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Michael Giliberto retired in 2010 as managing director within the Global Real Assets Group at JPMorgan Asset Management, the global investment management business of JPMorgan Chase, where he oversaw U.S. portfolio management and global investment strategy and research. He currently consults with investment management firms and, working with John Levy and IPD, continues to produce the Giliberto-Levy Commercial Mortgage Performance Index. He is a director of Empire State Realty Trust, which successfully completed its IPO in early October, and also of the Hunt Companies, a private real estate owner-operator. He has been an adjunct professor at Columbia Business School since 2007, having taught the equities portion of the Real Estate Capital Markets course and now teaching Real Estate Portfolio Management, first offered in spring 2013. In a recent interview with Jovaun Boyd ’14, he discussed the evolution of institutional investing in real estate, lessons on investing, and his teaching.
What are you most proud of from your time at JPMorgan?
Building, as part of a team, a suite of investment offerings that spanned the risk-return spectrum from core to opportunistic, and putting it into a comprehensive framework that we used to advise our clients on how to allocate their dollars within real estate, depending on the objectives they were trying to achieve for their overall portfolios. That would be the big picture of what my career there was about. Within that, I developed and ran one of the investment funds, supervised U.S. real estate portfolio managers, and had oversight for strategy and research. In that sense, I was on the macro end of the business more than the transactions side of the business.
The fund I created and ran for quite a few years was the first fund at JPMorgan that could admit all kinds of client capital, including foreign investors, insurance companies, and high-net-worth individuals. Prior to that, the investment structure we used only worked for U.S. pension plans.
From a business-strategy standpoint, the existing product offerings, when I got there in 1996, were focused on the U.S. defined-benefit pension market. While that market was strong, we needed to think about a broader business strategy. We were looking to go from what was effectively a niche business within the broader JPMorgan investment management group to being a much more significant component, paralleling what was happening in our asset class. Real estate might have been 5 to 7 percent of investor portfolios. We were much smaller than that within JPMorgan, so we sought to expand and diversify our business, from a client perspective and funds perspective, both domestically and internationally. I think of this as another achievement, one on the business management side: being part of the vision and execution of diversifying both our group’s sources of capital and where we placed that capital.
Over the course of your career, how has real estate institutional investing changed? Why has the allocation to real estate increased?
My first job was at Aetna, which at the time was a big insurance company, not the healthcare insurer they are today. They had a vast investment portfolio and they also managed third-party money. Back then, most private market real estate equity investing for clients was at the low-risk end of the curve, largely driven by the fact that clients were primarily pension plans. It was basically dictated by regulation that fiduciaries, such as people allocating the pension plan’s money, had to behave the way a prudent person would behave. Of course, in finance, prudent people diversify. A lot of the impetus for an allocation to real estate came from that central notion of diversification.
This also was why allocations to real estate continued to expand, although that proceeded with fits and starts. For example, there was a big increase in allocations in the ’80s and then the recession of 1990, where commercial real estate was front and center in causing the downturn, caused values to plummet. It soured a lot of people on real estate, and real estate’s illiquidity, especially in times of weak markets, became very clear.
Real estate had a long road back to recovery as an acceptable asset class after that. Fortunately, results have generally borne out the diversification rationale. Of course, in the financial crisis, there really was no “safe harbor” other than U.S. Treasury securities. But in the prior recession, the one that ensued after the tech stock crash, earnings were hit a little, but valuations were so favorable that we experienced falling cap rates, and total returns inclusive of capital value changes were flat to positive. This helped restore investors’ faith in the case that it can be helpful to include private market real estate in a mixed-asset portfolio. Since the end of the financial crisis, U.S. commercial real estate assets have done well. (Of course, investors who used a lot of leverage may not have fared so well.)
Another reason is the quest on the part of institutional investors to look for higher returns as we’ve had relatively low interest rates for a fairly long time. Not just post the financial crisis rebound, but post the 2000 recession, there was a period of low yields on high-grade bonds, and investors found their incomes being compromised and they couldn’t achieve the rates of return they needed to meet hurdle rates without taking on additional risk. This caused real estate to start offering more value-added and opportunistic investments, showing there are ways to get more out of real estate than the moderate returns core real estate typically offers.
