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KBS’ Chuck Schreiber on Managing Real Estate Risk

Connect Media sat down with KBS CEO Chuck Schreiber to gather insights on the market, managing risk and real estate investment. An edited transcript of the discussion follows below.

Q: There are a number of headlines today suggesting that the commercial real estate market may start to soften. What’s your take?

Chuck Schreiber: There’s been talk of a softening for five years now. We always seek to be prepared for changes in the market which can happen rapidly. We focus on 16 markets and businesses are doing well in those markets. For us it is important to be sensitive to the needs of our tenants so that our properties can compete at the top of those markets.

Q: What types of properties, and markets, does KBS focus on?

Schreiber: We are strong believers in Class-A high-quality multitenant office properties. It costs more to operate multi-tenant properties on a quarterly basis, but when you look at it over a 10-year hold period there’s generally much lower risk for the investor. If we realize something is going on in a specific market that will change the demand from tenants, we will modify our involvement in that market. Having a national portfolio allows us to modify our presence in one market – it gives us a lot of flexibility.

Q: Where do you see growth companies migrating today with respect to office space, especially when gateway markets can be overpriced not just for space, but for employees who need an affordable place to live?

Schreiber: Urban markets with the right mix of amenities and public transportation are high on our radar, as are markets that are home to major universities with an abundance of tech, engineering and science talent. Today we are seeing tenants make moves into existing KBS buildings or extending their leases. These growth companies are making decisions and a key member of that committee making the decision is the director of human resources. For most growth companies today, selecting a property and a location that will attract the right kind of talent is critical to their success.


We are strong believers in Class-A high-quality multitenant office properties. It costs more to operate multitenant properties on a quarterly basis, but when you look at it over a 10-year hold period there’s generally much lower risk for the investor.


Q: What other factors do tenants consider?

Schreiber: Decisions are being made with flexibility in mind. Many tenants want the ability to grow or contract. If they are on four floors and sign a seven-to 10-year lease, there is a good probability the demand for their space will change—growing smaller or bigger—during that time. This is why we find that the hard work involved in buying and operating multi-tenant properties usually pays off in the long run from a risk perspective for KBS and our valued investors.

Q: Does the amount of debt that you deploy in your acquisitions factor into how you operate your properties?

Schreiber: We run conservative levels of leverage anywhere from 40% to 50% on our portfolios. We are focused on longer-term debt of five to seven years or longer. We do an analysis once a year to confirm we will have the funds to consistently improve our buildings. We may buy an $80-million building and we could allocate $1 to $2 million in strategic improvements to make it compete at the top of its peer set in terms of rents we can earn and the amenities and modern finishes we can offer to our tenants. We may anticipate that in five years we need to spend another $1 million to keep it competitive. It’s an ongoing demand and not over-leveraging our properties allows us to do that.

Q: What is the outlook like for developers today who want to build a new office building in a great market?  What challenges do they face?

Schreiber: For the majority of the developers — and I am speaking of commercial office, retail and even industrial — if they are not substantially pre-leased it is very difficult to get a construction loan today. It’s hard to get dollars for speculative projects. They may have great land but if they do not have a tenant lined up for 80% of the space in a $100-million build, they will have a tough time getting a $50-million construction loan. Fifteen years ago, there was 75% to 85% leverage, but today they need twice as much equity. This means that the market is a lot healthier because we don’t have that risk of overbuilding.

We believe the biggest risk to assets in our portfolios is over-development. Tenants may be in an eight- to 15-year-old building and if a market is overdeveloped, that’s a big risk. This is why we are keenly aware of what is happening in every market we target for investment. We are blessed to have the portfolio that we built during the past six years, it’s a great time to own high quality Class A office space in the right markets.

Chuck Schreiber is the CEO of KBS, one of the largest office owners in the United States..

Pictured: The renovated lobby at the KBS-owned Meier & Frank building in downtown Portland.

 

Click here to read the original article on Connect Media

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CRE Investors: In-Place Rents 15% – 40% BELOW current market rates in select KBS buildings

The KBS Growth and Income REIT completed its most recent portfolio update webinar on Friday, March 15, 2019.  You can find the link to the webinar presentation at the bottom of the page along with supporting material for your review.

 

The biggest take away from the update was that the in-place rents with existing tenants are below current market rents.  In some cases, 40% below current market rates. 

 

The KBS strategy, to owning these CORE and CORE + buildings, is improving quality of the building and thus improving the experience for the tenant. The KBS philosophy is based on creating a work environment for the tenants so that the employees do not want to leave the building. KBS is focused on growth markets in urban areas where there is a technology company bias which is driving the growth in the sub-market. For employers to retain top tech talent, the workspace and work environment for this workforce, must be attractive, with the work/play/live focus of these employees.

 

The KBS Philosophy for investors in its REITs is transparency, all the way down to the tenant. Investors and CRE professionals can drill down and evaluate the actual market metrics and valuations of the buildings to determine how this type of cash flow and potential upside in asset/building value may fit into an investor’s portfolio.

 

Below you can find the description of the buildings in the KBS Growth and Income REIT and review the detail of the tenant composition of each building.

 

Building In-place Rent
Von Karman Tech Center, Irvine CA

(Page 12 of PPT)

43% BELOW current market rates
Commonwealth Building, Portland, OR

(Page 13 of PPT)

46% BELOW current market rates
Offices at Greenhouse, Houston

(Page 14 of PPT)

15% BELOW current market rates
213 West Institute Place, Chicago, IL

(Page 15 of PPT)

20% BELOW current market rates

 

Dec. 31, 2018:

 

Current distribution: 6% annual rate, paid monthly

Leverage: LTV is 57%

Total Lease Occupancy of portfolio: 93%

Tenant total: 73

NAV change for 2018: +4.66%

Total Return for 2018: ~+10.4%

 

Given the transparency and detailed portfolio disclosure by KBS, CRE professionals and potential investors can evaluate, analyze and determine if the KBS Growth and Income REIT fits within their investment allocation.

