As high-net-worth (HNW) investors zone in on commercial real estate opportunities for 2019, Opportunity Zones, multifamily, marijuana, retail and industrial are emerging as some of the key areas to watch.
Real estate investments made next year by HNW investors should be weighed against rising interest rates and the prolonged economic expansion, according to Doug Brien, co-founder and CEO of Oakland, Calif.-based Mynd Property Management, which specializes in multifamily assets.
“For deals to make sense, investors will need to make sure cap rates remain high enough to balance out rising interest rates,” Brien says. “In my opinion, a long-time horizon should be incorporated into any investor’s strategy if they’re acquiring properties at such a late stage in this rising interest rate environment.”
Ross Yustein, chairman of the real estate department at New York City law firm Kleinberg Kaplan Wolff & Cohen PC, echoes the cautious approach espoused by Brien.
“It’s always difficult to predict when the market will reverse or how bad it will be. Investors should keep in mind that commercial real estate can be a lagging indicator during the early stages of an economic contraction,” Yustein says.
NREI interviews with U.S. real estate professionals, including Brien and Yustein, indicate that the following are five of the themes that HNW real estate investors should track in 2019.
1. Opportunity Zones
Among real estate professionals contacted by NREI, the topic of Opportunity Zones surfaced to the top. Experts anticipate that next year many HNW investors will seek to capitalize on the federal tax reform legislation passed in 2017 that included the establishment of Opportunity Zones. The provision allows for deferment of capital gains taxes for investment in ground-up and redevelopment projects in economically depressed locations.
Across the U.S., government officials have designated 8,700 Opportunity Zones, ranging from several-block-long urban stretches in big metro areas to entire towns in rural states, according to the 2019 Emerging Trends in Real Estate report, published by professional services firm PwC and the Urban Land Institute (ULI).
Opportunity Zones are a “major focus” of HNW investors, according to Neil Madsen, founding principal of New York City-based real estate consulting and management firm Madsen Advisors LLC
“I expect there to be a lot of activity next year with Opportunity Zones, but I wonder whether the actual investment opportunities will materialize fast enough to absorb the available investment dollars,” Yustein says.
Still, Opportunity Zones could have a “meaningful impact” for HNW investors, according to Lee Roberts, managing partner of SharpVue Capital LLC, a Raleigh, N.C.-based wealth management firm.
“As with all tax provisions, though, it’s important not to let the tail wag the dog—it has to be a fundamentally sound real estate investment first,” Roberts says.
A number of fund sponsors are setting up opportunity funds as vehicles for Opportunity Zone investments.
“Opportunity funds enable investors to do well by doing good. While important details need to be known and carefully analyzed, such investments are worthy of consideration,” says George Mateyo, chief investment officer at Cleveland-based wealth manager Key Private Bank.
Brien recommends HNW investors consider multifamily investments in 2019, particularly “small residential” assets in urban infill locations where rental demand should remain strong, even in the face of an economic downturn. According to Brien, the majority of American apartment dwellers live in these properties, which have 50 units or less and make up a $430 billion-a-year industry in the United States.
“There tends to be more efficiency in this mom-and-pop market, meaning investors are less sophisticated and more deals can be found,” he notes.
Low-rise garden-style apartment properties might be a good defensive play for HNW investors in 2019, adds Madsen. These apartments are an affordable option for would-be homebuyers who are content with renting, at least for the time being, he says.
According to the PwC/ULI report, garden-style apartments are producing higher returns and higher-yield cap rates compared with other multifamily properties. Garden apartments stand to benefit from the “strong move” toward secondary and tertiary markets, along with heightened interest in suburban assets, the report says.
“I strongly believe that multifamily will be the safest asset class in 2019; people always need a roof above their head,” says Ellie Perlman, founder and CEO of Blue Lake Capital LLC, a Santa Monica, Calif.-based investment firm that concentrates on multifamily assets. “My strategy is to focus on class-B—10- to 20-year-old buildings—because the luxury high-end apartment buildings will suffer from high vacancy when the market shifts.”
While multifamily might be an attractive sector, Roberts urges HNW investors to exercise caution, given that the supply of multifamily properties has ramped up dramatically since the Great Recession. In many markets, he notes, multifamily is a relatively new product type, compared with seasoned markets like New York City and Washington, D.C., where reams of historic absorption data are available.
The absence of in-depth absorption data for some less mature markets makes it harder to predict how multifamily assets will perform in an economic downturn, Roberts says, “but we don’t see that uncertainty reflected in the pricing.”
A number of real estate professionals are buzzing about the prospects for properties serving the red-hot marijuana market.
Real estate attorney Melanie Scroble, a partner at Ocean Township, N.J.-based law firm Ansell Grimm & Aaron PC, says the increasing legalization of recreational and medical marijuana in the U.S. promises to usher in a “huge influx” of HNW investors who are trying to profit from this wave. San Francisco-based market research and consulting firm Grand View Research estimates the U.S. market for legal marijuana totaled nearly $7.1 billion in 2016 and forecasts a compounded annual growth rate of almost 25 percent from 2017 to 2025.
There’s “tremendous potential” in 2019 for properties that can accommodate marijuana-related businesses, in Scroble’s view, including retail stores, pot-growing facilities, warehouses and distribution centers.
To be sure, the retail real estate sector has suffered in recent years. However, opportunity awaits HNW investors who can hunt down distressed retail assets that are undervalued and are ripe for redevelopment, says Joe DiRosa, a Pennsylvania real estate agent who handles commercial and residential deals. One example: transforming a beleaguered retail property into a mixed-use project anchored by a multifamily component.
In that same vein, DiRosa suggests exploring entertainment properties such as bowling alleys, roller rinks and golf courses as prospective investments.
“The need for entertainment is the one retail segment that hasn’t been affected by Amazon,” DiRosa says. “These properties usually can be negotiated at a fair price, are usually large acreage in high-traffic areas, have automatic revenue and can always be torn down and redeveloped later.”
The e-commerce explosion fueled by Amazon and other players continues to spur demand for industrial space across the U.S., with both occupancy rates and rental rates still soaring.
Across the board, industrial assets are “highly favored,” particularly “last mile” facilities serving major population hubs, Madsen says.
“Retail’s pain will continue to be industrial’s gain,” says Danny Mulcahy, director of equity at Denver-based commercial real estate investment firm Northstar Commercial Partners Management LLC.
While no industrial landlord would scoff at an Amazon lease, not all industrial properties must be geared toward e-commerce tenants, says Roberts, the wealth management executive.
“We see opportunity in older buildings that are well-located and affordable for the plumbing supply company tenant, for example,” Roberts says. “That tenant still needs an infill location, but few municipalities allow new infill industrial and, at least in the Southeast, much of what exists currently is being turned into loft apartments and microbreweries. These assets have strong cash flow and may have some development upside in the future.”