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As the market cycle continues to inch to an end, investors are finding they must rethink certain metrics to fit the current market environment.
One example is a changing composition of total return. "So in a market like this, where you think it's peaking, we'll try to get greater than 50% of our total return from current cash flow," Paul Hughson, executive managing director of C-III Capital Partners, said at a recent event. "We won't have a residual basis."
Compare that to a value-add deal five or six years ago, where there would be a 40% return from cash flow, or maybe 30%, and there would be a large pop on the residual, he explained. "Today, especially given where the debt markets are, you can do transactions where you have 60%, 65%, 70%, 75% perhaps of your total return from cash flow and very little risk on the residual."
Hughson made his comments at a recent symposium held by Transwestern and GlobeSt. Real Estate Forum in New York City. Other participants included top level executives from BentallGreenOak, AXA Equitable Life and Clarion Partners.
A similar shift can be seen in the definition of core and core plus and how these assets are being priced. For example, at BentallGreenOak core plus is viewed as core but paid for with higher debt, Paul Boneham, managing director and co-head of asset management at the firm, said. BentallGreenOak is more willing to explore core and core plus for secondary markets, he added, noting the company is forming a fund to focus on that strategy.
Another change: Core plus has taken on some leasing risks that were associated with the core space, but not to the extent that they were in value-add. That, too, has shifted pricing a bit. "Whenever we look at a value-add opportunity, we find that it prices for us, at least for when we underwrite the deals, more along the side of a core plus transaction," Brian Watkins, managing director and head of acquisitions at Clarion Partners, said.
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Erika Morphy
Erika Morphy has been writing about commercial real estate at GlobeSt.com for more than ten years, covering the capital markets, the Mid-Atlantic region and national topics. She's a nerd so favorite examples of the former include accounting standards, Basel III and what Congress is brewing.