 

For the Webinar Slides, please click here

 

For the Webinar Video, please click here

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A 6% Annual Distribution Derived from an Institutional Portfolio

For those seeking a 6% annual distribution[1]derived from a portfolio of institutional quality office buildings, consider KBS Growth & Income REIT as part of your investment portfolio. The KBS Growth & Income REIT is available through KBSDirect.com and is managed by the 8th largest owner and operator of commercial real estate[2].

 

KBS Growth & Income REIT:

  1. Provides accredited investors the opportunity to purchase shares of the REIT free of any upfront commissions or sales loads
  2. Is free of any acquisition and financing fees
  3. Currently pays investors a monthly annualized 6% distribution

 

KBS Growth & Income REIT Portfolio3:

  1. Consists of four office buildings located in Irvine, Portland, Houston and Chicago
  2. Irvine, Portland and Houston over 95% leased
  3. Chicago leased at 84%
  4. Estimated value $206.2 million

 

KBS Growth & Income REIT Net Asset Valuation History4:

  1. $8.75: Estimated value per share as of August 9, 2017
  2. $8.79: Estimated value per share as of December 8, 2017
  3. $9.20: Estimated value per share as of December 7, 2018

 

KBS Growth & Income REIT Objectives5:

• To preserve and return stockholder’s capital contribution
• To provide stockholders with attractive and stable cash distributions
• To seek to realize growth in the value of its investments

 

KBS Growth & Income REIT will strive to meet these stated objectives with the careful selection and underwriting of the assets it seeks to purchase KBS Growth and Income REIT attempts to construct a portfolio that produces stable and attractive returns by spreading risk across different real estate investments.

 

Visit KBSDirect.com for Additional Information:

• Details of the assets in the portfolio
• Photo gallery of the assets in the portfolio
• Lease percentages of the assets
• Key tenants
• Financing structure of assets
• REIT structure
• Direct visibility of fees

 

Risks Factors
KBS Growth & Income REIT is only made available to “accredited investors” (as defined in the Rule 501 of Regulation D of the Securities Exchange Act of 1933, as amended). All investments have some degree of risk and an investment in KBS Growth & Income REIT involves significant risk. These risks include, but are not limited to: the possibility of the investors losing their investment: no guarantees regarding future performance; upon the sale or distribution of assets investors may receive less than their initial investment; fluctuation of the value of the assets owned by REIT; lack of a public market for shares of the REIT; limited liquidity; limited transferability and other risks outlined in the Private Placement Memorandum, which is available for review on KBSDirect.com.

About KBS
KBS is a private equity real estate company and an SEC-registered investment adviser. Founded in 1992 by Peter Bren and Chuck Schreiber, it is recognized as one of the largest commercial office owners globally. Since inception, KBS-affiliated companies have completed transactional activity of approximately $40 billion via 16 separate accounts and six commingled funds, for government and corporate pension funds. Additionally, KBS has sponsored five sovereign wealth funds and seven SEC-registered, non-traded REITs. For more information on KBS, its properties and real estate portfolios, please visit KBS.com. For information about KBS’ current offering, please visit KBSDIRECT.com.

Forward-Looking Statements
The foregoing includes forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. The Company intends that such forward-looking statements be subject to the safe harbors created by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include statements regarding the intent, belief or current expectations of the Company and members of its management team, as well as the assumptions on which such statements are based, and generally are identified by the use of words such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends,” “should” or similar expressions. Further, forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time, unless required by law. Actual results may differ materially from those contemplated by such forward-looking statements. The REIT makes no representation or warranty (express or implied) about the accuracy of any such forward-looking statements. These statements are based on a number of assumptions involving the judgment of management.

Securities offered through North Capital Private Securities (“NCPS”). Member FINRA/SIPC.

 

 

1Distributions are paid monthly and there is no assurance the REIT will continue to declare and pay cash distributions. For more information regarding distributions, please refer to the REIT’s public filing.
2The ranking by National Real Estate Investor is based on volume of office space owned globally, as of December 31, 2017.
3 As of September 30, 2018. Total leased percentage includes future leases that have been executed but have not yet commenced.
4 For data regarding the valuation methodology, please see the SEC 8k filings for periods ending June 30, 2017, September 30, 2017 and September 30, 2018, respectively. All filings are located on the SEC EDGAR website.
5 There is no assurance the REIT will be able to meet the stated objectives.

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KBS Sees Growth in Value Across its Portfolios

NEWPORT BEACH (January 30, 2019) —KBS, one of the largest commercial office owners globally, announced today the net asset value of its portfolio increased 6.15% in 2018. KBS’ real estate portfolio consists of 118 properties located in prime urban markets throughout the United States valued in excess of $11 billion as of December 31, 2018. The assets are held through five public non-traded REITs as well as eight funds managed for two institutional separate account relationships. During 2018 KBS completed the full liquidation of two of its public non-traded REITs.

 

In addition to growing the value of its real estate, KBS made weighted average distributions to investors for its public non-traded REITs (excluding its opportunistic REITs) of nearly 6.0% and for its institutional funds in excess of 7.0% on invested capital.

KBS CEO Chuck Schreiber commented, “While we hear a general consensus that the commercial real estate market is softening, the substantial and disciplined growth of KBS’ portfolio suggests there is still ample opportunity for continued growth and return for owners who are strategic with respect to the markets and the type of office property purchased and operated.”

 

KBS’ strategy focuses on investments in urban markets that are attracting tech and creative users and have a wide range of amenities that help companies attract today’s top-tier talent. These include markets with good public transportation as well as entertainment, housing and dining amenities.

