As it burst onto the world scene in 2020, COVID-19 impacted asset classes and investment strategies across the board. While real estate was no exception, the industry managed a generally strong recovery—albeit with a wide dispersion among sectors. Now the question is, what’s next? A panel of experienced investors probed that very question at Commonfund Forum 2022.
The panelists were: Anar Chudgar, Managing Director, Artemis Real Estate Partners; Mary Lang, Head of Americas Direct Logistics Strategies and Portfolio Manager, CBRE Investment Management; and Jordan Socaransky, Principal and Portfolio Manager, Westport Capital Partners. Paul Von Steenburg, Managing Director, Commonfund Asset Management, moderated the panel. Highlights of the discussion follow.
Von Steenburg: To start, let’s ask: How is the current inflationary environment impacting your investing activities?
Lang: It's a really interesting time in the logistics industry. I’ve never seen anything like it … a foundational shift in how we move products around the U.S. What’s shocking is that of all new warehouse completions in 2021, 80 percent were pre-leased or pre-bought and the previous highwater market was 30 – 35 percent. So, from the investor’s perspective this is really de-risking speculative development.
Socaransky: I am concerned that in some sectors rents and revenues are not keeping up with costs, meaning that NOI (net operating income) margins are under pressure. You’ve seen double-digit growth in multi-family—it has kept ahead of costs and that’s why cap rates can stay at 3 percent. But when rates stop increasing because of affordability that 3 cap could become a 4 cap and you lose 25 percent of your value. But I think that when supply chains calm down and there’s better availability of building materials, we’ll see some lost ground regained.
Von Steenburg: Can the industry take on higher fed funds rates without seeing a reduction in prices, realizing that it will vary by sector?
Chudgar: Existing assets will be affected because they will have to be refinanced and the refi will depend on value and that value depends on how much you have levered it. Or you can sell it for an appropriate value. Higher rates will help rent growth in residential sectors. I’m less certain about the office sector because of demand. It helps that we have more liquidity than in previous cycles. A lot is coming from the U.S. government and other domestic sources as well as from foreign investors, now including Eastern Europe.
Socaransky: The bottom line is spreads—the risk premium on top of real interest rates. It’s said that the spread has been historically wide for a long time. As rates rise maybe it eats into spreads a little. But there’s still some cushion. In sectors like multi-family or hospitality where the leases are shorter you can reprice, giving you more protection than something like industrial. We’re still in a low-rate environment and even after seven fed funds rate increases, we’d be around 2.75—3.00 percent, which is merely reverting to a pre-covid level, not the economic crisis/recession level.
‘I’ve never seen anything like it … a foundational shift in how we move products around the U.S.’
— Mary Lang, CBRE Investment Management
Von Steenburg: Let’s discuss sectors we don’t always hear a lot about. Jordan, you are active in cold storage. But the one public REIT in that area is performing poorly. Can you talk about the sector and what you are doing?
Socaransky: The frozen food industry globally is a $300 billion a year business with a 4-6 percent CAGR (compound annual growth rate). What supports that industry is a $200 billion asset base. Only about 5 percent of those assets are automated, and the balance is 30–50 years old, very small, antiquated warehouses that are manually intensive to operate and energy inefficient. Keep in mind, labor and energy are the two biggest expenses. So, there is a real need to reinvent the industry. Our approach has been to build new high bay, 120- to 150-foot-tall giant consolidators of inventory requiring 20 percent of the labor and 30 percent of the energy and are five to 10 times larger. What has plagued the REIT you mention is an old, inefficient asset base that’s heavily reliant on labor, and they have not been able to raise their revenues in line with expenses.
Von Steenburg: Anar, what investment opportunities is Artemis finding attractive today?
Chudgar: We have been doing self-storage for 10 years. We’ve been aggregating small portfolios and trading them to sovereign entities that are looking for yield. As the residential market continues to rise, so has self-storage. We continue to see migration—the urban exit post-pandemic but now the Gen Zs are moving back to the cities and the demand for well-located self-storage is strong.
We are also investing in student housing. Investors worried whether post-pandemic students would return. But that was overplayed, and students went back very seamlessly. We focus on bigger public universities where there’s consistent growth of the student population.
We also have a fund that concentrates on real estate in the health care industry. This includes senior housing, medical offices and life sciences. Unlike traditional offices, there has been a huge wave of interest in life sciences facilities because of the growth in R&D and technology. Medical offices are the same — hospitals are trying to control costs and need offices where they can deliver more outpatient services.
Von Steenburg: Mary, you have some experience in data centers. What is your view on opportunities to invest in that sector?
Lang: Data centers had been hot but cooled among public REITs. There are three key challenges. The first is the headline risk—their huge energy requirements. Second, the reason data centers are so large is the need to “cool to compute.” I worry that someone will develop a smaller, faster chip that can cool itself and reduce the need for space from 200,000 square feet to 50,000. Finally, it’s the only real estate asset beholden to a third party, namely the utilities. Developers need to think years ahead because it takes five years to build a new substation to power future data centers. But there are opportunities. First, the yield in data centers is still there if you can get a joint venture partner to work with you on the development side. Second, think about making a platform investment in the data center operators themselves. Because the money-making ability is not in the real estate but in operating the facility. If you’re charging a tenant $80 per kilowatt-hour in rental rate (Note: data centers are not priced in dollars per square foot), $30 of that goes to the operator. So being a platform investor in the space is something that should be of interest.
