Exclusive Research: How HNWIs View CRE in the Wake of COVID-19Exclusive Research: How HNWIs View CRE in the Wake of COVID-19

Commercial real estate pros expect HNWIs to increase their allocations for commercial real estate.

Although the global pandemic has taken a bite out of global wealth, high net worth individuals (HNWIs) appear poised to put more of their capital to work in commercial real estate.

The latest NREI research on HNWI commercial real estate activity shows that nearly 60 percent of survey respondents expect HWNIs to increase their allocations to commercial real estate over the next 12 months. Although views on allocations have been choppy over the past few years due to concerns about slowing economic growth, that figure is an uptick compared to 53 percent in the December survey who said allocations were likely to rise. It also sets a new high watermark in the five-year history of the survey. Nearly one-fourth of respondents (24 percent) expect allocations to remain the same, while a minority (9 percent) think allocations will decline.

NREI surveyed a cross-section of participants in July to gain insights into how allocations and strategies related to commercial real estate investment may have shifted in light of the global pandemic, which has tipped the U.S. economy into recession as well as contributing to stock market volatility and new record-low interest rates. Nearly one-third of survey respondents identified themselves as private equity investors, while the balance consisted of a mix of brokers, financial intermediaries and developers among others.

“What I believe your survey is capturing is a long-term trend driven by both supply and demand,” says Allan Swaringen, president and CEO of JLL Income Property Trust, a non-traded NAV REIT. On the demand side, there is greater interest in real estate coming from the baby boomer generation of investors who have acquired wealth and are now focused on where to put it to work to both preserve capital and generate income for retirement, he says. Speaking to the supply of real estate investment products, Swaringen believes HNWIs are more aware of a wider variety of real estate investment options, including non-traded REITs. “We have spent a lot of time and effort over the last five to 10 years trying to develop commercial real estate solutions that are really tailored to the high net worth investor,” he says. JLL Income Property Trust’s investor base currently includes more than 17,000 HNWIs.

HNWIs started 2020 flush with capital. According to Capgemini’s World Wealth Report 2020, global wealth held by HNWIs—typically those who have upwards of $1 million in net assets—grew by 8.6 percent last year with U.S. individuals posting an 11 percent increase. Capgemini does expect the pandemic to erode some of those gains with early analysis showing an estimated decline of between 6 percent and 8 percent during the first four months of 2020. Some industry participants believe that HNWIs are more keenly focused on rebalancing investment portfolios rather than putting new capital to work.

“The significant drawdown in equities in March was shocking to a lot of people,” says Davin Carey, a managing financial advisor at Carey & Hanna Tax & Wealth Planners, an Oxnard, Calif.-based firm that advises HNWI clients on tax and wealth planning. “Any time we go through a shock to any part of the market or any part of the economy, clients are rudely awakened to reevaluate what their risks are.”

Investments that have less volatility and less potential for huge drawdowns have been a bigger part of the conversation with HNWIs, notes Carey. Real estate assets generally fill that void and also have the ability to achieve tax-efficient growth, capital preservation and the potential for appreciation and income, he adds.

Survey methodology: The NREI research report on high net-worth investment in commercial real estate was conducted via an online survey distributed to NREI readers in July. The survey results are based on responses from 474 participants. Of the total survey respondents, 32 percent identified themselves as private equity investors, 12 percent investment sales broker and 10 percent each as developer or financial intermediary. The respondent base includes a mix of individuals from owners and executives to brokers and research analysts. However, more than half (55 percent) described their role in the commercial real estate industry as an owner/partner/president/chairman/CEO or CFO-level executive. Respondents operate in all regions with 48 percent active in the South / Southeast / Southwest; 47 percent in West / Mountain / Pacific; 45 percent in the East and 36 percent in the Midwest / East North Central / West North Central. In addition, respondents are active across property segments. However, most are involved in multifamily at 63 percent, office 50 percent and retail at 50 percent.

HNWIs tend to be a diverse group with different views on both allocations and investment strategies.

Overall, respondents believe HNWIs have a healthy amount of capital already placed in commercial real estate with a mean allocation of 19.2 percent.

In total, 41 percent of respondents estimate HNWI allocations to be 10 percent or less of investment portfolios, while one-third of respondents (32 percent) said that allocations range between 11 and 25 percent; and 27 percent believe that real estate allocations are 26 percent or higher.

