Independent Thinking^®

Q&A with Harbert Management’s Jon-Paul Momsen

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. The firm now has the opportunity to invest in a diverse portfolio of mid-size multifamily, office, industrial and retail real estate investments through Harbert Management’s United States Real Estate Fund VI. Here, we interview Jon-Paul Momsen, co-chair of Harbert’s real estate platform.
 
Q: Please describe your approach. What does Harbert mean by the value-add side of the market?
A: We create value through the enhancement of cash flow streams. We look to improve the quality, quantity, and duration of cash flows through physical repositioning and/or increasing occupancy of the property. Enhancing the cash flow streams in turn leads to value creation that is not dependent on market growth. Our success as a real estate investment firm has its roots in the successful owner, operator, and developer experiences of Harbert Corporation. Our operational experience as a fully integrated development and leasing firm allows us to feel very confident in the value-add end of the market.
 
Q: What is the outlook for value-add properties now?
A: Given where we are in the cycle, the general price recovery for all sectors of the market has run its course, and cash flow yield is being priced at a premium. We want to be where others aren’t. We look for assets where cash flows are impaired, but where there is an opportunity to enhance them and the pricing makes sense. The potential for improved cash flows is higher for value-add assets, and we continue to see opportunities across product types and market.
 
Q: How about by geography and asset class within the value-add sector?
A: The multifamily real estate sector has seen the most capital in inflow. There are still opportunities, but they are fewer and farther between. We are finding good opportunities in office, and retail is generally improving. As a rule, though, we tend to be more defensive. In the current market, we are more likely to avoid high growth recovery markets (like Phoenix) in favor of markets that might be more stable in the downturn (like San Diego).
 
Q: How will real estate perform in a rising interest rate environment? How could rising inflation expectations impact the real estate market?
A: In our view, rising inflation will lead to rent growth, a positive for the revenue performance of our portfolio. Obviously, rising inflation includes some amount of economic growth, too. On the other hand, the negative side is that cap rates will likely expand, pushing property values down. This is probably worse for core real estate managers than for us. In the value-add space, we are creating value by enhancing cash flow streams, which mitigates downside risks, and allows us to underwrite cap rate expansion in our base case returns. So, rising inflation is a net positive.
 
Q: What are your thoughts on the new administration, as it might impact your fund?
A: Based on his statements so far, the new president will propose and Congress will pass stimulus based on tax cuts, infrastructure spending, or both. This fiscal stimulus will certainly generate growth in the medium term, although the Federal Reserve will continue to pull back on its monetary stimulus at the same time. The long-term impact on deficits, of course, is another story. A potential wild card in all this would be getting into a trade war that might impact domestic economic growth.
 
Q: The partners of Harbert have a history of investing significant amounts of personal capital alongside their investors. How does that shape your risk tolerance? Does this change your investment focus?
A: We believe that the capital we commit to our own funds aligns our interests with other limited partners. As an investment team, we have always thought from a principal’s perspective, not as an asset aggregator. For us, the investment decision is all about the risk-return profile. We don’t chase returns, and we are cognizant of risk and capital preservation.
 
Q: Private real estate is a long-term investment, sometimes more than five to seven years. Over that time period, economic cycles can change significantly. How do you invest throughout the cycle? What sort of assumptions do you make about economic growth and/or recovery when evaluating opportunities?
A: First, when we underwrite, we don’t underwrite underlying broad market return growth to drive our business plans. Whatever the market does, it shouldn’t materially change our return profiles. If the market is robust, that’s gravy. If the market struggles, it shouldn’t matter, as we don’t underwrite growth to drive our business plans in the first place. Second, we want to mitigate the exit risk of cap rate movements. If cap rates stay low or compress, property values rise, which is a windfall to the fund. If cap rates expand, we’ve already mitigated that right from the outset in our underwriting.
 
Furthermore, we always underwrite long enough duration on our business plan to make sure it can hold its head up over a longer periods. In a good cycle, we may take advantage of it through earlier-than-planned exits. We have consistently underwritten expansionary cap rates. Assets in Fund VI already have cap rate expansion priced in, and we will moderate our investing pace based on where we are in the market. The way we underwrite means we will invest less going into the peak. Finally, we don’t put too much debt on our properties, so we are never forced by our lenders to act.
 
For questions about the Harbert fund and about the Evercore Wealth Management Efficient Architecture investment platform, please contact Stephanie Hackett at [email protected].