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Trends Watch: Commercial Real Estate

Feb 23, 2023

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with David Wallace, Principal, TRX Capital.

What is your outlook for commercial real estate?

My outlook is negative. Despite a significant ~28% price decline in 2022, publicly listed REITs aren’t too compelling today. Their dividends (and economic cap rates) are low versus fixed income instruments and their growth potential is hampered by higher financings costs, resulting in less accretive acquisitions. Meanwhile, the private real estate market (including non-traded REITs) hasn’t repriced much at all off record high valuations — likely lagging due to longer transaction timelines and internally driven mark-to-market mechanisms. As such, I think we could see private market values fall quite a bit this year (narrowing the valuation gap versus publicly listed REITs).

What are the greatest opportunities you see and why?

Although I expect continued downward pressure on real estate values, there are defensive instruments issued by publicly listed REITs that are interesting, particularly after repricing in 2022, including preferred securities, bonds and some structured tranches. In the private market, I expect to see similar opportunities emerge in the form of preferred equity, mezzanine debt and JV recapitalizations. The latter could get particularly interesting since the private market uses much more leverage than publicly listed REITs and, unlike after the financial crisis, “blend and extend” could be tougher this time if interest rates are high while valuations are down (particularly in the office sector where revenues could also be challenged due to work-from-home headwinds). 

What are the greatest challenges you face and why?

My challenge is to bring a longer-term, fundamental value mindset (from a 15+ career in private equity real estate) into the public stock market arena where short-term performance and noise dominate. Doing so helps me capitalize on the impact of broader public market volatility on a REIT’s more static asset base (which is ultimately tethered to valuations in the much larger private real estate market).

What keeps you up at night?

Since last summer, I’ve been thinking that a ~5.0% federal funds rate (if held long enough) would be adequate to rein in inflation. Consumer price index (CPI) data was supporting this view; however, I was disappointed by Powell’s dovish tone at the February Federal Open Market Committee (FOMC) amid loosening financial conditions. For example, going into the meeting, bond markets were already forecasting rate cuts in 2023; after Powell’s presser, the 10-Year Treasury Yield dipped below 3.4%. This trend is concerning:  If financial conditions loosen too much/too soon (with China reopening while we have renewed exposure to oil prices without the strategic petroleum reserve) inflation could prove sticky, and rates might have to go even higher. This would be tough on real estate values and why I prefer to invest in defensively structured positions within REIT capital structures (with the occasional short on more vulnerable REIT common equity). Speaking of “keeping me up at night” – shorting real estate is always tough due to its strong track record and enduring intrinsic value (but any publicly traded company can be overvalued).

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.

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Elana Margulies-Snyderman

Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.

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