TOO MUCH, TOO FAST? Investment Markets Eyeing Free-Flowing Capital With Some Concern
Some Worry Rising Capital Flows into CRE Threatening To Overheat Some Markets
By Mark Heschmeyer
March 25, 2015
As the San Diego City Employees’ Retirement System’s (SDCERS) board this past month debated putting an additional $30 million into JP Morgan’s Strategic Property Fund, a 100% core fund in which it already had invested $60 million, it had a major concern.
JP Morgan’s Strategic Property Fund bought $3.45 billion in core properties last year and has a queue of investors lined up to pump in another $1.7 billion. Compared with its peers, the JPMorgan fund has been one of the most active in buying core commercial properties, and SDCERS officials raised concerns that the manager had “pushed out capital too quickly.”
In the end SDCERS approved the additional commitment, concluding that the fund had deployed its capital in a “prudent manner,” and with the understanding that its new commitment most likely would take four to five quarters to invest fully.
The sentiment in the SDCERS boardroom is shared among other major CRE investors who express increasing concern over the impact of the large amount of investment capital flowing into commercial real estate is having on prices and underwriting.
For now, the concerns appear to be limited to the market for large trophy assets in a handful of coastal core markets.
“There’s no doubt that capital flows into commercial real estate are rising and threaten to overheat some markets, but the real concerns are limited to relatively few trophy assets in select gateway markets,” said Andrew J. Nelson, chief economist | USA for Colliers International in San Francisco. “There is little evidence of excessive pricing on a broad scale.”
Nelson said there has been a lot of attention paid to a few transactions in which some foreign buyers have supposedly overpaid for trophy assets because they were purportedly more concerned with parking dollars in safe U.S. assets rather than achieving a market rate of return.
“Only time will tell whether these purchases ultimately earn a competitive return, but a review of the market data does not suggest that foreign buyers are driving prices to unsustainable levels,” Nelson said. “Rather, the high prices they pay on average reflects their preference for top markets and more expensive asset types.”
David Bahr, senior commercial appraiser with Standard Valuation Services in Mineola, New York, said that geopolitical instability has been a friend to U.S. sellers, particularly in the New York City area, where Russian, European and Chinese investors have been very active.
“All this (overseas) money only complements the institutional and high net worth private investors’ capital hitting the markets,” Bahr said. “Supply is great but demand is excessive.”
How Much Is Too Much?
The answer to the question of what constitutes too much money in the marketplace often depends on the role that person plays in the market. Real estate brokers and sellers generally believe the more money, the better. For lenders, a flood of capital can be a double-edged sword as more money means more competition to finance deals and the likelihood they have to adjust their underwriting criteria to compete. For large buyers, it drives up the price of core properties; and for smaller investors, it can create unrealistic price expectations from sellers.
“There is a ton of money out there chasing commercial real estate, but in my opinion, you can never have too much capital at least from a seller’s perspective,” said Paul Carr, senior managing director, spearheading the capital markets team at DTZ in Tampa. “Most buyers probably don’t enjoy having the additional competition, but we have seen what it is like to not have enough capital chasing deals, especially in challenging markets.”
Overaggressive investors are just creating more competition in the market place, which again, is not a bad thing if you are a seller, he added.
Mark Alexander product council chair for medical office properties for SVN in Chicago, also said the concept of ‘too much’ is relative to the times.
“I don’t think you can adequately measure ‘too much’ or ‘too little’ capital. The free market is always a pendulum swing, and now it is swinging towards growth,” Alexander said. “The extra capital out there is startling mostly because we are not used to it (after) coming off such a lousy downturn. It may be too much but it is unstoppable in the natural swing of the market. It makes life better for us brokers as more deals will get done.”
With so much capital in the marketplace competing for borrowers, loan underwriting guidelines are easing almost on a daily basis, allowing lenders to put out more and more dollars to prospective borrowers.
Christian J. Johannsen, senior executive managing director of NAI Miami, said he believes buyers are “over investing,” paying huge prices for assets that don’t necessarily warrant the prices.
“This is facilitated by the easily available and very cheap money that they have already raised, have commitments for, or can borrow,” said Johannsen.
Albert M. Lindeman and Jeff Albee, co-chairs of SVN’s national office product council, said they see a definite ‘use it or lose it’ mentality among investors in the market.
“Most private equity funds and syndicators will acquire rather than return their money to investors. This can have an overall negative impact to the market by overheating it,” said Lindeman and Albee.
Smaller Investors Feeling the Heat Most
Bradley Djukich, chief operating officer of Gotham Corporate Group in Los Angeles, which focuses on sub $20 million to $50 million property acquisitions, said the influx of foreign capital has led to hyperinflation of asking prices on many assets.
“In my niche, this has been development sites and hotel assets,” said Djukich. “How can a domestic buyer with fiduciary obligations to his capital investors compete with a Chinese syndicate looking to get money out of China and into the U.S., regardless of returns?”
Hillock Land Co. in Newport Beach, California, pursues infill-urban development projects. It too finds challenges posed by the current glut of money in the market backing new development as sellers re-evaluate the market potential for existing assets based on their development potential.
“High (price) expectations among sellers is present in all assets of all sizes,” said Danny Kradjian, managing partner of Hillock Land. “Often, these assets are not attractive to institutional players, as they do not have the densities or size required to allocate existing capital in a fund, or meet targeted returns in the future. Thus, these assets are normally pursued by small-scale operators.”
But the sellers don’t necessarily understand that distinction.
“With sellers placing a premium on their assets due to the overall level of activity in the market, local operators are being priced out,” Kradjian said.
As a result, Kradjian said he sees two typical outcomes. Sellers with high expectations hold on too long to their existing assets and eventually lose prospective buyers. Or, out-of-market buyers pay a premium for assets on which they are unlikely to achieve necessary return.
Perhaps Mark S. Davis, senior appraiser of Meridian Appraisal Group in Winter Springs, FL, summed up the concerns among investors when he said, “When investors have access to cheap credit money, they transition from investors to speculators. The incentive in the current economic environment is to borrow and spend, not to save and invest. What’s easy to see is that everybody around you is paddling like hell to catch this big wave of credit money that must go somewhere.”
Link to Article: Too Much Too Fast