12/22/2015 | by
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Analyst Explains “Healthy Skepticism” Toward REIT Development

Jed Reagan, senior analyst at Green Street Advisors, joined REIT.com for a video interview at REITWorld 2015: NAREIT’s Annual Convention for All Things REIT at the Wynn Las Vegas.

Reagan gave an overview of how Green Street sees development in the REIT industry.

“Green Street has a healthy skepticism about the development business. It’s a business that when it works, it can work in a big way, but there are definitely risks that come along with development that can be underappreciated sometimes,” Reagan said.

Reagan explained that it can be difficult to time development properly: “A lot of companies in the past have gotten out over their skis at just the wrong time in the cycle and gotten burned.” Development can also create additional funding risk that can put further pressure on balance sheets, he said.

In monitoring development, Green Street creates a model for every development project that a REIT is pursuing.  Green Street assigns a profit margin, based on the expected economics of the deal.  The firm also assigns an appropriate “hurdle rate” for a project based on its risk characteristics, Reagan said.

Reagan observed that demand in the office sector has been quite weak to this point in the cycle, while supply has been held at bay. However, development is starting to creep back into a handful of markets, particularly technology-focused markets that include the San Francisco Bay Area, Seattle and Austin, Texas.

Meanwhile, supply in energy-driven markets such as Houston is a cause for concern, according to Reagan. “There’s a lot of supply, including speculative supply coming in, while demand is starting to trail off in a pretty meaningful way,” he said.

Overall, though, new office supply is expected to remain moderate, Reagan stressed.

Reagan also noted that office REITs have clearly become more active on the development side. REITs have generally been disciplined in terms of pre-leasing risk, he observed, although some are starting to get a little further out on the risk spectrum.

 “We’re always mindful about risk around development funding. Over time, we’d like to see REITs positon themselves with conservative leverage so that in the event of a downturn they’ll be relatively well-positioned,” he added.