STRATEGIES FOR IDENTIFYING VALUE IN A MARKET...

Contrarian Real Estate Investing | May 2017

CONTRARIAN REAL ESTATE INVESTINGSTRATEGIES FOR IDENTIFYING VALUE IN A MARKET THAT SEEMS

FULLY PRICED AND FAIRLY CROWDED

ADAM DUCKER, MANAGING DIRECTOR

TAYLOR MAMMEN, MANAGING DIRECTOR

NREI WEBINAR | MAY 9, 2017


RCLCO is the leading knowledge solutions provider to the real estate industry

• “First call” for those seeking strategic and tactical advice regarding property

investment, planning, and development

• We provide end-to-end advisory and implementation solutions at an entity,

portfolio, or project level

• Engaged on ~500 projects annually touching

more than $5B in real estate

• Affiliated with more than 25 leading industry

associations, including ULI, PREA, NMHC, etc.

• Office Locations: Los Angeles, CA; Austin, TX;

Orlando, FL; Washington, DC,

• Mission: To help our clients make strategic,

effective, and enduring decisions about real

estate.

• Advisory Groups: Institutional, Urban Real

Estate, Public Strategies, Community & Resort,

Strategic Planning & Litigation Support

ABOUT RCLCO


“CONTRARIAN” = IDENTIFYING UNDERAPPRECIATED

OPPORTUNITIES

Questionable Fundamentals;

but investorsare still active

Great Fundamentals;

highly favoredby investors

Poor Fundamentals;

investors are out of the market

Good to Great Fundamentals;

which investorsdon’t yet appreciate

Strong

Long-Term

Structural

Growth

Weak

Long-Term

Structural

Growth

High Investor Appetite

Low Investor Appetite


INVESTMENT OPPORTUNITIES PRESENT THEMSELVES

IN EACH QUADRANT

Dangerous territory…

Stable returns rely on improving operating

performance, predictable investor

appetite

Returns from identifying good

opportunities despite headwinds or where investors have been

too quick to exit

Outsized returns result from strong operating

performance and improving values as

investor appetite grows

Strong

Long-Term

Structural

Growth

Weak

Long-Term

Structural

Growth




Dangerous territory…

Invest alongside structural trends

Rely on expertise to identify and underwrite

underappreciated opportunities

Build the case!

IDENTIFYING VALUE OF GEOGRAPHY / PRODUCT TYPE

DYNAMICS WITHIN THE FRAMEWORK

Strong

Long-Term

Structural

Growth

Weak

Long-Term

Structural

Growth




INVESTING ALONGSIDE LONG-TERM STRUCTURAL TRENDS

• Critical to identify:o What hasn’t yet peaked (or maybe

isn’t proven) in terms of demand

o What isn’t or isn’t likely to be

oversupplied

• Opportunities: o Seniors housing

o Industrial/logistics

o Medical office

o Housing (in general)

Great Fundamentals;

highly favoredby investors

Stable returns rely on improving operating

performance, continued investor appetite

Invest alongside structural trends


LONG-TERM STRUCTURAL TRENDSAging Population Requires More (and New Types of) Seniors

Housing and Other Services

Projected Population and Growth Rate, Total Population and Age 75+; United States of America

Source: US Census Bureau

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

2015 2020 (f) 2025 (f) 2030 (f) 2035 (f) 2040 (f) 2045 (f) 2050 (f) 2055 (f) 2060 (f)

Po

pu

lati

on

Gro

wth

Rate

Po

pu

lati

on

('0

00

s)

Total US Population 75+ population

Projected Total US Population Growth Rate Projected 75+ US population Growth Rate


LONG-TERM STRUCTURAL TRENDSNo Matter What Happens to the ACA (“Obamacare”), We’ll Need

More Healthcare Facilities

$-

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

$800,000

$900,000

2002 2004 2006 2008 2010 2012

0-18 19-44 45-64 65+

Healthcare Spending by Age Group; United States of America

Source: Centers for Medicare & Medicaid Services


eCommerce is the Only Type of Retail Experiencing Sales Growth in

2017 (Good for Industrial)