HNWIs tend to be a diverse group with different views on both allocations and investment strategies. For many, investment strategies have shifted in the wake of COVID-19, but they have shifted in different ways depending on whether the view is to use real estate investments as an alpha driver or a shock absorber for investment portfolios during uncertain times, notes Ben Adams, CEO of Ten Capital Management, a privately held real estate investment management firm based in Cleveland.

“We have some clients who have absolute stars in their eyes about future distress. They are really licking their chops and can’t wait to see those investment opportunities,” says Adams. At the same time, other investors are looking to real estate to generate consistent, stable cash flow without the wild volatility that has been characteristic of the stock market of late, he says.

Respondent views varied on HNWI preferences on commercial real estate investment types. They said HNWIs were comfortable with riskier value-add or opportunistic investments. In all, 56 percent of respondents consider HNWIs to be very or extremely interested in value-add, while half are very or extremely interested in opportunistic. Core and core-plus strategies also rated high with nearly half of investors (each at 48 percent), while those who said HNWs were very or extremely interested in distressed investments drew a slightly lower favorable response of 42 percent.

Although some advisors and sponsors see HNW investors who are looking to take advantage of opportunistic investments, most see a group that is moving more cautiously. That caution also is evident in the broader investment market with commercial real estate transaction volume during second quarter that fell 68 percent compared to the same period a year ago, according to Real Capital Analytics.

Depending on the asset class, there is “hesitation to react until the other shoe drops”, which means the slow transaction volume could linger until a vaccine is developed and distribution, potentially into 2023 or 2024, wrote another respondent. “COVID has made all investors, especially HNWIs, rethink portfolio allocation and put more emphasis and thought into cycle-resilient real estate. Property types such as multifamily, single-family rentals, student housing, condos, etc. will be favored more as office and retail attract less interest from tenants,” wrote another survey respondent.

The factors that are most important in HNWIs' decision to invest in commercial real estate have shifted slightly.

Similar to past surveys, the biggest objective respondents identified for HNWI and family offices when investing in real estate was preservation of wealth.

On a scale of one to five, wealth preservation averaged a 4.1 in the current survey. However, that does show a decline in what has typically scored between 4.5 and 4.6. Views on asset value growth and income production, which have been moving in lock step, also dipped from 4.1 last year to 3.8 in the current survey, followed by tax purposes at 3.7 and estate planning at 3.5.

“Particularly for our investors on the 1031 side, there has definitely been a shift to more wealth preservation relative to cash flow,” says Whitson Huffman, chief strategy and investment officer at Capital Square, a national real estate firm specializing in tax-advantaged real estate investments, including Delaware Statutory Trusts (DSTs) and Qualified Opportunity Zone funds.

“That is not to say that they want to give away the farm from a cash flow perspective, but there is definitely more focus on surety and safety,” he says. For example, there is still healthy demand for DSTs and net lease assets, but investors are nervous about being locked into a long-term net lease property given all the destruction they are seeing across the restaurant and retail sectors due to COVID-19. “There is a lot of hesitation about what the post-COVID world will look like, how people will shop and interact with the built environment post coronavirus,” says Huffman.

Wealth preservation remains a major focus for investors due to the uncertainty of COVID-19 and the current economic downturn, agrees Peter McMillan, co-founder of Pacific Oak Capital Advisors, a sponsor of commercial real estate-focused alternative investment programs.

“That is somewhat unfortunate, because we think there are better opportunities today than we have seen since the Great Recession, yet high net worth individuals are probably more concerned with wealth preservation today even though the opportunities for investing are more attractive than they’ve been in close to 10 years,” he says.

Multifamily and industrial remained entrenched at the top of the list for HNWIs.

HNWIs are using a variety of different vehicles to invest in commercial real estate.

Private equity funds remain the most popular choice with 56 percent of respondents who see HNWI allocations going through private equity real estate funds versus 52 percent in the 2019 survey. Other investment vehicles also saw an uptick compared to last year with top choices that include direct investment in multi-tenant assets at 44 percent; net lease assets at 41 percent; publicly traded REITs at 36 percent; and private real estate debt funds at 32 percent. Other options that are less popular are crowdfunding at 10 percent and club deals at 14 percent.

One notable shift detected in the survey was increased interest in allocations to publicly-traded REITs. Respondents who expect HNWIs to buy REIT stocks increased from 27 percent in the December 2019 survey to 36 percent, which also marks the highest level of interest in public REITs in the past five years. Investors are expressing more interest in finding “fallen angel” types of investments in the public REIT space due to the significant drop in stock prices, says Carey.

