Pitcairn Update, October 2015
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When great minds come together to share perspectives and experience, great ideas often emerge. For this reason, Pitcairn frequently brings together investment professionals to gather insight and develop strategies that may benefit our clients. Pitcairn hosted a roundtable discussion for a group of experienced real estate investors from family offices around the country. These professionals shared their unique perspectives on multiple real estate markets within the US and across the globe, which led to a thoughtful and provocative discussion on current real estate trends and the role of real estate in the portfolios of wealthy families. In this article, we have summarized the most interesting and useful discussion points to share with you.
Why Real Estate?
Pitcairn Chief Investment Officer Rick Pitcairn opened the roundtable by reiterating the important role real estate has long played in helping wealthy families and individuals achieve their investment objectives. “For some families, real estate ownership has been the primary source of family wealth,” said Mr. Pitcairn. “However, even for families who built their wealth in other ways, real estate plays a vital role in a diversified investment portfolio, helping to reduce risk and achieve longer-term objectives.”
With characteristics that differ from other major asset classes, real estate can offer specific advantages for wealthy families. “Buying and holding real estate can be an attractive strategy for generating current income and for transferring wealth to future generations,” points out Managing Director Andy Busser. Real estate ownership can also offer capital appreciation, helping to defend a portfolio against inflation. Performance cycles for real estate and REIT securities tend to vary from those of other major asset classes. “As a result, owning real estate and real estate securities, such as REITs, serves as a valuable diversification tool to enhance a portfolio’s risk/reward profile,” states Mr. Pitcairn.
A Look at Regional Opportunities
In the US, primary “gateway” markets have arguably become overheated, while others are just warming up. The consensus of the group was that markets such as New York, Washington, DC, San Francisco, and (for condos) South Florida have attracted an excess of capital, both domestic and foreign, and may now be reaching a point of overvaluation. These markets have reported record high prices for both commercial and residential properties. Construction abounds, with cranes a common sight throughout these cities. The boom is being driven by local economic growth, as well as interest from foreign buyers, particularly from China, Russia, and Latin America, who see US real estate as a safe haven from instability abroad and a store of value for their wealth. As a result, the returns investors must accept in these gateway markets is at record lows.
As a result of high prices in gateway markets, investment capital has begun to spill over into secondary and tertiary markets. Several roundtable participants noted that such markets can offer more attractive opportunities based on underlying economic fundamentals. Secondary markets such as Denver, Austin, Phoenix, Nashville, Dallas, and Atlanta are enjoying solid economic growth and offer higher potential returns and generally lower prices. Growing secondary and tertiary markets such as Columbus, Raleigh-Durham, and Salt Lake City offer still higher returns, but investors generally face less liquidity in these markets.
Housing Sector Trends
Residential housing represents approximately 40% of the US real estate market. Within the residential sector, multi-family construction has benefited from a trend toward urban living. Roundtable participants discussed how young couples and families are postponing what used to be a preordained move to the suburbs, while empty nesters are flocking back to cities to enjoy access to the arts, museums, and universities. In addition, with young people renting longer and older people returning to rental living, the surge in multi-family dwellings is not surprising. In many cities residential and condo construction is being built right in the middle of central business districts. In New York City, old office buildings are being converted for modern apartment living.
Amid the financial challenges of the recent recession, the number of available single-family homes rose to abnormally high levels, but the US now has a more normal inventory, and in fact may be short on supply in several markets. With low mortgage rates and delayed purchases finally being made, the US is likely to see an acceleration in single-family construction in many markets soon, which will be a boon to job growth. According to Wes Huang of the real estate investment firm Petrus Partners, “Single-family construction in most markets is recovering well. As construction increases, it is creating attractive investment opportunities in residential land.”
Though mortgage rates are likely to rise a bit as the Federal Reserve adjusts its monetary policy, the panel expressed confidence that rates are likely to stay relatively low for a number of years, a positive for single-family home construction and sales. Pent up demand was cited as another likely catalyst. “Many people have put off buying a single-family home for the past 7-10 years. Now these families are at a point where they want the type of homes, services, and schools for their children that are typically found in the suburbs. And suburbs mainly consist of single-family housing,” said Mr. Huang.
Real Estate beyond Our Borders
On the global front, roundtable participants noted extraordinary building sprees that have occurred in Russia and China, two countries that produced strong real estate returns over the last 15 years. The risks in those countries now are exacerbated by slowing economic growth in both countries, according to several roundtable participants.
Despite attention focused on the seemingly insatiable need for housing as China’s immense population migrates to cities, nobody really knows precisely what that demand imbalance is. China saw significant development of urban apartments, which rely on economic activity, particularly white collar employment, to fill rental units. While China’s economy has grown impressively, growth in knowledge-oriented white collar jobs has been slower to emerge. Related to this, there are also questions about the availability of sound financing sources for future building in China, as individuals have engaged in a great deal of speculative borrowing from the shadow banking system. On the industrial side, China is facing events like the recent shuttering of a steel plant that had employed over 15,000 people. In short, China’s economic growth is slowing, private financing may be harder to come by, and government spending on infrastructure may be a key economic stimulus. The group agreed that the challenge for Chinese officials will be to make sound infrastructure investments based on their merits rather than as political favors.
According to Chris Keber of Hines, an international real estate firm, Russia has delivered some of the highest returns in the global real estate arena over the last 15 years. “Russian real estate has been available for purchase at very attractive prices because foreign investors have not been clamoring for that market. Another factor in Russia’s favor is that property rights are now highly prized, a reaction to historic situations where government actions have superseded individual property rights. As a result, real estate rights in Russia are very well protected.”
Tips for Successful Real Estate Investing
Throughout the roundtable discussion, speakers emphasized strategies for successful real estate investing, including:
- Build a diverse real estate portfolio that includes different types of holdings (commercial, residential, business, retail, etc.) in multiple regions and countries. This decreases the impact of boom and bust cycles that are endemic to real estate investing. REITs can be effective vehicles for this approach.
- Use leverage judiciously, when necessary. Banks are comfortable lending because they have experience in real estate. Individuals are comfortable borrowing; after all, nearly everyone has at some time had a mortgage on a home. However, our roundtable participants were unanimous in cautioning that too much leverage puts real estate owners at serious risk when markets weaken – as they inevitably will. Over-leveraged real estate was a fundamental catalyst behind the 2008 financial crisis.
- Don’t follow the crowd. Truly successful real estate investors buy on dips, when losers are selling.