Eq: Real Estate
Two of the most common ways to invest in real estate are through REITs or private real estate. While both have similarities, there are some key differences in terms of structure, liquidity, access, risk, and return.
REITs are similar to mutual funds in how they are traded and valued. However, they must derive 75% of their income from real estate investments and distribute 90% of taxable income to shareholders. There are a variety of REITs that encompass the whole industry such as retail, commercial real estate, senior housing, multifamily, office, etc.
Unlike private real estate, there is no end date, and they can operate in perpetuity. Private real estate differs from REITs in that they tend to be pooled investment vehicles that give investors fractional ownership.
While REITs must abide by strict tax laws, there is no similar requirement for private real estate. Another difference is that private real estate tends to not offer income. Instead, their goal is to pool capital to acquire and develop a property, hold it for seven to ten years, sell it at a profit, and return proceeds to investors with the operators taking a cut.
Finsum: There are many ways to invest in real estate. Two of the most common are REITs and private real estate. Here are some key differences between both options.
In a CNBC interview with Sara Eisen, Goldman Sachs CEO David Solomon warned that there was more pain ahead for commercial real estate. The bank is marking down its holdings as the sector faces a torrent of headwinds.
The most notable include the rise of remote and hybrid work which is structurally reducing demand for office space. E-commerce continues to take a greater share of spending which is affecting retailers with physical locations. Finally, higher rates have also added to the industry’s woes as many owners are defaulting on properties rather than refinancing loans.
Due to this, the bank is posting impairments on its loan book and equity holdings which will impact its upcoming results. In the first quarter, the bank wrote off nearly $400 million in real estate loans. Solomon believes that other banks will also be making similar moves.
However, Solomon sees the challenge as being manageable and not significant enough to thwart Goldman’s overall business. But for smaller banks, it could be a bigger problem since they tend to be more heavily exposed to commercial real estate.
Finsum: Commercial real estate is facing a tough time due to higher rates and reduced demand for office space. In an interview, Goldman Sachs CEO David Solomon shared how the bank is dealing with the challenge.
Over the last year, Elon Musk has been increasingly pessimistic about the US economy and warning that a more severe downturn is coming. Recently, he warned that the prospects of commercial real estate would suffer due to a lack of financing given stresses in the banking system, and workers who are not returning to offices. In an article for TheStreet, Luc Olinga covers Musk’s thoughts on the matter.
Now, the Tesla founder and CEO is also warning that the residential real estate market could face similar pain as inflation and a weakening economy mean that demand will be tempered, while supply is artificially constrained as homeowners with low mortgage rates are unwilling to sell.
He sees the same underlying factor negatively impacting residential real estate and commercial real estate - banks raising their lending standards which curtails demand. This would lead many prospective buyers to fail to qualify for a mortgage.
On top of this, there are a myriad of other economic stresses such as inflation and higher rates leading to higher costs and payments. At the same time, Musk sees it as inevitable that the labor market experiences its own downturn, adding to pain for the US economy and housing market.
Finsum: Elon Musk has been quite vocal in warning about risks to the economic outlook. He recently shared why he thinks residential real estate could follow commercial real estate lower.
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All asset managers are adapting to this macro environment in their own ways. In terms of private real estate, funds are taking more time to make investment decisions, exploring new sources of financing, and structuring creative methods to deploy capital. Jenn Elliot covered the cautious behavior among private real estate funds for WealthManagement.
It’s a sharp turn from the last couple of years when funds were much more aggressive in terms of investing and raising capital. Now, raising capital has become much more difficult given that the risk-free rate of return is above 5%. Additionally, rising recession risk, stumbles in the banking system, and stress in commercial real estate have also muddied the picture.
One silver lining is that many investors have been sidelined which means there is less competition for deals. Thus, private real estate funds have more time to evaluate ideas and can be more selective.
However, the most significant headwind is that a deflationary mindset has become pervasive. Essentially, most investors expect that prices will decline over the next year. In some ways, this becomes a self-fulfilling prophecy. So far, damage has been contained to commercial real estate where there have been a few high-profile defaults and redemption requests.
Finsum: Private real estate funds are behaving much more cautiously due to higher rates and increasing economic uncertainty.
Ethan Roberts covers the weakness in office REITs over the past couple years in a Benzinga article and whether there is any opportunity to buy the dip. To recap, the sector’s struggles began due to the pandemic with remote work gaining in popularity, leading many companies to downsize or abandon their offices.
Not surprisingly, office REITs were crushed and their struggles were exacerbated by high interest rates. Many of these REITs dropped more than 50% and are trading below their March 2020 levels, despite the broader market being substantially higher.
However, some contrarians are turning more optimistic on the sector. They believe that valuations have become very compelling especially given that public market valuations are much cheaper than private markets. Additionally, there are increasing signs that corporations are pushing back against remote work culture by insisting that workers must go to the office at least a couple of times per week.
In addition to this, real-time metrics like metro ridership and miles driven also seem to confirm that more workers are returning to the office. Finally, with increasing cracks in the labor market and expectations that the unemployment rate will increase over the next year, workers have less leverage and may be forced to return to the office.
Finsum: Office REITs have been crushed over the past couple of years due to the pandemic and high rates. Now, there are some reasons for optimism.
In an article for Seeking Alpha, Jussi Askola covered the aggressive buying of REITs by the Blackstone group and bullish comments from Steve Schwartzman and John Gray, who are the CEO and COOs of the Blackstone group, respectively. Their investment decisions are monitored due to their leadership of the private equity giant, and its successful long-term investing track record. Additionally, private equity groups are large owners of real estate, so they could have particular insight into the sector.
This is evident in public filings of REITs whose shares fell precipitously last year due to the rise in rates and weakness in real estate. The company has built up a portfolio of REIT assets, totaling nearly $30 billion. Essentially, the company sees a discrepancy between real estate assets in private and public markets with public markets offering more favorable valuations.
And, it signaled on a recent conference call that it says more upside in other types of liquid real estate securities as other investors pull back from the asset class. And, they note that these opportunities present themselves in REITs that are exposed to strong sectors with no distress. One factor that may appeal to Blackstone is that many REITs currently have a nearly 30% discount to their market value.
Finsum: Blackstone is being contrarian with its aggressive buying of REITs while most investors flee the sector.