 

 

“In many of these markets, we are seeing limited supply due to the cost and constraints on new construction, and as a result rental rates continue to climb,” said Schreiber. “It has not been uncommon in the last year for existing tenants to approach us seeking to renew their space early and even seeking to secure additional space in anticipation of growth in their office needs to hedge against rising rental rates.”

According to Cushman & Wakefield’s Q3 2018 Marketbeat report on the U.S. office market, office-using employment increased by 600,000 jobs and unemployment declined from 4.4% to 3.9%. While national vacancy rates are projected to increase slightly, rental rates are projected to climb. According to the report, average asking rents have increased over 27% since the second quarter of 2011, the lowest level in recent years. The fastest growth has been in the tech sector led by San Francisco where rents have doubled.

 

In 2018, KBS became one of the first large-scale operators to offer a direct investment real estate fund for accredited investors online. The KBSDirect.com platform is a user-friendly portal where accredited investors can invest in an institutional-quality portfolio of diversified multi-tenant office buildings without paying any up-front commissions.

“We saw an opportunity to better serve retail investors by offering them a means to invest in institutional quality real estate with lower fees and greater transparency so they can do their own research and make their own self-directed investments,” said Schreiber. “This essentially means that 100% of investors’ invested capital goes to the real estate, thus providing opportunity for enhanced returns.”

KBS is also working with registered investment advisers (RIAs) to introduce them to KBS and the level of transparency KBS provides and placing the commission-free fund on their own platforms as an alternative investment vehicle that can hedge against higher risk investments.

“We are very excited about the coming year and the opportunities to serve our tenants with exceptional space in some of the best locations in the U.S.,” concluded Schreiber. “We are also excited about growing our direct investment efforts so that accredited investors and registered investment advisors have the opportunity to invest in risk-adjusted, institutional-quality real estate without upfront commissions.”

 

About KBS
KBS is a private equity real estate company and an SEC-registered investment adviser. Founded in 1992 by Peter Bren and Chuck Schreiber, it is recognized as one of the largest commercial office owners globally. Since inception, KBS-affiliated companies have completed transactional activity of approximately $40 billion via 16 separate accounts and six commingled funds, for government and corporate pension funds. Additionally, KBS has sponsored five sovereign wealth funds and seven SEC-registered, non-traded REITs. For more information on KBS, its properties and real estate portfolios, please visit KBS.com. For information about KBS’ current offering, please visit KBSDIRECT.com.

 

Forward-Looking Statements
The foregoing includes forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. The Company intends that such forward-looking statements be subject to the safe harbors created by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include statements regarding the intent, belief or current expectations of the Company and members of its management team, as well as the assumptions on which such statements are based, and generally are identified by the use of words such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends,” “should” or similar expressions. Further, forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time, unless required by law. Actual results may differ materially from those contemplated by such forward-looking statements. The REIT makes no representation or warranty (express or implied) about the accuracy of any such forward-looking statements. These statements are based on a number of assumptions involving the judgment of management.

 The valuation methodology for the Company’s real estate properties assumes the properties realize the projected cash flows and expected exit cap rates and that investors would be willing to invest in such properties at yields equal to the expected discount rates. Though the valuation estimates used in determining the real estate values are based on real estate appraisals provided by Duff & Phelps’, CBRE, Cushman & Wakefield, Colliers’ or the Company’s and/or the Advisor’s best estimates of value, the Company can give no assurance in this regard. These statements also depend on factors such as: future economic, competitive and market conditions; the Company’s ability to maintain occupancy levels and rental rates at its real estate properties; the borrowers under the Company’s real estate debt securities investment continuing to make required payments; and other risks identified in Part I, Item IA of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 and subsequent periodic reports, as filed with the SEC. Actual events may cause the value and returns on the investments to be less than that used for the purposes of estimated net asset per share values.

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KBS signs largest lease in Denver in 2018

KBS continues strategy of successfully upgrading

Class A office buildings in its portfolios

 

KBS, based in Newport Beach, California, announced the signing of 384,716 square feet in leasing at Granite Tower in Denver during the fourth quarter of 2018.

Among these leases is a 12-year extension for 295,743 square feet with Anadarko Petroleum Corp., the largest lease signed in Denver in 2018. Other new tenants at the property include Inflection Energy LLC, MountainView Financial and Causey Demgen & Moore P.C. Granite Tower.

“KBS’ overall strategy has been to acquire high quality office assets that are well located, then implement aggressive renovations to properly compete with significant developments occurring across the country. Our thoughtful and forward-thinking renovations at Granite Tower have proven key to attracting and retaining premier tenants at the property,” said Rodney Richerson, Western regional president for KBS. “We look forward to fostering long-term relationships with our new and existing tenants while continuously working to meet their changing needs.”

KBS continues its strategy of identifying Core and Core-plus commercial office buildings, and then upgrading those assets with tenant amenities that the current workforce, and employers now expect.  KBS has executed on this strategy nationwide.  Examples of this strategy can be found in several assets like the Commonwealth building in Portland, Oregon, where the lobby was completely changed, bike rooms, a gym and showers were installed, along with better floor layouts and common areas for all tenants to use.  Leasing levels have risen to over 95% occupancy, and at rates higher than only a few years ago. The Commonwealth building in Portland is an asset in KBS Growth and Income REIT, which is currently the only KBS REIT open to investors at this time, There are no commissions charged to investors to invest into the KBS REIT.

Granite Tower in Denver is part of the KBS REIT II portfolio, which is closed to new investors and has already sold several assets, returning capital to investors.  Granite Tower is a 31-story, Class A office tower located in Denver’s Central Business District (CBD). The property is in close proximity to Coors Field, home to the Colorado Rockies, and Union Station, a lively neighborhood known for its dining and shopping options.

“The bustling area provides access to a balanced professional and personal life,” said Clint Copulos, senior vice president for KBS and asset manager for the property. “Tenants can enjoy the office amenities while being within walking distance to restaurants, retail and more.”

