— By Brandon Banks, Managing Director, Midloch Investment Partners —
A funny thing happened coming out of the COVID crisis. It’s not something I would have expected, but it makes sense. Perhaps it was just a question of when.
For the first time since the Great Recession, some Western and Sun Belt markets have cooled to a point where value investors are seeing attractive investment opportunities in their midst. As is the case nationally, some of these deals are the result of higher interest rates and reduced proceeds pinching (if not punishing) over-leveraged sponsors that need to recapitalize their properties, but still the trend is apparent.
I’m a native Westerner from the Sacramento area, and it’s almost by nature that we expect Western markets to grow faster than the nation as a whole. In fact, the West has seen largely nothing but high notes over the past 10 to 15 years. This includes consistently increasing asset values, low-priced capital, and supply and demand in relative balance, with a seemingly perpetual undersupply for some property types in many markets.
Today, the West and Sun Belt still shine brightly…generally speaking. But even in these areas, the post-COVID cooling has been pronounced. Some properties that would have traded in the sub-4 percent cap rate range just a couple years ago are now available for sale north of a 5 percent or even 6 percent cap.
To be sure, the discounts and distress are not across the board.
Here’s where we’re seeing pockets of opportunity for attractive investment:
Phoenix and Tucson, Ariz.
The multifamily market has seen a wild run up in rents with immense cap rate compression. It will take a while to work this off before rents and prices cool sufficiently enough to be compelling. That said, there is opportunity in the industrial market for both logistics and distribution, especially last mile. This isn’t due to distress or discounting, per se, but because investors that have the capital to acquire middle-market properties aren’t necessarily interested. In other words, the market never really overheated to begin with.
Salt Lake City and Denver
Both markets remain fundamentally strong even as they’ve cooled and continue to absorb new multifamily construction. As with Phoenix and Tucson, most of the opportunity for value investors lies with other property types that have not been over-supplied.
Las Vegas
Despite Las Vegas’ history as a boom-and-bust town, efforts to create a full-time residential market appear to be succeeding, as evidenced by the attraction of new professional sports teams. While there is an overhang of multifamily supply, it’s not as significant as it is in Phoenix. This bodes well for value investors that may be able to take out distressed investors in tight spots.
California’s Central Valley
Sacramento Valley to Bakersfield, Calif., remains the highest traffic inland port and logistics corridor in the country. But even this corridor displays pockets of distress and discounts post-COVID, particularly for industrial assets. Value investors are scouring the map.
Albuquerque
Of all the markets discussed, Albuquerque is inherently most similar to a Midwestern market given its more muted in-migration that’s balanced by a more limited supply. There hasn’t been a run-up in pricing that many other Western and Sun Belt markets experienced. On a macro level, the market’s demographics are challenging, but there are pockets of opportunity with products that serve higher-income residents in submarkets that are not overbuilt and offer desirable amenities, including schools.
Has the West become the Midwest? Not quite, but the new reality is sobering. What goes up doesn’t go up continually, and when it comes down — or, at least, moves sideways — there are new opportunities created for value investors on the hunt.