The market outlook from a capital source perspective is changing, even more so than we initially thought. In December 2015, Meyers Research assembled more than a dozen high-level institutional real estate investors in a New York City setting for an open discussion about the nature of real estate capital flows, with a specific focus on the residential sector. At that time, there was broad consensus that a national economic recession was expected within three years, and that investments in land and residential must be short-term in nature or they would not happen. The thought that investing in longer-term deals where the exit strategy coincides with a recession is bad business. To exacerbate the issue, other cash flowing real estate asset classes produced record returns in 2015, making land and residential investments less attractive.
However, some things changed during the first quarter of 2016. At the Meyers Research Frame breakfast in New York in March 2016, we again assembled a collection of institutional real estate investors and found a notable shift in perception, including the following:
- The train may arrive early: While a national economic recession is still on the horizon, the recession is now expected within the next two years, which makes investing in a residential land opportunity more interesting.
- Possible repricing ahead: In fact, some groups are suggesting that land will be “on sale” within the next 6-18 months. Widespread distress is not expected, but neither are decreasing home prices. It’s simply an expectation that some return-based land owners may be experiencing deal fatigue and be willing to accept a modest return rather than endure another cycle.
- “Multiple” Opportunities: Some of the larger, more patient capital sources are expecting this to be an attractive buy opportunity where they can “play for the multiple”. The challenge is that few of these investors are looking to develop land. The heavy capital requirements of land development are not justifiable today and banks remain tepid toward land development. It is not a stretch to expect the for-sale market to remain undersupplied, or at least not oversupplied, for a protracted period. This condition surely will reduce the risk of capital loss for patient investors but make things challenging for homebuilders who need land as their most basic raw material.
Wall Street has been overpricing the risk associated with public homebuilders for several months, in many cases due to growth strategies that do not seem feasible. The argument can be made that public builders have a unique opportunity to capitalize on this situation by becoming land developers. With access to inexpensive corporate debt, land development may just provide an avenue for the bottom line growth that “The Street” so desperately wants. While this may seem radical in an era of “land light” strategies, there appears to be mounting evidence to support this theory.
Steve La Terra, Managing Director – Advisory Phoenix
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