2011 Real Estate Symposium: Equity Capital MarketsPublic and Private
By David Strongwater ’12
Andrew Jacobs ’96, managing director and partner of Metropolitan Real Estate Equity Management and adjunct professor at the School moderated a discussion on investor demand within the real estate equity universe – from publicly traded REITs to real estate private equity and investments. Jacobs was joined by some of the industry’s most well-respected professionals, namely Martin Cicco, senior managing director and head of real estate at Evercore Partners, Ross Smotrich ’83, managing director and senior research analyst at Barclays Capital, and Douglas Weill, founder and managing partner of Hodes, Weill & Associates.
Attendance at the panel was robust and enthusiastic, with even some of the most seasoned professionals looking for guidance in today’s complex and uncertain real estate investment market. In general, the panel was optimistic regarding the continued demand for quality real estate investments in both the public and private markets, with one major qualification being a flight to quality – managers, partners, and investments.
Jacobs kicked off the panel by asking the panelists to share their views on where we currently stand with respect to the recovery and investment timing. Smotrich commented that the current market shares some similarities with the 1990 to 1994 period, though there are notable differences. The current market offers no opportunities to purchase real estate for pennies on the dollar. This can be attributed to the increased demand for real estate, particularly from private equity investors who still have ample cash in their coffers. Additionally, publicly owned real estate is well capitalized. These, among other factors, have led to limited government intervention, which results in real estate investment opportunities to “drip out slowly” rather than a flood of product on the market, which would drive prices sharply downward. Weill agreed that private equity has significant “dry powder” on the sidelines, and that REIT’s have strength in this market, given their low leverage. However, he believed the current market to be very different from that of the 1990 to 1994 period. Weill stated that unlike during previous significant downturns, there is a large amount of organized capital today. In fact, large equity or debt investments which come to market today could see hundreds of qualified bidders. Cicco pointed out that a major difference during this downturn and recovery is that this time, the government never got control of the actual assets, and rather injected the banks with fresh capital. One insightful example Cicco provided was the current battle over the Archstone portfolio, with the estate of Lehman Brothers holding onto the investment, long after their bankruptcy. He added that as a result of previous mistakes, banks have become smarter in determining the hold period for their investments, and when to sell.
The panel was next asked by Jacobs to share where they see opportunities within the foreseeable future, as well as where they expect investor demand to originate. Weill stated that he expects demand to be driven by sovereign wealth funds, pensions, and endowments. He also believes that the next few years will be good vintages for real estate investments. From his perspective, as one of the top fund advisors, Weill has seen institutions maintain their target allocations for real estate on a percentage basis, with some even increasing their allocation to real estate recently. This seems to be driven by institutional investors reverting to traditional real estate investing principles, with stable, low yields, quality income streams, and protection against inflation. Cicco commented that the REIT business is becoming more correlated with broad equities, and in fact, many investors are faced with the question of whether REIT investments fell within the real estate bucket, or the equities bucket. Furthermore, he stated that non-listed REITs have become popular, as they are not forced to mark-to-market. Smotrich stated that he believes there will be investment opportunities forthcoming, as a result of banks compliance with increased regulation. He also believes that REITs stand to most benefit from these opportunities given their well-capitalized nature.
Jacobs next asked the panel to address the increased volatility today, and if it could be attributed to hedge funds. Smotrich believes that most of the volatility stems from the current market conditions, rather than from hedge funds. Cicco stated that regardless of specific short-term market conditions, institutional capital needs to be invested. However, while investors need to address regulations, they also must address the issue of recycling of managers. This results in an increased demand for fewer, high quality managers on the direct investment side. Weill believes the landscape of managers will change dramatically as a result of increased scrutiny of manager selection. This should lead to a bifurcation of the manager world based on size, strategy, and investment history. This can be partially attributed to the “Madoff effect” whereby investors are afraid of what is behind the curtain. Weill went onto add that proven success in the distressed debt business is currently very marketable.
Continuing within the institutional investor space, Jacobs asked the panel to touch upon whether they felt such institutions were increasing their participation in direct investments. Cicco pointed out several complications to the current institutional market, including the general lack of sellers today, and the fact that only the best-in-class are able to raise funds. However, with investment periods ending and changing managers, we might see an increase in activity in the coming years.
The conversation then steered to the international markets, and their increasing importance to investors. Weill began the active conversation on the topic by commenting on the increasingly global nature of the asset class, with cross-border investments large, and increasing. He added that this growth will come, in large part, by major international pension funds, which might be first deploying capital in real estate around the world. Smotrich added that this increase in cross-border activity has led to some level of cap rate convergence around the world. Cicco commented that there remain some attractive opportunities in Europe, while the supply/demand balance in Brazil has the makings of a real investment market. Cicco went on to add that REITs are becoming increasingly global in their coverage and their presence in emerging markets, with the first Mexican REIT offering completed in early 2011. However, although international investments should continue to grow, Cicco mentioned that only a few real estate companies will be able to be true global players, given the difficulties of managing a wide-ranging portfolio. Jacobs brought the topic together by establishing the value proposition that investors must consider – for example, a low 20’s return in Brazil compared to a mid-teens return in the United States.
The panel concluded with a lively question and answer session, which covered topics ranging from non-listed REITs to the domestic lodging market, to the core versus suburban value proposition, to the return of a substantial CMBS market. Panel spectators were left with a keen understanding of the state of equity markets, as discussed by four industry leaders. After reflection upon the various perspectives presented during the panel, it appears that although deals will not be flooding the market over the next few years, there are still ample opportunities in the private and public markets, provided that investors carefully select their investments, and actively manage them. Investor demand remains quite strong for quality managers who can prove they have a strong track record, and a high-quality and repeatable strategy.