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.

For these and other investors, rent control has become a key issue to watch, and is creating, in some markets, what Hughson and his colleagues are calling a hostile environment for commercial real estate.

"A lot of the prime markets today are openly hostile to commercial real estate owners," Hughson said. "So, where you have regulatory environments, you have taxing environments that are not beneficial. Chicago is not beneficial. New York is not beneficial….California."

It is not solely rent control that has these and other investors worried. At the same time, they are battling additional forces, such as declining returns and other onerous new regulations that also can make a market seem hostile to the industry.

How are investors handling these issues? With forethought and a lot of caution. In some cases, they are recalibrating the composition of their total returns in order to fit the current market environment. In other cases, they are exploring entirely new markets that better meet their investment profile. In almost all cases, they are watching as events evolve and determining what that means for their underwriting.

WHAT WORKS RIGHT NOW

One line of defense that some of these investors have in place, is a changing composition of total return. "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," Hughson said. "We won't have a residual basis."

Compare that to a value-add deal from 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% of your total return from cash flow and very little risk on the residual."

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, said. BentallGreenOak is more willing to explore core and core plus for secondary markets, he claimed, adding that the company is forming a fund to focus on this strategy. Another change: Core plus has taken on some leasing risks that were associated with the core space, but not to the extent that it was with 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, Clarion Partners managing director and head of acquisitions, said.

It should be noted that many of these new strategies are due not necessarily to a suddenly hostile marketplace—as investors might find California and New York to be—but due to the cycle's long run.

AXA Equitable Life, for instance, has been a publicly-traded company for a little over a year and thus is dealing with a different set of issues, said Nicki Livanos, director of real estate investments for the firm. These issues include lending according to where the cycle is. "We've actually increased our allocations with commercial mortgage loans, as well as to equity limited partnerships," she says. In 2019, she adds, the firm expects to close about $1.5 billion, up from about $1 billion a year ago. Still, AXA Equitable Life is keenly aware of the risks associated with such strategies of core plus and, say, value add. It has taken additional risk in construction-to-perm loans. In particular, secondary markets that are highly infilled are the lender's sweet spot right now, while it is typically not doing construction-to-perm loans in the primary markets. "Since we are pretty late in the cycle, we are taking very measured risks," Livanos said.

Another move related to the cycle's position: many investors are seeking out new markets to stay competitive. Clarion Partners, for instance, is open to smaller cities for some of its funds, such as Nashville and Austin, according to Watkins. "We're looking to branch out into those secondary markets as a way of increasing yield," he said. "Obviously, the low interest rate environment has had a really strong pressure on pricing, and the demand is focused in the certain asset classes and certain asset types, which increases the demand for a particular asset that we may be going after. So it's a very competitive marketplace for us."

The asset class, to state the obvious, also matters greatly. Industrial is still viewed as a slam dunk, for instance. Watkins noted that Clarion Partners likely did about $4.5 billion in acquisitions last year, about 40% of which was in industrial. The firm also has invested about $1 billion in the biotech office markets.

On the other hand, panelists were quick to identify a slowdown in the pace of suburban investments—again due to where the cycle is right now. Much depends, though, on the definition of suburban, Hughson pointed out. C-III Capital Partners may buy an office that is not located in the center of a city but still is situated within an urban core that has walkable amenities.

"I think the terms that we look for to describe the suburbs are urban, suburban, transit-oriented, walkable to retail amenities, you know, creative office," Hughson said. "Those are the suburban office buildings that we would be looking to acquire. The true commodity suburban office building, we are not interested in."

A lot of it has to do with Millennials that don't really want to drive, don't own cars, and want to rent everything, Livanos said. "So, the transit-oriented development in a suburban setting that is close enough to an urban environment or looks, feels like an urban environment, is actually doing fairly well."

Another strategy that appeals to many of these investors is workforce housing. It can check the boxes on a lot of issues, including affordability, and it also positions some companies to be more competitive. "Shifting strategies to workforce housing allows you to renovate, not necessarily currently but years down the road, so that you're not competing against a full value-add player all the time," Watkins said. "But you're going to do that renovation seven, eight years from now just before maybe a sale in year ten and still be able to position 30% or so below the top end of the market."

RENT CONTROL'S BITE

Perhaps the most significant cautionary step that these investors are taking is a more judicious approach to underwriting—especially in markets where rent control has entered or will likely come into play.

"You just have to make sure that you're comfortable that there is a risk that the laws might change in the future, which undermine or hinder the performance of the asset," said Watkins. "Pricing that [risk] upfront to the best that you can is the way that we're trying to handle it," he adds.

BentallGreenOak, for its part, is not avoiding any specific cities because of these new rules, according to Boneham.

On the other hand, the transactions people know that they need to be able to defend their underwriting assumptions and investment level, he continued. "It's self-select."

Rising taxes serve as another challenge facing real estate investors, according to Livanos. But the affordability issue even seems to trump that to a certain extent. In general, she said, "the unfriendly environments that we've seen so far are obviously New York, Chicago, California and Washington State." The problem is there is more and more divergence in incomes and there is really no public answer to affordability, she continued, and there's also no public-private coordination to solve the affordability issue.

"We've seen historically that a public answer isn't necessarily going to work. We've seen historically that a lot of private-only doesn't work. So, there has to be some coming together of the two parties to resolve the issue," Livanos said.

Even the opportunity zones, which she said were a great idea, are not really solving any affordability issues.

Other regulations are also hindering real estate developers, Watkins added, citing environmental impact rules and insurance issues.

"We're seeing insurance be a large factor in our underwriting that's got to be taken into account, and the areas that we want to be investing in, West Coast and Florida are the high risk areas for earthquakes and hurricanes." Watkins reported thata Clarion Partners is very actively pursuing an insurance program to make sure that it has the best policies in place.

Panelists also pointed to regulations underway in Portland, in which new developments must include an area for the homeless to rest. This applies to all projects including multifamily, office or retail.

"What it's doing is making [certain] deals more attractive because people don't want to be in the area where there's people loitering," said Hughson. "It's challenging for tenants. They don't like it."

With all the concern about rent control and other regulations, these investors are still adhering to the basic rule of com-mercial real estate, which is to follow the demand—and now that often means developing in the heart of some of these "hostile" markets.

Tech and biotech are the two biggest drivers in demand for office space, and Clarion Partners is actively investing around these drivers, Watkins says. That includes Cambridge, San Francisco, Seattle and Portland, he said—markets that are looking for those creative office spaces. And yes, they're looking for multifamily to support that office growth, whether it's top tier or class-B, he added. It would be ironic if the stakes weren't so high. But, as regulations mount, we can expect this dichotomy story to play out in market after market.