How One CRE Fund Manager Is Adapting to a New Cycle Phase
Prior to the pandemic, ElmTree Funds LLC, a real estate fund manager based in Missouri, invested in three high-growth real sectors of commercial real estate—industrial, office and healthcare facilities. Those investment strategies were driven by trends such as the growth in online shopping and the proliferation of small, convenient medical treatment centers, as well as the physical office culture that existed before the arrival of COVID.
With post-pandemic uncertainty around the future of office buildings, ElmTree has had to reshuffle its sector allocations. About 90 to 95 percent of the firm’s investments are now focused on new single-tenant, build-to-suit, net lease industrial assets occupied by investment-grade companies, such as Amazon, Target, Caterpillar, FedEx and GE. The remaining 5 to 10 percent of ElmTree Funds’ investments are focused on newly constructed office buildings.
ElmTree manages a family of comingled funds, in which a group of investors, including institutional investors and family offices, own shares in the pool of assets acquired. The firm’s last comingled fund, for example, totaled roughly $900 million, with approximately 30 institutional investors.
The firm also takes subscriptions from individual institutional investors, customizing and managing their accounts separately. The investor owns all assets acquired by the fund, but in some cases, ElmTree forms a joint venture with the investor and contributes 3 to 5 percent of the capital deployed.
Another change that’s impacting ElmTree’s current strategies is the pull back on access to real estate debt, with cash buyers now being among the most active players in a marketplace where cap rates are rising and values are falling. In a recent conversation with WMRE, ElmTree Partner Annie Hsieh, the firm’s investor relations lead, discusses how and why investors like ElmTree are benefiting from this unique marketplace opportunity for cash buyers.
This Q&A has been edited for length, style and clarity.
WMRE: Who are ElmTree’s investors?
Annie Hsieh: Our investors tend to be the usual suspects in real estate: private equity and institutions, such as public and private pensions, endowments, foundations, insurance companies, family offices, and the like, and their portfolios are typically very diversified, including their real estate portfolios.
WMRE: What types of properties does your company invest in these days?
Annie Hsieh: We’re dialed into newly constructed and build-to-suit industrial and office assets. In this environment we’re probably 90 to 95 percent industrial and about 5 to 10 percent office. Within both of those asset types, we’re focused on single-tenant net lease, and our tenants are Fortune 100, investment-grade tenants, typically tier-one brands that are household names, like Target, Amazon, Verizon, Intel, and Pepsi.
WMRE: What kinds of fund strategies is ElmTree pursuing at this moment?
Annie Hsieh: Our firm broadly invests in the asset types that we’ve already discussed, but specifically targets assets that provide opportunistic returns target. We capitalize our investments through both commingled vehicles and separately managed accounts, depending on the client.
WMRE: How are ElmTree Funds’ equity-raising efforts going right now?
Annie Hsieh: Even just in the last three to four months, we have seen investor sentiment really start to improve. I think a low point was right after Labor Day, when there seemed to be quite a lot of uncertainty around the [interest] rate trajectory and inflation expectations. A lot of investors, kind of across the spectrum, came out of the gate saying that they were going to take a pause on new and alternative investments for all of 2023.
But that perspective has moderated a little bit. Just remembering back to lessons of the Global Financial Crisis, investors realized that the vintages you miss always end up being the best ones, and there’s really no way to invest your way out of vintage diversification. So, now a lot of what we’re hearing from investors is that they’re going to be really selective, as they are definitely still feeling a lot of denominator effect issues.
WMRE: Are investors more or less interested in committing to commercial real estate plays right now and why?
Annie Hsieh: With current uncertainty, there is more appetite for industrial than for office. Office is still very much a question mark for a lot of investors, which are not fully comfortable with this asset type and tend to shy away from it. With the increase in work-from-home and hybrid work no one knows where the trajectory is going to end up, how much office space is going to be occupied when leases expire and tenants downsize space or eliminate in-office work altogether.
But industrial is still very strong: there’s a lot of buy-in to the belief that we’re still in the early innings of this new industrial age. Discussions with our corporate tenant partners indicate that there are still quite a few years of industrial infrastructure that needs to be built out to service existing customer demand. And there is an expectation for a very strong pipeline of interesting opportunities in the industrial sector, at least for the next three to five years in both the logistics and manufacturing space. There are a lot of conversations around re-shoring, near-shoring and bringing manufacturing back home. We’re only just starting to see some of that in our pipeline, but expect to see a lot more in the second half of 2023 and into 2024 and beyond.
High growth in e-commerce and continued on-shoring of manufacturing makes industrial assets really attractive to investors, especially since other parts of the economy might be contracting. We are seeing a shift of tenant mix in our pipeline. Retailers came out of the box during the pandemic and now are further along in building out a stable supply chain. But we are still seeing a lot of activity from companies that are behind in their plans, like consumer durables and third-party logistics providers.
WMRE: Has ElmTree changed its return expectations over the past year and if so, how?
Annie Hsieh: Not really. We’re starting to see pricing in the industrial space get pretty interesting, but I think that’s a broad sentiment that you can apply to other sectors of real estate right now. Basically, real estate gets interesting when the liquidity gets taken out of it. If you have capital to deploy in this rate environment, it provides leverage at least in the near-term and optionality if one has expectations that rates will come down over the course of the next 12 months.
We take a very conservative underwriting approach, and we’re not baking in a lot of potential changes in the rate environment. But the pricing environment is moving in our favor in terms of having a little bit of tailwinds around buying that is really constructive for overall returns in this kind of vintage.
We basically provide capital to developers and corporations to go vertical on new industrial facilities. Prior to rate hikes last summer, there was a ton of liquidity available for these developers and corporations from banks and investors, so pricing got very competitive to invest in the types of assets that we buy.
Now that there is less liquidity in the market overall, the pricing has gotten a lot more interesting, a lot more attractive for us to invest. We believe this advantage will last at least 12 months in the industrial sector, but possibly two to three years. In terms of the high growth that’s expected in the industrial sector, there’s continued appetite for these assets, both by investors domestically and globally.
The return targets vary, as we invest on behalf of a broad spectrum of investors and customize separately managed accounts to whatever the institutional investor wants. But basically, we target opportunistic returns [the industry definition of opportunistic returns is high teens to low 20s] in our commingled vehicles.