1. Acquire Distressed Retail Assets

Acquire beaten down mall and retail CRE assets as the premise that they are obsolete and everyone will be shopping at Amazon in the future is a false paradigm. Many Class B retail

assets are trading a 7.5% plus cap rates and those with high vacancies can be retenanted with service, food or niche service (bowling alleys, entertainment venues, etc.) type tenants. This investment strategy requires significant retail management and leasing expertise and should only be undertaken by investment firms that possess this experience.

2. Invest in Niche CRE Sectors

Approximately 85% of CRE investment funds are targeted to the four primary investment sectors of office, retail, apartment and industrial. These assets are the most overpriced and competition for deals is still fierce. However, the niche sectors that include self-storage, manufactured housing, senior housing, data centers and others are, in general, selling at 1%-2% higher cap rates than the traditional sectors with the same growth and return prospects. During the last few years, the self-storage, manufactured housing and data center REIT sectors have been three of the best performing with three year returns of; 7.7%, 8.8% and 5.6%, respectively.

3. Invest/Finance Development Joint Ventures

Commercial banks are very cautious in making construction/development loans and with higher projected GDP growth, the demand for new CRE space should accelerate. This increase demand will primarily effect office buildings and industrial properties. The Basel III rules for commercial banks created a new loan classification for CRE construction loans labeled as; “High Volatility Commercial Real Estate (HVCRE) loans. HVCRE's are defined as; “a credit facility that prior to conversion to permanent financing, finances the acquisition, development or construction of real property.” If a bank has HVCRE loans, then the capital charge is set at a level 50% higher than non HVCRE loans. A CRE construction loan can avoid being classified as HVCRE if; the loan to value ratio (depending on the property type) is less than 75% for land development and 80% for commercial/residential construction properties, the borrower has invested at least 15% in equity and the borrower equity investment remains in the project until either refinanced or sold. Therefore, many banks will be reluctant to fund any construction deal that may even remotely be a HVCRE. This lack of construction capital will open the door for shadow lenders and investors to provide this badly needed funding and make development deals that do have bank financing even more valuable.

4. Sell Class A Apartments

As we have stated in our investment strategies for the last two years, sell Class A apartments. Class A apartments especially in hi-beta markets are still selling a low cap rates and should be sold. The proceeds should be reinvested in Class B&C apartments in tertiary markets where caps rates are in the 7% plus range. Also, the number of new apartment units being built around the country is continuing unabated. From 2013 through November 2016, apartment permits and completions have totaled, 1,563 and 1,184 units, respectively per the Mortgage Bankers Association third quarter 2016 Data Book.

5. Invest in Non-U.S. REITs

All investors, both individual and institutional should have an allocation to REIT stocks. As shown in the REIT Statistics section below, the ten-year return for equity REITs per NAREIT was 4.44% while for the FTSE/EPRA NAREIT Developed Index (which excludes U.S. based REITs) the return was more than twice the U.S. rate at 10.3%. Investing in non-U.S. REITs provides portfolio diversification which not only generates higher returns but low correlation and thereby lower market risk than U.S. REITs and other asset classes.

6. Target Smaller and Tertiary Markets Instead of Core Markets

National real estate investment firms should refocus investment efforts on smaller and tertiary markets instead of the core markets like; San Francisco, New York, Boston, Seattle, Miami, Houston, Washington D.D., Chicago, etc. The share of transaction volume invested in global core markets has risen to 40% as shown in the graphs below by Prudential Real Estate Investors.

The competition for deals in core markets is very robust and the cap rates are still compressed, which will lead to very low returns on equity. We here at VOM have discussions with investment firms all the time and often argue that buying a Class B office building in a smaller market like Tucson, AZ at a 7.5% cap rate will generate a higher risk adjusted return than a Class A office property in San Francisco at a 4% cap rate.

7. Seek Properties with High Income Growth Potential

With the rise in interest rates, investors will need to target CRE properties with higher income growth. The 10 Year Tnote has increased from 1.6% last fall to 2.5% today and is expected to be 3%-3.5% by year end. The cap rate for a property can be calculated by the formula; Risk Free Rate (Rrf) plus Risk Premium (Rp) less the Growth Rate (G). If we use the 10 Year Tnote of 2.5% as the Rrf, the CRE risk premium or Rp of 6% and income growth or G of 2.5%, then an average cap rate is 6%. If interest rates continue rising and the 10 Year Tnote hits 3.50% later in 2017 and the Rrf and G remain the same, average cap rates will rise to 7%. CRE sellers are usually 12 months behind changes in market valuation and cap rates and therefore will not sell at a 7% cap rate, thereby forcing buyers to seek properties that have higher income growth potential. This will mean a higher focus on value-added and opportunistic investments with higher return potential.

