Developing a Resilient, Balanced Market Strategy

By James Hochman, Chief Financial Officer, and Frank Tetel, Managing Director, Acquisitions

At Grubb Properties, we are often asked how we analyze and select the markets and locations of our real estate investments and fund portfolios. Market analysis and location selection are central to our investment process and are among the fundamental inputs that drive the composition of our portfolios. 

At its core, our process involves a deep, value-based analysis and a forward-looking perspective that may have a contrarian feel to it. This combination is really shorthand for our edge in the market. It is this edge that has enabled us to secure great locations and prices that—in hindsight—are fantastic. This acquisition strategy is both scalable and repeatable. These factors are central to our continued strategy outperformance, the growth of our business and the advancement of our essential housing mission through the Link Apartments℠ brand.

Staying True to a Dual Market Strategy 

A focus on highly resilient markets and high-growth markets underpins the strategy of our essential housing product. We pursue this dual strategy for both our Qualified Opportunity Fund (QOF) and our traditional investment funds. This means that the Opportunity Zone sites we select must meet the same rigorous analytical criteria as those outside of the OZ. This ensures alignment to our strategy. 

Fundamental to our approach to market selection is the heavy premium we place on resiliency. We have identified five key pillars that help us narrow the field when locating the most resilient markets: 

        1. climate-related risk;
        2. presence of state and/or federal government; 
        3. presence of public and well-capitalized private universities; 
        4. presence of a highly developed hospital and medical infrastructure; and 
        5. presence of a developed public transportation system. 

Within specific markets that meet the requisite combination of these five pillars, we take a much closer look to identify locations providing market elements that map to our essential housing strategy. Leveraging the granular quantitative analytical work of RCLCO—well known for its quantitative analytics and strategic planning framework regarding property investment, planning and development— we have collaborated to develop our proprietary index. This index drills down to the ZIP codes within desired metro markets and produces a score based on 38 weighted variables. This produces a heatmap which, in conjunction with our other research, we use to identify the best neighborhood locations for our Link Apartments℠ product. 

Our nearly 60 years of experience have taught us some tough lessons. We have learned the importance of assessing a potential acquisition within the portfolio so we can ascertain its contribution to it and the risk that it carries. This informs the prospective purchase decisions as we focus on the desired market exposure in the portfolio. In fact, we may choose not to expand in locations that meet our criteria, because we feel we are already at the correct position size in that location for our portfolio and risk appetite. 

Gateway Markets Provide Necessary Balance 

In the depth of the Covid-19 pandemic, Grubb Properties moved aggressively into the so-called “gateway” markets that are some of the country’s largest and highest barrier-to-entry markets. Our expansion to Los Angeles, New York City, and the San Francisco Bay Area looked highly contrarian as our peer group rushed into the Southeast. The market weakness in each of these gateway markets created a temporary window of opportunity that allowed us to acquire locations at a much lower cost basis than otherwise would have been possible. Our investment thesis was that the de-rating of these gateway markets would be temporary and that the risk-reward tradeoff was highly compelling and asymmetric. 

Already, data shows these markets’ residential real estate fundamentals have roared back, with occupancy and rent rates exceeding COVID pre-pandemic levels. We believe this rebound will be sustainable as the country returns to normalcy and the resiliency pillars hold. In each of these locations, we further fortified our investment by hiring full-time team members with deep local experience to ensure we get the formula right. 

As our peer group moved into the Southeast, the wave of new interest drove prices up, so that the cost to develop a new project in this region experienced higher proportional increases than in New York or Los Angeles. We expect rent growth in the Southeast to slow over the next few years as that tremendous wave of new supply hits these markets. In contrast, much of future rent growth is likely to shift to gateway markets including New York and California, which are now seeing record demand with limited new supply in the pipeline. 

The Southeast is our backyard and naturally represented our largest exposures before the company’s expansion into these gateway markets. Many of our forthcoming Southeast projects were started before the pandemic, so we acquired them at a lower basis, which is proving an important competitive advantage. While we still have investments and additional developments planned in the Southeast, adding projects in the gateway markets leverages the unique investment opportunity and will help ensure our portfolios are more well-diversified and less exposed to risk from any one type of market. 

The preceding article was excerpted from “Developing a Resilient, Balanced Market Strategy,” a new white paper from Grubb Properties. Download the full paper.