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Watch List (March 24) High Asset Values Making it Hard for Opportunistic Investors to Deploy Dry Powder

Also This Week: Some Prominent Non-Traded REITs Have Come into Play
March 23, 2016
Buoyed by the strong increase in property values in recent years, 82% of private equity and institutional investors expect to commit at least as much capital to real estate in 2016 as they did last year, according to institutional investors surveyed by Preqin for its 2016 Investor Outlook: Alternative Assets report.

In addition, 53% of investors are below their strategic targets to real estate and many expect to increase their targets in the medium-to-longer term.

There is a problem, though. It is becoming increasingly challenging to deploy that raised capital, with high asset valuations cited as a primary concern, according to analysts with Morgan Stanley Research. As a result, capital raised to invest in U.S. commercial real estate continues to pile up, leading to record amounts of dry powder.

“This is a double-edged sword that highlights the rising risks of record-high prices while the capital that ultimately needs to be deployed may serve to partially mitigate the risk of falling prices.” Morgan Stanley analysts wrote in a report entitled Mo Money Mo Problems.

There is ample capital to invest: $107 billion of capital was raised in 2015 to invest in U.S. CRE and funds now have a record $231 billion in dry powder available to invest. Value-added and opportunistic funds raised the most capital in 2015 (about $75 billion combined), shifting away from the core strategy of prior years, according to Preqin and Morgan Stanley.

However, with that much money challenges arise. For starters, demand across all CRE property sectors remains well below the last CRE peak in 2007, according to Morgan Stanley analysis of federal data. Demand here is measured by investment as a percent of gross domestic product (GDP).

Office and retail investment are near their lowest percentage levels since the late 1970s. Demand for multifamily structures is comparable to early 1990 levels, at around 0.3% of GDP. Those numbers though are on the increase across all property types (aside from retail), with office and multifamily leading the way, Morgan Stanley noted.

This increasing outlay is coming seven years into the economic recovery - one of the longest periods of recovery on record. Invariably, some investors wonder how long the up cycle will last.

“There is an increasing lack of consensus in the market as the percentage of investors that have a positive view on the market has risen, but 12% now express a negative perception compared to none the year before,” Morgan Stanley noted.

The vast majority (68%) of surveyed institutions cited valuations as the primary concern in 2016, while performance (30%) and deal flow (27%) were noted as other considerations.

KBS Realty, Behringer Harvard Shopping Some Non-Traded REIT Portfolios

Non-traded public REITs formed near or at the last peak of the commercial real estate cycle from 2005 to 2007 have hit the disposition stage of their life cycle, putting nearly $3 billion of property available on the market.

This past week, KBS Realty Advisors engaged Evercore Group LLC to act as financial advisor in exploring sale or investment options for two of its REITs: KBS Real Estate Investment Trust and KBS Real Estate Investment Trust II. Both REITs targeted core office and industrial properties.

The group of non-traded public REITs exploring sales also includes Behringer Harvard Opportunity REIT I and II, which were formed primarily to acquire opportunistic and value-add properties. Both Behringer Harvard REITs are actively disposing of properties individually.

Of the four, KBS REIT controls the largest bundle of properties by far with 364 properties having a total asset value of about $1.1 billion. However, KBS REIT II controlled the higher dollar value of assets at $1.36 billion consisting of just 12 office properties.

As of Dec. 31, 2015, KBS REIT controlled 364 real estate properties of which eight were listed as held for sale. Its 356 properties held for investment encompassed 7.7 million rentable square feet. The properties are in 30 states and include office, industrial and bank branch properties. It was 85% occupied with average annualized base rent per square foot of $17.09. The weighted-average remaining lease term was 4.3 years.

As of Dec. 31, KBS REIT II controlled 10 office properties, one office/flex property and an office campus consisting of eight office buildings. Together, the portfolio encompasses 5.2 million rentable square feet. Its portfolio was approximately 87% occupied with annualized base rent of $135.8 million and an average annualized base rent per square foot of $29.80. The weighted-average remaining lease term was 5.4 years.

As of Dec. 31, Behringer Harvard Opportunity REIT I owned four properties outright and three properties through investments in joint ventures. In addition, it has a non-controlling, interest in a joint venture consisting of 18 properties. Its mix of holdings includes three office properties, two hotels, a mixed-use multifamily retail complex and land in the Bahamas. The properties posted $55.4 million in revenue last year. Its total assets value was listed at $307 million.

As of Dec. 31, Behringer Harvard Opportunity REIT II owned 12 properties, including five apartment complexes, two student housing complexes, two office buildings, and one each medical office building, hotel and self-storage facility. The properties posted $50.3 million in revenue last year. Its total assets value was listed at $344 million.

More Value-Add and Opportunistic CRE News

In an environment where investment money goes to the biggest players Interstate Equities pulled in $200 million pretty quickly for its third value-add fund. And, HRI Properties received another $50 million from Almanac Realty Investors.

CNL Healthcare Properties II just got the go-ahead to raise up to $2 billion in a new initial public offering. It will be targeting value-add and development health care properties.

In a contrarian play, Normandy Real Estate Partners teamed up with Sigular Guff to acquire a high-vacancy 600,000-square-foot Herndon, VA office park.

A $400 million venture comprised of The Bascom Group and funds managed by Oaktree Capital Management closed on its third investment in the last three months.

Other newly reported value-add buys include:
Cedar Grove acquires South Carolina apartments;

Lightstone acquires a Hampton Inn in Lansing, Michigan; and

Baceline buys Roebuck Plaza in Birmingham for $4.4 million.

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