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Real Estate – Can’t Touch This!

June 26, 2020  | by Paul Von Steenburg

COVID-19 | Real Assets

Few markets have been as heavily impacted by the onset of the global pandemic as real estate.  Real estate is considered a hard asset that “you can touch and feel”, but during a pandemic no one wants to touch or feel anything. Additionally, government restrictions on movements to and from physical locations and landlord recourse places a unique strain on the asset class. 

Leading up to the COVID-19 crisis, real estate markets remained relatively disciplined from a pricing and leverage perspective. Beginning the year, publicly traded REIT leverage levels were approximately 10 percent lower than in 2007 (the height of the previous cycle) and it seemed that investors got religion on the excessive use of leverage in both the public and private markets. Additionally, unlike the expensive relative pricing versus treasuries in 2007, capitalization rate (income divided by property value) spreads held firm near their longer-term historical average. 

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In 2007, cap rates to treasury spreads were at their lowest level in the last 20 years.  In some sectors or geographies, spreads even went negative. Further, the ten-year yield stood above 5 percent before equities began to decline and at 4 percent when Lehman Brothers collapsed. At those levels’ treasuries represented a reasonable relative value investment for investors seeking to generate returns that achieved long-term objectives. Additionally, with real estate appearing relatively expensive, investors repriced the asset class — pushing cap rates up over 150 basis points and spreads back toward their average — contributing to significant declines in real estate values.

Today, the 10-year yield stands at approximately 70 basis points, hardly creating a relative buying opportunity for long-term investors seeking to achieve a 5 percent real rate of return or a 7 percent nominal rate.  Further, cap rate spreads are at their widest level in 20 years, which presents a relatively attractive investment opportunity for long term investors. We believe the combination of low treasury rates and attractive spreads will keep cap rates from expanding like they did during the Global Financial Crisis and serve to moderate declines in most sectors of the asset class.

Authors

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Paul Von Steenburg is a member of the Commonfund Asset Management Investment team and is primarily responsible for asset allocation, manager sourcing, due diligence, and investment monitoring for investment portfolios with a focus in real asset strategies and private real estate investments. He serves as a member of the Commonfund Asset Management Investment Committee. Paul also serves on advisory boards of the firm’s investment managers. Prior to joining Commonfund, Paul was a Vice President in the consulting division of Wilshire Associates, where he advised institutional investors. Paul was also the Chair of Wilshire’s Hedge Fund Committee, where he was responsible for conducting research and providing advice on the selection of hedge fund managers. Prior to Wilshire, Paul worked in equity research for Waddell & Reed Asset Management. He also spent five years with the Instinet Group as Manager of the Global Correspondent Trading Group. Paul earned a M.B.A in Finance from Cornell SC Johnson College of Business and a B.S. from Rutgers University. Paul also holds the Chartered Financial Analyst and Chartered Alternative Investment Analyst designations.
Paul Von Steenburg
Managing Director, CFA, CAIA
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Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.