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Flexibility is key as office market tackles the ‘WeWork effect,’ says investors

Flexibility is the key to investment success in todayʼs market, according to experts who gathered for a Real Estate Master Class hosted by Morgan Stanley, Fried Frank and CollabNet.

“Like other industries, real estate is getting more difficult to look at from a long-term outlook,” said Praedium Group founding principal Russell Appel told the attendees at Morgan Stanley’s 522 Fifth Avenue offices in Manhattan.

“The challenge investors have is that real estate is a long-term asset class, yet demand for space – with the exception of housing – is being impacted by myriad technological changes. Forget looking out 10 or 15 years from now; it’s even challenging to look five years ahead.”

JP Morgan Chase & Co. Managing Director of US Real Estate Acquisitions, Peter Sibilia, said simply, “Investors must pay more heed to being flexible,”

Sibilia cited the “WeWork effect,” in which even large companies such IBM – which recently committed to a full-building lease at the shared workspace giant’s 88 University Place, Manhattan location – are seeking more flexible space.

But Morgan Stanley Real Estate Investing Managing Director and Global Head of Research and Strategy, Tony Charles, said that while WeWork is disrupting the market, it only comprises a small share; Manhattan had 30 million square feet of leasing in 2016, and WeWork only accounted for less than three percent of that total.

“We have to be more sensitive to changes in different types of industries, whether technology or driven by other things, because we ultimately have to satisfy the demand of our tenants,” Appel asserted.

“Building owners can talk about strategic issues on panels all they want”, he said “but at the end of the day, they still have to lease space.”

“One way real estate can satisfy those demands is to take a more hospitality-driven approach,” noted Sibilia, “even if you’re an office or residential landlord. It’s all about amenitizing buildings, creating a concierge service for tenants and staying ahead of technological trends.”

“On the investment side, there’s clearly recognition that real estate is in the later point in the cycle, even if the new administration is hoping to change that thinking,” Appel said.

“If potential returns compress, then investors will use leverage as a way to extend higher returns. However, there is sensitivity in the market in respect to leverage and risk this time around, given that the downturn was only 10 years ago.”

The breakfast panel discussion was moderated by Kenneth I. Rosh, corporate partner and head of Fried Frank’s Private Equity Funds Practice who said that, despite some headwinds, “We are finding that the market for real estate fundraising remains strong, especially for major sponsors with a global investor base.”

According to Tony Charles, most Morgan Stanley Real Estate Investing clients are interested in equity funds, although there is some interest in debt funds.

And while JP Morgan Chase & Co. invests primarily in equity, its mezzanine business is seeing a tremendous amount of attention, despite deals becoming squeezed and opportunities harder to come by.

“But whether equity or debt, the marketplace is looking for more current cash instead of capital appreciation, and debt tends to have more of a cash component to it and less upside,ˮ said Appel.

“The market is more income-yield sensitive today, as the thinking is that we’re in the later stage of the cycle and the big upside in capital appreciation may have been earlier in the cycle.”

According to Sililia, despite the long-standing belief that real estate cycles are directly tied to economic cycles, “all key metrics points to a relatively strong U.S. economy today. There’s no real sign of a crash, although one concern from an investor standpoint is potential inflation.”

Overall, the panelists ssaid that the investment market remains competitive, with both foreign and domestic sources seeking deals.

Sibilia reported that while value-add and opportunistic yields are tough to find, there are opportunities abound through recapitalizations

No matter where you stand during the cycle, “now is always the hardest time to invest,” Appel quipped, recalling how 2010 felt difficult.

“Looking back, it was the best time to invest – maybe even into 2012. The market always feels challenging. Clearly, there’s more liquidity in the market today than there was in 2010 and 2011, but we’re worried about different things.”

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