The Alternative Investment Favored by the Wealthy

mountaincity

The Blackstone Group Inc. (better known simply as Blackstone), one of the largest investment firms in the world, recently closed on the world’s largest commercial real estate fund with $20.5 billion in capital commitments.

This new fund was in addition to the $153.6 billion it already had in real estate assets under management. Blackstone’s latest fund raised eyebrows in a maturing market where high returns are no longer the norm, especially in the high-profile, gateway markets in which Blackstone likes to play. They don’t mess with small deals in small markets.

In a market of shrinking cap rates, why would Blackstone be diving headfirst into these waters? And is there a way for the non-Blackstones of the world to make money in this market?

So why would Blackstone be diving into a market of shrinking cap rates? According to real estate research firm CoStar, commercial real estate cap rates in the gateway markets of Boston, N.Y.C., D.C., Chicago, San Francisco and L.A. range between 2-4%, down from peaks of around 4-6% in recent years due to increasing foreign competition.

So why is Blackstone doubling down on commercial real estate?

Let’s start by saying this isn’t Blackstone’s first rodeo. Investing in real estate since its start in 1984, real estate is nothing new to Blackstone, and it is familiar with commercial real estate’s resilience and knows it always bounces back.

Even taking income out of the equation, Blackstone knows commercial real estate appreciation will always outpace inflation. With this monster fund, my guess is Blackstone is offering its investors a hedge against an impending economic downturn along with inflation-busting returns.

Anybody familiar with Blackstone shouldn’t be surprised by its monster real estate fund. A 2007 Fortune Article called Blackstone’s CEO Steve Schwarzman “the master of the alternative universe” because Blackstone made its name by investing in alternative assets.

Blackstone has long avoided Wall Street volatility – preferring the higher risk-adjusted returns offered by alternative assets like real estate, private equity, and hedge funds.

So to answer the question of why Blackstone is diving into commercial real estate in a mature market, the simple answer may be because the 2-4% cap rates in commercial real estate will be better than negative returns on Wall Street in a recession. With an average annual return of 10.6% in the past 20 years, Blackstone knows order will be restored, and returns will bounce back. In the meantime, its investors will be protected with a recession-resistant, asset-backed investment.

Now that we’ve answered the question of why Blackstone would be taking such a big plunge in this market, on to the second question of whether non-behemoths have any way to make money in this commercial real estate landscape. And the answer to that question is yes if you know where to look.

Although returns have matured in the big, gateway markets, the same has not been true in secondary, or as more appropriately dubbed “high-growth” markets with cap rates ranging between 5-7% where high rollers like Blackstone and foreign investors refuse to play. So why the opportunity in high-growth markets? It seems the influx of investment in the gateway markets along with the corresponding rise in rents has driven businesses and residents out of these markets to the high-growth markets – benefiting the commercial real estate market in those areas.

High-growth markets are experiencing population and rent growth driven by a workforce attracted to these markets for the lower cost of living and higher quality of life, with typically better tax and regulatory environments friendlier to businesses.

Migration from gateway markets has led to corresponding job gains, which has led to substantial increases in commercial real estate rental rates.

For commercial real estate investors, another appeal of high-growth markets are the value-add opportunities that still exist that you don’t see in gateway markets. One sector of particular attraction is the multi-family sector, especially in the affordable housing subsegment. In the years since the Financial Crisis, affordable housing is the one segment where supply has not caught up to demand.

Affordable housing will be most equipped to handle a downturn where demand for lower-cost housing will increase as wages shrink.

For qualified investors, significant opportunities exist for investing in private funds focused on high-growth and small markets. While you as an individual investor cannot invest in larger funds like Blackstone, you can seek out private companies with advantages over a Blackstone such as:

  • Invested in high-growth markets
  • Smaller, more nimble operations for making key decisions
  • Lower Fees
  • Lower overhead
Commercial real estate is always a good investment whether you’re in a gateway, high-growth, or small market.

As an alternative investment favored by the wealthy and large institutions, commercial real estate offers the type of above-market risk-adjusted returns necessary for building long-term recession-resistant income and wealth. Although big boys like Blackstone and foreign money dominate gateway markets, value-add opportunities are still plentiful in high-growth and small markets, especially in the affordable housing segment.

Come explore opportunities available to protect your money with asset-backed, inflation-resistant investments just like the wealthy and large institutions.