The academic and entrepreneur talks about the drivers of return in certain kinds of real estate markets.

In a change of tack, academic and entrepreneur, Dr Rainer Zitelmann writes about his approach to property investing. He has written several articles for this publication on matters concerning wealth and psychology, attitudes to wealth and inheritance. The editors of this news service are pleased to share these views; to respond, readers should email tom.burroughes@wealthbriefing.com or jackie.bennion@clearviewpublishing.com

Christoph Kahl, founder of the German-American real estate investment and management company Jamestown, is one of Europe’s largest investors in the US real estate market. Across the US, his company maintains more than $10 billion of real estate assets under management. Whereas Kahl’s business model used to focus exclusively on raising funds from German investors, Kahl now solicits capital from investors worldwide. Jamestown has launched a total of 26 closed-end funds which, for example, invested in Rockefeller Center, General Motors Building and One Times Square in New York between 1984 and 2005. These 26 funds sold all of their real estate assets in the years leading up to 2011, giving investors an average annual return of 19 per cent. A fund for institutional investors was launched in 2011 and has generated returns of 12.9 per cent every year since.

$1 Billion profit
In 2010, Kahl attracted attention with a single transaction, which was crowned as the New York real estate market’s biggest deal of the year. Jamestown and co-owner Taconic sold 111 Eighth Avenue in New York to Google for $1.8 billion. When Jamestown acquired a 70 per cent stake in the property in 2004, it was valued at just under $800 million.

New York: Chelsea market
Kahl also turned heads with Chelsea Market, an office building in New York. In 2003, he acquired a 75 per cent stake in the building, which was valued at $280 million at the time. This investment demonstrates the factors that determine success in the real estate market. At the time, the Chelsea district was not regarded as being all that attractive and office rents in Manhattan Midtown South were almost 40 per cent lower than in Midtown. However, Kahl expected the gap to close.

Chelsea Market was upgraded and repositioned. By 2011, it was already worth nearly $800 million when it was sold to another fund at the instigation of the 25 per cent co-owner. In 2018, Jamestown sold the property to Google for $2.4 billion.

Much has changed in the decades since Kahl entered the US market. “In the past, timing was everything and the value of real estate was largely driven by interest rate changes,” says Kahl. Today, in contrast, it is important to discover potential in a building - potential that other investors have failed to recognize. “We often buy imperfect assets, the kind that have either not been effectively managed or positioned, but where we see untapped potential. Once the property is perfect, we sell it again,” says Kahl.

Multifamily market
Until recently, Jamestown primarily invested in office assets. But what does Kahl think of the US multifamily apartment market, which has proved profitable for investors in recent years? Kahl believes that the home ownership rate - the proportion of Americans who own their own homes or condominiums - will not return to its pre-financial crisis highs. Young Americans want to stay flexible. And they don’t take the same pride in home ownership as post-war generations did at a time when almost everyone aspired to own their own home and car. As a result of this shift in priorities, the rental housing market is profiting from rising demand.

So what are the biggest mistakes being made by investors? “They are not as aware of risk as they should be. The longer the economy grows, the more careless investors become. Many seem to assume that this phase of growth will never end.” Kahl himself takes a very different view. He sees an asset manager’s core task in structuring a portfolio so that it can generate attractive returns, even in the bad times. Between 1984 and 2011, none of the more than 60,000 private investors who invested in one of Jamestown’s 26 prior mentioned funds lost money.

Location, location, location?
Within the real estate industry there’s a very well-known saying: “Location, location, location.” But, according to Kahl, what many real estate investors do not understand is that a good location doesn’t have to stay good, the same as a bad one doesn’t have to stay bad. “Many thought Fifth Avenue in New York would always stay a top retail location; they believed their investments were assured and nothing could go wrong. But that turned out to be a mistake, because at some point rents for retail space climbed so high there that very few retailers were willing and able to pay them. Subsequently, rents have fallen sharply, many units are vacant and prices have eroded.”

The examples of Chelsea Market on the one hand and Fifth Avenue on the other prove just how much the location can change - and that canny investors who anticipate the change at an early stage can reap the rewards.

Doing nothing is sometimes the best strategy
Shortly before the financial crisis, in 2006 and 2007, Kahl sold 75 per cent of his company’s real estate assets. At that time, prices had been driven to dizzying heights and the investment market was almost exclusively dominated by optimists. During the financial crisis, the market collapsed and almost dried up completely. From 2005 to 2011, Kahl bought next to nothing because there were hardly any properties available at reasonable prices. Sometimes doing nothing is the best strategy - and at times like these, it’s certainly better than buying overpriced properties. Only once prices had fallen back by about a third from their peak did Kahl start buying again.

Alignment of interest
When Kahl advises private and institutional investors, he tells them to make sure that their interests are closely aligned with those of their asset manager. Many asset managers are paid based on the volume of the assets they manage. Therefore, they tend to buy as many real estate assets as possible, even very expensive ones. In 2011, Kahl launched the first open-ended real estate fund in the US that had as one of its key components a performance-based fee model. “The asset manager earns more when the fund delivers particularly good results and less when the fund doesn’t do so well,” explains Kahl. In his eyes, it is essential to have such a congruence of interests. After all, it gives the asset manager the maximum incentive to achieve the most attractive returns possible for investors.

About the author
Rainer Zitelmann holds doctorates in history and sociology. He is the author of 21 books, the most recent of which is The Wealth Elite