Real Estate & Infrastructure: Finding Opportunity After the Repricing

Hi. Welcome to Commonfund Point of View. I'm Julia Mord, Chief Investment Officer of Commonfund OCIO. In this podcast, we give you our latest views on capital markets and investing in fifteen minutes or less. Today, I'm joined by my esteemed colleague, Paul Von Steenburg, Managing Director and Head of Real Estate and infrastructure investing at Commonfund. Paul, I wanna start. The real estate market has been going through a revaluation over the last several years. Where do we stand in the process today? I think we're we're pretty well through the process at the moment. You know, the the market has been going through a revaluation over the last three years or so, given the interest rate increase in twenty twenty two and twenty twenty three. I would say, you know, if we put a number on it, maybe eighty percent through through the process. But it's very sort of sector specific. So some sectors like the office sector or even life sciences assets, you could say there's probably some room for for further revaluation. The REIT market repriced immediately, was down sort of twenty five percent or so, and it's taken the private markets a while to sort of catch up from a valuation perspective. And in some cases, we've actually seen some cap rate compression or improvement in values in certain sectors like logistics or housing. And so it's a bit spotty. It's a bit sort of sector specific. But generally speaking, you know, the market has, you know, it finds itself on a firmer footing on a forward looking basis. There's generally, you know, positive sentiment at the moment on sort of forward returns for the overall real estate market. After going through a three year period where there has been a revaluation, that period has really been the longest in history. Even longer than the GFC, the sort of the swings haven't been as great, both down and up. But that period of reevaluation, again, has been longest in history. So I think there's generally pretty positive sentiment on a forward looking basis. Interesting. What are the positives and negatives facing the asset class today? Well, you know, I think from a from a negative perspective, there's some concern around the recent interest rate increase, right, from the the we got down to four percent on the ten year, and now it's back up to sort of four forty. That's leading to some level of consternation. But there is room, I think, in real estate values to sort of absorb that, unlike the interest rate increase we saw in twenty twenty two. And you know, certainly not a significant rise in interest rates, I think, would be a headwind, but that isn't certainly in the in certain banks' cards at the moment. Geopolitical risk is also causing some issues. Right? The constant sort of news cycle holding back corporates from making investment decisions in their infrastructure and their real estate. From a positive perspective, generally speaking, fundamentals are pretty good from a revenue and NOI growth perspective. Really, across most sectors, there's areas of significant strength. Obviously, centers and senior housing are seeing very positive fundamental growth. The other positive is from a debt market perspective, we're seeing spreads compress and debt being generally available. So unlike a few years ago or even a year ago, a lot of sectors were able to get day one positive leverage on a going in basis. That's generally a positive aspect of the market today. But really, the most fundamental underpinning from a positivity perspective is the supply picture. Because of the rate increase, because of construction cost increases, really supply pipelines have been coming for the last three years. And in some cases, for a decade in places like retail, we've seen very little supply growth. And so the underlying fundamentals from that supply demand picture is pretty healthy. Probably the thing that's missed most in the markets because most folks are focused on more of the demand side versus the supply side. I wanna hone in a little bit. There appears to be a blurring of the lines between what is real estate and what is infrastructure. Data centers, medical office, cold storage, and housing all sit in an ambiguous middle ground. How are you defining the boundary between real estate and infrastructure in your portfolio? And does that distinction even matter anymore from a return and risk perspective? Yeah. Think it's certainly a debate in the market. You know, folks talk about it a lot. I think, generally speaking, we don't think about it that much. I mean, we we don't really need to define. We're not allocating specific buckets in either one of those categories. We're investing in one aspect of the portfolio. And so really, we're looking at it from return generation perspective, what can the strategy return for us, and then the risks we're taking in order to generate that rate of return. So we're really agnostic to whether it's real estate or infrastructure. Generally speaking, the categories that you mentioned over the last three years that are sort of in the middle of those two segments have been the better performing segments of the real estate market, certainly data centers, cold storage, but not all cold storage. So some cold storage has performed very poorly, other strategies have done well. And then some segments of housing, so not all of housing has performed well, some subsegments of housing have generally performed well. And so really, it really doesn't matter to us. We're really trying to just find what the best opportunity set is in the market. And that shifts over time. And so, as certain areas do well, more capital flows into that area, and then that leaves opportunity in a different area. Data centers are probably the hottest topic in the market today. We've been investing for a number of years. Where do you see that opportunity set today? Yeah, it's certainly the most crowded aspect of the market today. As you mentioned, as we, you know, began investing a number of years ago, there were very few funds in the market. We were fortunate to find a good partner in that segment, and it's been a great place to invest. That being said, there's just a tremendous amount of capital in the sector. At the same time, we do think it is a long term trend that started decades ago and continues with the digitization of economy and how we go about our daily lives and business. And so we do think it's a long term trend. We continue to deploy capital into the sector, but we are very cautious around the risks that our managers are taking. So we've been very specific in how we deployed capital into that market to, we think, a relative basis, be more risk mitigated than what you're I think you're seeing in the broader broader market. I also wanna shift to to private real estate. I know you manage both public and private portfolios. Where are you finding genuine illiquidity premium in private real estate today? I think when we're investing in closed end funds, we're you know, we need to generate a return that's in the teens to sort of compensate for taking that illiquidity risk. And so generally, trying to generate thirteen to fifteen percent net rates of return in our private portfolio, we think, is appropriate compensation given the fact that it also generates cash flow. Diversifying to the broader portfolio. It has some inflation protection characteristics to it. And we think the combination of all those things make it an attractive area to invest for investors locking up their capital. And so, think that's really what we're looking for when we're investing in managers. And so, I it's appropriate compensation, certainly relative to what's available in the public liquid real estate markets, and even relative to the broader equity public market, if we're able to achieve that, which we've been able to do over, you know, probably one of the most difficult periods for the asset class in history. On a forward looking basis, we think it's even even more trite. Last, I wanna spend a little bit of time on our due diligence process and specifically on sourcing the right GPAs. With hundreds of real estate and infrastructure managers in the market, how are you differentiating between GPs who generally have an edge? So either through proprietary deal flow, operational capabilities, sector specialization versus those who've benefited from a decade of cheap debt and rising valuations? Yeah, it's a great question. We talk to a lot of GPs. We have a lot of meetings every day, every week. And so I think once you go through that process and you talk to a lot of folks, you begin to get a sense of what sort of the relative advantage of any particular area or group might have. I think importantly, though, you have to have the right sort of reference frame, if you will, and sort of framework for what you're looking for managers. We generally take a point of view that we're looking through all the things that you just mentioned, sort of the operational capability, the sector specialization, the proprietary deal flow. We think those are critical aspects. We have a bit of an overlay where we do try to find ourselves where we think the relative value may exist in the market, and then find groups that are really well positioned with those characteristics to take advantage of those opportunities. So we have a bit of a sort of a macro overlay about how we think about investing in the sector. That being said, we do find managers that we think just have a relative edge and can do it over multiple cycles. And so we'll continue to back those groups regardless of maybe the the the macro underpinning that that maybe what's supportive at the moment, we think they have a relative edge. Good. Well, thank you, Paul, for your thoughtful insights into the current landscape for real estate and infrastructure investing. Well, that wraps up our Point of podcast. Please join us in July for our next episode of Point of View.