What qualities make a great real estate investor or portfolio manager?
Having conviction and clarity about your view, and at the same time having the willingness to ask how you could be wrong and having mechanisms or processes that help you identify if your view is incorrect or needs to be modified. If you’re in the business of seeking alpha, you clearly have views on things in order to position your portfolio in a way that you think will lead to positive excess return, hopefully in a risk-controlled manner, but you also need to think how you could be wrong. I’ve seen cases where people, even those with sophisticated approaches to real estate investment, have missed critical risks. Part of a disciplined process is to ask, When we’re doing this, are we also creating some other risks that we didn’t intend to take?
What are the greatest lessons you’ve learned as a real estate professional?
That no matter how much you think you know, markets will always throw something new at you. I think that’s true for real estate and probably every other investment discipline. Also, that good partners are terrific to have, but you find out who your good partners are when things don’t go so well.
Another lesson is that there is no substitute for walking a market. No amount of numbers, spreadsheets, or brochures can really replace going out and seeing an asset, walking its market, and getting a sense of the liveliness, or lack thereof, of a place. We’ve seen what happens when you don’t do that and you rely on third parties. Because real estate is not a highly liquid market where you can do high-frequency trading and things like that, one of the benefits of having a lot of experience, further informed by running models and quantitative analysis, is that, eventually, you find yourself having a good intuitive sense of what works and what doesn’t. It’s really that notion of mastery that applies in so many areas. If you spend enough time and dedication doing something seriously you get a good feel for it. I wouldn’t necessarily say you can always trust your gut, but you can use your judgment to allow you to move very quickly to having an impression of an opportunity that’s favorable or unfavorable. You can confirm that or disprove it with more numbers or data. It’s a form of efficiency that develops from being in the field for a long time.
What is your assessment of the U.S. real estate market in the current environment? Where are we in the cycle?
If we think about the recovery, the first part of the recovery as it pertained to commercial real estate was a recovery driven by cap rates coming back down from very high levels, prompted by the financial crisis and the lack of liquidity in the asset class, which resulted from the contraction of debt financing and the collapse of the CMBS market. The first part of the recovery was a normalization of cap rates in private markets to catch up with what had already occurred in public markets.
The second phase was impounding into valuations future earnings growth, and seeing when earnings would start growing again from the recessionary trough. If you reference something like the NCREIF index, because of the long leases in most of the sectors other than apartments, the trough in real estate earnings occurs after the trough in corporate earnings. The same thing with its peak—it’s slower, it’s more tempered because of the multiyear nature of the leasing structure. So the trough in earnings occurred after the bottom in the market.
Earnings clearly haven’t peaked but they’re coming back around now—they probably have been for more than a year. That’s going to be the last leg of the recovery: when actual earnings growth is in line with economic growth. More specifically, real estate is not a fast-growth industry. Especially without leverage, you’d be very hard pressed to make a case that industry growth rates should exceed corporate earnings or, more importantly, the growth rate of nominal GDP. It probably should be slower than nominal GDP because you have fast-growth industries and slow-growth industries that average out to nominal GDP.
The good news is that with valuations seemingly fairly stable, I think we’re getting closer to a point of normalization. Who’s to say what that normal looks like, but the returns that have been generated to date have largely reflected a capital value recovery due to falling cap rates. Today, rates of return for unleveraged, core real estate are in the single digit numbers, say 6 to 7 percent. You get there by having a 4 to 4.5 percent distributable cash flow yield and a couple percentage points of growth. It’s not a complicated dynamic. Of course, you can leverage it. It’s certainly a good environment currently for leveraging, and if you think that values have stability and cash flows have stability, it’s perhaps a great environment to be leveraging.