LONG-TERM STRUCTURAL TRENDS

(15%)

(10%)

(5%)

0%

5%

10%

15%

20%

25%

30%

Warehouse Clubs + Superstores Grocery Dept Stores Ex Discount Discount Dept Stores GAFO* E-Commerce

Retail Sales Growth; 1993 to February 2017

Source: Centers for Medicare & Medicaid Services


LONG-TERM STRUCTURAL TRENDSHousing in the U.S. is Only Just Recovering

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

1970-2000 Average 2000-2016 Average 2003-2006 Average 2012 - 2016 Average

Total Completions ('000s) HH Growth ('000s) Completions:HH Growth Ratio

Housing Completions Relative to Household Formation

Source: US Census; RCLCO


USING EXPERTISE TO IDENTIFY & UNDERWRITE

UNDERAPPRECIATED OPPORTUNITIES

• Real estate is supremely inefficient (every

parcel is different, many of them still great)

• Strong operators really do create value;

characteristics of organizations that do this

type of investing well:

o Ability to ask tough questions of themselves & evolve

o Creative capitalization

o Discipline in underwriting

o Actual asset management

o Fine-tuned market observers

Poor Fundamentals;

investors are out of the market

Returns from

identifying good

opportunities despite

headwinds or where

investors have been

too quick to exit

Rely on expertise to identify and underwrite

underappreciated opportunities

• Examples:o Suburban office

o Retail

o (Upscale/Luxury) Hotels


Investors Uniformly Assuming Significant Risk In Suburban Office

— Certainly Mispriced in Places


(100)

(50)

-

50

100

150

200

250

300

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Q1 1

98

9

Q4 1

98

9

Q3 1

99

0

Q2 1

99

1

Q1 1

99

2

Q4 1

99

2

Q3 1

99

3

Q2 1

99

4

Q1 1

99

5

Q4 1

99

5

Q3 1

99

6

Q2 1

99

7

Q1 1

99

8

Q4 1

99

8

Q3 1

99

9

Q2 2

00

0

Q1 2

00

1

Q4 2

00

1

Q3 2

00

2

Q2 2

00

3

Q1 2

00

4

Q4 2

00

4

Q3 2

00

5

Q2 2

00

6

Q1 2

00

7

Q4 2

00

7

Q3 2

00

8

Q2 2

00

9

Q1 2

01

0

Q4 2

01

0

Q3 2

01

1

Q2 2

01

2

Q1 2

01

3

Q4 2

01

3

Q3 2

01

4

Q2 2

01

5

Q1 2

01

6

Q4 2

01

6

Cap

Rate

BPS Spread (Right Axis) Office-CBD Office-Suburban

CBD and Suburban Office Cap Rates; 1989-Q1 2017

Source: Real Capital Analytics


Retail is Under Threat and Not Favored, but Opportunities Clearly

Exist


Vacancy by Retail Center Type

Source: CoStar

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Q1

General Retail Mall Power Center Shopping Center Speciality Center All Retail


Supply Concerns Leading Investors Away From Hotels, But Likely

Create Opportunity Around the Corner


Net Change in Hotel Keys

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6 (

f)

201

7 (

f)

201

8 (

f)

Net Change in Supply

2000-2015 Avg Change in Supply

Cap Rates by Property Type

Source: PKF Hotel Horizons ReportSource: Real Capital Analytics

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

All Hotels Full-Service Limited-Service Botique


OUTSIZED RETURNS RESULT FROM LEVERAGING BOTH

APPROACHES

• Difficult to identify: markets may be

inefficient, but they’re not stupid

• Difficult to underwrite: how do you know

you’re right, and everyone else is wrong?

• Difficult to finance: where are the comps?

