“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” -George Soros
What the above quote screams at me can be summed up as “risk management!” As humans, we like to share stories of our “great trades” while conveniently leaving out the ones that didn’t go so well (or failed entirely). There are reasons why the long-term portfolio performance of the average investor is about a third of what the S&P 500 has returned. While I encourage you to read the referenced article, the concise conclusion is that investment success (or lack thereof) comes down to human behavioral characteristics.
Markets toy with our emotions. It feels good to buy stocks when markets are doing well, and we seem hard-wired to want to sell everything when the market is in a downturn, but those actions are typically the opposite of what an investor should do if the goal is to achieve better long-term returns. While this “human psychological shortcoming” broadly applies, it ignores the critical caveat that more investments are available to us than ever before. Some investment types/structures can help mitigate the emotional-investment rollercoaster (perhaps a topic for a future edition), which also applies to our ongoing real estate exploration.
Back to the lecture at hand
In Part 5, we covered the risk/reward spectrum of commercial real estate at a high level, and the goal of today is to continue down that vein for deeper insights. While Part 6 was more focused on current investor concerns within commercial real estate, it also (hopefully) reaffirmed the message that all real estate is not created equal while providing some real-world context for today’s installment of Alt Blend. Here we go!
Both AND
Now that we understand how real estate varies across a risk/reward spectrum (Core, Core Plus, Value-add, and Opportunistic) and eight major property types, let’s consider the alignment of particular properties/types with specific investment goals. You may have already asked yourself, “If my objectives are X, Y, and Z, where should I focus my attention? Should I be more concerned with the project type or property type?”
I don’t think it’s a question of one or the other. These two general classifications (project/property type) only tell part of the story. Thus, we need to focus on both the property type and project type AND several other factors, especially the subtype of the property.
What’s your type?
Referring back to our general property types from Part 4, we should be able to pinpoint some factors that can drive differences in attributes of underlying property subtypes. We’ll find that those attributes will align with different investment objectives. For example, if investor A’s goal is to maximize upside potential while accepting a significant risk of loss, there will be particular projects and subtypes that work for them. But those projects would be inappropriate for investor B, whose goal is to find an optimal mix of risk/reward with minimal chance of loss – i.e., a good return for minimal expected volatility or downside risk.
“Resilience” is a good way to describe what investors often look for in a real estate investment. I put myself in that category concerning the characteristics that work well within client portfolios. To use a baseball analogy, we don’t need to hit home runs if we can consistently hit doubles and rarely strike out. Or, in the context of public market investments, if we can get equity-like returns with bond-like volatility, then that can justify the liquidity sacrifice that comes with real estate investing. As alluded to in today’s quote, these qualities can help us “lose less.”
With that in mind, let’s go through our list of property types to highlight subtypes that have (in my opinion) notable attributes – especially those “all-weather” or resilient qualities.
Multifamily:
- Workforce housing: Despite the more challenging rate environment currently generating scary real estate headlines, many managers we’re in touch with continue to see good value and opportunity in apartment buildings in growing areas like the Sunbelt. Live-work-play communities can add convenience to people’s lives, and easy access to our jobs and social activities can be a great way for landlords to retain tenants. For those who can’t afford to buy a home, multifamily living may be the next best option. Or it may represent an upgrade with more amenities for those making more income as they build their careers. Thus, these properties can be in demand regardless of the economic cycle.
- Student housing: a large university with consistent and growing enrollment – especially in areas with limited ability to expand the supply of attractive apartments for students – translates to being able to increase rent and maintain high occupancy. Also, people may return to school in economic downturns, potentially increasing demand in recessionary environments.
- Senior living: If they can afford it, no one wants their family members to receive care in a questionable facility. Thus, a high-quality senior-care property (which can include several services across a spectrum of care) can be in high demand, regardless of the environment. Many locations even have waitlists due to demand exceeding supply. One unexpected regulatory challenge in senior living management during Covid was that some sites were temporarily not allowed to accept new residents for several months; that’s an issue if your business plan includes quickly needing to fill beds for cashflow purposes. Mostly, however, substantial recession resilience can be found in these properties.
Office:
- Traditional office: We previously covered that there can be a substantial difference across these classes (A, B, C) of office space. I’d consider the best Class A space in medium/large cities to be pretty resilient, but it will very likely come with limited upside potential. But maybe a boring and highly predictable cash flow is enough for some investors (e.g., probably not bad for a large pension fund).
- Medical office: In my experience, medical office buildings are often low or mid-rise structures in the suburbs, where people go to see their doctor or dentist. They may also add convenience for patients by including a variety of ancillary services (e.g., a lab or MRI business down the hall from the doctor’s office). I personally feel like these buildings are never very nice, and maybe that’s because landlords tend to have additional leverage (not debt) over their tenants. Why? Because medical businesses tend to be relatively local to their patients. While we may work with accountants, lawyers, or financial advisors on the other side of the country, our doctors and dentists tend to be near where we live or work. Because of that geographic concentration, medical professionals risk losing patients when changing locations. In addition, there are specialized equipment and layout needs that medical offices specifically cater to. Thus, medical office tenants can be long-term and rather “sticky” vs. other office types. Also (given your employment or benefits status hasn’t changed), do you stop going to the dentist or doctor because the economy is in a recession? All of that amounts to consistency for the owner of these property types (and seemingly little pressure to make substantial upgrades to them).
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