You want to understand the cycle so it can inform your estimates of earnings, but you want to look through the cycle to be an investor. You want to determine the longer-term forecast for the potential of earnings to grow. To me that’s the important thing rather than exactly where we are in the cycle. We can consider the cycle as influencing our growth-rate expectations. We can think about how the cycle does that, how we feel about that influence, and where our expectation of values end up. To me, the investing part always comes down to a relative value: What are you paying to get that stream of future results? Even if it’s a value added investment, at some point people expect there will be a stream of earnings that can be capitalized and will drive the value of the investment.
One of the big unanswered questions in real estate, putting my researcher’s hat on, is what is the “right” or “fair” premium for higher-risk real estate investing. Put aside differing amounts of leverage that are used for core, value added, and opportunistic and just looking intrinsically at the asset plays themselves. How much premium is right, and how do we go about figuring that out? We know there won’t be one right answer because developing an apartment in Manhattan is different than spec office development in suburban Atlanta, but there’s still some sort of baseline level of risk premium. How might one approach that, and how should investors think about it?
What was the impetus for the Real Estate Portfolio Management course?
A recognition that a fair number of students are going to either investment management firms or private equity firms that are in the business of building and running portfolios, and also a view that, looking at the landscape of MBA real estate programs in the United States, including at Columbia, there really wasn’t a course for someone interested in making decisions about structuring and running an investment portfolio as distinct from decisions to buy or sell buildings. A lot of it was driven by a perceived marketing opportunity, a distinguishing factor for the program at Columbia, but even more so a recognition that there’s an additional level of skill or experience that’s complementary to what’s developed in other parts of the curriculum but that needed to be more clearly crystallized and focused on. I think it fit a need in the program for people looking to go in that direction, whether to start their own funds or work for another fund manager, private equity firm, etc.
What do you hope that students take away from the course?
Some of those points I made before about asking how you can be wrong, really looking at risk in the big picture, and trying to draw insight about the connection between the risks you take and the level of reward you should expect to achieve. In the class, students get a lot of exposure to the voices of people who have done this for a living. I have a lot of guest speakers. I have my experience as a portfolio manager that I can draw on, but that’s inherently limited, so I make sure to get people from different firms and with different perspectives into the classroom so that students can hear a wide range of ideas.
What do you enjoy most about teaching? How did you get into teaching at Columbia?
The thing I enjoy most is the give-and-take and discussions we get into in class. To me that’s the best part, when we have lively discussions, when I can challenge the students and they can challenge me and other speakers, when they can share their experiences, questions, and opinions. When we have a good classroom experience going, I can usually feel it. I think everybody can. To me, that’s the most rewarding part.
I knew both Lynne Sagalyn and Chris Mayer from having previously been an academic and working in the research community. Dan Adkinson, who was a colleague of mine at JPMorgan, and Chris Mayer were teaching Real Estate Capital Markets. I sat down with Dan and Chris to express my interest in teaching again some day. Within a year, I had the opportunity to pick up the equity part of the capital markets course while Chris went on sabbatical.
What advice do you have for students looking to build successful careers in the real estate industry?
Don’t shy away from taking a job that might seem unglamorous at the outset if it will give you a lot of exposure to seeing assets and markets. Get international experience if you can. Even if you’re doing a lot of grunt work and modeling, try to be meticulous and thoughtful about it. Modeling is one of those things that will build your gut feelings over time. You’ll pick up things, such as how much of asset value is driven by residual value versus by the earnings stream, and you can then understand the relative merits of deals that may have the same IRR but get there in different ways.
Tell me about your band.
I play lead guitar in a band called Winston Wolfe. It’s best defined as a bar band. We play a lot of blues and rock. I enjoy it because it’s a way of shutting off the logical, thinking part of me and getting in touch with the emotional part. With a lot of the music we play, there is ample room for improvisation within the structure of a song. The thing that’s really cool is the creativity that allows. Not everything has to be planned out and thought about and rehearsed. It’s rehearsed in the sense that you have a fairly precise song arrangement, but within that tight framework, you can have a flight of fancy and see where the moment takes you musically.