Five Challenges Facing Investors Today
Chris Loeffler is the CEO of Caliber (CaliberCos Inc.), an alternative asset manager and fund sponsor with approx. $500M in AUM.
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In the opening months of 2022, the private real estate sector has benefited from positive macroeconomic momentum, boosted by rising GDP, record levels of job growth, strong consumer spending and stimulus programs.
The landscape, however, is not entirely serene. Participants in private real estate markets—including individual investors, asset owners and portfolio managers—are facing several challenges:
1. Sustained Inflation, Strained Supply Chains And Tight Labor Markets
In January, the annual U.S. inflation rate accelerated to a 40-year high of 7.5% as what arguably began as a pandemic-related trend has become a broader, sustained phenomenon. The sharp increase in prices is driven by strained supply chains, tight labor markets and an uptick in energy costs. Together, these forces make certain real estate investments more expensive and create the potential for heightened volatility across wide swaths of the market.
That said, private real estate has the reputation of performing well during periods of elevated inflation. For investors seeking a hedge against inflation, the challenge is to identify the right private real estate investments. These could include opportunities with favorable supply and demand conditions that allow property owners to pass higher costs to tenants or development projects where rent growth and cap rates can protect profit margins in the face of rising construction costs.
2. Rising Interest Rates
In light of stronger hiring, consumer spending and inflationary pressures, the Federal Reserve is expected to reduce its balance sheet and embark on a series of interest rate increases. As a result, the private real estate market will be challenged to manage interest rate risk and navigate the subsequent impacts on property values and investment performance.
To minimize any damage from rising interest rates, real estate investors will need to think carefully about leverage, with a sharp focus on managing higher borrowing costs, bolstering cash flows and creating value.
3. A Growing Focus On ESG Factors
Environmental, social and corporate governance (ESG) factors, once seen by many participants in real estate as peripheral concerns, are now taking center stage. Several developments are fueling the sense of urgency, including net-zero commitments, new regulatory standards and a massive transfer of wealth to younger generations.
In this environment, asset owners and investors are reconsidering their fundamental approaches to developing and operating real estate by asking:
• What ESG factors are material?
• How should ESG be incorporated into asset and portfolio valuations?
• What ESG risks do private real estate investors face, both direct and indirect?
• How can private real estate participants create new sources of value for investors, tenants and communities?
Real estate investors who proactively address ESG challenges will be well positioned to generate attractive financial returns, establish wider competitive moats and, perhaps most importantly, improve the world for future generations.
4. Changes To The Way We Live And Work
The Covid-19 pandemic spurred significant changes to our daily lives. Today, real estate investors are challenged to assess if, and to what extent, the changes will be sustained. What will stick, and what will be tossed aside as society feels “normal” again?
Such assessments must be made on a granular level—often property by property. In the office sector, for example, outcomes for individual buildings could be vastly different depending on location and whether a building’s layout can be reconfigured or made more flexible.
The analysis is similarly complex for the hospitality sector. Vacation travel might be rebounding, benefiting hotels in certain locations. Business travel, on the other hand, might be slower to recover, putting a damper on hotels, retail centers and restaurants, which rely heavily on expense-account spending.
5. Powerful New Technology
A boom in property technology (proptech) is catalyzing change in the private real estate sector, empowering asset owners and investors to improve all areas of business operations, from design and construction to tenant relations, climate risk assessments and financial management. Data analytics and artificial intelligence, for example, can help predict property values, pinpoint new investment opportunities and determine the timing of rent increases.
As the pace of proptech adoption accelerates, real estate enterprises are challenged to stay ahead of the curve. To remain competitive, private real estate companies must succeed in identifying and implementing optimal tech solutions.
In summary, the private real estate market is poised to benefit from supportive fundamentals in the months ahead. While several challenges do exist, I believe that they ultimately present opportunities for well-positioned market participants to come out ahead.
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