As the commercial real estate market becomes increasingly bifurcated, $362 billion global investment manager Barings is increasing its focus on asset management and is adopting a more flexible approach as to what fits its debt and equity portfolios.
Joe Gorin, head of US Real Estate – Equity at the Charlotte, North Carolina-based firm, said asset management has always been critically important, regardless of the market environment. “But it is of heightened importance now on a number of fronts,” he told Real Estate Capital USA.
“The challenge right now is some product types are performing a lot better than others and [with this comes] a real valuation issue across the board, regardless of fundamentals. This is creating complexity in terms of how to transact on the debt and equity side. So, we almost find ourselves in this moment of paralysis.”
The firm, which ranked in Real Estate Capital USA’s RED 40, an annual ranking of US-focused commercial real estate debt funds, has found that in an environment where it is not always possible to transact, looking at organic portfolio value creation is key
“We want our asset managers to be the quarterback of the asset,” he said. “If there’s an opportunity to renovate units and achieve rent premiums, you can get a 20 percent return by doing that. It is the same thing as going out and putting that money into a new acquisition.”
On the debt side, it is a different ball game, noted Gorin, but there are some lines that are blurred between debt asset management and equity asset management.
“There are numerous instances where a deal will come into the debt side of the business and it doesn’t fit the thematic strategy on debt – or we don’t like the spreads we’re going to get – and we think it could be interesting on equity,” he said. “More often than not, on the equity side, we stick our nose up at it and say, ‘Why would I take equity risk here?’. It is important to understand how to steer your team and approach your investment criteria and thesis.”
When it comes to value creation, Gorin said debt asset managers have to think like equity managers.
“[They must ask], ‘Could there be value creation down the road?’ and ‘Are we going to have to take the keys back here? Or do we put that creative structure together to extend the debt and see the value creation on the other side?’”
Asset managers must also be focused on capitalization and debt maturities – not just a few months away but over the next two years.
“A lot of this stuff was financed in a different time and place, and so making sure that you’re meeting your debt requirements is an important component of it,” he said.
The residential – including single-family rental, build to rent and multifamily – and the industrial sectors are areas where strong fundamentals continue to exist for Barings.
“There is a need for – and shortage of – housing,” Gorin said.
While certain locations might be approaching some pockets of oversupply, generally the fundamentals for residential are strong.
“The same goes for industrial,” he added. “There are pockets where people have probably started building too much, but overall absorption is still positive and rents are still high.”
When it comes to office, Gorin believes there is going to be a subset of properties that will be worth more than they were in the past. The biggest challenge is when market participants try to hold on to values in the absence of transactions.
“You’ve got this disconnect between public and private pricing [presenting] challenges all over the place,” he said. “If you’re a debt investor and you have dry powder, you’re probably excited right now. You can have huge spreads and a great stock picker on the debt side.”
But for an equity investor it’s hard to transact – especially in the core, core-plus space.
“If you’re an equity investor you have to offer up returns that are probably higher than what you can get in the corporate space on debt. That’s where the challenge lies at the moment – we haven’t seen enough distress in the system to get value-add investors really excited.”
Recent office acquisition
The firm this week joined with Boston-based developer Greatland Realty Partners to acquire 275 Grove Street in Boston’s 128 West submarket. The property offers nearly 510,000 square feet of office space with an opportunity to convert into office and lab space.
“We’re not scared of office – we will invest on the equity side and on the debt side. We’re open for business all day long,” said Gorin.
When it comes to conversion, Gorin also sees increased opportunities to convert office to residential. “However, that will not fix all problems because of some of the physical limitations and the location – everything has to work just right,” he noted.
“The exciting part for office investors is they can start to invest again. The way many [market players] from previous cycles started – at discounts to replacement cost, not having to underwrite, peak rents and growth there from, exit cap rates that have spread to the risk free. You’re getting to the point in the cycle where if you find those good opportunities, the smart investors are able to invest.”
When looking ahead, Barings looks at a multitude of criteria.
“We’re looking at where the puck is going; future trends; existing trends; risks; opportunities, and which permeates across both debt and equity.
“Does that mean you buy anything at a discount to replacement costs? Even if it’s 80 percent discount to replacement costs – my answer is no. I don’t care if you [try to] sell it to me for $1. If I can’t put the fundamentals alongside it, I’m not taking it.”