, prices are at a new all-time high. The chart clearly shows the modest drop in housing prices that resulted from the early 1990’s recession and the severe drop in prices following the 2008 credit crisis. Over the last 24 months, home prices have started increasing again as the economy improved, employment picked up, and interest rates remained low. Nonetheless, broadly speaking, housing prices remain significantly below their prior peak in 2006. A few interesting things to note:

  •  The 10-City Composite Index fell 34% from a peak in April 2006 to a trough in January 2012. The index has subsequently increased 16% from those lows.
  • Las Vegas had the largest drop falling 62% from peak to trough. However, housing prices in Las Vegas have jumped 34% from the bottom. Las Vegas still remains the most depressed housing market where, even after the recent advance, prices are only about half of what they were at the peak.
  • Denver is the only major market that has returned to peak pricing levels. Boston has been the second most resilient market, where prices are only 10% below the prior peak.

The rebound in housing prices is providing a nice boost to U.S. GDP, employment, and the stock market. As housing prices rise, fewer homeowners are underwater on their mortgages (i.e., owing more on their mortgage than their home is worth) which improves consumer credit quality, leads to lower mortgage delinquencies, and gives homeowners more flexibility to refinance or sell their homes. All of these trends still appear to be in the early stages at this point. As long as interest rates stay low, we expect these trends to continue in the months ahead, providing a boost to the economy and the markets.

Queue Levels for Core Real Estate Managers

This week’s Chart of the Week examines queue levels of core real estate managers. Real estate’s recent performance along with its yield premium has led to increased investor interest, and consequently the formation of contribution queues. Contribution queues are the value of the cumulative dry-powder to put to work, i.e. what could potentially get called by managers in a quarter.

This week’s Chart of the Week examines queue levels of core real estate managers. Real estate’s recent performance along with its yield premium has led to increased investor interest, and consequently the formation of contribution queues. Contribution queues are the value of the cumulative dry-powder to put to work, i.e., what could potentially get called by managers in a quarter. If 100% of capital is called, the contribution queue is eliminated: prior quarter queue − capital called + new investor commitments = current quarter contribution queue.

Queue levels have to be monitored carefully because they could potentially dilute investment returns. The pressure to call capital and earn management fees might outweigh adhering to investment discipline or paying fair value for an asset. Additionally, the pressure to put money to work could lead to style drift by going outside of appropriate geographies or property types in order to increase fund size. If a significant queue exists for a particular manager, he/she may feel the pressure to put this money to work and overpay for an asset, as opposed to adhering to a more disciplined investment process. Such a practice is critical in today’s market: if one overpays in the beginning, an asset’s return potential is decreased.

Evaluating the last two years of data, the industry’s quarterly contribution queue has averaged $6.3B. For the last two years, the average queue into a fund has ranged from $292M to $426M, but two funds are driving an upward bias with these values. Excluding these two managers, the quarterly average queue into a fund has ranged from $84M to $184M. Most important to note is that queue levels have remained relatively stable as prices have rebounded. Overall, the steady level suggests that managers are remaining disciplined when completing transactions and not rushing to put money to work.

The State of Real Estate: Location, Location, Location…Where Are We?

October 2013 Investment Perspectives

Core real estate has been an attractive investment since the market’s recovery began in the first quarter of 2010. In this three-and-a-half-year period, the NCREIF Property Index (“NPI”) has returned a stunning 50.7%. Given this 13.1% three-year annualized return and unrelenting appreciation gains reported quarter after quarter, investors may wonder if they are too late to enter into private real estate or if their current investments are poised for a downturn. This newsletter will address these very issues by examining the health of the real estate market as suggested by the key indicators of performance, fund leverage and cash balances, transaction volume, asset values, income environment, and investor appetite.

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Emerging Trends in Alternative Asset Classes

2013 Marquette Investment Symposium session

In this presentation from our 2013 Investment Symposium, we explore various emerging trends in the alternatives space, including low volatility equity, tail risk, managed futures, gold, MLPs, GTAA, risk parity, farmland, direct lending, and opportunistic credit.

Presenters:

 

Investment Symposium 2013
Recorded September 13, 2013

Please contact us for access to this presentation.