2011 Real Estate Symposium Main Panel: Designing and Executing Investment Strategies in Unprecedented Uncertainty
by Anoop Varghese ’12 and Andrew Stone ’13
The main panel on designing and executing investment strategies centered on an outlook of cautious optimism amidst a backdrop of unprecedented uncertainty for real estate markets over the next few years. Lynne Sagalyn, Earle W. Kazis and Benjamin Schore professor of real estate, and director, the Paul Milstein Center for Real Estate, Columbia Business School moderated the session and continually asked the panelists questions about their plans to opportunistically deploy capital. Panelists included Joseph Azrack ’72, managing partner at Apollo Global Management, Dan Neidich, CEO of Dune Real Estate Partners, and Frank Cohen, senior managing director at Blackstone. A common theme throughout the panel was that we are in a volatile period with many cross-currents including political uncertainty, liquidity risks, and balance sheet constraints, but the panelists were “cautiously optimistic” about the long-term outlook for real estate. The discussion started with an overview of where each participant saw opportunity in the current environment.
Blackstone is seeing better operating results than general headlines would suggest. Based on weekly data gathered from Blackstone’s diverse property portfolio, real estate fundamentals are trending positively despite sluggish housing starts and middling macroeconomic sentiment. Gateway markets, such as Boston, San Francisco, and New York, with their highly educated work force and concentration of intellectual capital will drive job growth and positive demand for real estate given supply constraints. Contrastingly, markets that depend on housing to create jobs are still showing signs of weakness. From an acquisitions perspective, Blackstone is looking to purchase sound institutional quality assets in short-term distress, recapitalize overleveraged properties, or structure deals with public companies with large capital needs.
Dune is still seeing signs of a bifurcated market where high quality vanilla projects are easily financeable and more difficult projects are not. Similar to Blackstone’s observation, operating performance, particularly at the firm’s European shopping centers, has been strong. Dune is primarily looking at recaps, “loan-to-own” note purchases, and some development, primarily in the United States. Dune has even been able to finance a ground-up development of a Four Seasons hotel in Florida, which Neidich said was tough to secure, but possible outside of new condo development. When evaluating new deals, Neidich emphasized that now more than ever, it’s all about the entry price and where you are relative to peak NOI. Looking forward, Dune expects transaction activity to increase as carry costs rise for capital that is sitting on the sidelines.
Azrack emphasized the volatility (particularly within the public markets) being caused by turmoil in Europe and the impediment it poses to the de-leveraging process. Apollo currently believes that we are three - four years into this crisis with another three – five years of de-leveraging to come, which is why they are underwriting new deals with relatively flat growth assumptions. To complicate matters, Apollo cited the difficult reality that historically bi-lateral negotiations inevitably become multi-lateral in today’s economy. That said, Apollo sees this as an opportunity in the US to earn mid-teens equity returns with no leverage by acquiring good assets, in good submarkets, under financial distress. Additionally, Apollo has also been structuring high-single/low-double digit mezzanine or preferred securities, from 0-65 LTV with a three - seven year term, but describes the financing market as thin. For example, Apollo is developing a hotel in Manhattan and only found one lender willing to finance the project at 65 LTV.
The conversation then broadened to cover real estate cycle dynamics, unemployment, and demographic considerations. According to Azrack, the last real estate downturn was a real estate specific problem, but now we have systemic risk in the overall economy that may hurt the real estate market. However, the panelists had different points of view when asked if their firms were underwriting growth. The answers ranged from no growth to modest growth given that there is little to no new supply across most property sectors, a growing economy (albeit slowly), and an obsolescence factor. The panelists also commented on using replacement cost as a benchmark, but to take it with a grain of salt as land value can be manipulated easily and may ignore functional obsolescence and deferred capital expenditure.
The panel then discussed the opportunity fund business model and potential changes to it. The panelists noted that it is still too early to tell, but that opportunity funds are well capitalized and there are fewer market participants compared with prior years (e.g., AIG and Lehman no longer exist). Regarding the opportunity fund fee structure, the panelists said that it is going to take a while to play out. Cohen highlighted that he often heard in 2008/2009 that real estate opportunity funds will go away, but it has yet to happen.
The panel concluded with a question and answer session during which the discussion ranged from demographic trends to typical return requirements. The panelists mentioned that we are in the midst of a secular shift in which baby boomers and Generation Y are looking for an urban living experience. In the past, employers relocated to suburban areas to be closer to their employees. However, we are seeing this trend reverse as employees seek out a rich urban experience. As far as returns were discussed, the panelists noted that they are hitting their targets. However, Azrack concluded by saying that “this is the weirdest market I’ve seen in 40 years. It is a phony market because of the (low) cost of money. This could go on for a while, maybe 5 years.” That said, Neidich commented that global investors still view the US positively.