INVESTMENT: CAPITAL MARKETS AT FULL THROTTLE.

• Author: Brierley, Phil

2020 IS A CHALLENGING YEAR TO DO MARKET ANALYSIS. The unknowns still dominate, as America gears up towards a vaccine roll-out, a new presidential administration enters, and congress begins to implement a new set of stimuli.

As I look back at 2020, and into 2021, I am reminded of something Mark Gibson, the head of JLL Capital Markets, outlined; if you look forward 12 months, to December 2021, what do you think the world looks like?

Is there a "new normal"; work from home is the standard, brick & mortar retail is eclipsed by online sales, COVID continues to make in-person gathering difficult, unemployment is pervasive, and a wave of distressed assets force owners to lock in losses? Or, in December 2021, has there been a spring back to pre-COVID life; offices are full, pent up demand makes brick and mortar retail flourish, in-person gatherings are sought out, unemployment is falling, and there is cap rate compression as buyers take advantage of low interest rates?

Your view will change your investment perspective, and much like everything else during this period, there will be winners and losers. I tend to err on the side of a snapback, but it is hard to predict with certainty. Real estate fundamentals are difficult to generalize, even asset to asset, in 2021.

From a capital markets perspective however, the picture is clearer. There are three reasons to believe that the next few years will be extremely positive on the capital side.

CAPITAL IS ACTIVE, REAL ESTATE IS PREFERRED

One outcome of dramatically lowered interest rates has been the search for fixed income alternatives by institutions seeking to maintain their yields. The largest fixed income substitute is real estate, and we have seen demand increase accordingly. Institutional target allocations to real estate have increased aggressively. Allocations through 2020 were at 9.4 percent, almost twice what they were in 2010 (5.6 percent) and are planned to grow to 11 percent through 2025. The sheer volume of product required to fuel institutional allocation growth creates demand that will have an impact on pricing in 2021, regardless of asset fundamentals.

Along with the pressure of institutional allocations, the development of private clients and family office direct real estate investment has also grown. Two thirds of family offices were established after 2000, and on average, intend to increase direct real estate holdings by 45 percent over the next two to three years. Adding to this already strong demand story, is the unprecedented amount of dry powder sitting on the sidelines with wealth managers, amounting to $205 billion in 2020,111 percent more than at the height of last cycle in 2008.

If you remember your undergrad economics courses, this is what a shift in the real estate demand curve looks like.

DEBT LIQUIDITY IS HIGH, LENDER FLEXIBILITY IS HIGH

Concerns over debt liquidity ebbed as 2020 progressed. RCA's national lender count by property type, an indication of how liquid the debt markets are, has held stable between 2019 and 2020, at around 150 for both commercial and apartment. The hotel sector, unsurprisingly, plummeted.

This willingness of lenders to engage with borrowers, and continue to finance and refinance, is in part due to the make-up of lenders in the market going into 2020. CMBS, the most rigid of all lender types, and the big challenge in the prior recession, makes up less than 15 percent of total debt capital in 2020 (vs. 55 percent in 2007). Additionally, lender discipline from 2008 to 2019 held strong, and loan to value ratios across commercial assets going into 2020 were below 65 percent, down almost 500 basis points from the highs of 2007.

The upside of more loans sitting within flexible lenders, with lower LTV's across the board, means the surge of distressed assets many of us were concerned about in early 2020, seems unlikely to materialize. Unless fundamentals continue to feel downward pressure for a prolonged period, much of the distress will be limited to asset-by-asset issues. Buyer and seller pricing disconnect will continue into 2021, but on the institutional side, the need to deploy capital is likely to eventually win out.

Another outcome of lowered interest rates and high liquidity has been a rush towards refinancing. Mortgage originations are down nationally in 2020, but only by 35 percent, less than transaction volumes (down 42...