 

 About KBS

KBS is a private equity real estate company and an SEC-registered investment adviser. Founded in 1992 by Peter Bren and Chuck Schreiber, it is recognized as one of the largest commercial office owners globally. Since inception, KBS-affiliated companies have completed transactional activity of approximately $40 billion. KBS has managed these investments via 16 separate accounts and six commingled funds, including sovereign wealth funds and corporate pension funds. Additionally, KBS has sponsored seven SEC-registered, non-traded REITs. For more information on KBS, its properties and real estate portfolios, please visit KBS.com. For information about KBS’ current offering, please visit KBSDIRECT.com.

This release may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended, including KBS REIT II’s ability to invest in and manage a diverse portfolio, the performance of Granite Tower and the performance of the Denver real estate market. These statements are subject to known and unknown risks, uncertainties and other factors which may cause KBS REIT II’s actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.

* Prior performance is no guarantee of future results. Estimated portfolio values are as of December 31, 2017. Assets shown in prior KBS funds may not be representative of assets in current open offerings. Prior funds are listed to illustrate KBS historical acquisition and disposition activity and geographic distribution and may not be representative of future investment activity.

KBS Holdings LLC intends to sponsor an offering pursuant to Regulation A under the Securities Act of 1933, as amended. No money or other consideration is being solicited at this time with respect to such offering, and if sent in response to these materials for such an offering, it will not be accepted. No offer to buy securities can be accepted and no part of the purchase price can be received for an offering under Regulation A until an offering statement is qualified by the U. S. Securities and Exchange Commission, and any such offer may be withdrawn or revoked, without obligation or commitment of any kind, at any time before notice of its acceptance given after the qualification date. An indication of interest made by a prospective investor in a Regulation A offering is non-binding and involves no obligation or commitment of any kind. There are no guarantees regarding future performance. See Risk Factors. Securities offered through North Capital Private Securities (NCPS). Investment risk – liquidity, risk of loss; not tax, investment, accounting advice; past performance not indicative of future results; consult with a professional (attorney, advisor, accountant); conduct your own research and due diligence; forward looking statements; information believed to be correct but don’t rely upon it / no warranty; not an offer to sell securities; information may not be complete; investments not suitable for all investors; not a recommendation; platforms are not brokers; member FINRA and SIPC.

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Fear of being a late cycle CRE investor

When speaking with investors, and at real estate investment conferences, the common theme from participants is the fear of investing in commercial office buildings and other income producing CRE, currently, when there is a perceived ‘top of the cycle’ for commercial real estate.

 

The term ‘cycle’ implies that once CRE reaches the ‘top of its cycle’, then there will be a downturn to CRE assets and thus lower returns or incur losses for investors.

 

Debunking certain terms for CRE:

 

But what if the term ‘cycle’ is an inaccurate description of the dynamics for performance of CRE assets? Some investors and consultants may be making a mistake to use the term ‘late cycle’ for ‘Real Estate’. That is a generic characterization of all real estate.

Let’s take commercial office as an example.  Do commercial office buildings share the same economic dynamics as retail malls, residential homes, multifamily rentals, etc.? The answer is no.  Within the commercial office market, do class A Office buildings in major markets share the same economic dynamics as a Class B suburban office building in a second-tier market? No, it does not.

So, the word ‘cycle’ assumes that investment in CRE will peak and then turn down or trend negative.  At many investment conferences, consultants will put up a chart showing a curve with a cycle that turns negative for CRE, at certain point.  In actuality, there is not a smooth cycle for CRE sponsors and investors. What has happened to the consultants and their charts when they predicted the end of the ‘cycle’ for CRE investment in 2015? 2016? 2017? 2018?

 

Confusing ‘Cycle Downturn’ with lower return expectations

 

One should be careful about confusing a strong and tight CRE market, with a pending ‘downturn in the CRE cycle’.  These are not the same things.  One example of this is where fully leased Class A office buildings have experienced gains in their value due to tighter markets, low supply and little to no new construction in the market.  This scenario should not be confused with a consultant speaking at a conference about the top of the cycle and thus a downturn for the ‘cycle’. This is not how sponsors and investors view the market.  These top assets are kept for their cash flow and ‘in-place’ tenant leases in an area that is experiencing job growth and economic expansion. This is not necessarily the beginning of a downturn.

The difference in this example is that there is no cycle to the specific asset/building if the in-place tenant leases are long term and there is little to no supply of comparable buildings in the immediate market.  The return profile for a new investor investing in that type of asset will be lower, but that does not mean that the cycle is turning down. If the market for Class A office is tight and returns to investors are 4% – 8% depending on leverage used, then that is the market.  It does not mean the end of a ‘cycle’.  This is a common mistake made by some media pundits and bloggers, and some consultants, when they describe a strong/tight CRE market as ‘late cycle’ just because the return profile is lower than a previous period when the markets were less tight and not as strong as they are currently.  There were some ‘experts’ talking about late cycle investments being made in 2015 – 2017. They advised investors to avoid these types of investments because of a pending ‘downturn in the cycle’.  So far those ‘experts’   have not been right, and the institutional investors who made those investments are holding their investments and collecting their cash flow as the assets remain stabilized in a tight market.

 

Publicly traded REITs and the confusion they cause for Private/Direct CRE investments

 

Publicly traded REITs have many investors and media analysts who follow them.  All too often publicly traded REITs are confused with private CRE investment.  Both modes of investment into CRE are completely different.  But since publicly traded REITs receive more of the media coverage than private CRE investment Funds, statements like ‘late cycle investing’ and ‘the CRE cycle is poised for downturn’ get picked up in the media and are promoted by many media consultants and advisors.

