The Pension Fund Real Estate Association's 18th Annual Plan Sponsor Conference, held in Chicago, could not have taken place at a more uncertain time. Richard Lowe reports from what felt like the eye of the storm
We live in uncertain times. The phrase could be read as an understatement in the current global economic and financial climate. Certainly, times would have to be pretty uncertain to compel panellists at this year's Pension Fund Real Estate Association in Chicago to demand a media blackout on its morning panel sessions.
But with Lehman Brothers having fallen just days before and the US government's Troubled Assets Relief Program (TARP) having just failed to pass in its first incarnation, the 18th Annual Plan Sponsor Conference did not take place in usual circumstances.
The event brought together, as it does every year, a large community of US pension funds, real estate investment managers and advisers.For 2008, there was a record number of delegates - some 850 - who no doubt flocked to the summit keen to learn what the rest of the industry was thinking amid the financial and market turmoil.
The seriousness and pessimism in the air was not confined to the pre-lunch hours of the opening day. The words of the synopsis provided for the opening afternoon panel discussion - originally written before some of the events that would rock Wall Street - had taken on a different hue since they were first penned: "Many investors worry that delayed fallout from the economic downturn means the worst is yet to come in the US private real estate market."
The theme of the discussion was about "possibly finding solace" in the listed real estate markets. The panel included Mike Kirby, founder, chairman and head of research at Green Street Advisors, and a widely respected authority on US listed real estate.
Earlier in the year, Kirby was notably bearish on the outlook for US REITs in 2008. It seems even he might have been too conservative in his estimations for the sector. "When I made a prediction earlier this year that the values would fall by as much as 30%, people thought I was off-base," he said. "The latest predictions are more than this."
But despite the recent volatility and severe falls in capital values, Kirby was adamant that pension funds should maintain an exposure to the REIT sector. He cited a number of reasons, including: numerous academic studies suggest that, over the long term, REITs will provide returns in line with direct property, in spite of the short-term volatility; some of the best people in the real estate industry work within the REITs market; there is a strong alignment of interest; and, put simply, REITs will make investors more money.
Kirby added that the direct real estate market in the US had not yet gone through the repricing that affected the majority of other asset classes. He estimated that values would probably fall 15-20% below 2007 levels. He said there was going to be a "sea change once the private market realises what has happened".
The general consensus from the conference was that pension funds were unlikely to be investing capital in real estate in the short term, at least not until some clarity had returned to the markets. This is also likely to apply to new funds that have recently raised capital, with investors happy for fund managers to hold off with their investments until stability returns.
There were also signs that investors were beginning to scrutinise the terms of funds more closely and they were also having to seriously consider the possibility of general partners going bankrupt in such turbulent market conditions.
Just hours before the TARP bail-out legislation was passed, a keynote speech was given by Dr Frederic Mishkin, a former member of the governing board of the US Federal Reserve. He set out a sobering commentary on the recent events and what they meant for the US economy, the global financial system and real estate markets around the world.
Mishkin described the current economic situation as one of the most frightening of his life, forecasting that sub-prime losses would eventually amount to more than $1trn (€800bn). He said that one of the factors behind the situation in which the US and the world found themselves today was financial innovation. He said he believed that rapid financial change, triggered by innovation and deregulation, almost inevitably led to a lending boom and asset price bubbles.
Such innovation was necessary for a growing economy in the long term, but it could destabilise financial systems in the short term. The current real estate asset bubble, he said, had been stretching the balance sheets of institutions.
Mishkin warned that a populist political move to punish Wall Street and the investment banking community for the current financial disarray would do massive harm to the economy. Regardless of pressures from the US electorate angry with the excesses of the sector, Miskin said any move on the part of the government to "let's nail these rich bastards" would be disastrous. The most important objective was to restore confidence among investors.
Regardless of whether the TARP bail-out plan was passed, he said, markets no longer had confidence in the US administration since Lehman Brothers was allowed to fail. However, if TARP was not passed it had the potential to create what Mishkin called a "super disaster". The worst case scenario, if the problems were not addressed properly, would be a 10-year stagnation, like that seen in Japan in the 1990s.
There was a general agreement that new regulation in some form was needed in light of the recent developments. However, there was some concern that there could be a bout of over-regulation. One speaker said there were "only a few holes" in the current regulatory system. He admitted that they needed plugging, but he feared the regulatory system was likely to see an unnecessary "overhaul".