Marcus & Millichap CEO Bullish on ‘Unbelievable Amount’ of CRE Trading

It’s been “fascinating” for Marcus & Millichap’s CEO to witness the “extremes” of the commercial real estate industry this past year. On one end, hospitality, senior housing and lower-tier shopping centers were devastated by the pandemic. On the other end of the spectrum: life sciences, industrial and single-tenant-net-lease assets have prevailed even through the darkest parts of the downturn. Now, he said, there’s “motivation to sell and motivation to buy” across all markets and asset types, which fueled record trading in the second quarter of 2021.

Speaking at NAIOP’s 2021 CRE Converge conference in Miami last month, Marcus & Millichap President and CEO Hessam Nadji said he’s “never seen as much demand for the full spectrum of commercial real estate” as he does now.

"It will slow down at some point; it’s not possible for it to stay as red hot as it is today. But, in the meantime, the fundamental drivers behind why people are trading and why capital is coming into commercial real estate is very much supportive of it.”

Hessam Nadji, Marcus & Millichap

Eighteen months after the onset of the pandemic, Nadji said the firm’s more than 2,000 brokers working across the country are facilitating an “unbelievable amount of trading,” ranging “from low-risk, low-reward, cash flow-based investments — all the way to [high-risk, high-reward] turnaround projects that involve complete repositioning and reuse of older shopping centers.” That’s in addition to deals involving property types such as self-storage, medical offices and everything else that falls somewhere in-between.

And this transaction activity is not all fueled by big venture vehicles looking for a place to park excess capital or deals done through 1031 exchanges, Nadji noted. While one-third of Marcus & Millichap’s clientele comprises large institutional players, he said, 70% is made up of “true private investors — including partnerships, high-net-worth individuals and private funds.”

In other words, the turbulent economy has not deterred the “entrepreneurial long-term vision” that typically guides the commercial real estate industry. “Hospitality assets, for example, are seeing more demand right now than anyone would ever imagine, even though the [net operating incomes, or NOIs] are nowhere near being predictable, let alone there in the first place, to justify the kind of pricing we’re seeing,” he said. “That’s because everyone believes in the long term, for the most part.”

“Are those making that bet going to be happy about it two years from now? I'm not so sure. But I think they will be very happy about it five years from now.”

Hessam Nadji, Marcus & Millichap

Of course, some property classes will take more time to recover than others, he continued. Office footprints, for example, are being reduced in the shift to hybridized work ecosystems, while public transportation concerns continue and changes in worker preferences and safety demands limit office rebounds.

“So, will the office sector ever recover to its fullest, best point in the cycle?” Nadji asked.

That’s the bet. “Are those making that bet going to be happy about it two years from now?” he asked. “I'm not so sure. But I think they will be very happy about it five years from now.”

Mistakes will be made, of course, “but there is also the indication of a great, fundamentals-driven cycle that has legs,” he added.

In the meantime, there are plenty of opportunities out there for less patient investors. “Suburban multifamily, for example, is the hottest asset class — both in terms of renter demand and buyer demand — that you can find anywhere,” he declared. “Student housing has also moved up quite a bit.”

“The name of the game is mixed-use."

Hessam Nadji, Marcus & Millichap

And in the ‘burbs, it doesn’t stop at housing. Suburban offices, for instance, are not plagued with as much uncertainty as their core-business-district counterparts. Responding to LoopNet’s question about why suburban markets are hot overall, Nadji explained that “the 35- to 55-year-old age group is growing robustly. Millennials are getting better, higher-paying jobs, forming families and spending more money — and it’s all very good for the economy.”

Where this is all happening, he said, is predominantly in the suburbs.

“The name of the game is mixed-use,” he continued. There’s a wave of millennials who were urban dwellers that are now moving to the suburbs and bringing with them new demands and expectations. As a direct result of this, in the surrounding metro areas of Boston, Seattle, Los Angeles and San Francisco, to name just a few, “you’re seeing suburban revivals,” he said. “More walkable, mixed-use environments in which there’s housing, retail and office space are popping up everywhere, and to me that’s really exciting.”

A lot of the neighborhoods in suburban markets have been “pretty mature for some time, and there's a lot of product that has now aged.” According to Nadji, from a development perspective there’s a great amount of opportunity, “and capital for it,” in reuse, renovation and repositioning.

Getting those reimagined, older suburban property plays appraised correctly is a challenge, though. There are not enough sales comps for appraisal, which also makes it hard to get a loan. “So, there is going to be some pain, but it’s also a great opportunity to think about reuse and modernization of a lot of older product that isn’t going to compete very well in this next round.”

This demand drifts beyond just suburbs to secondary and tertiary markets in general, Nadji continued. “Pre- [Great Recession], the market was not using any discipline or discretion by market type because there was just so much capital chasing yield that it didn't matter,” he explained. “But that obviously didn't end too well.”

Then, there also wasn’t the job base nor the significant migration to secondary markets that we have now, he said. “Think about how many companies and jobs are now being created in secondary and tertiary markets versus primary markets. They're far more popular not just for temporary investment yield, but fundamentally, as an economy.”

Now, he said, almost 60% of trading volume has been capital going into secondary or tertiary markets.

Industrial is another “incredibly strong asset class and a huge topic of discussion,” he said. “Do we have pockets of overbuilding? Clearly. Do we have five to seven metros dominating the vast majority of where the boom of product has been going? Yes. But look at the volume of construction that has been absorbed year after year. As an industry, we are nowhere near running the risk of overbuilding.”

A boom in warehouses and distribution centers is offsetting a decline in retail due to the embrace of e-commerce, as so many more people now “expect to have their deodorant delivered to their doorstep in two hours,” he joked.

But on the flip side, experiential retail will come back strong “just like hotels.” Nadji expressed his bullishness for fitness centers, bars, movie theatres and other experiential retail destinations such as the Topgolf chain.

All of this activity hinges on cap rates, he noted. With the exception of senior housing and office sectors, which are neutral, all asset types are seeing downward pressure on cap rates.

Lower cap rates are a good thing, he insisted. “This is supported by two things: the incredibly low cost of debt and aggressive terms because of the liquidity that’s out there, but also the resounding release of pent-up demand that’s supporting job growth and economic expansion.”

The “biggest thing we have to worry about,” he said, “is inflation.” But inflation also means job growth, he added.

“If you think about the alternative investment environment, [commercial real estate] makes sense,” he said. “There is really nowhere else to put your money, get the cash flow and get the tax treatment advantage. That's why, I think, the demand is there.”

This level of trading activity though, he cautioned in his concluding remarks, “is not sustainable as a new normal. It will slow down at some point; it’s just not possible for it to stay as red hot as it is today. But, in the meantime, the fundamental drivers behind why people are trading and why capital is coming into commercial real estate is very much supportive of it.”