If one looks at the media coverage of publicly traded REITS from 2018, there was plenty of reporting and coverage of publicly traded REITs thatdiscussed significant volatility, loses in share price due to market liquidations and fear, and concern of retail CRE imploding and going bankrupt.  These headlines for publicly traded REITs had very little to do with the strong performance achieved in the Class A commercial office sector and other CRE strategies, and more importantly, the stability of the pricing and asset values of private CRE investment.  While many bloggers and news letter writers spoke about how the publicly traded REIT index out performed the S&P 500 index in 2018, very few articles mentioned that the vast majority of publicly traded REITS were down on the year.

For the institutional investors who focus on private CRE investment, their returns had very little crossover or correlation with the negative returns of publicly traded REITs.   Many people just equate the negative performance of publicly traded REITs with all CRE investment, and that is completely wrong. In the private CRE investment world, savvy institutional investors do not pay a market multiple for liquidity, whereas retail investors buying publicly traded REITs, do.  The worst part for these investors in publicly traded REITs isthey can suffer the losses of the REITs trading at discounts to the actual NAV of the RE assets due to swings in the market, and in some cases, the discounts to theNAV can be at significant levels, with very little chance of ever recovering to the true NAV. There are only two ways for publicly traded REIT investors to recoup losses due to heaving selling pressure: 1) many new investors enter the market to purchase that specific REIT, thus closing the negative discount spread, or 2) a takeover and purchase of the entire REIT at a value close to the real NAV.

 

Don’t be misled by inaccurate generic terms for CRE

 

CRE investors of all types should not be misled by terms that don’t really pertain to actual direct investing into incoming-producing CRE.  Private/direct investment in to class A commercial office buildings outperformed publicly traded REITs in 2018.  Don’t be misled by ‘experts’ talking about how bad things were for generic CRE investing. That just was not the case.  Every deal and market is unique with specific economics and targets.  There is no generic ‘cycle’ to all real estate. Do your own analysis of the specific investment opportunities and try not to pay any commission to make an investment in to professionally managed CRE.

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Will Direct Investment into CRE Finally Get Respect?

In 2018, direct investment into most income producing commercial real estate outperformed U.S. equity markets according to a December 17 release by the National Council of Real Estate And Investment Fiduciaries (NCREIF). The volatility of the U.S. equity markets was significantly higher than the volatility of private direct investment into income producing CRE. Even most publicly traded REITs underperformed most private direct investment into CRE.

 

“Will investing directly into income producing commercial real estate finally get more attention by individual investors in 2019?”

 

Most investors are aware of the increased volatility in the global equity markets, and it looks like volatility could continue in 2019.  Thus, as many investors plan their investment strategies for 2019, many will be concerned about potential volatility and uncertainty of returns and dividends.

 

Individual investors, who are concerned about the volatility in traded markets, may want to look at how some large institutional investors mitigate their exposure to traded market volatility.  The institutional investors who allocated capital at the end of 2017 and in 2018, to mainly Class A multitenant commercial office buildings (with high tenant occupancies), experienced stable cash flow derived from rental income, net of the operating costs of the assets.  The dividends and distributions paid to investors were generally constant and met expectations because the relative stability of income from in-place leases spread over many different tenants.

 

The key variables to total return for investors in Class A office buildings (with high tenant occupancy) are:

 

  1. Income from rent collected less operating expenses
  2. Any change in valuation of the asset, or the sale or re-financing of the assets/buildings.

 

This is very different than investors buying publicly traded stocks which trade at a multiple to their cash flows and in most cases at a multiple to their book value. A stock market investor can perform all the analysis on a publicly traded company, and estimate what a company may be worth, and what the earnings might be, but there is no way for investors to determine what the multiple or premium will be for a specific stock at any given time.  The multiple will be determined by other investors and market participants and their willingness to pay a premium for an actual set of cash flows.

 

This is different than income producing Class A commercial real estate assets where there is typically much less fluctuation in the actual NAV of the building in the short run, because there are few fundamental changes to a building and its cash flow in the short run, and since there is no traded premium attached to the asset, there is no risk of massive multiple contraction, as there can be in publicly traded stock valuations.  In the traded equity markets, the fundamentals can be exactly the same for a specific company, but if investors suddenly decide that they will no-longer pay 25x earnings and will only pay 20x or 15x earnings, the stock price is going to decline significantly in the short run.

 

In 2018, total returns for a large cross-section of Class A Office assets, in markets that KBS follows, ranged from 3% to 15%. The total return comprised of dividends and distributions ranging from 3% to 7%.  Valuation gains on buildings and assets ranged from 1% to 9% for a large cross-section of Class A office assets.

 

So many of these investors in Class A commercial real estate achieved total returns in 2018 of 6% to 12% with minimal volatility in the return stream and valuation of the assets. This 6% to 12% total return in 2018 compares favorably to the negative return of -4.4% for the S&P 500 Index in 2018.  In addition, there was minimal volatility with the total return of the CRE investments, whereas the U.S. equity markets were quite volatile, especially in Q4 2018. In December 2018, the U.S. equity markets experienced a significant decline, (S&P 500 Index -9%), as investors fled the markets. Fundamentals of the entire market did not change that much to warrant a decline of over 20% in Q4 for most averages.

 

Measuring Risk/reward and the certainty of distributions to investors

 

When most investors analyze the risk of an investment, they are concerned with:

  1. Return of capital
  2. Dividends and distributions
  3. Gains on the value of the asset
  4. Liquidity or sale of the asset

 

When analyzing these factors for Class A commercial office buildings, there is the ability to analyze each one of these factors with more certainty than the vast majority of publicly traded equities.  The biggest difference being that investing in income producing Class A office buildings does not have the risk of paying a market multiple that can fluctuate or evaporate just because investors are selling at a moment in time.

