The market has noticeably changed albeit almost 30 months later than we all expected. In oversimplified terms, we had a rough Friday (pandemic), continued the party (free money) and are now calling in sick to work on Monday (inflation, etc.).  As we inched later and later in the present cycle risk seemingly disappeared from the concept of “risk adjusted” returns.  The best assets increasingly traded at comparable yields to lower quality buildings suggesting that “risk” no longer carried a material premium.  With uncertainty now present, the flight to quality is underway as investors seek relative safety in more established markets and more resilient property sectors such as housing and logistics.  Here are a few ways we are navigating the “new new normal” and staying active in pursuit of compelling investment opportunities:
  • Play offense when others play defense.  Our investment portfolio sits at under 50% loan to value with an average +/-3.50% interest rate fixed for over 5 years and relatively flexible prepayment terms to maximize value creation at sale when execution optimal.  Our leverage profile allows for patience with respect to each asset’s business plan without the maturity and/or interest rate pressure frequently at play in today’s market. Our debt is relationship oriented – real people and real conversations with regard to decisions today and tomorrow. Our conservative approach to leverage allows us to stay active in the market despite the meaningful increase in rates over the past 90 days which has substantially impacted floating rate borrowers.  

  • Our bidding activity tells the story.  We are continued believers in the fundamentals underlying industrial in major metros.  Demand is robust, supply is constrained, and liquidity continues to exist in the capital markets.  Yes, Amazon slowed their incredible leasing progress, but many other users exist in the rapidly growing e-commerce sector.  Last year we invested over $50M of equity into several industrial assets.  This year the vast majority of our offers to date are in pursuit of industrial.  The capital markets have shifted but the fundamentals remain historically strong.  As a reminder only 14.3% of retail sales in the United States (as compared to almost 30% in China and 27% in the United Kingdom) are consummated online which continues to bode well for increased logistics demand.  We will continue to devote attention to the industrial sector as a long-term part of our real estate thesis and plan to launch a dedicated industrial investment vehicle in the coming months.  

  • We’re strategic, but open to an opportunity.  We’ve always had an agnostic view of real estate.  Pursue the best deal at the best time matched with our internal capabilities. We’re more strategically engaged in pursuit of industrial and multi-family today but see opportunities, despite the headlines and albeit very selectively, in both office and retail.  We recently completed a reposition of an office asset that we acquired pre-pandemic and is now 100% leased.  But the contrast between commodity and non-commodity has never been more dramatic.  Office must have a compelling story to be considered relevant as a use.  It either works or it doesn’t.  We see opportunity where an “office is dead” mentality manifests in fear based selling at attractive values for otherwise high-quality product.

  • Inflation meets multi-family.  Rent growth has never been stronger across much of our apartment portfolio. We have always thought of multi-family as a great inflation hedge given the monthly mark to market nature of the rent roll.  We admittedly did not forecast rents to grow by as much as 40% on lease trade outs (i.e., new leases on vacant units versus previous in-place rent).  To put it in perspective, we acquired an apartment community in 2012 with in place rents of $1,670.  Today those rents have risen to a peak of $2,950, a 75%+ increase over the past decade (and a 37% increase on an inflation adjusted basis).  Overall growth trends over the past decade highlight the long term benefits associated with investment in well located housing.

  • Leverage has changed.  We’re moving from over a decade of positive leverage into, well, uncertainty.  We are a fixed rate borrower and moderate leverage at that.  Enhance the returns, but not financially engineering investment performance as a mantra.  Last year we borrowed in the 2.75% to 3.25% interest rate range fixed for up to 7 years on a handful of acquisitions.  Today interest rates price to a range of 4.50% to 5.00% on comparable assets and business plans while the same assets have increased in value since acquisition (though off peak pricing earlier this year).  A negative leverage environment (more prevalent in primary markets where going in yields are lower) puts increased pressure on exit value and appreciation (versus income) to achieve return.  Asset prices are starting to adjust to new rates, albeit slowly.  We see this correction as an opportunity to compete against more highly leveraged buyers.

  • Rotate capital into the next opportunity.  We try not to fall in love with our real estate.  Easy in theory, hard to do when you’ve poured your blood, sweat and tears into repositioning an asset.  Further, there are frictional costs in selling and we don’t view our platform as transactional in nature as we often hold longer term when a business plan warrants patience. But at times the potential downside far outweighs the future upside as market demand, supply, capital markets and/or investor appetite shifts in a way that creates longer term risk relative to reward. We evaluate each asset in our portfolio quarterly and on a case-by-case basis to assess the long term and continued opportunity to add value and create greater upside for our partners. When our analysis concludes that downside exceeds upside, we commit to a cost and tax efficient sale and pursue new, value add oriented real estate investment opportunities.   

We remain active in the market in pursuit of compelling investment prospects, but mindful of the shifting landscape. We appreciate the shared experiences and collaboration inherent in our partnership as we push forward in less certain times. Times of change often bring opportunities and we look forward to finding continued ways to create value together.

Your Partner,
Doug Arthur and TEAM SENTRE