Principal Asset Management is witnessing an evolution of investor asset allocations to commercial real estate as more market players look to non-traditional property types and locations.
Indraneel Karlekar, senior managing director and global head of research and portfolio strategies at the Des Moines, Iowa-based manager, believes the structural shifts occurring in the US, European and Asian economies are changing the way people deploy capital into different property types.
“Ten years ago, 60 to 70 percent in REITs [was invested in] traditional property types and the remainder was non-traditional,” he told Real Estate Capital USA. “Fast forward to today and it’s the reverse – 30 percent is traditional 70 percent is non-traditional.”
To that end, the firm is also adapting its own business strategy, with Karlekar noting Principal is increasing its activity in sectors like life science, data centres, self-storage, and student housing assets.
“There is a plethora of alternative property types that we didn’t really like that we now [see] an important opportunity set emerging,” he said.
This also applies to subsectors within the robust and traditional residential space.
“Think about how different generations use housing; it’s not just multifamily, it’s recreational vehicle, it’s manufactured housing, it’s built-to-rent single family,” said Karlekar. “This gives a flavor of how quickly the housing market is expanding to include alternatives.
When it comes to the office sector, there are some unknowns, with Karlekar noting price discovery is very much an ongoing process and values are down 50-60 percent.
“The big questions on the minds of lenders [are] when does the broader office market start to stabilize [and] what’s the right valuation to ascribe to an office building?” he said.
“Once we get a signal from the Fed that it’s done [raising rates] or at least pausing [rate hikes], the market will probably start to then pencil in a bottom to real estate values,” he continued. “When that happens, investors and lenders will start to step back into office, but very much on an asset by asset, business-specific, location-specific, quality-specific basis.”
Location, location, location
There has also been an evolution of investor portfolios when it comes to geography, too with Karlekar noting pricing trepidation is affecting the formerly hot Sunbelt southern markets – a region which has seen a tremendous amount of investor interest over the last five years.
“I think lenders have become a little bit more careful about how they want to underwrite those assets in the Sunbelt and the South Mountain, the southern markets,” said Karlekar, adding he has seen rent growth and transaction volumes beginning to decline.
But to caveat that, the coastal markets have as a result become more competitive.
“From a lender’s perspective the West Coast, New York, are seen as better protected in terms of barriers to entry, less supply and return to work, which is returned to office which is now fuelling pretty strong tenant demand,” added Karlekar.
He continued: “I think you’re seeing a little bit of a bifurcation play out in terms of how the lenders, the lending community is looking at the market.”
“Good sponsors generally are able to access a variety of capital options up and down the stack all the way from senior secured to mezzanine to prefer but I think lenders are becoming more discerning about pricing, the more markets the lower barriers to entry versus markets and high barriers of entry,” he said.