Building under construction

Conventional wisdom says when interest rates go north, real estate goes south. And that may be the case for 2019, but here’s the rub: The recent stock market correction and worries of a potential recession means diversification into other asset classes, even real estate investment trusts, is a must. A review of 2019 forecasts in the real estate arena shows a push for specific purchases, although caution is advised.

REITs in general are not getting much love for 2019, but real estate is. “Real estate fundamentals are expected to remain solid in 2019, despite the market’s late cycle, rising interest rates and structural change disrupting the office and retail sectors,” Nuveen says in its forecast for the year. ”Positive global growth forecasts and an overall balance of supply and demand continue to support net operating income and property values. Commercial real estate continues to attract capital, with stable income returns generally exceeding those available in fixed income. However, little or no capital appreciation can be expected and putting new capital to work remains challenging.”

Sector-wise, Nuveen sees the best opportunities in data centers and manufactured housing. Further, the firm states that residential apartments globally will continue to benefit from strong demand as “middle-income families and millennials [are] priced out of homeownership. Global real estate debt’s stable income returns and lower volatility have offered risk protection for real estate equity portfolios.”

LaSalle Investment Management recognizes the uptick of inflation and “late-cycle anxiety that have permeated the North American economy,” but states that “core values should demonstrate resilience.”

That said, LaSalle’s Bill Maher, head of research and strategy for North America, warns that “late-cycle investing requires higher degrees of both caution and conviction to keep a real estate portfolio performing at a high level.”

LaSalle also cautions that “new supply poses a potential cyclical risk,” especially if there is a macroeconomic slowdown. They note that the Opportunity Zone program established in the 2017 tax overhaul may lead to a “flood of new supply that impacts overall market fundamentals.”

No Denying Climate Impact

Another “flood” is based on the reality of climate change, and how investors “increasingly consider property elevation and flooding risk,” the LaSalle outlook states.

According to a PWC/Urban Land Institute study, “Emerging Trends in Real Estate 2019,” sustainable investing in the asset class is growing. In fact, it found in 2018 that planned investment of almost $40 billion was invested in sustainable real estate by institutional investors.

The paper added, “[sustainable investing] principles are shaping operations in institutional portfolios, and investment managers focused on REIT stocks are similarly evaluating corporate management through ESG metrics. REITs are being scored on energy efficiency, carbon footprint reduction and conservation policies. Socially, employee engagement, community involvement, and corporate ethics are considered. Governance metrics examine risk management and value creation, as well as shareholder alignment and board independence. ESG variables particular to each property type have been identified and performance comparisons within peer groups analyzed. At least one global REIT asset manager excludes companies that do not have a qualifying score on the Global Real Estate Sustainability Benchmark (GRESB).“

It adds that “with target dates extending up to 2030 and beyond, this trend is likely to be powerful over the next decade or more. In many ways, the ESG approach will be one pillar of public-private partnerships going forward.”

The reasons for this move are material as well: The cost of major disasters in in the U.S. ballooned in 2018, to more than $300 billion, five times more than in 2017, and more than twice as much as in 2012, the most recent high.

Best Investment Moves

PWC states that the best bets for real estate in 2019 include:

  • Industrial development: E-commerce expansion isn’t over, and warehouses are still in need. These properties offer “great risk-adjusted returns.” One thing that could cause trouble is a “trade war of serious proportions.”
  • Garden apartments and multi-family assets.
  • Quick value-add flip deals: PWC states that this with this “late-cycle opportunity,” however, location definitely matters: “Geographic focus needs to be in markets where assets have not yet been priced to perfection. These are mainly second-tier markets in the South and Intermountain states. “Affordability to middle-market tenants — both commercial and residential — describes where underserved demand can be satisfied. This is not low-hanging fruit by any definition; but for yield-oriented investors with turnaround expertise, such deals are right in their wheelhouse.” The survey found the top five areas for overall real estate prospects are: Dallas/Fort Worth, New York/Brooklyn, Raleigh/Durham, Orlando and Nashville.
  • Redeployment of obsolescent retail assets: This isn’t new, but still a potential investment into 2019: “If a site is sufficiently large, mixed use is a great option for close-in suburbs looking to exploit maturing millennials’ desire to enter their next life-cycle phase. There also is an opportunity to turn the tables on the e-commerce trend that fostered the obsolescence by redevelopment into distribution facilities.”

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