• Examples we’re seeing right now:

Great Fundamentals;

which investorsdon’t yet appreciate

Outsized returns result from strong operating

performance and improving values as

investor appetite grows

Build the case!

o For-sale residential

o Suburban apartments

o “Missing Middle” residential

products

o Multitenant industrial

o Hybridized product types


UNDERAPPRECIATED TRENDSFor-Sale Residential Potentially Coming Out of the Wilderness

60.0

61.0

62.0

63.0

64.0

65.0

66.0

67.0

68.0

69.0

70.0

Homeownership Rate

U.S. Home Ownership Rate U.S. Housing Starts

Source: U.S. CensusSource: U.S. Census

0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

0.0

200.0

400.0

600.0

800.0

1,000.0

1,200.0

1,400.0

1,600.0

1,800.0

2,000.0

Ho

us

eh

old

s

Un

its

(0

00

s)

Single-Family Housing Starts

Increase in Households (3-Year Rolling Average)


UNDERAPPRECIATED TRENDS

Average Effective Rent by Place Type, United States

Investors Overly Focused on (Sexy) Urban Apartment Markets

Despite Similar Performance of Other Place Types

Source: Axiometrics; RCLCO Place Type Characterization System


UNDERAPPRECIATED TRENDSMarket Has Turned Away Without Basis from “Economic”/Place

Type Missing Middle

Average New Multifamily by Place Type, Atlanta MSA

Source: Axiometrics; RCLCO Place Type Characterization SystemYear Built


UNDERAPPRECIATED TRENDS & PRODUCT TYPES: MISSING

MIDDLE

Image: Opticos Design

3%

4%

8%

8%

4%

10%

17%

32%

31%

49%

27%

18%

17%

20%

21%

40%

48%

18%

27%

0% 20% 40% 60% 80% 100%

All Households

Single-Family Owned

Single-Family Rental

Multifamily Rental

Post Grad Young Workers, No Kids

Family Middle Aged, No Kids

Older Workers & Retirees, No Kids

71.3%65.9% 60.1%

28.4%

31.0% 36.1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Top 50 Metros Gateway Metros Philadelphia

Suburban Urban Rural/Park/Institutional

Family Lifestage Distribution by Housing Type;

United States

Place Type of Current Residence; Millennials (25-34)

Source: U.S. Census Source: U.S. Census


Small-scale (Usually Multi-tenant) Industrial Exhibits Strongest

Market Fundamentals

UNDERAPPRECIATED TRENDS

Percentage Change in Industrial Inventory by Size

Category; 2007-2017 (YTD)

Average Industrial Vacancy by Size of Building;

2007-2017 (YTD)

1%

3%

8%

16%

7%

25,000-150,000 SF

150,000-250,000 SF

250,000-500,000 SF

500,000-1,000,000 SF

1,000,000+ SF

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017YTD

25,000-150,000 SF 150,000-250,000 SF

250,000-500,000 SF 500,000-1,000,000 SF

1,000,000+ SF

Source: Costar Source: Costar


TR

EN

D

Increasing Residential

Transience

Rise of Work From

‘Home/Sole Proprietorship’

Retail Box Store

Obsolescence

SO

LU

TIO

N

Short-Term Furnished Rental Residential/Office Hybrid

Conversions Mall Anchor Medical Office

UNDERAPPRECIATED TRENDSEvolving Trends in American Life Driving New and Creative Product

Hybridization

Novus Residences

eLofts; Alexandria, Virginia

Saul Urban

Unban Suites; Washington, D.C.


UNDERWRITING “CONTRARIAN” STRATEGIES

• Contrarian investment

strategies bear a higher

burden of proof:o “What we’re observing really is a

structural change.”

o “I know about the threats, but this

asset is different.”

• Contrarian returns should earn

higher returns (for the same

level of risk):o Clearly delineate and understand the

risks

o Quantify and evaluate the risks

o Answer whether the market pricing

makes sense

• Contrarian investor

characteristics: o Inquisitive culture

o Research-driven approach

o Appreciation for “the cycle”

o Patient and flexible capital

• Investment vehicle/approach

matters:o Fundraising, lifecycle, and approach

make it difficult for commingled funds

to be contrarian


CONCLUDING THOUGHTS/QUESTIONS

• So, how might you think of constructing a portfolio “staking”

investments in these categories?

• How do we overlay thinking about market cycle and this

approach?

• How do we use debt or creative capital stack formation with each?

• How do you underwrite a manager’s contrarian strategy?

STRATEGIES FOR IDENTIFYING VALUE IN A MARKET...

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