TIAA-CREF’s Global Real Estate CIO Phil McAndrews is finding plenty to like in the U.S. market.
As stock and bond markets quake, the underpinnings of the commercial real estate market seem strong enough to take a punch, as long as the market volatility doesn’t turn into a sustained rout, says Phil McAndrews, chief investment officer for TIAA-CREF Global Real Estate. He oversees $90 billion in assets, with about $22 billion of those in the TIAA Real Estate Account,
Barron’s: Commercial real estate logged its sixth straight year of double-digit returns. Is the cycle on its last legs?
McAndrews: We are in a mature phase of the cycle. True and acknowledged. But right now, we don’t have signs that real estate fundamentals are out of alignment. In the U.S, there isn’t an oversupply in our sectors: office, industrial, retail, or apartments. Net operating income, an indicator of the sector’s health, is growing.
What was the impact of the Federal Reserve’s interest-rate hike?
Little to no effect, at this moment. When the Fed raises rates in response to inflationary pressures, there’s another side to that. Inflation is good for real estate. When rents go up during inflationary periods, net operating income rises. When NOI increases, cap rates [a valuation metric that is essentially an inverted price/earnings ratio] rise, so it’s all good news. Assuming no other major shifts in the economy, real estate has the ability to take a punch because fundamentals are in good shape and income prospects are also good, which should allow values to hold up.
That sounds like a rare upbeat outlook in a market filled with gloom.
The correction in the global stock markets will be meaningful for commercial real estate if it is indicative of a sharp decline in risk appetite, affecting everything other than riskless assets, like U.S. Treasuries. If we begin to see a drop in transactions, followed by widening spreads, then the question will be whether the drop in risk appetite is prolonged enough and serious enough to slow economic growth to the extent it affects commercial real estate fundamentals.
What will you monitor in order to gauge if fundamentals are taking a hit?
A sustained and significant decline could dampen employment growth and therefore tenant demand to rent space. Diminished tenant demand could in turn have a deleterious effect on rents and values. A key indicator will be the pace of leasing and rent pricing in the strongest markets and assets across our portfolios.
What’s the case to own real estate?
We see real estate as the first alternative. It offers diversification from stocks and bonds and also provides a certain amount of protection against inflation due to a rental-income stream that is adjusted upward, often with escalation clauses in leases based on the consumer price index. While never immune, the sector is well prepared to tolerate a surprise from the economy.
(Excerpt from Barron’s January article)