In a market marked by continuous trading, investors still manage to find deals
The Bay Area has been an investment magnet for many commercial real estate investors across the globe since the recovery following the great recession began. The rise of the new economy spurred by technology and e-commerce has accelerated the importance of the region over some other traditional investment safe havens, and investors have been gobbling up core-plus and value-add properties as quickly as they can. As investment interest grew, so too did competition among investors who have become as diverse as ever, and all indications point to a market that will continue to behave this way well into 2019.
“The Bay Area has the best growth story in the United States and the world,” said Russell Ingrum, vice chairman at CBRE Capital Markets in San Francisco.
The Bay Area investment market finished out the second quarter of 2018 with more than $5.5 billion in total sales for the quarter, according to Cushman & Wakefield’s Marketbeat Bay Area Investment Q2 2018 report, which is slightly higher compared to the year before, with $5.4 billion in total sales for the fourth quarter of 2017.
The buyer pool is deeper and more diverse than ever before.
The numbers reveal the highest activity in Silicon Valley, with 44 properties sold for $1.753 billion in the second quarter, according to Cushman & Wakefield’s report. East Bay follows close behind with 25 properties sold for $1.132 billion, and San Francisco and the Peninsula pulled in 15 and 16 properties each at $1.478 billion and $1.062 billion, respectively. The North Bay trailed behind with 3 properties sold for $80 million.
Both San Francisco and Peninsula outperformed the 2017 fourth quarter numbers, when 17 properties sold in the city at only $781 million, and 14 properties on the Peninsula at $536 million, according to Cushman & Wakefield’s Marketbeat Bay Area Investment Q4 2017 report. The remaining regions, while selling slightly under their 2017 fourth quarter numbers, comparatively sold a larger volume of properties of lesser dollar value. East Bay, for example, sold 42 properties for $1.413 billion in the 2017 fourth quarter.
While the office sector accounted for 60 percent of the total investment activity during the second quarter with more than $3.2 billion of volume, with the apartment sector and industrial sector ranking at second and third, the most active player in the capital sector was the private buyer. Representing 33 percent of total investment activity in the Bay Area, the private sector accounted for 58 property transactions totaling $1.8 billion in volume. Institutional funds followed behind with 29 percent of total investment activity, with equity funds and REITs coming in at 26 percent, according to Cushman & Wakefield’s report.
“The buyer pool is deeper and more diverse than ever before, in particular in San Francisco,” said Kyle Kovac, executive president at CBRE Capital Markets in San Francisco. “In addition to typical institutional investors, which include private equity, pension funds and REITs, we are now seeing a high volume of high net worth individuals and family offices enter the market in an ultra-competitive way.”
In fact, the private equity sector in the greater United States continues to boom with more than $3.6 trillion of private capital raised since 2012, keeping it at the head of the investment game. Real estate follows close behind in second place, doubling assets under management since 2009 and reaching $565 billion in mid-2017. Unspent funds allocated to real estate reached a record $266 billion at the end of March 2018, according to Newmark Knight Frank’s 2018 Active Capital Report.
According to Kovac, investors in San Francisco have been bullish particularly regarding the leasing demand in the market.
“As such, assets that have near-term tenant rollover are particularly attractive to the investment community,” Kovac said. “Stabilized core deals are also seeing strong investor interest as San Francisco continues to be a leading gateway market and significantly supply constrained. Our average sales price per square foot is still significantly below replacement cost, which is attractive to investors.”
Because investors are always wary of economic recession, however, Ingrum pointed out they can be both bullish and bearish in the real estate market, especially.
“Everyone is buying and everyone is selling,” Ingrum said. “It is a continual process. What makes investors bullish is growth. Despite the growth [in the Bay Area], investors are concerned with an economic recession that would significantly reduce or eliminate growth. So what we see are investors that are simultaneously bullish and bearish.”
As the Bay Area continues to increase in competition, and as the market continues to grow more expensive, investors are looking to recognize market trends ahead of their competitors and perhaps accept lower returns in order to succeed.
“Generally, people are willing to accept a slightly lower return in order to be successful,” Ingrum said. “Most investors would rather accept a lower return than to underwrite rent or expenses that cannot be achieved in the market.”
Kovac added that off-market opportunities are also becoming more attractive to investors so they can avoid already widely-marked processes.
“It’s not like you’re getting a deal, but you’re getting an opportunity of seeing it without competing,” Kovac said. “Often times, that’s just as valuable.”
While urban locations such as San Francisco are preferred, those opportunities are highly competitive and limited, which can lead to investors looking elsewhere in the Bay Area.
“Most people prefer urban locations and access to mass transit, but there are only so many of those assets available, so people are forced to expand outside of that in order to deploy the capital,” Ingrum said.
Heading into 2019, the Bay Area can expect continually steady investment as it continues to grow.
“Investors will continue to invest in the Bay Area because this market has the best growth story in the world,” Ingrum said. “It also has a very controlled supply pipeline – one of the best in the country relative to absorption.”
The Bay Area can also expect to remain one of the foremost commercial real estate destinations in the nation, as evidenced in Cushman & Wakefield’s report. The report said San Francisco/Peninsula, Silicon Valley and East Bay were among the top 20 markets in terms of volume, ranking 13th, 14th and 18th, respectively, according to Real Capital Analytics.
According to Newmark Knight Frank’s report, increasing local wealth accumulation in the U.S. will also raise domestic demand for real estate.
The Bay Area additionally as a whole was in third position behind New York City and Los Angeles, representing one of the strongest regional economies in the United States, according to the report. Dallas and Chicago completed the Top Five markets in the U.S. in terms of volume.
“The Bay Area and San Francisco in particular will continue to have a disproportionate share of investor interest in 2019 relative to virtually every market in the United States,” Kovac said.