The next chapter in the real estate recovery is well on its way. Many segments are showing good signs of stability. Housing is improving. Class A industrial is inundated by fierce bidding. User demand is robust for buildings to purchase. Developers are active with many spec developments coming online. My non-real estate friends even know about multi-family housing. We are ready for a long period of smart buying for the long term. I call this period The Golden Age because it will consist of reasonable prices, excellent prospects for growth and minimal downside risks. All through the Great Recession, purchases have been made. But as low as these prices were, they were risky deals because the outcome was still uncertain. Now that the worst is behind us, we are at the start of a new cycle. This also means that Property Owners who did not want to sell at the bottom will fulfill their long delayed plans to part with good real estate. In other words, we are entering a stable period with less risk and the ability to create lifelong investments in real estate.
The Golden Age is characterized by stability, modest income returns, and careful location selection. Investors will start buying for the following reasons: 1) Better yield than available in other investments. 2) Position the investment so it can benefit from improving demographics and infrastructure investment. 3) Manage the debt with low leverage. 4) Begin to profit from buying at the bottom of the cycle. As a note of caution, although I use the phrase Golden Age positively, there will still be many pockets of stagnation when it comes to the effects of globalization, regulation, and an unbalanced economic recovery.
Because there will be a wide field to play in, decisions will need to be made where to start. The most obvious are solid buildings that are functional and well located. Locations near downtowns, transit infrastructure, industrial centers, and along major boulevards will be particularly attractive. Buyers should keep an eye on repurposing the property as occupancy trends change. Locations with growing demographics mean there will always be demand. Buying right is essential. And make sure there are not a lot of long term owners nearby who can undercut your rents.
Properties with future development potential are excellent vehicles to create long term wealth. They will be purchased with a view to land value even if there is an added residual cost for marginal improvements. If underwritten correctly, there will be a pop in appreciation after receiving a steady cash flow in rents. The purpose is to control a strategic location whether as a critical industrial property or in an area of improving demographics. Properties like these take work to find, but new tools, which I will discuss in a forthcoming SIOR article, are making the job of acquisition managers easier.
The biggest hurdle is lagging rents. Particularly in B buildings, rents are nominally the same as they were 20 years ago. But if deals make sense on current income, its unlikely rents will drop any lower. In fact with a growing economy and a short supply of good buildings, rent increases are the greater likelihood. Many new purchases are yielding a minimum 5% return on a relatively safe industrial building. 5% is not great historically but it’s very respectable in comparison to other investments. Professionally managed investment groups should easily exceed this benchmark with their higher levels of skill and experience. No one is anticipating a resurgent economic rebound. In fact, more slow growth is ahead with the possibility of recession. The emphasis should still be defensive. This means adequate returns, stability, and a proven location for better times.
The Golden Age is also good for property owners. They will be able to sell the properties they’ve been clinging to since before the dark days. Rising prices and more activity will give the Seller more choices. New investment groups are forming as conditions improve and this will lead to competitive bidding. If the property is near major infrastructure investments or development projects, these may cause values to rise. Often, new infrastructure leads to a new zoning plan that will allow more development rights. However, do not expect to collect the development profit without doing any of the work. And remember, lending is still tight for most properties.
Perhaps the most pertinent point for my client base is that when they purchase a property for their business they should select sites like an investor. This means avoid secondary locations unless you are purchasing substantially below market. The Great Recession proved that obsolete buildings located on cul-de-sacs are virtually unsalable. Try to stay on major boulevards, corners, and busier streets. But Users should not fear paying more than investors because the risks are much different. As long as the mortgage is close to rent, it’s a good buy.
Beginning next year, investment plans will start to take shape. But do not expect a fast start. The damage has already been so great the turnaround will only unfold slowly and it won’t be how most investors envisioned a rebound. Extreme bargains were rare and most are gone. But an even better table has been set – a Golden Age of real estate for intelligent investors.