Staying ahead of market and sector shifts is essential for real estate investors. At ARA, our Research and Investment teams collaborate to distinguish meaningful, demographic-driven trends from fleeting market buzz. In the latest edition of In Conversation, ARA’s Britteni Lupe and Eric Cannon explore strategic entry points into emerging sectors and markets, offering insights into ARA’s rigorous approach to identifying and evaluating these pivotal shifts.

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Eric Cannon: Hello, and welcome to another segment of ARA In Conversation. I'm Eric Cannon, Portfolio Manager of ARA’s Value Added Strategy, and I'm very pleased to be joined here today in Los Angeles by Britteni Lupe from our Research and Strategy group. Britteni, thank you for joining me.

Britteni Lupe: Thank you for having me.

EC: Britteni, I wanted to have a conversation with you today for our viewers about the importance of entry points into new property sectors and new submarkets or neighborhoods, and I think it would be helpful if you outline for our viewers, your group's evaluation framework for analyzing new property sectors.

BL: Absolutely. When research is evaluating a new market or sector to go into, it's really about finding the right combination of factors that warrant moving into it. We’re going to look at a bunch of different metrics, but I want to break them down into three main groups for you.

The first that we would look at is underlying demand drivers, and with this one, what we're really asking ourselves, it's, “What is fueling that demand?” And this could be something like demographic shifts – perhaps we're seeing a surge in population in one city, or maybe there's a market that all of a sudden is a hot migration location, and we want to know why.

Is it the fact that there's good weather? Is it the fact that maybe there's no state level income tax there? This also includes job and economic growth, so perhaps there is an industry that is showing a lot of potential job growth, and we want to know which markets have a heavy concentration of that in them.

We're always monitoring for the next big tech hub city somewhere in the nation. We want to get there before others. And then this also includes lifestyle trends. The whole work-from-home versus return-to-office debate. We want to know which markets are favoring which side more heavily, because that's going to influence the office real estate in that market.

This also trickles into consumers and whether they're preferring to shop online or whether they're preferring brick and mortar stores, again, because that's going to impact industrial and retail in those markets.

The second bucket that we would look at would be barriers to entry. Here we're asking ourselves, “What is keeping competition in check? Is it land availability, is it construction costs, or is there oversaturation?

I think back to the retail sector a few years ago. Oversaturation made it really hard to justify new investment in that sector, and that limited the upside of the retail sector for several years. So, it's important to keep that in mind.

The third and final bucket is specialized knowledge. And when I say that, what I mean is operational expertise. Senior housing and life sciences, they pop up in mind with this one in particular, and that's because in order to build out life science and senior housing, you have to have a lot of specialized knowledge in how the tenant is using the space so that it can actually be conducive for them.

Ultimately, it's about identifying those markets and sectors that sit in the middle of that Venn diagram, if you will, of underlying demand drivers, structural demand tailwinds, market depth and liquidity, and then the ability to execute well. And this is because our goal is not just to identify those markets and sectors that have strong long-term propensity for outperformance. It's also because we want to set ourselves up for success throughout the entire life cycle of an investment. And if we can connect these dots early on, it allows us to not only do that, but to also avoid chasing after any buzzworthy thing that crops up.

EC: I think it's clear for our viewers that the research team has – there are a lot of inputs to go into this multidimensional framework of evaluating new sectors. Could you talk a little bit about how we put this into practice and a sector we've identified that we really like?

BL: Absolutely. So purpose-built single-family rentals come to mind with this because I think they're a great example of using this framework to advise entry into a new sector, and that's really because SFR, it's not driven by just one factor, it's driven by a combination of demographic and economic realities that make it so compelling.

One demographic that we're seeing a lot of demand come from is the renter who is saving for home ownership. They want to buy a house eventually, but they need more time to save for that down payment, especially with how expensive home prices have gotten and how high mortgage rates are. Single family rentals, they give them the opportunity to save and have that financial flexibility but also offer other benefits like access to good school districts for those with children, more space for remote work setups, and then also yards for those with pets. Whatever it really is that they need, SFR provides that but also gives them financial freedom.