8. Invest in or Own CRE Brokerage Firms

Higher GDP growth and inflation will continue to grow the volume of CRE leasing, sales and financing transactions. This will bode well for firms in the CRE brokerage and financing sectors. Transaction volume have been at record levels the last few years and it is expected to continue at a more robust pace with the new Trump administration. One leading indicator of transaction volume is the stock price gains of the major CRE service provides. Although some of the stocks are down from their multi-year highs, their growth prospects are solid.

9. Invest in Hotel and Lodging Assets

The positive and robust growth policies of the new Trump administration should increase GDP growth from an average of less than 2% under the Obama administration to 3.5% or better. Higher growth will lead to higher interest rates (as discussed above) and higher inflation, both of which will be very positive for hotels and resorts and the lodging sector, as a whole. If inflation increases from the new normal CPI of less than 2% per year to 3%+, then real estate assets with shorter duration leases like hotels should be favored. Hotels have one night leases and will thrive in a higher growth and inflation environment. Hotel REITs have been one of the best performing sectors in 2016, with a total return of 14.44% (through 11/16), as investors anticipate higher growth and returns in the future.

10. Join Trumps $500B to $1T Infrastructure Construction Plan

The Trump administration has called for a large $500 billion to $1 trillion infrastructure and renovation program in a public/private partnership structure for highways, roads, bridges, airports, schools and hospitals. This will be a further boom to the CRE industry and those developers and service providers participating in the renovation projects will benefit tremendously. CRE investors that own property contiguous to and nearby large infrastructure developments will also benefit. Large CRE developers and service providers should be available to bid on and participate in this infrastructure once in a lifetime real estate program.

WALNUT CREEK, CA—The CRE industry is still in a valuation bubble. That is according to Joseph Ori, executive managing director of Paramount Capital Corp. “Although average prices have moderated somewhat, overall values are still too high and cap rates too low, especially for core properties in core markets.”

The industry though, he says, “is very upbeat with the new Trump administration and its pro-growth and inflation pumping policies. These policies should increase the demand side of real estate which has been somewhat muted during the last four years.”

Overall, Ori says he is very optimistic for CRE in the next few years and offers his 10 CRE investment strategies for 2017.

The views expressed in the commentary below are the author's own.

1. Acquire Distressed Retail Assets

Acquire beaten down mall and retail CRE assets as the premise that they are obsolete and everyone will be shopping at Amazon in the future is a false paradigm. Many Class B retail

assets are trading a 7.5% plus cap rates and those with high vacancies can be retenanted with service, food or niche service (bowling alleys, entertainment venues, etc.) type tenants. This investment strategy requires significant retail management and leasing expertise and should only be undertaken by investment firms that possess this experience.

2. Invest in Niche CRE Sectors

Approximately 85% of CRE investment funds are targeted to the four primary investment sectors of office, retail, apartment and industrial. These assets are the most overpriced and competition for deals is still fierce. However, the niche sectors that include self-storage, manufactured housing, senior housing, data centers and others are, in general, selling at 1%-2% higher cap rates than the traditional sectors with the same growth and return prospects. During the last few years, the self-storage, manufactured housing and data center REIT sectors have been three of the best performing with three year returns of; 7.7%, 8.8% and 5.6%, respectively.

3. Invest/Finance Development Joint Ventures

Commercial banks are very cautious in making construction/development loans and with higher projected GDP growth, the demand for new CRE space should accelerate. This increase demand will primarily effect office buildings and industrial properties. The Basel III rules for commercial banks created a new loan classification for CRE construction loans labeled as; “High Volatility Commercial Real Estate (HVCRE) loans. HVCRE's are defined as; “a credit facility that prior to conversion to permanent financing, finances the acquisition, development or construction of real property.” If a bank has HVCRE loans, then the capital charge is set at a level 50% higher than non HVCRE loans. A CRE construction loan can avoid being classified as HVCRE if; the loan to value ratio (depending on the property type) is less than 75% for land development and 80% for commercial/residential construction properties, the borrower has invested at least 15% in equity and the borrower equity investment remains in the project until either refinanced or sold. Therefore, many banks will be reluctant to fund any construction deal that may even remotely be a HVCRE. This lack of construction capital will open the door for shadow lenders and investors to provide this badly needed funding and make development deals that do have bank financing even more valuable.

