Yield-seeking investors turn to alternative real estate investments generally overlooked by major players. These are often real estate sectors that have been dominated by private and family investors. As a result, buyers may find pricing that achieves superior risk-adjusted returns and an opportunity to provide a superior level of management. An investment manager stated that their “core fund is adding a lot of niche products, includ- ing medical office, self-storage, and trucking terminals.” Others mention data storage, student housing, senior living facilities, and manufactured housing. In addition, we have included dis- cussions of mixed-use product and residential condominiums, which also appear to be niche strategies today.
Mixed-use product is the highest-rated product in the niche product survey. Typically, investors are referring to retail with
Data storage has been a lucrative sector for a few institutional investors, ranking third in our niche product survey. Demand for data servers that support an increasingly cloud-based system of data storage has been very strong. For facilities in prime loca- tions relative to data cables, cash flow has been excellent. Data center REITs provide a point of entry for investors. A developer said, “I wish we had invested in those years ago, because no question right now they are incredibly important assets and are only going to grow as more people want to shop online and depend upon general logistics and efficiencies.” An institutional adviser, who has developed data centers in a joint venture with a REIT, said, “They have done really well, and they are expand- ing this program. Most are reuses of existing buildings in great locations. In the future, they will do more ground up.”
Self-storage has been a growing and popular sector over the past several years, ranking fourth in our niche product survey. Consumers require storage for stuff that they cannot accom- modate at home. A pension fund adviser notes, “The boomers are aging and have already bought too much stuff, keeping the private storage industry busy.” Households moving or downsiz- ing also drive demand for self-storage. In major markets, rental rates and occupancy are quite healthy. The self-storage REIT sector has been on a roll. An investment manager said, “Over 6 percent of our portfolio is in this sector.” Some investors feel that this sector has peaked in its pricing and expect restrained
returns in the future, however. A head of real estate investments for a life insurance company notes, “Cap rates keep dropping and there is not a lot more room for values to climb.”
Student housing has been a popular sector in recent years, and a number of REITs have been quite successful invest- ing in this product. In our subsector survey, it received only a moderate rating for 2017. The typical product has been highly amenitized, targeting affluent parents concerned for the safety and comfort of their college-age children. Some investors be- lieve this sector has largely played out, with sufficient supply to meet the demand from a small high-income market. However, most believe the volume of students at respected colleges and universities will remain strong for the foreseeable future. Another investment adviser said, “We are buyers of student housing. This is somewhat recession resistant, especially for properties not at the top of the pricing market.”
In our survey of residential property types, age-restricted senior housing is the top-rated subsector. People live longer, and are more affluent in their senior years. Growth accelerated during the 2000s as seniors born in the demographic boom years of the 1920s began to enter their 80s, the target threshold for senior living. Today, that wave is subsiding. However, those arguing in favor of the sector point to the large number of seniors living through their 90s, medical procedures that allow for a Exhibit 4-15 Prospects for Niche and Multiuse Property Types in 2017
Development prospects Investment prospects Agricultural land Development land Suburban mixed-use town centers Self-storage Data centers Infrastructure Urban mixed-use properties
Agricultural land Development land Suburban mixed-use town centers Data centers Self-storage Infrastructure Urban mixed-use properties
Abysmal Fair Excellent Abysmal Fair Excellent
Source: Emerging Trends in Real Estate 2017 survey. Note: Based on U.S. respondents only.
longer ambulatory lifestyle, and increasing affluence of seniors. A real estate economist noted that “the baby boom generation that led to the apartment boom in the 70s . . . is going to lead to a senior housing boom.” A fund manager indicated that “he does really like senior housing, especially independent living and assisted living, perhaps with a memory care wing.” He calls them “hotels without the volatility.”
Demand for senior living facilities tends to be strongest in metro markets with large and affluent populations. A particular chal- lenge for operators is labor. An investment manager/adviser said that his “biggest worry with this sector is wage pressure.” Assisted living residences in particular require large staffs. While institutions typically invest in the real estate, which is leased to an operator, labor clearly provides some sector challenges. On the other hand, few institutional investors find the skilled nursing sector attractive, given its extraordinarily complex operations and heavy governmental regulation.
Development of residential condominiums has come rela- tively late to this cycle. Typically, as an economy recovers, the rental market is in demand first, followed by for-sale product as potential buyers become more confident in the economy. During the current recovery, there has been evidence of demand for condos, particularly in the top gateway markets, where inventory of unsold units has seen historic lows and price escalation has been rapid. Unlike in past recoveries, however, supply response has been slow. Two factors are responsible for this: 1) banks and their regulators are reluctant to approve the risk of a large project; and 2) institutional investors view condo development as increasing capital at risk.
The housing market crash starting in 2008 was not kind to the sector. More recently, there are perceptions of overdevelopment of ultra-luxury condominiums in places like Manhattan. Early entrants into the condo market have generally achieved outsized returns, based upon early recovery land and construction costs and strong emerging demand in gateway markets. That oppor- tunity seems to be past. One condominium marketing executive
referred to those early investors who plunged into a market with limited capital availability as “bungee jumpers.”
Costs are a particular issue for high-rise product, even in those metro areas with proven luxury markets. A condominium market- ing executive limited this universe to Manhattan, San Francisco, Chicago, Miami, Honolulu, Toronto, and Vancouver. These high- end condos are facing resistance, particularly in Manhattan, where some developers are carving up large units for greater affordability. Where developers have produced units for $2 mil- lion or less, for the “merely affluent” as a New York Times article suggests, absorption is quite rapid.
In some value-add and opportunity funds, condo development using equity and mezzanine debt or preferred equity financ- ing has been attractive. Some investors note that if the for-sale market were to crash during construction, the project could convert to rentals until the market recovers, as was common during the last recession. If this were to occur, investors would be unlikely to achieve their return hurdles but would hopefully avoid a bloodbath.
Manufactured housing facilities have long been dominated by families and other private investors who provide land with infrastructure to accommodate manufactured homes. In strong urban locations, such properties can generate strong rental return, with relatively low operating costs. Management is often notoriously bad, so professionals can add considerable value. This sector has only recently been recognized by institu- tional investors, and then only by a few. In many cases, these properties are in good locations, where the underlying land is quite valuable. These can be tricky for investors given that communities often view these properties as valuable sources of affordable housing. Some impose special rent controls or provide other protections. A life insurance company executive noted that “more capital is coming into it.” Nevertheless, in our survey of residential property types, it ranked toward the low end of the enthusiasm scale.
Summary
The remarkable diversity of U.S. real estate means that our mar- kets are not only deep but also broad. From the largest investor to individual households looking to acquire property assets, there is something for everyone. Granularity is a positive feature and, as one Midwest residential developer put it, “It is best to stick with what you know.”