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Are California CRE Investors Going to the Midwest in Search of Higher Yields?

Local real estate investors priced out of California’s CRE markets might be looking to the Midwest in search of higher yields.

An outflow of California-based commercial real estate investors in search of higher yields are increasingly targeting Midwest markets, pushing the cap rates of properties in the area lower, according to industry sources.

“It’s pretty incredible how many California buyers are looking to the Midwest,” says Jeff Lefko, vice president at Hanley Investment Group, a Corona Del Mar, Calif.-based real estate brokerage and advisory firm. “A lot of what causes this is California buyers are very priced out of that median real estate in California right now.”

Southern California properties in particular currently sell at some of the lowest cap rates in the country across all product types, according to a recent report from real estate services firm CBRE. For example, the cap rate on a stabilized industrial property in the Inland Empire currently averages between 3.75 percent and 4.25 percent, CBRE reports. A cap rate on a similar property but located in Indianapolis ranges between 5.25 percent and 5.50 percent. In Kansas City, the cap rate would be between 6.00 and 6.25 percent.

Meanwhile a cap rate on a stabilized neighborhood shopping center in Orange County, Calif. today averages between 4.50 and 5.25 percent. A similar center in the Minneapolis/St. Paul market would sell at a cap rate of between 5.75 percent and 6.26 percent.

When buying properties in the Midwest, investors are generally looking at cap rates in the low 5 percent range, according to Lefko. An equivalent property in California with the same exact lease structure would sell at a cap rate that’s 100 to 150 basis points lower, he notes. A cap rate on a slightly lower quality, class-B center could reach 8.00 percent.

Of all the multi-tenant pads in the Midwest sold at a below 7.0 percent cap rate recently, approximately 65 percent of these properties were sold to a California-based buyer, according to research by the CoStar Group. According to Lefko, very similar metrics can be seen across single-tenant product types. Hanley Investment Group has sold 35 multi-tenant and single-tenant properties in the Midwest in the last 12 months.

However, California-based investors do seem to have a preference for single-tenant net lease assets when buying properties in the Midwest. Overall net lease investment volume increased by 33.8 percent to $20.6 billion in the second quarter of 2019, according to a recent report from real estate services firm CBRE. That trend has been driven primarily by investors seeking attractive risk-adjusted returns in a world of low yields, according to CBRE researchers.

“It’s got to be a very passive investment, everything has got to be worked out, the investor doesn’t want to have a lot of responsibility and doesn’t want to have a lot of responsibility across the country,” says Lefko. “So, I would say it’s predominant with single-tenant net lease, but it definitely is also in that multi-tenant game as well. I’d say the most popular is probably that two- to five-tenant pad.”

Still, not all industry sources see this trend playing out. Abby Corbett, managing director and senior economist with the CoStar Group, says the data query she recreated did not support the claim that California buyers are investing in Midwest properties en masse. Meanwhile, Michael Roessle, CoStar’s group director of market analytics, says that while he wouldn’t say California-based buyers have been a majority in the Midwest, there have been some recent large deals by California buyers in select Midwest markets, such as Minneapolis.

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