Cadre Vantage: Quarterly Insights (Q3 2021)

Executive Summary

• The current investment environment is hyper-competitive, but we believe quality assets can still be found.
• Commercial real estate provides diversification outside of more volatile stocks and other market-driven assets and can serve as a strong hedge against inflation.
• Cadre’s disciplined investment process is designed to achieve attractive risk-adjusted returns in markets poised for sustainable growth and price appreciation across cycles.

The commercial real estate market is experiencing unparalleled growth and price appreciation. Rising inflation, low interest rates, and an abundance of capital are fueling demand for commercial real estate investments in many markets, compressing cap rates and leading to significant valuation increases in favorable sectors such as multifamily and industrial.

While more people than ever are looking for quality investments in the current climate, there are still opportunities for those with the ability to identify specific markets, sectors and asset classes that support compelling risk-adjusted returns.

At Cadre, we take a multidimensional approach on behalf of our investors, digging deeply into each operator, each asset, and each submarket at a granular level before investing in what we believe to be the most attractive deals.

Investment Flexibility is Key to Success

The market has shifted a great deal in the last 18 months. The wall of capital flooding commercial real estate is currently focused on a narrow segment of the marketplace, namely multifamily, industrial, and quality office spaces, as well as assets in niche sectors (e.g., properties equipped for life sciences). Tenant demand is strong for these property types, which makes them relatively easy to underwrite, and financing is readily available.

As prices continue to rise and the market reorients to a lower cap rate regime, investors are faced with a dilemma. Should they anticipate that trends will continue over the expected hold period of that property, typically five to seven years, or should they accept lower returns with the potential for more downside risk if cap rates reverse course?

Capitalization (Cap) Rates

One of the most important metrics in commercial real estate, the capitalization (cap) rate represents the yield of a property based on its current price. To calculate the cap rate, we divide the property’s net operating income (NOI) by its purchase price.

Much like the coupon on a bond, the higher the price, the lower the cap rate, or yield.

Currently, cap rates are generally compressing. That means cap rates are going down because prices are rising.

We believe that it is still possible to achieve attractive risk-adjusted returns. This is where Cadre’s hyper-local market focus, flexibility, operator network and data science efforts provide us with a unique advantage. We are able to quickly determine which opportunities are worth pursuing, and move on attractive deals without delay. In many cases, sellers value promptness with a transaction, especially for off-market deals, and buyers are able to access these deals if they can close a deal quickly.

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Multifamily

The multifamily sector remains a shining star for good reason: Multifamily has the potential for stable income that may offer protection from rising inflation. When combined with historically low levels of new supply and a greater willingness to rent, it is easy to understand why many investors expect continued strong price appreciation. Quality multifamily assets in choice locations are still highly desirable investments.

Office

The future of the traditional office continues to be an unknown, perhaps chronic, question. In many cases, the Delta variant of COVID-19 has further postponed a long-delayed return to the office. Some large companies, however, are taking advantage of the environment by opportunistically expanding their footprint. Google recently announced the most expensive office purchase since the pandemic began—and one of the priciest in U.S. history.^[1] Google’s $2.1bn purchase on the West Side of Manhattan could be a harbinger of an office sea change, or it could simply mark a single shot fired into the void.

Outside of gateway urban markets, we are beginning to see good momentum in suburban office pricing, and we are also finding attractive investment opportunities in niche sub-strategies, such as properties equipped for life sciences.

Hospitality

Recovery in the hospitality market continued to be a mixed bag this quarter. Hotels across the country were filled with summer vacationers, but business travel is still significantly below pre-pandemic norms. Will demand for tourism and business travel ever fully recover? That remains uncertain. Much is still dependent on borders remaining open and states’ various travel restrictions. While we’ve seen improvement in hospitality, the “new normal” is still unknown.

Industrial
The pandemic has supercharged the shift toward online shopping for everything from groceries to clothes and even to medicine. With this increased online demand from consumers comes growing demand from businesses for storage, distribution and logistics centers. The right industrial assets in high-growth markets continue to offer the potential for significant investment returns.

When Does it Make Sense to Realize an Investment?

How does a manager know when it’s time to sell an asset? What do they look for? How do they go about it? To many investors, the actual process is a mystery. Cadre’s team is continually in dialogue with local brokers, sponsors, and developers to best understand the local market, liquidity, and pricing, which helps us decide when to sell an asset. We consider current and expected future cap rates and whether our forward-growth assumptions still compare favorably to the value we could achieve through a sale. Sometimes selling into a strong market is more lucrative than following an original business plan to completion.

Learn about the value we created for investors with our recent realization in the full Q3 Letter to Investors by signing up for Cadre.

What Makes an Acquisition Attractive?

Cadre follows very specific guidelines in the selection of markets and assets. At the heart of our process is a straightforward directive: identify the highest-growth, affordable commercial real estate markets in the U.S. in which we can acquire assets that will appreciate and generate attractive risk-adjusted returns for Cadre’s investors.

In the current investment climate, Cadre’s Acquisitions team has an eye out for multifamily and industrial value-add opportunities, along with development deals in attractive markets. We primarily invest in markets located in the Cadre 15^[2], our proprietary ranking of the top 15 commercial real estate markets in the U.S. that we’ve identified as having strong potential for growth and risk-adjusted returns.

We execute a rigorous due diligence process to determine whether or not a specific property is a good investment for Cadre and our clients. We confirm our investment professionals’ outlook with cutting-edge data science techniques to augment the traditional underwriting process. This combination of personal expertise and proprietary forecasting tools is a unique capability of Cadre, and essential to our investment process.

What metro areas do we consider poised for continued growth? Learn more about Cadre’s acquisition process in the full Q3 Letter to Investors, available to Cadre members.

Become a Cadre member to access our Quarterly Letter to Investors.

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