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By Alex Pugatch ’12 and Adam Simensky ’12
Professor Lynne Sagalyn kicked off the fourth annual Columbia Business School Real Estate Symposium with one word to describe the state of the Real Estate program: “strong.” According to Professor Sagalyn, about 50 students now participate in the program every year, up from only 20 to 35 per year in the earlier days of the program. Sagalyn stressed that Columbia truly lures “the best and the brightest” of young aspiring real estate professionals.
The 2011 Real Estate Symposium keynote address was delivered by Richard B. Saltzman, president of Colony Capital. Mr. Saltzman shares responsibility for his firm’s global operations, with investments throughout the world with an aggregate value of $45 billion.
While Saltzman believes that we’ve come off the bottom of the market, he acknowledged that the current investing climate is one of the most challenging he’s ever witnessed throughout his 32-year career – mostly due to the confluence of uncertainties surrounding the markets, creating a “cloudy crystal ball.” He believes that we’ve come off the bottom (which occurred in 2009/2010), but highlighted three great uncertainties facing investors.
Firstly, Saltzman touched on the vulnerability and risk regarding the general financial system. This uncertainty echoes prior periods, namely the 1998 Russian Debt Crisis (a “head fake” to some degree) and the credit crisis following Lehman Brothers 2008 bankruptcy (more of a major economic catastrophe). Today, the uncertainty is centered on the European sovereign debt crisis and in Saltzman’s view is somewhere in-between the previous two crises mentioned. The good news regarding the current financial situation is that it’s clear that government leaders and financial ministers want to do anything and everything they can to fix the problem; the bad news is that the tools at their disposal aren’t really good enough to get the job done. In Saltzman’s opinion, the “serial fixes” and “band-aids” being put into place now will likely not be adequate..
The second uncertainty surrounds the prospect of significant financial regulation. While Saltzman views the Volker rule, the Dodd-Frank bill, and the Basel III regulations as healthy for the long-term economic outlook, in the short-term, these regulations will constrain capital formation at a time when it is desperately needed. With less risk capital available from institutional lenders, borrowers will continue to be faced with lower loan-to-value ratios and higher spreads.
Finally, Saltzman highlighted the uncertainty and risk surrounding the current domestic political climate. With politicians refusing to come to terms on monetary and fiscal policies and tax reform, it will be difficult for investors to predict the market. Additionally, the turmoil surrounding the GSEs has made it very difficult to know how housing will be financed in the future. All these factors together have contributed to Saltzman’s “cloudy crystal ball,” describing today’s environment as “the cloudiest period [he] can recall.”
Next, Saltzman highlighted some differences between the current investing climate and that of the late 1980’s, when the Resolution Trust Corporation and the invention of new financial tools provided a pathway out of the oversupply-fueled bear market. Many thought this cycle would play out similar to the last real estate downturn, but, although there are a lot of parallels, there are a number of significant differences.
First, Saltzman mentioned that in this crisis, commercial real estate wasn’t the culprit; it was the victim of an oversupply of housing and unscrupulous subprime lending. Unfortunately, the problems we are seeing today are due to a drop in demand, not an oversupply of commercial real estate – a problem that Saltzman sees as much more dire.
Second, Saltzman stated that interest rates today are at record lows, especially compared to the relatively high rates of the late 1980’s. This low interest rate environment has created a lot of liquidity which has made it harder for the market to bottom-out. In the previous low-liquidity environment, we had a clearer view of the bottom of the market, as there were simply no bidders.
Saltzman’s next point highlighted the bifurcation we are seeing in the markets today: we live in a world of haves and have-nots. In the public markets, the largest, most liquid names trade briskly while everyone else trails behind. These “haves” possess the best access to capital, but they are still taking a cautious approach to investing due to competitive liquidity and the macro headwinds discussed earlier that are creating risks. Saltzman said that the IPO market window has mostly shut down, although the window would open for the IPO of a good company as long as it offers something new to the market and is not simply a commodity.
The private markets have seen the same bifurcation, with open-ended core funds in the “have” position with long entry queues for five to eight percent unlevered returns. The huge demand for these funds show that investors, especially institutional investors, are placing a greater emphasis on control over exit. This desire for exit control is further highlighted by the fact that traditional closed-end co-mingled funds are having more trouble raising funds and negotiating fees.
As his final point, Saltzman discussed some strategies that Colony has been pursuing. He cited the investment “flavors du jour:” core and distressed. He mentioned that people are interested in investments in 24-hour gateway cities, and that the cap rate differentials for these investments compared to those in less-favored markets can be 300 to 500 basis points or more. Saltzman stated that if an investor can invest in debt, at the top of the capital stack, he should be able to generate low to mid-teens returns with a safer investment, and will be able to take advantage of favorable, modest financing. In the worst case, this investment will leave an investor with a large amount of equity when he bought debt.
In closing, Saltzman mentioned that Colony is “cautiously optimistic,” and that real estate investors need to be patient due to the length of time typically associated with significant deleveraging. He also advised to diversify capital sources as much as possible. Despite all of the uncertainty facing investors, he sees the glass as half-full, and his fears of a domestic double-dip recession have faded. Ultimately, in this low-interest rate environment, Saltzman sees commercial real estate as a good value compared to other asset classes, and in particular fixed income investments.