The Long Game
Investors Need Managers to Update and Communicate their Long Term Perspective
Real estate investment managers have excelled in triaging their assets and updating their investors in recent weeks, clearly an improvement over the 2008-2009 financial crisis. As this situation comes under better control, the near-term investment opportunity is likely to be next on managers’ minds. Human nature leads us to shorten our perspective during times of crisis. Yet, managers would benefit from remembering that their institutional clients are long term investors. Forward-thinking managers are now considering how tenant needs will evolve in the years post-COVID. They are preparing for seismic shifts in demand drivers at their properties. Investors need their managers to update and communicate their long term perspective for property markets more than ever.
During the last financial crisis, we had inputs for the variables in our financial models. There was uncertainty about market rent and absorption, but historical precedent was a reasonable guide. Those market variables were being driven by necessity, not choice, making them more predictable. More people rented apartments because they had no money to buy homes, co-working thrived because people had to start their own businesses when no one was hiring. In contrast, the COVID pandemic will generate long-term choice-driven changes in how we use and occupy our real estate. Consequently, the outcomes are significantly more uncertain. This puts much more risk in the system and will lead to a wider range of investment performance outcomes.
Changes by choice are complex. Office assets, for example, may experience reduced demand from companies choosing to have more employees work from home. Yet, revised floor plans will increase the square feet per employee. With counteracting forces at work, what will be the impact on net absorption?
There may be other material effects too. With lower density offices and more employees working from home, our need for parking may decrease. On the other hand, many commuters may avoid public transit and need more parking. Alas, what happens to the support retail around offices if employee counts are reduced? Less take-out lunches, fewer stops at the pharmacy near the office, and fewer people getting together for the after-work beer, will all reduce the rent that those tenants can pay.
In multifamily, we may experience a new wave of rent controls in many municipalities, capping the upside on revenue growth. However, apartment demand may grow given the loss of home purchase down payments in the stock market. But will it? Millennials are having their second child, and many are now choosing to move to the suburbs. They may choose to rent a single family home instead. Pre-crisis, the trend had been toward revitalizing older inner ring suburbs with public transit access. Now, with fewer commute days, fear of public transit and a need for value, those young families may decide to move further out again. And suburban office – low rise, without elevator ‘choke points’ and without the need to travel by public transit – may experience a surge in demand consequently.
Investors need managers to carry out these scenario analyses across all property types. Managers hold the most detailed insights into property type usage. They are most capable of observing changing use patterns in real time and forming the clearest views on long term value. So now, as managers prepare to make more opportunistic investments that will arise from the crisis, they need to develop their forward looking reference points to complement the traditionally backward looking “price-per-pound” or “discount to replacement cost” metrics.
Real estate is a long term asset and institutions are long term investors. The market for investors in these assets does not function well with significant uncertainty. Not knowing the future uses, and therefore occupancies, rents and NOIs, makes valuation and strategy a complex and opaque analysis. Managers need to develop a clear vision of the potential changes to come in real estate and the impact on value. Managers need to take time to study, consider, and communicate their long term vision, not only their short term investment plan. Investors need to know they can rely on their managers to play the long game.