Independent Thinking^®

Q&A with Jon-Paul Momsen of Harbert Management

Editor’s note: Evercore Wealth Management supplements its core investment capabilities with carefully selected outside funds across the range of the firm’s asset classes. Among those are the Harbert Management real estate funds, which invest in diverse mid-size multifamily, office, industrial and retail real estate. Here we speak with Jon-Paul Momsen, co-chair of the Harbert real estate platform. Please note that the views of the external managers interviewed in Independent Thinking are their own and not necessarily those of Evercore Wealth Management.
 
Q: Let’s start with office space, the poster pandemic fallout investment. What is your outlook for the sector?
 
A: The office sector in general has been the most negatively impacted by the double impact of rising cap rates [an assessment of the annual yield of a property; the net operating income is divided by its asset value] and declining space market fundamentals. With the prospect of declining net operating income and materially higher interest rates, both lenders and buyers have moved away from the sector, resulting in a dearth of available capital not seen in over 10 years and further reinforcing – and exacerbating – the increase in cap rates as a reflection of increased risk. This “one-two punch” has led to significant valuation declines and distress among office landlords.
 
It remains unclear if work-from-home will evolve and how it will impact overall demand for office space. However, it seems clear that as more companies announce delayed reoccupancy plans, significant layoffs, especially in the tech sector, and employee resistance to returning to the office will continue to put pressure on office fundamentals. These vicissitudes combined with ongoing challenges in the capital markets and an inflationary environment, lead our investment team to the belief that office investment performance and liquidity will continue to be challenging. We expect to see growing distress among existing office owners in the face of debt maturities.
 
Q: You’ve recently been more focused on multifamily and industrial real estate investments. What do you find attractive in those asset classes?
 
A: The investment team believes that an opportunity exists in the multifamily sector to generate above-market rent growth by exploiting the wide rent gap between the top of the market and three-star properties. Well-located three-star assets can be enhanced and increased rent realized through targeted renovations and operational improvements. The widespread housing shortage in the United States has been a key driver of apartment performance for the past decade, as a deep and growing renter pool drives demand for new and existing units. This overall shortage, coupled with a growing housing affordability issue, has resulted in the vast majority of renters seeking the value of an affordable rent at a well-maintained workforce housing property with quality, focused management.
 
The industrial sector produced the highest total returns of all U.S. property types over the past decade, driven by strong cyclical demand that further accelerated during the pandemic. While supply levels are ramping up, we believe strong demand fundamentals support continued industrial outperformance compared to most other major property types. The accelerated adoption of e-commerce and continued population growth are driving significant demand for industrial products and creating investment and development opportunities for industrial space. Importantly, most of our industrial investments are urban-infill, multitenant properties, which were generally purchased on significantly higher initial cap rates than would have prevailed for very large distribution center industrial properties. Given the very tight supply/demand fundamentals for urban-infill industrial properties, we have retained pricing power and been able to drive strong leasing activity and rental revenue increases across the portfolio, resulting in material net operating income growth.
 
Q: Are there particular geographies that you are targeting?
 
A: We intend to target metropolitan areas with at least one million people and attributes consistent with outsized economic and demographic growth trends. These markets may possess some or all of the qualities of low costs, high in-migration levels, high educational attainment, and above-average income levels. The fund further intends to focus on metropolitan areas with an outsized concentration of STEM (science, technology, engineering, and math) and TAMI (technology, advertising, media, and information) employment. These conditions are expected to be especially prevalent in the Sunbelt markets targeted by the fund, which have generated outsized economic and demographic growth over the past several cycles.
 
Q: The combination of higher interest rates and high inflation are creating headwinds for a lot of investors. Where do you see risks for real estate in an economic slowdown?
 
A: We like to look at real estate from a capital markets and space markets (supply/demand) perspective. From a capital markets perspective, across all property types, the sudden and severe interest rate increases are putting pressure on some borrowers who need to refinance their loan or who borrowed floating rate debt and need to put more equity into a deal to meet interest coverage covenants. In the multifamily market, we expect short-term situational distress for some owners with strong medium- to long-term performance. In the industrial sector, the new-built, big-box logistics market is facing growing headwinds as an unprecedented supply wave meets softening demand; however, in the urban-infill multitenant sector, there is not a supply issue and demand remains robust. Finally, in the retail sector, the combination of COVID stimulus funds, strong job market performance and inflation have driven strong retail sales. We see risk of a consumer slowdown in the face of the depletion of savings account balances and nascent weakness in the job market, which will only get worse in a recessionary environment.
 
Q: Alternatively, will these macro headwinds provide market inefficiencies or buying opportunities?
 
A: Historically, market dislocation created by macroeconomic headwinds have tended to create opportunities for experienced, disciplined, and well-capitalized buyers to take advantage of market inefficiencies and to find compelling risk-adjusted acquisition opportunities that provide for long-term value growth.
 
For further information, please contact Evercore Wealth Management Partner and Portfolio Manager Stephanie Hackett at [email protected].