Nontraded REITs Capitalize On Depressed Property Valuations

New Wave of REITs Emerges as Investors Capitalize on Low Property Values

Amid an economic downturn and high interest rates, four major investment firms are leading a new wave of nontraded REITs, leveraging the challenging market conditions and low property prices.

Surge in filings: A new league of REITs, led by firms like EQT Exeter, Invesco, Sculptor, ExchangeRight, and BentallGreenOak, has emerged. They've recently filed in the last two months to create nontraded REITs, favoring long-term strategies over short-term gambles. Their eye is on an expected property value dip, opening the door for acquiring premium assets at a bargain.

Why now? The surge in nontraded REITs comes at a time when shareholders are pulling out of nontraded REITs like Blackstone Real Estate Income Trust and Starwood Real Estate Income Trust due to concerns over inflation and recession. The new entrants, however, are betting on the downturn and leveraging their fresh, unaffected portfolios to take advantage of the market situation.

The divergence: Over the last five years, nontraded REITs, focusing on multifamily and industrial assets, have yielded returns of 59%, outperforming publicly traded REITs' 20%. The shift towards privately transacted nontraded REITs, especially from 2021, implies that most opportunities now cater to individual investors, as institutions hold back.

Investment strategies: The key to the success of these new REITs lies in their investment strategies. While some, like ExchangeRight, are focusing on essential retail properties leased to grocery stores and healthcare providers, others, like EQT Exeter, are looking at business-tenanted properties such as industrial or life science facilities and consumer-used assets like multifamily or self-storage properties.

➥ THE TAKEAWAY

Why it matters: With the anticipation of further property value declines, the establishment of new REITs has shown a strategic shift by investment firms. They aim to leverage the current market conditions to build new investment portfolios, free from the recent value degradation seen in the sector. This trend reflects a broader market strategy: Investors now see opportunities in challenges, demonstrating resilience and adaptability in the face of economic changes.

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The Cost of Concessions: Landlords Feel The Pinch

The cost of concessions in office lease transactions is rising in major metros, impacting landlord profitability and giving tenants more negotiating power.

Hefty concessions: Concessions, including free rent periods and tenant improvement allowances, have shot up in Manhattan's office market, especially for prime and newly constructed buildings. While deals with triple-digit starting rents are often coupled with hefty concessions, the share of total lease value going to concessions has risen faster for Class A deals with starting rents below $100 PSF.

Look at the ratios: According to CompStack, it's crucial to examine concessions ratios, which are effectively discounts on the income value of a lease, especially considering wavering lease terms and transaction sizes post-2020. Higher concessions ratios lower landlord income, raising questions about the value of tenants with lower rents and fewer concessions.

NYC takes the lead: Concession ratios are rising for Class A deals in Manhattan. The average concessions ratio for Class A office buildings with starting rents of more than $100 PSF has risen 200 bps since 2018 to 10.8%. For Class A office properties with rents below that threshold, concessions ratios have shot up 430 bps. While Manhattan outpaces major office markets like Chicago, Bay Area, and San Francisco, NYC's overall concession ratio has grown faster since 2018.

➥ THE TAKEAWAY

The tenant is on top: CompStack's biggest takeaway is that growing concession ratios show the negotiating power tenants still have. Landlords may need to rethink their strategies to maintain profitability while meeting tenant demands.

Vacancy rates in US offices have soared, with San Francisco suffering the steepest increase of 19.8% since 4Q19 followed by NYC and Austin, as remote work trends persist and new office construction contributes to the oversupply.

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