Scott Rechler’s Stock Picking in Commercial Property

The commercial real estate industry is undergoing major changes as a result of rising interest rates, maturing loans, and changing tenant demands. Investors are forced to rethink strategies. RXR Realty CEO Scott Rechler says that broad investment approaches are no longer effective. Investors must instead carefully select high-quality investments, much like picking individual stocks in an unstable market.

Rechler shared his vision of the future of commercial property in a wide-ranging discussion with Walker & Dunlop’s Willy Walker, on the Walker webcast. He touched on everything from the dislocation of the office market to the evolving role AI plays in the workplace. When it came to identifying today’s best risk-adjusted return, Rechler’s answer was rental housing.

Multifamily – The best risk-adjusted investment

Rechler said that if you were to choose a class of assets that would help you “stay rich” today, then it would be multifamily. “Rental housing, whether multifamily or single family rental, is still the best risk adjusted return.”

He believes that despite near-term challenges such as the need to reequitize maturing loans and absorb new supply, demand will continue to exceed supply on the long-term. Higher interest rates have already slowed new construction, worsening an already severe housing crisis.

“This will not be solved overnight,” said he. “We’re in a housing crisis now, and will emerge from this cycle with a worse housing crisis than when we started.”

Rechler believes that this imbalance will lead to an increase in rents, especially in markets where there is a strong job growth. The shortage is likely to persist, as construction financing continues to be expensive. This will further reduce the pipeline of new supplies.

Office: An opportunity for the select

Rechler believes that while many institutional investors have written office real estate off, there are significant opportunities for those who can differentiate between distressed assets that are worth acquiring and those which should be left behind.

He said, “This is an investor’s market.” “There is no one strategy that works for all office properties.” Some office properties are obsolete and others, especially in prime locations, are trading at prices that we haven’t seen for decades.

RXR has actively repositioned its office portfolio by using an internal framework called Project Kodak. This framework classifies buildings into “digital” and “film”. The concept was inspired by Kodak’s failure to transition from film to digital photography.

Digital assets are located in highly-amenitized buildings and continue to attract tenants of the highest caliber. These buildings are modern and adaptable to changing workplace needs. They still attract strong leasing interest.

Film assets are functionally outdated–outdated structures in struggling submarkets which no longer meet the expectations of tenants. RXR has either converted or divested these properties.

RXR has invested $1.7 billion in repositioning its digital assets and recapitalizing them, while severing ties with properties that are underperforming or looking for alternative uses. One such alternative is conversion to multifamily, an increasingly viable strategy in markets like New York, where new tax incentives have made office-to-residential redevelopment more feasible.

Rechler stated that “our average price for high quality New York office buildings is below $500 per square feet, with cap rates of around 8%.” “Five years down the road, we will look back and wish that we had done more.”

The impact AI on office demand

Rechler believes that artificial intelligence will be the next major disruptor of office demand.

He said that AI is a topic that could have a significant impact on office demand. “There are subsets of the workforce–particularly administrative and back-office roles–that could be significantly reduced, which would in turn affect how much office space companies need.”

He remains optimistic, however, about the leasing market. He points out that in January 2024, New York City saw 3.6 millions square feet of leasing activity, surpassing the pre-pandemic levels for 2018 and 2019. He also pointed out that many companies who initially downsized after the pandemic have expanded since, realizing that they need more space than originally thought.

Investment Takeaways: The “Get Rich or Get Poor” asset classes

Rechler has identified distressed office assets as a great opportunity for those who want to get wealthy.

He said, “This is an important moment for the next generation.” “If you buy the right office building at today’s price and know what you are doing, you will be very happy in five years.”

On the other hand, he warned investors against being tempted into seemingly cheap deals for struggling assets without a clearly defined turnaround strategy.

He said that the biggest mistake people make today is to chase low price per foot figures without understanding the asset’s long-term viability. “These deals are sucking in a lot of investors.”

Final Thoughts – Playing the Long Game

For all the near-term turbulence in the commercial real estate market, Rechler’s outlook remains fundamentally optimistic–especially for those who take a long-term approach.

He said that the U.S. was still the best place to invest in the world. “If you look at the future five or ten years out, the opportunities that are available to us today – whether in multifamily, selected office assets, or repositioning outdated properties – are some of the best ever seen.”