Economy
Every industry is dealing with the consequences of higher inflation and interest rates. Private real estate is no exception as construction and financing costs have soared. For Private Equity & Real Estate News, Peter Benson shares how the industry is grappling with these challenges and whether it will start to impact returns.
Although inflation has been trending lower for the past few months, builders continue to grapple with higher insurance costs especially in certain coastal markets. Many are finding that insurance rates have doubled or tripled in certain cases especially as incidents of extreme weather increase.
Another headwind has been an increase in property taxes as many local governments are dealing with lower tax revenues. Overall, rents have not increased enough to offset these additional costs, resulting in less income for landlords. Additionally, there is a glut of multifamily units that are coming online in major markets, leading to less opportunity to raise rents. Further, rents are at a historically high level relative to income which is also an indication that they cannot be further increased.
Many private real estate fund managers are dealing with the challenging environment by prioritizing cash management to ensure that they have enough reserves to get through the current environment and take advantage of dislocations that emerge in the coming months.
Finsum: Private real estate operators are dealing with a very challenging environment given that rents cannot be further raised, while rates are elevated. Another burden is that insurance costs have doubled or tripled in many cases.
In SeekingAlpha, Jussi Akola discusses the opportunity in REITs and identifies some that are yielding more than 8%. REIT stocks are down significantly over the past 18 months due to higher rates and increasing pessimism around real estate prices. Yet, prices have remained resilient despite these headwinds. Additionally, many REITs continue to increase their dividends and are quite attractive on a valuation basis.
And, there are some indications that the macro environment is improving. For one, recent economic data in terms of mortgage applications and housing stars has shown an uptick. Longer-term trends in terms of inflation and the economy also support the notion that the Fed is close to the end of its tightening cycle which should be a boost to the sector as well.
Akola likes Global Medical REIT which is a REIT that invests in medical offices in secondary markets and has an 8% dividend yield. By investing in less competitive markets, it has higher cap rates with less competition from new projects. Additionally, longer-term trends around medical spending are also supportive given the aging population and long-term trend of healthcare inflation outpacing inflation.
Finsum: REITs have significantly underperformed over the past 18 months. Yet, some investors see value in the asset class due to an improving macro environment.
In an article for MarketWatch, Brett Arends discusses the tradeoffs of traditional real estate investing vs REITs. While many people have built wealth by buying and renting homes, Arends believes that investing in REITs is a better option for most investors given costs and complications.
Additionally, the upside of real estate ownership is less appealing in an environment of higher borrowing costs. Many real estate investors are making the mistake of looking at returns over the past 30 years and projecting them forward. However, the last 30 years saw interest rates decline by a significant margin which is unlikely to be true over the next 30 years.
REITs offer exposure to real estate as well and have outperformed home prices by about 3% annually. Currently, home prices remain elevated, while REITs are down 40% over the past year in many cases, leading to attractive yields and compelling value.
Further, REITs are much more liquid and can be bought and sold instantly through any brokerage. In contrast, real estate transactions have massive costs and take time. Additionally, REITs are inherently more diversified than a real estate investment which means less risk.
Finsum: Brett Arends discusses why the risk-reward equation currently favors REITs over traditional real estate investing given costs, value, and complexity.
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In an article for SeekingAlpha, Armada ETF Advisors make the case for why public real estate is due to outperform vs private real estate given the gap in valuations. Over the last couple of years, the combination of the Fed’s rate hiking campaign and weakness in segments of the real estate market like commercial real estate have led to major drawdowns for publicly traded REITs.
In contrast, private real estate has fared much better. According to Armada, these types of wide differentials in performance have been reliable indicators of mean reversion, historically. In addition to favorable valuations, the firm also believes that the headwind of higher rates is about to recede given trends in inflation and budding signs that a recession is imminent.
Over the last 2 decades, there have been 8 instances when REITs underperformed by more than 10%. Each instance was followed by a period of strong REIT performance in absolute and relative terms.
It’s also a rare opportunity for investors to acquire high-quality real estate assets at cheaper prices than what is available in private markets. Typically, the situation is inverted given the greater liquidity of publicly traded REITs.
Finsum: Private real estate has outperformed public real estate by a significant amount over the past year. But, it could be an indication that a major mean reversion is imminent.
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.