So-called “delegated investors” - institutional investors like pension funds and private equity funds that manage money on behalf of others - were responsible for 39% of all commercial real estate purchases in Boston from 2001 to 2015. In Pittsburgh, that number was 14%. The disparity prompts a natural question: “What’s wrong with Pittsburgh?”

So wondered Andra Ghent, then a researcher at UNC, who studied industrial, retail and office transactions across the 39 largest U.S. MSAs during that period. Her findings were clear: liquidity - measured by transaction volume - was the single most distinguishing feature of markets with high institutional ownership.² But did institutional investors strongly prefer markets where assets are easier to trade, or was there something else about these high-liquidity markets that make them institutional?

Ghent explored this question. She found that delegated investors prefer assets with credit tenants (public companies or the U.S. federal government) more than non-delegated investors who invest on their own behalf. Yet after controlling for tenant quality, delegated investors’ strong preference for high-liquidity markets persists.

The same held true for a city’s demographics: Institutional investors prefer MSAs with large college graduate populations and high overall population growth rates, but after controlling for these variables, these demographic advantages did not explain the strong preference for high liquidity.

Ghent also tested asset-level characteristics, finding size to be important, as delegates’ assets were on average 75,000 square feet larger than properties owned by direct investors. Delegates also buy younger, slightly higher quality properties than direct investors on average. None of these attributes explained the strong preference for high liquidity markets.

Most interesting was a question about manager skills: Were delegated investors “simply better at predicting CRE returns?” If true, that would imply “cities with higher turnover have higher returns,” which would be interesting. The Haystack wanted that answer to be yes, but after controlling for this outcome, cities that actually did see higher returns did not explain the strong preference for liquidity, which again persisted. Hmm.

This raises a critical question: Why are delegated investors so intent on finding market liquidity? Especially when it comes with costs: Cap rates are meaningfully lower in high-trade-volume markets, suggesting institutional investors are willing to pay a liquidity premium that can surpass 200 basis points across cities.

A theory as to why… These delegated investors are fiduciaries, and like in any agency relationship, there is not perfect alignment between principal and agent. In this case delegated investors often earn compensation that can be optimized with shorter hold times, so there’s an incentive to be able to sell assets quickly. Ghent subscribed to this theory and there’s some supporting evidence: Delegated investors actually hold assets on average one year less than non-delegated investors.

In the end, the preference for market liquidity by individual firms becomes self-reinforcing. If delegated managers are more likely to need market liquidity to optimize their upside, they are more likely to end up in MSAs with higher concentrations of other liquidity-seeking delegated managers, and it is this clustering and self-reinforcement that gives rise to an “institutional” market. That’s how you get from Pittsburgh to Boston.

Editorially, this made the Haystack a little sad. We were brought up to revere institutional markets as citadels of value, places with perpetual growth drivers and massive appreciation potential where the smartest investors concentrate their attention. They still are hugely appealing cities, with larger assets, abundant creditworthy tenants and strong demographics. They just aren’t necessarily better in terms of intrinsic investment quality. The Haystack will now take seriously becoming a Steelers fan.

The Rake

Three good articles.

• Camden posts near record-low resident turnover rates - Multifamily Dive

  Camden is seeing strong retention and renewal rates, but, like other apartment REITs, is maintaining a cautious outlook amid ongoing market uncertainty and a sharp drop in new construction starts.

• April Housing Starts Show Divergence Between Multifamily and Single-Family- CRE Daily

  In April multifamily construction surged even as single-family starts declined. Despite the uptick in multifamily activity, permits are down, the development pipeline is shrinking, and developers remain wary about the sector’s near-term outlook.

• As Congress Considers Renewal, Can Opportunity Zone Investment Reach More Distressed Areas? - BisNow

  Congress is considering an overhaul of the OZ program to better target investment in truly distressed and rural areas, after criticism that most OZ capital to date has flowed into already-growing urban markets.

The Harvesters

Someone making real estate interesting. They don't pay us for this, unfortunately.

 Who: EliseAI

What: The runaway best technology partner for multifamily managers, especially groups that aspire to centralize operations and increase efficiency. They recently released practice-management and patient communications software for healthcare providers as well.

The Sparkle: You’d never know you’re not talking to a person. That was our response as mystery shoppers talking to EliseAI about renting an apartment in Denver. We got the information we needed, and frankly it was fun. Operators tell us it will diminish significantly hours required to manage a building. We could go deep and tell you what makes EliseAI special but this is a short-form section so instead see this fantastic write-up from our good friends at Thesis Driven.

From the Back Forty

A little of what’s out there.

For those outside gaming circles, it’s easy to underestimate the industry’s scale and demographic reach. An industry group study says 61% of Americans played more than an hour of video games every week, and nearly one in three gamers are older than 50. 50!

In 2022, global video game revenue exceeded $180 billion, dwarfing the $26 billion generated by the worldwide box office that same year (Visual Capitalist).

Link: https://www.theesa.com/resources/essential-facts-about-the-us-video-game-industry/2024-data/

Thank You To Our Sponsors

Editor’s Note: The Real Estate Haystack believes in sharing valuable information. If you enjoyed this week's newsletter, subscribe for regular delivery and forward it to a friend or colleague who might find it useful. It's a quick and easy way to spread the word.

1  https://novelinvestor.com/wise-words-from-sam-zell/

2  Andra C. Ghent, What’s wrong with Pittsburgh? Delegated investors and liquidity concentration, Journal of Financial Economics, Volume 139, Issue 2, 2021, Pages 337-358, ISSN 0304-405X, https://doi.org/10.1016/j.jfineco.2020.08.015.