“Generally, we don’t do a lot of public REIT investment, but when we saw the massive drawdown in volatility, we had a lot more conversations with clients who were looking for opportunity to invest in some of those beaten down publicly traded REIT names, because of valuations, incomes and the rebound potential,” he says.

Multifamily and industrial have been at the top of the list for HNWI for the past few years and they remain fairly entrenched in that position. Consistent with the 2019 survey, nearly three-fourths of respondents (72 percent) continue to view multifamily as the top property type favored by HNWIs. The popularity of industrial also rose higher from 48 percent a year ago to 58 percent in the current survey.

Multifamily and industrial are two property types that have arguably gotten the most favorable press in recent years and as such have been at the top of investment strategies for the past few years, notes Swaringen. Investors like the e-commerce story behind industrial, and COVID-19 is driving those online sales even high.

“However, I would continue to advocate for the high net worth investor that they need to continue to diversify across property types and geographic regions to avoid concentration risk,” he adds.

Other property types that rated high were medical office at 40 percent and self-storage at 37 percent. Of note, interest in single-family rentals that had been hovering at about 11 percent for the past few years jumped to 23 percent in the current survey. That interest is likely being fueled by baby boomers themselves are embracing the convenient renter lifestyle, notes Michael D. Underhill, chief investment officer at Capital Innovations LLC in Milwaukee, Wis.

Although office has continued to show a decline in sentiment over the past few years, sliding from a high of 34 percent in the 2016 survey to 17 percent in the current survey, Underhill also believes investors are increasingly favoring suburban over CBD office, a trend that has accelerated during COVID-19. “Investors have been spending time examining suburban office as the next trend that is worth paying close attention,” he says. Fewer HNWIs are likely to increase allocations to retail (9 percent), student housing (7 percent) and hotels (4 percent) due to the considerable near-term headwinds in those sectors.

COVID-19 may have heightened the attention to dynamics and drivers within individual markets.

It is still early to gauge how COVID-19 may shift regional or geographic investment strategies. There is a lot of speculation as to whether the pandemic may cause investors to view gateway markets more negatively due to the contagion hot spots that have emerged in urban centers.

“There has not been enough time to say that there has been a sustained shift, but I would say that generally amongst managers we are starting to see more interest for suburban buildings and low-rise buildings than we have in the past, and there is certainly more concern being expressed about high-rise buildings in a dense CBD,” says McMillan.

Survey results show that HNWIs continue to favor primary markets with 60 percent who said that had a strong or extreme preference for multifamily markets, 38 percent for secondary markets and 11 percent for tertiary markets.

If anything, COVID-19 may have heightened the attention to dynamics and drivers within individual markets. “We’re getting a lot more questions from investors about why we’re selecting the markets we’re selecting, and what impact those markets have felt from COVID-19,” says Huffman. In addition, HNWI are biased by their own experience with COVID-19 and where they live.

For example, some investors in Atlanta are seeing the suburbs benefit from people who are coming to the area from other big cities, while at the same time investors in the Northeast are seeing people leaving New York City in favor of smaller towns in Connecticut or Vermont, and they’re trying to figure out how to capitalize on those trends, he says.

Certainly, the current market is creating new challenges and opportunities for those entities looking to raise capital from the HNWI market. Some HNWIs have moved to the sidelines as they wait to see how things play out in the second half of the year before committing any new capital. “It has caused a temporary pause given lack of price discovery in markets and tightening lending terms. But that pause is not likely to last as the risks of the pandemic are better understood,” wrote one survey respondent.

When asked what events are likely to have the greatest negative impact on HNWIs’ allocations to real estate, 52 percent said a prolonged recession, followed by a change in the tax code at 42 percent, real estate downturn at 41 percent and an increase in interest rates at 35 percent.

One of the persistent frustrations for investment advisors and private equity fund managers raising capital is access to HNWIs. Additionally, the current environment does pose an added challenge with some investors who are concerned about the prospect of prolonged economic stagnation.

On the flip side, there is potential opportunity for investors to line up for investment in early entry point opportunities in the recovery.

“Given the current state of COVID-19, investors are seeking low volatility quality properties and preservation of capital. Seller are still looking for transparency on where the economy and real estate market is heading. The opportunity is interest rates are still very low and there are great opportunities out there,” wrote one respondent.