The other demographic that we're seeing a lot of demand come from is retirees who are looking to downsize. They really need access to that locked up home equity, and so they're selling their homes and they're renting. But the thing is, they don't want to rent in traditional multifamily apartments. They're used to the privacy, space, community that comes with living in a single-family home. So purpose-built single-family rentals, they allow them to maintain the lifestyle that they're used to, but also it allows them to have access to their funds. And that's the thing about SFR – it really offers the home ownership experience without having that financial commitment.

And of course, specific markets and their supply considerations must always be in our minds, but it's really the long-term demand drivers here that make it such an interesting long-term play.

EC: I agree. I want to spice things up a little bit – why don't you throw some water on an alternative property sector that a lot of investors in the marketplace like that we don't feel as strongly about for future outperformance?

BL: Absolutely. The sector that comes to mind is student housing, and we're going to use the same level of analysis here, and it's going to be demographics and economics, once again, that led us to our conclusion. At first glance, student housing seems to have a steady demand pool. After all, universities are still enrolling millions of students annually.

But when you dig in deeper, you see that the rate of enrollment has declined steadily for over a decade. And this largely has to do with the fact that each subsequent generation is just smaller than the last. So that pool of potential students is shrinking. But not only that – tuition costs, they've gotten really expensive, and it's leading a lot of young people to question the return on the investment of that degree.

We’re starting to see a lot of alternative options pop up for young people, and they're becoming more popular, like trade schools or even entering the workforce right out of high school. So, while there might still be pockets of opportunity, especially amongst the Ivy League schools or those top-tier schools that still have strong enrollment trends, the overall outlook for student housing does beg caution. I think it's a really great example of stepping back from the headlines and assessing whether a sector really has sustainable long-term potential.

With all of that being said, Eric I think it's also important to note that a core buyer might approach this a bit differently than a more nimble value-add buyer. Since you're the head of our value-add fund, Eric, let me ask you: do you think that there's an advantage or an arbitrage play to getting into a market or a sector early before it fully matures?

EC: Absolutely. Typically, low land values characterize emerging neighborhoods and they provide opportunity as compared to more established neighborhoods for outsized appreciation.

In our value-add strategy, in particular, we have a proven history of investing early in transforming emerging neighborhoods ahead of this wave and capturing that appreciation. So most notably, we've developed new apartment communities on the waterfront in East Boston and in the University City neighborhood of Philadelphia as examples.

BL: This brings to mind a lot of the internal conversations we're having at ARA, where we talk about the lessons that we have learned from one of the major food groups – office, multifamily, industrial, or retail – and applying those lessons so that we can shorten the learning curve with these niche or specialty sectors.

Can you talk to me about one of the experiences that we've had with a niche sector or a new market, and what were some of the lessons that we learned?

EC: Absolutely. Well, as you know, back in late 2019 or early 2020, your group led a deep dive into the research of alternative property sectors, aside from the four main food groups of office, industrial, retail, and multifamily.

You looked very hard at purpose-built build-for-rent, cold storage, data centers, student housing, senior housing, medical office, and the conclusion was that the best opportunity moving forward was in purpose-built build-for-rent single-family rentals. Acting with conviction, we aggregated through acquisition 12, purpose-built communities located through attractive, fast-growing Sunbelt markets in the U.S.

We've now been operating and owning those assets for four-plus years, and I think we've really learned, operationally, how they're different from traditional multifamily. We've also learned what our residents in our communities desire, because it's not the same as the traditional apartment renter.

They clearly want more space, but it's not just about that. It might be about the yard, it might be about community amenities, it might be about a garage versus a private driveway, and that's informed us moving forward and analyzing new investments to really weed out things that we don't think, ultimately, the end resident is going to want.

BL: Right. Well, I love to see the relationship between research and acquisitions, and I think that this really goes to show the importance of identifying these sectors or markets early on.

EC: Absolutely. It's critically important to do so, and the benefit of investing within ARA is that we're large enough organizationally to have a deep research function, and yet small enough to be entrepreneurial and act as a first mover into some of these sectors and neighborhoods to capture opportunity.

This transcript of the ARA In Conversation discussion has been edited for clarity.

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