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By Rahul Chandiok ’14 and Dennis Giuliano ’15
|Moderator:||David Sherman ’82, President and Co-Chief Investment Officer New York, Metropolitan Real Estate Equity Management|
|Panelists:||Ted Bigman, Managing Director and Head of Global Real Estate Securities Investing, Morgan Stanley Investment Management|
Steven Hason, Managing Director and Co-Head, Americas Real Estate, APG Asset Management US, Inc.
Nancy Lashine ’81, Managing Partner and Founder, Park Madison Partners
“What are Real Estate Investors Looking For?” framed investor needs against discussions of market and economic trends, with each panelist providing a valuable perspective from his or her unique role.
Sherman opened the panel with an overview of market and industry conditions. Though the “world is awash in liquidity,” Sherman explained that cash has been inefficiently utilized by investors. He noted that core assets in the United States and other developed nations currently trade at a premium while riskier assets, such as value-add or opportunistic classes, remain well below prior peak levels. Sherman pointed out that the gap between core and riskier assets is larger than it has been in recent years.
Shifting focus to the local market, Sherman cited that office rents in Midtown Manhattan remain 10-15 percent below pre-recession levels. This suggests a promising trend over the next few years as fundamentals continue to recover. Sherman also noted that the distressed acquisition opportunity has evolved quite a bit over the last few years. Sellers are no longer financially distressed, so opportunities to acquire assets at a deep discount are now rare. At the same time, a wide range of assets remain under-capitalized, under-managed, and under-performing leaving experienced operators significant room to take advantage of recovering fundamentals. Conditions like these indicate a substantially different investment environment than that which existed prior to the recession. Sherman described the capital-raising landscape as a point of reference, citing that only 30 to 40 managers today, compared to 300 to 400 pre-crisis, are able to raise sufficient capital.
After concluding his introduction, Sherman asked the panel to identify the best sources of value for real estate investors today. Bigman, who currently focuses on value-oriented public real estate securities, stated that publicly listed REITs trade at a large disparity relative to their respective private valuations. For example, core assets like apartments and malls now trade at discounts relative to perceived NAV. Disparities like this suggest that now may be a good time to invest in core public securities.
In contrast, Hason opined that core assets were more appealing two to three years ago, while better prospects today may be in core-plus and value-add investments. In fact, Hason noted that some of today’s best opportunities may actually lie in selling assets, where investors can take advantage of the market’s liquidity.
Moving on to fundraising, Sherman asked Lashine which projects and funds are able to draw the most capital. She responded that a fund manager’s track record is the most important parameter for investors. Describing the market’s response to the financial crisis, Lashine described the flood of capital to American core properties over the last three years. As a result of that buying frenzy, institutional investors are now more tolerant of value-add and opportunistic projects. Although the United States remains a dominant focus for many institutions, there has been a resurgence of interest in European debt markets, specifically mezzanine financing. Lashine noted, however, that it has been difficult to deploy capital in the European debt markets.
With regard to emerging markets, Lashine noted their relative lack of popularity with investors compared to developed-world opportunities. Hason interjected to describe a herd mentality prominent in the institutional investing world. Instead of acknowledging the value apparent in some emerging markets, many investors continue to seek opportunities in overpriced core markets. Though largely in agreement with Hason’s assessment, Sherman responded that prices in some emerging sectors, such as office real estate in Brazil, must decrease to restore appeal to investors.
Sherman inquired next about public offerings, specifically, the structure of IPOs and their viability as exit opportunities for funds. Bigman responded that changing market landscapes in the past five years have made it tougher to use IPOs as an exit strategy. Bigman also noted the additional expense, complexity, and legal hurdles involved in arrangement of an IPO. Citing the “bear” attitude of the market toward office and retail REITs, Bigman stated that with those assets a public offering may be unattractive. Sherman added that many IPOs are starting to come from smaller fund managers without a strong or lengthy track record, which could be a detriment in an environment where strong managers are almost always required for IPO success.
Turning to the audience, Sherman took a question on the anticipated effect of imminent interest rate increases. Hason responded that the potential for future rate increases should be considered during each investment’s underwriting process. In particular, emphasis should be placed on the correct estimation of future interest rates when calculating the present value and potential exit cap rates of investments. Lashine noted that rising rates may engender a shift in thinking as investors focus on dividend income instead of total return from assets, a situation where rate increases may not diminish the appeal of certain real assets. Bigman added that although many investors have grown accustomed to American REITs outperforming bonds and equities in recent history, changing rates will likely restore normal market conditions where REITs outperform bonds but underperform equities.
Another audience member inquired about REITs in emerging markets. Bigman responded by stating that many REITs in emerging markets are land development plays, which makes them difficult to compare to similar opportunities in developed markets. Bigman noted that while some special cases, like income-producing Brazilian REITs, could produce results similar to U.S. REITs, it is difficult to accurately assess the future of public real estate equities in the developing world.
The final audience question asked if management fee structures were likely to change in light of the global financial crisis. Sherman responded that issues with existing fee structures arose during the highly levered pre-recession bull market. As such, there are still instances where fund managers receive higher returns (based on fees plus carried interest) than a fund’s investors. Hason stated that management fee structures will continue to evolve, possibly involving ad hoc arrangements depending on the number of investors and the size of the fund. Hason stressed that the solution must incorporate fees that are proportional to manager success and that incentivize value creation for fund investors.
The sixth annual Real Estate Symposium took place on December 9, 2013, at the Columbia University Club of New York, drawing 200 attendees representing classes from 1959 to 2013. Please visit the event page for more details and reports on other speakers. Hosted by the Paul Milstein Center for Real Estate and the Real Estate Circle of Columbia Business School, the Real Estate Symposium is an annual educational forum that brings together accomplished Columbia Business School alumni and top industry leaders for a broad-based discussion of topical issues, high-profile transactions, trends, and challenges facing the real estate industry.