 

In a diversified portfolio of several Class A office buildings consisting of several tenants in each building, an investor can better analyze the certainty of the cash flow and distributions compared to a portfolio of stocks.  The value of the portfolio of Class A office buildings will typically not fluctuate very much as the asset is not liquid and might be valued 1-2 times a year.  This can compare favorably to a portfolio of stocks that can fluctuate with significant volatility in the short term, depending on market conditions.

 

Instant Liquidity vs. Longer Term Hold

 

Liquidity is the biggest differentiating factor between direct investment into CRE and investing into equity markets.  Direct investment into CRE is not for investors who will need their investment capital returned in two years or less. Direct investment into Class A commercial office buildings is usually made by institutional investors and some individual investors who are looking for some certainty of distributions from rental income, lower volatility of asset values and a more predictable approach to try and achieve a target total return objective.

 

2019 Investment Strategy Options: Class A CRE

 

If individual investors are setting their investment plans for 2019 and are concerned about experiencing a significant amount of volatility while trying to achieve high single digit returns, they may want to consider evaluating direct investment in to a diversified portfolio of Class A commercial office buildings where there is transparency provided by the owner with regard to financing of the building, tenant composition, lease terms/lengths and the sponsor’s view and evaluation of the local market.  Finally, if an investor does review and analyze a vehicle to make direct investments into Class A CRE, the investor should try not to pay a commission to invest into the vehicle.  There are options to invest directly into CRE without paying a commission to do so.

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What’s the ‘ALTERNATIVE’…….
To stock market volatility and uncertainty for 2019?…..CRE?

Many people and investors are feeling some pain and angst as they are experiencing the increased volatility in the global equity markets.  Many investors perceive uncertainly about so many investment factors.  Some of these investors are nervous about return expectations for their traditional investments for next year. As investors set their investment plans and strategies for 2019, some are concerned about the level of volatility in traditional investments (stocks, bonds and mutual funds) that they might have to endure to achieve their return goals.

To diversify away from the recent volatility, correlation and uncertainty of traditional investment in stocks, bonds and ETFs, there may be an ‘ALTERNATIVE’ for individual investors to consider. . .

ALTERNATIVE?……… Income Producing Commercial Real Estate?

 

Rewind to December 2017 and return expectations for 2018

 

Before evaluation of investment plans for 2019 is discussed, it is worth while taking a quick look back to late December 2017, when investors were setting their investment plans for 2018.  As 2017 was coming to a close, the US equity markets were completing a strong performance year with the S&P 500 index gaining 21.8%, the Russell 2000 gaining 14.6%, and the FAANG stocks: Facebook (+53%), Amazon (+56%), Apple (+46%), Netflix (+55%), Google (+33%). There was a new tax cut for business passed by Congress in late 2017, so some investors felt that this momentum could continue into 2018, and they could set a PASSIVE investment strategy to investing in indexes, ETFs and other traditional portfolio options like stocks and bonds.  A few investors and advisors even said: “Set it and forget it” with regard to PASSIVE investment strategies for 2018.

 

Coming off a strong 2017, and expecting the positive market momentum to continue in 2018, some investors were less interested in making investments into income producing CRE, with return profiles of 6% to 12% (based on asset growth and income, produced by the asset).

 

2018 returns did not play out to the expectation of many investors.  The S&P 500 is bouncing around a return of 0% for 2018, as year-end nears.  Equity indexes have experienced much more volatility in 2018 compared to 2017, causing nervousness about return expectations for 2019.  Meanwhile many Class A CRE assets produced returns of 6%-12% in 2018, with much less volatility than those traditional assets.

 

Setting investment objectives and goals for 2019: Assessing Uncertainty for investment return factors:

 

There is no certainty to investment return.  Each investor must determine their own risk tolerance first, and then set their investment return goals based on their tolerance for risk.  The hard part for many investors is how to assess risk and set expectations for potential return.  Looking forward to 2019, many investors are concerned about what the certainty may be for both growth and income (asset price growth and dividend/income returns) on their investments for traditional investments (Stocks, Bonds, ETFs)

 

Alternative Investment option? Income Producing Commercial Real Estate?

 

For some investors, there may be an alternative investment option that could be of interest for investors looking for non-correlated investments to traditional investments, with potentially less price volatility in the short term.

 

Income Producing Commercial Real Estate Assets

 

These types of CRE assets typically have existing cash flow being produced by rental income from tenants. Depending on the asset class and market location, the cash flow to investors might be in the range of 5%-10% depending on the leverage and financing structure of the asset.

 

The risk to the investor is the certainty of the cash flow coming from rental income of the asset.  A Class A commercial office building, with over 95% occupancy, with leases from multiple credit worthy corporate tenants, that do not expire for at least 5 years, should have more certainty of cash flow from the asset compared to the cash flow to investors from traditional assets: stocks, bonds, and ETFs.  Also, there can be much more short-term volatility to traditional investments that trade on an exchange, compared to a Class A Office building with high occupancy that does not have its NAV traded daily on an exchange. Class A Commercial Office assets are long term investments and thus do not have their NAVs priced every second or every day.

 

2019 investment strategy options

 

Some investors can evaluate, analyze and review investment options for 2019, and then gauge what type of risk/certainty there may be to achieve returns that may be derived from dividends/interest and asset price gains of a Class A commercial office building. Then, compare that risk to traditional investments.  Those investors can then compare the certainty/uncertainty of traditional investment returns and make their own assessment for the likelihood of achieving total returns of 0%, 5%, 10%, 15%+??? . . . or losing money.

 

If some investors are concerned about potential volatility in their traditional investments, and uncertainty for returns in 2019, they may want to evaluate and consider an ALTERNATIVEinvestment option: Income producing Commercial Office Real Estate Assets.

 

If an individual investor decides to evaluate and eventually invest in income producing CRE assets and funds, the investor should make sure that their investment capital is going directly into the asset or investment vehicle with zero slippage or commission to invest into that asset or investment vehicle.

 

Welcome to the Investment Revolution!