4. Sell Class A Apartments

As we have stated in our investment strategies for the last two years, sell Class A apartments. Class A apartments especially in hi-beta markets are still selling a low cap rates and should be sold. The proceeds should be reinvested in Class B&C apartments in tertiary markets where caps rates are in the 7% plus range. Also, the number of new apartment units being built around the country is continuing unabated. From 2013 through November 2016, apartment permits and completions have totaled, 1,563 and 1,184 units, respectively per the Mortgage Bankers Association third quarter 2016 Data Book.

5. Invest in Non-U.S. REITs

All investors, both individual and institutional should have an allocation to REIT stocks. As shown in the REIT Statistics section below, the ten-year return for equity REITs per NAREIT was 4.44% while for the FTSE/EPRA NAREIT Developed Index (which excludes U.S. based REITs) the return was more than twice the U.S. rate at 10.3%. Investing in non-U.S. REITs provides portfolio diversification which not only generates higher returns but low correlation and thereby lower market risk than U.S. REITs and other asset classes.

6. Target Smaller and Tertiary Markets Instead of Core Markets

National real estate investment firms should refocus investment efforts on smaller and tertiary markets instead of the core markets like; San Francisco, New York, Boston, Seattle, Miami, Houston, Washington D.D., Chicago, etc. The share of transaction volume invested in global core markets has risen to 40% as shown in the graphs below by Prudential Real Estate Investors.

The competition for deals in core markets is very robust and the cap rates are still compressed, which will lead to very low returns on equity. We here at VOM have discussions with investment firms all the time and often argue that buying a Class B office building in a smaller market like Tucson, AZ at a 7.5% cap rate will generate a higher risk adjusted return than a Class A office property in San Francisco at a 4% cap rate.

7. Seek Properties with High Income Growth Potential

With the rise in interest rates, investors will need to target CRE properties with higher income growth. The 10 Year Tnote has increased from 1.6% last fall to 2.5% today and is expected to be 3%-3.5% by year end. The cap rate for a property can be calculated by the formula; Risk Free Rate (Rrf) plus Risk Premium (Rp) less the Growth Rate (G). If we use the 10 Year Tnote of 2.5% as the Rrf, the CRE risk premium or Rp of 6% and income growth or G of 2.5%, then an average cap rate is 6%. If interest rates continue rising and the 10 Year Tnote hits 3.50% later in 2017 and the Rrf and G remain the same, average cap rates will rise to 7%. CRE sellers are usually 12 months behind changes in market valuation and cap rates and therefore will not sell at a 7% cap rate, thereby forcing buyers to seek properties that have higher income growth potential. This will mean a higher focus on value-added and opportunistic investments with higher return potential.

8. Invest in or Own CRE Brokerage Firms

Higher GDP growth and inflation will continue to grow the volume of CRE leasing, sales and financing transactions. This will bode well for firms in the CRE brokerage and financing sectors. Transaction volume have been at record levels the last few years and it is expected to continue at a more robust pace with the new Trump administration. One leading indicator of transaction volume is the stock price gains of the major CRE service provides. Although some of the stocks are down from their multi-year highs, their growth prospects are solid.

9. Invest in Hotel and Lodging Assets

The positive and robust growth policies of the new Trump administration should increase GDP growth from an average of less than 2% under the Obama administration to 3.5% or better. Higher growth will lead to higher interest rates (as discussed above) and higher inflation, both of which will be very positive for hotels and resorts and the lodging sector, as a whole. If inflation increases from the new normal CPI of less than 2% per year to 3%+, then real estate assets with shorter duration leases like hotels should be favored. Hotels have one night leases and will thrive in a higher growth and inflation environment. Hotel REITs have been one of the best performing sectors in 2016, with a total return of 14.44% (through 11/16), as investors anticipate higher growth and returns in the future.

10. Join Trumps $500B to $1T Infrastructure Construction Plan

The Trump administration has called for a large $500 billion to $1 trillion infrastructure and renovation program in a public/private partnership structure for highways, roads, bridges, airports, schools and hospitals. This will be a further boom to the CRE industry and those developers and service providers participating in the renovation projects will benefit tremendously. CRE investors that own property contiguous to and nearby large infrastructure developments will also benefit. Large CRE developers and service providers should be available to bid on and participate in this infrastructure once in a lifetime real estate program.