When it Comes to Real Estate Returns, HNWIs are Realists


January 3, 2021

By Beth Mattson-Teig

An Origin Investments Survey finds that many investors with deep pockets are pragmatic and not looking for “unicorn” opportunities in the real estate space.

High-net-worth investors (HNWIs) are putting more money to work in real estate investments. But are they getting sufficient bang for the buck on the risk they are taking?

Chicago-based Origin Investments recently surveyed more than 300 HNWIs nationally to gain insights on plans to invest in commercial real estate, strategies on where they want to place capital and return expectations at this stage of the cycle. What is clear is that a majority of HNWIs continue to see opportunity ahead in commercial real estate. More than 61.5 percent of survey participants expect to make private real estate investments over the next 12 months.

Those results are consistent with the WMRE’s own research. WMRE’s 2020 survey on HNWI commercial real estate activity showed that 60 percent of survey respondents expected those individuals to increase their allocations to commercial real estate over the following 12 months.

One of the persistent challenges for sponsors and advisors working with HNWIs is getting return expectations to align with what current market conditions can deliver. The Origin Investments survey asked investors about return expectations across different multifamily strategies. How much wealth do people want to create over their hold period given the level of risk they are taking? The investment firm focuses on multifamily assets with its open-end Income Plus Fund and Qualified Opportunity Zone Fund, as well as a third fund set to launch in late first quarter that will focus on ground-up multifamily development.

The survey asked investors specifically about the minimum internal rate of return and multiple on equity they would expect to achieve over a 5-year hold period on a:

  • 1990 class-B multifamily property that requires $5 million in capital renovations
  • 2020 stabilized class-A multifamily property with a 6 percent annualized yield
  • Class-A ground up multifamily development
  • Class-A ground-up development project in a qualified opportunity zone

Survey results show that most HNW investors are realistic on the returns multifamily can deliver. More than two-thirds of respondents (69 percent) have expectations of achieving between an 8 percent and 11 percent net IRR or a 1.5x-2.0x multiple on equity. However, 31 percent of HNWs have exceedingly high, bordering on unrealistic “unicorn” expectations defined as net IRRs of more than 14 percent and multiples of 2.0x or greater, says Michael Episcope, co-CEO of Origin Investments. “What we are seeing in the market and what we are able to underwrite and confidently deliver to investors in a ground-up multifamily fund is just shy of 2.0x,” he says.

Where return expectations were most surprising was on stabilized class-A assets. Three-fourths of survey respondents (74 percent) expect to generate returns of 11 percent IRR or multiples of 1.7x or greater, which is unrealistically high given the risk profile, notes Episcope. Stable class-A apartment assets are being priced at 4 percent cap rates today. So, even with the positive leverage component, assets just don’t produce that much yield, he says. “The way that I interpret that is that people are not going to take real estate risk, no matter what the asset is, unless they can make a certain minimum return or floor on their capital,” he says.

Investors favor apartments, industrial

The Origin Investment survey found that HNWIs view multifamily as the most favored property sector with an average weighted score of 4.18 out of a possible 5, followed closely by industrial at 3.81 and manufactured homes at 3.54. Investors were less bullish on student housing at 2.93, office at 2.36 and retail at 2.04. (Those numbers are also consistent when what WMRE surveys have found.) Investors gravitate to multifamily for several reasons, including the strong underlying demand and its track record of out-performing other property types on a risk-adjusted basis over the past decade. “I think everyone understands that multifamily is an essential asset, and it is going to be less volatile of retail, office or even industrial,” says Episcope.

Multifamily and industrial have become increasingly popular in light of disruption that has hit other areas of real estate, adds Michael D. Underhill, chief investment officer at Capital Innovations LLC in Pewaukee, Wis. “Physical distancing has directly changed the way people inhabit and interact with physical space, and the knock-on effects of the virus outbreak have made the demand for many types of space go down, perhaps for the first time in modern memory,” he says. In contrast, housing remains a necessity, and HNWIs also have discovered the positive impact e-commerce has had on industrial. Affordable housing in particular offers compelling investment and return opportunities because affordable housing in high-cost cities remains drastically undersupplied, notes Underhill.

Like many investors, HNWIs like the potential of high-growth secondary markets. Survey participants rated Austin, Texas; Charlotte, N.C.: Nashville, Tenn., Denver and Colorado Springs as the top five among 18 U.S. cities.

CRE values remain a concern

The pandemic doesn’t appear to have diminished HNWI interest in real estate. “There is still a good amount of interest from high net worth investors, and they are still looking for opportunities,” says Claudio Dombey, founding and managing Partner, Investor Relations for Accesso Partners. That being said, investors were hoping to capitalize on “deals” resulting from the pandemic, and that didn’t happen as prices didn’t go down significantly in 2020, he says. “So, there is still a lot of dry powder to be invested during 2021 when the opportunities arise,” he adds.

Accesso Partners works with HNWIs and families from Latin America, Israel and the U.S. The firm focuses primarily on suburban office investments and also launched a new multifamily fund in 2020 to offer more diverse options to investors. HNWIs are concerned about how work from home trends will impact demand for office space, whereas the concern related to multifamily is that increased competition could push property prices higher and put pressure on returns. “Multifamily is always very resilient, the big concern is the high prices,” says Dombey.

The Origin Investments survey found that HNWis are most concerned about property valuations (35 percent) and the prospects for economic growth (27 percent). “People are concern about valuations, because they really haven’t corrected in a post-COVID world, even though the fundamentals have declined,” says Episcope. “But I do think values in real estate are fair and not overpriced today. When we look back, what looked fair may actually look cheap in 12 or 18 months.”