As the recovery of U.S. real estate markets isnow firmly under way, certain geographic areas and property types provide the best near term investment opportunities. The assistance of a trusted advisor is key to the realization of investment yield.
Geographically speaking, Gateway Cities hold their value and appreciation in most property types. These include Boston, New York City, Washington, DC, San Francisco, Los Angeles, and Seattle. These Gateway markets are constrained by supply while the Secondary Markets have the benefit of unconstrained supply, but value is located in pockets across the landscape. The Secondary Markets comprise such cities as Houston, Denver, Dallas, Atlanta, San Diego, Miami, Chicago, Phoenix, and Philadelphia. These markets are waking up and the value proposition for investors and developers is the proverbial location, location, location.
Value can be realized through the acquisition of unfinished projects in certain locations, as well as land for infill projects, and transit oriented locations near shops, restaurants, and entertainment districts. A location near amenities is something that doesn’t require capitalization in order to attract buyers or tenants.
Additionally, unique markets located in oil and gas rich territories such as North Dakota, Southern Kansas, West Texas, and Wyoming are short on housing and commercial amenities for workers and their families. While these opportunities can boast internal rates of return in excess of 30%, being well capitalized is critical to success in these unique areas.
Prospects for positive returns on major commercial property types in 2013 include multifamily, student housing near major universities, industrial distribution, and certain hotel properties. Out of this group, hotels are the weakest overall, but underserved markets push demand. Office and Retail demand have not come back strong enough to suggest any significant demand. However, these uses can be successful as part of mixed use urban infill and Transit Oriented project types, but on their own in suburbia we would suggest waiting a few years.
Setting realistic expectations for investment returns on real estate development is critical. The days of the fire sale and 50% IRR’s have passed and those assets have been long picked over by opportunity funds, value investors and high net worth individuals. Rules of thumb for investing today in Multifamily and Industrial are as follows:
- Multifamily properties – banks and investor groups are looking for unlevered cap rates north of 7.5% so that return on equity will exceed 10-12% in the initial period and exceed 18% IRR over a 5 year -holding period.
- Industrial properties – banks and investor groups are looking for unlevered cap rates of 10% so that return on equity will exceed 13-15% in the initial period and exceed 20% IRR over a 7-10 year -holding period.
- Purchasing at a 9 or 10% cap rate of existing assets might make sense in certain markets, but be careful of assumption creep and buying at a 7 or 8 cap and expecting adequate appreciation on the exit.
While the positive spread between mortgage rates and cap rates is one measure of a mathematically successful project, having a market study that suggests an underserved demand in the city you wish to develop and selecting an advisory team with a track record of success are critical to realizing sustainable returns on invested dollars.
-Ken
For more information on how you can benefit from our advisory group please contact Ken (ken@laidev.com)