What are the prospects for investing in real estate in a potential rising interest rate environment? The first two articles this week address the return prospects for core real estate in a rising rate environment. The third article is an update on the phenomenon of private equity funds purchasing homes for long-term rental.
Taper Protection: Where to Go when Rates Rise. “Faced with the dilemma of where to allocate capital to generate income, direct “core” real estate is an optimal solution in the current investment landscape. Core real estate is characterized by high-quality real estate assets, leveraged between 0% – 30%, a stable tenant base and conservative income-focused return targets. The writer produces historical results of how core real estate has performed in rising-interest-rate and inflationary environments. “Based on the historical information….private core real estate has performed well during rising-interest-rate periods and has been uncorrelated with (i.e., has not been strongly influenced by) periods of rising interest rates.”
“The demand for real estate has improved along with the economy since the global financial crisis. New supply of real estate has remained muted. With increasing demand and limited supply, I expect real estate to deliver above-average income growth in the near-to mid-term. If interest rates increase because of improving economic conditions (job growth, improvements in the housing market, etc.), demand for real estate will increase, which bodes well for the asset class…with institutional real estate managers forecasting unlevered core real estate returns of 8.1% annually from 2013 to 2015 with 60-70% of that return derived from income, bond investors can solve their interest rate and income woes by allocating to core real estate.”
Eight reasons why core property investment still makes sense. This White Paper is prepared by the Global Real Estate and Strategy team of TIAA-CREF, the behemoth serving the retirement income needs of individuals in higher education and research. The White Paper, dated April 26, 2013, offers in-depth analysis of the attractiveness of “core” real estate in the present environment (see above article summary for core real estate definition). The White Paper offers eight reasons why core investing continues to make sense. In summary, “an expansionary real estate cycle, attractive pricing, strengthening economic and employment conditions, improving fundamentals and operations, and cheap readily available mortgage financing clearly support core investing.” I would add that attractive valuations provide a buffer to price declines in a potentially rising interest rate environment. One of my friends, a real estate “high roller” in Nashville, commented that this white paper is a “lucid, intelligent assessment of the current climate and way to mitigate risk.”
Private Equity Seeks Single Family Homes to Rent. Mortgage foreclosures are a major national problem until they’re not. Now that private equity groups have stepped in to buy and rent single family homes, the share of mortgages in foreclosure has fallen to the lowest level in four years. This article from Bloomberg discusses several aspects of the phenomenon of private equity allocating significant capital to the ownership and rental of single-family homes. Unable to find enough distressed properties, private equity has now turned to buying new properties directly from builders. 118 homes have been bought in Nashville. The economics of buying to rent may be turning, however, with rents leveling off and the home prices appreciating.
And in case you missed it, click here to read last week’s blog post on the recovering bond market and cause for investing in Emerging Markets.
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J. Mark Nickell & Co.
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