What CRE category is undervalued?

Question

I'm selling some apartments at what feel like crazy low caps. I'd like to 1031 the money into a value play of some kind. Retail is the traditional next step but I'm concerned about the outlook for anything except AAA locations.

I'm considering:

- Industrial - Apparently this is where the smart money is going in my market, but I don't know the first thing about making a good play here

- Health care - Pretty much recession proof but it's hard to compete with the REITs for quality product

- Office - Terrible in my market, might be good in others

- Restaurants/bars - Cap rates almost as low as residential for quality local tenants, and much lower for NNNs

Where are you guys seeing high cap rates and good outlooks?

@joel owens - I'm sure you have some good comments here as always!

Ramon Jenkins · Answer

I kind see what you mean about the multifamily values in your investing area.

Example 14 unit building hit the market today.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Rental income average $835  ( 1 and 2 bedrooms mixtures )

Property taxes around $22,000 per year ( ouch )

Current asking price around 1.2 million

After running some quick numbers -> less than 1% rule

-> 5 to 6 cap rate

K.marie  P.,

@Ben Leybovich, @Jon Klaus : might have some insight regarding CRE

Nick L. · Answer

@Jenkins Ramon Yes that is around where I am selling. I am for sure not a buyer at those caps, so I must be a seller.

@Joel Owens Your observations reflect my own quite closely - especially since we are in quite different markets. Am I distilling your comments correctly in saying the following?

1. Retail strip malls can still offer good value

2. Medical office space has growth potential

3. Industrial is down right now but might be a good long term value play

4. Stay far away from SFR, multifamily and office

Joel Owens · Answer

Multifamily is just too frothy. Over the next 6 months for clients I am expecting to close out about 100 million in volume on the commercial side.

I specialize in multifamily and retail. The other asset classes I have friends (other brokers) who have been doing that niche for decades.

On a macro scale every asset class cycles generally in 10 year increments but at different points in time.

My view currently is that SFR in many markets started a recovery in 2009, 2010. Duplexes to Quad's 2011, large multifamily and STNL ( single tenant net lease ) 2012,2013, and retail strip centers and medical office 2014,2015.

There is still tread left on retail. Most of my closings are retail now. I have many clients from New York and California selling at a 3 cap and trading into a 7.5 to 8.25 cap rate center.

Industrial is making a comeback but I would say a few years behind retail and office in many markets is still taking a beating. Medical is hot but regular has been lackluster as the smaller micro spaces are just recovering. When the economy seems better is when people will use funds to go after starting their own business and buy or lease office space. Biggest downside to office is the footprint has been reduced for companies with work from home / limited commute programs. So even if not much new office is being built there is an oversupply from the space contraction. I personally do not like regular office as it is very easy for a tenant to leave a space in one night versus a built out retail space that can make it difficult to relocate and expensive.

90% plus of retail closings last year were furniture and clothing related stores. I avoid those like the plague with the centers we are looking at. I am seeing a lot of TV shows touting residential now. I saw this in 2007,2008 when about 2 to 3 years of that had occurred. Nobody can predict anything but seems SFR will have a dip in 2 to 3 years from now. When everything has reached a critical mass phase on new development across all sectors of real estate then a downturn is imminent.

We are not close to that happening in this current cycle from what I am seeing. Nothing is 100% just what I see day in and day out and investor & lender sentiment in the market.

Nick L. · Answer

@Daniel Chang

You make some good points. I guess I was pretty vague. More specifically, what I would like to do is to find some opportunities where I can (a) add value through my work, (b) have a reasonable expectation of natural cap rate compression, and (c) have a favorable risk/reward balance.

Of course every market is different and for sure SoCal is completely unlike Milwaukee. I was just hoping to tap into the collective BP wisdom to help shape my search for a forward investment. For example, in the 2009-2012 period, multifamily was a clear winner because there was a huge tenant demand coupled with fire sales and irrational investor fear. I am hoping to find something like that.

Maybe I should just sit on the cash and wait 5 years until the current overbuilding of Class A apartments plays out and they are all sold off at bargain prices!

Nick

Daniel Chang · Answer

Nick,

I'm only talking in generalities, since you don't specify many details, such as if you are investing for cash flow, for appreciation, for repositioning/value add, etc.

Anytime you state something like "this is where the smart money is going", it sounds like that it has already appreciated.  Also, be careful as stating things such as "healthcare is recession proof".  You are not in the healthcare business, you are in the real estate business.  That comment has no bearing on whether you should buy an asset built for healthcare, nor will your property have a higher ROI or lower vacancy.  For instance, you buy a building with an urgent care.  That urgent care can lose money (many do) and hence not be able to make lease obligations.  These comments only make sense on a macro scale, but have no bearing on the few properties you may acquire.

It sounds like you are selling out of multifamily because you see it overvalued (low caps) and looking for a CRE category that is undervalued (on average of course).  Based solely on what you stated, your "value play" would be to go into office based on you stating that it's "terrible".

In my market (Inland Empire, So Cal), all asset classes are overvalued.  However that's why you are in real estate.  You can always find an undervalued asset in an overvalued category.

Joel Owens · Answer

Regular office is a few years out. Lot's of vacancy. Some love it I am just not big on it. I am not against the other asset classes it just seems there are no properties to buy at what I would consider purchasing at.

What CRE category is undervalued?

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