The Changing Face of CRE Investment

By Manuel Fishman, Shareholder, Buchalter Nemer

It’s pretty well-known within (and outside of) the real estate industry that Blackstone is the largest owner of real estate in the United States, if not the world, with more than $102 billion of assets under management. It is also one of the largest landlords of residential real estate as well.

That has not occurred in a vacuum. Insurance companies, hedge funds and institutional pension advisors acting for special accounts, as well as sovereign funds, are becoming the norm for ownership of “core” real estate in the major cities. Twenty years ago, wealthy families were sole owners of large portfolios of real estate—one only has to remember the family names associated with various holdings from that time. Today, these companies have either transformed into funds, pension advisors or minority partners in large acquisitions that are relationship based.

Why has this happened? The volatility of the public markets has pushed many large “money managers” to diversify and the value of real estate has traditionally been a good space for predictable returns. Coupled with the imposition of in-depth internal financial reporting and cost management, the revenue from real estate has become a good investment for public and private insurance and retirement fund companies.

What does this mean? For one thing, decisions are now made by asset managers and investment officers, not local property managers. These decision makers view real estate dispassionately: as revenue and cost centers. This affects the way all service providers now must contract with, and report to, ownership. There is far more standardization, and far less desire to negotiate with smaller tenants. The flip side to this is that in hot markets, such as Los Angeles and San Francisco, these institutional owners compete for top tenants, who are less sensitive to contract rent prices, but want creative office space for their employees. Institutional owners have that cash to spend for the right tenant. This results in rising rents, which has a ripple effect throughout the market, oftentimes pricing out smaller but traditional tenants (i.e., law firms and accounting firms). For a reality check, do a back of the napkin calculation of how may tech and “consumer app” tenants are now in your buildings.

Secondly, institutional investors have differing “hold” periods that are intended to weather economic cycles. This is a stabilizing factor, but it also results in a high barrier to entry for competitors. When a first-class office building in a major market comes online, various institutional owners have different risk profiles and different allocation pools, and this can lead to unusual bidding strategies for a valuable asset that inadvertently increases the market price. Of greater impact to service providers is that when one of these buildings sells, there is often a change in the service providers, such as lawyers, brokers and approved contractors. Local industry groups can also see wide swings in membership based on an institutional owner’s desire to participate in such groups.

Perhaps the most pertinent lesson from this change in ownership is that all of us, as individuals, are now personally invested in primary market downtown office buildings. When municipalities increase taxes and assessments, enact new legislation imposing new building code requirements, impose affordable housing set asides as a cost of entitlement, or fail to fund infrastructure like public transportation, this impacts our personal investment in commercial real estate and the value of our retirement accounts. We all have an individual stake in the value of commercial real estate—something that was not prevalent as recently as 10 years ago when institutional owners were limited to large insurance companies.