 

Investing in KBS Growth & Income REIT includes substantial risks. These risks include, but are not limited to: the possibility of losing your entire investment; no guarantees regarding performance; upon sale or distribution of assets you may receive less than your initial investment; fluctuation of the value of the assets owned by KBS Growth & Income REIT; lack of a public market for shares of KBS Growth & Income REIT; limited liquidity; limited transferability; reliance on KBS Capital Advisors LLC, the REIT’s advisor, to select, manage and dispose of assets; and various economic factors that may include changes in interest rates, laws, operating expenses, insurance costs and tenant turnover. Shares of KBS Growth & Income REIT are not suitable for all investors. Investors should read and consider the PPM carefully before investing.
KBS Direct makes no representations as to the appropriateness of an investment in KBS Growth & Income Real Estate Investment Trust for ERISA plan fiduciaries and IRA owners and no investment advice is being provided. ERISA plan fiduciaries and IRA owners should consult with their own advisors and counsel before making an investment in the REIT’s shares. This is not an offer to sell securities. Offers to sell, or the solicitations of offers to buy, any security can only be made through a private placement memorandum and other official offering documents that contain important information about risks, fees and expenses.
Securities offered through North Capital Private Securities (NCPS).

 

DIY Portfolio Graphic_v2-01-2

Building a Do-it-Yourself CRE Investment Portfolio

Investing into commercial real estate directly is becoming a new wave for investors looking for an alternative to traditional investing into stocks and bonds.  Direct access to commercial real estate, and technology at the sponsor level, has created online accessibility to detailed information about real estate assets, sponsors and potential investments.

 

Why are many investors looking to invest directly into commercial real estate?

 

With the equity and bond markets displaying recent volatility, the traditional investment markets may not present the most interesting risk/reward investment opportunities for some investors.  Many investors are turning to alternative investment options, and specifically to investments into commercial real estate. Real estate investing is generally for the longer term and is typically not liquid in the short term.  The longer-term hold period for a CRE investment may reduce the volatility of the investment as prices of buildings and CRE investments do not get marked-to-market every second as traditional investments do in traded markets.  Investing into CRE is attractive to some investors because it is a diversification away from the potentially volatile traditional markets, and may be  more predictable for cash flow purposes.

 

DIY Investing: Direct access to CRE investment information 

 

So once an investor has decided to join the revolution of investing into commercial real estate directly, how should one consider building a portfolio of multiple investments into various different types of CRE?

 

First investors must gather information on CRE markets and understand where the opportunities are for different types of CRE investments. Part of this process is evaluating the risk/return profiles that are interesting to the specific investor.

 

The first question to be asked by an investor: Are you investing for cash flow for immediate yield, or are you investing for capital gain at the end of the investment?  When a CRE asset is producing sustainable cash flow from rent collected, the asset can then distribute that cash flow to investors, once expenses and debt service is covered. CRE assets with strong cash flow and attractive distribution rates, tend to have less upside to investors at the end of the investment, unless the market for that asset improves over time. The other option for investors is investing in CRE assets for growth and potential capital gain at the end of the term for the specific investment.

 

Below, you will see a pyramid of various investment returns and profiles.  Don’t yield shop! BEWARE of the temptation to Yield Shop.  A sponsor may display a high yield or target IRR for an investment, but that means nothing. It is often just a projection by the sponsor.  Investors must understand that to reach for higher return targets, there is significantly more risk involved. Also, cash flow and distributions to investors can be very different depending on which type of CRE investment is made.

 

 

At the bottom of the pyramid, in the green section, investors can evaluate return profiles of 5% -9%. These types of properties are more established buildings with existing tenants and cash flow. These types of assets can be Class A/B buildings in Office, Multi-Family, Industrial or Retail. The end investor is typically looking at these types of investments for steady cash flow and lower risk to the value of the asset. Questions must be asked by the investor about tenant and rent sustainability; location risk, and leverage and financing risk to sustain the cash flow. There may be upside potential in the assets if the specific market for that the asset appreciates in value, and another buyer will pay a higher price than the entry price for the current investor.

 

The middle part of the pyramid, in the blue section, investors typically focus on value-add real estate where the sponsor and investors are going to potentially enhance value by making significant upgrades to the asset. These upgrades cost money and thus there is often very little, or any cash flow distributed to investors in the first few years of ownership. The goal is to enhance the value of the property and then lease up that property to a sustainable level so that it can be sold to another type of buyer in the future. Thus, the gain to the investor comes when the building starts producing cash flow and is eventually sold at a higher price above its acquisition price.  The risk to investors is that if the cost of the value-add takes longer than expected and if the expected tenant lease rate increases are not achieved it could impair the  the value of the building on resale.

 

The top of the pyramid, in the yellow section, investors are striving for a much higher return profile and thus are taking significantly more risk to try and achieve this return.  Typically, the +15% return profile is for ground up development projects, which includes new construction or a complete teardown of an old asset and then new construction on the lot. There could be no cash flow for years as the project is built. These types of projects can include: office, multi-family, industrial, retail, hotel/leisure/lodging and residential. Investors may achieve gains in their target ranges if the assets are sold to new buyers or refinanced at levels significantly higher than the development costs and financing costs of the project.

 

Building a DIY CRE portfolio:

 

The pyramid is used to suggest that when building a CRE investment portfolio, that a larger amount of capital is allocated to the return profile with a more predictable cash flow from sustained assets: the bottom of the pyramid in Green.  This way an investor can have a base to the CRE portfolio of both cash flow and some potential upside growth in the value of the CRE.  The value-add section of the portfolio will have a smaller allocation compared to the ‘cash flow’ base of the portfolio because it is taking on more risk than the bottom GREEN section, and the cash flow will not be as immediate in the first 1-3 years of the investment. Finally, the YELLOW SECTION of the allocation will be even smaller, as the risk is even higher than the previous 2 portions of the pyramid.  The YELLOW SECTION of the allocation could have very little or no cash flow until the project comes on line.  Market conditions may change for the worse by the time a project comes on line, and thus investors must be prepared for this risk.

 

A blend of all these tranches of the CRE pyramid is a potential way to begin building a CRE investment portfolio for the DIY investor.  In the end it comes down to the risk profile of the investor and what the goals are for building an alternative investment portfolio with CRE as an allocation for yield and/or growth.  Evaluate the type of CRE asset, the sponsor, the location, the risk to cash flow and value, and the exit plan. Work with sponsors where there is total transparency and the ability for the investor to gather as much information as possible on the investment options.

 

Welcome to the DIY CRE INVESTMENT Revolution.

Meier & Frank_PSY5B_EXT_27

CRE’s Most Cliche Question: “What Inning Are We In?”

Many investors in CRE are asking the question: “What inning are we in for the CRE investment cycle?” They are concerned about being late in the CRE cycle because they hear this question over and over.

This question about ‘what inning are we in?’ is too generic and not really the correct question. It’s like asking, “How is the weather is in the United States today?” It is not very helpful or relevant to anyone interested in their local weather. The same goes for real estate investing.

In this article we are going to focus on Commercial Office buildings.

 

Cycles versus Events:

Too many investors and consultants refer to the ‘real estate cycle’ when analyzing investments into CRE. Again, this is too generic to view all CRE in a cycle. Regions and cities have completely different dynamics and investment outlooks for different types of buildings. For instance, at any given time, the Austin, TX market can be completely different than the Seattle market. Certain parts of New York City can be very different than other parts of NYC. Portland can be very different than San Jose. Thus, to just ask ‘what inning are we in?’, assumes the investment ‘game’ is close to ending and that the ‘cycle’ will turn down. Now how many times have we heard ‘that the cycle was topping out’… three years ago (2015), two years ago (2016), etc.?

Events can cause downturns in a specific market or type of investment. Today is very different than the events that caused such sharp downturns in CRE back in 1990, and 2008. Today there is much less easy financing available to develop office buildings from the ground up. There is not a constant supply of office buildings coming online in various cites causing large vacancy overhangs. The speculative development of office buildings is greatly reduced compared to the late 1980s and mid 2000s.

 

Return expectations

So, what has changed? Investors must not confuse lower return expectations with the end of a cycle. The return profile that investors are hoping to achieve, when they invest into commercial office buildings, has come down in the past years. There are no ‘+15% returns/IRRs’ available in a Class A commercial office building where a building is over 85% leased. That spread has closed significantly over the years as many investors entered the market and paid higher prices for Class A buildings. There is a vast amount of money looking to invest into Class A office buildings and thus the return profile has come down significantly. Investors must adjust their expectations. But a lower return profile does not mean the end to the ‘cycle’. It may be disappointing for some investors to only achieve a 4%-7% return in Class A office buildings with high tenant occupancy. But that is the current market.

 

Don’t YIELD SHOP

When interest rates are relatively low, and return profiles for CRE decline, investors may be tempted to reach for high return targets for investments, not realizing the potential additional risk they are taking. Real estate is illiquid and not a short-term investment. The first question an investor should ask is whether the investor is investing for current yield and cash flow payouts, or is the investor foregoing current cash flow in search of higher returns when a project or asset comes online and begins to pay out cash and is then hopefully sold at a higher price to meet the target IRR of the investor.

Currently there are many small CRE deals being offered to individual investors via platforms and small sponsors. Individual investors may be tempted to shop for, and chase deals that have higher potential target IRRs. Just remember that a target IRR means very little. It is just a projection of assumptions made by the sponsor.

 

So what inning are we in for CRE Office Buildings?

We will refrain from using the other most used cliché in CRE: “Location, Location, Location”. CRE Investment is about the specific deal, which includes the location, the financing, the cash flow, and the vacancy and most importantly, the potential for exit at a higher valuation. Investors must look at the sponsor and its capability to add value to the assets and exit the investment in a positive manner for its investors. So, the cycle does not end for CRE. The market for CRE adjusts return profiles and yields, and thus investors must do the same. The right markets and right assets can still provide attractive relative returns if the investor and sponsor are willing to do the hard work of analyzing the risk and reward of a specific CRE investment.

 

Staying with the Baseball theme:

There are many CRE investment ‘games being played’, in specific markets, and specific assets. Each one of those CRE Investment ‘games’ are in their own specific ‘inning’. Now it is time to evaluate the ‘situation/investment’, and then execute on the investment plan for that specific ‘game/building’.

 

Investing in KBS Growth & Income REIT includes substantial risks. These risks include, but are not limited to: the possibility of losing your entire investment; no guarantees regarding performance; upon sale or distribution of assets you may receive less than your initial investment; fluctuation of the value of the assets owned by KBS Growth & Income REIT; lack of a public market for shares of KBS Growth & Income REIT; limited liquidity; limited transferability; reliance on KBS Capital Advisors LLC, the REIT’s advisor, to select, manage and dispose of assets; and various economic factors that may include changes in interest rates, laws, operating expenses, insurance costs and tenant turnover. Shares of KBS Growth & Income REIT are not suitable for all investors. Investors should read and consider the PPM carefully before investing.
KBS Direct makes no representations as to the appropriateness of an investment in KBS Growth & Income Real Estate Investment Trust for ERISA plan fiduciaries and IRA owners and no investment advice is being provided. ERISA plan fiduciaries and IRA owners should consult with their own advisors and counsel before making an investment in the REIT’s shares. This is not an offer to sell securities. Offers to sell, or the solicitations of offers to buy, any security can only be made through a private placement memorandum and other official offering documents that contain important information about risks, fees and expenses.
Securities offered through North Capital Private Securities (NCPS).