A record attendance at PREA's spring conference focused on the current industry woes at home, as well as opportunities in emerging markets. Stephanie Schwartz-Driver reports
It is going to take around 18 months for capital markets in commercial real estate to return to normal - that was the consensus among the more than 700 delegates attending the PREA Spring Conference, held in Boston on 26-27 March.
The delegates were there in search of clarity, suggested Mary Ludgrin, chairman of Heitman and PREA board member. But as one delegate suggested privately, the record attendance may also have been due to the fact that few people are transacting in the current credit logjam.
The conference opened with talk of the economy and the casualties of the economic crises, made all too clear as Bear Stearns CEO Alan Schwartz had to be replaced on the first panel. Nariman Behravesh, chief economist and executive vice-president of Global Insight, set the theme and the tone as he said baldly: "We are in a recession - the question now is how deep it is."
While many speakers suggested that the worst might be over, others pointed at signs of further insecurity. "The war now is a credit-liquidity fight," said Wesley Edens, founding principal, chairman and chief executive officer at the Fortress Investment Group, "but inflation is a real risk factor down the road. Everything we try to build costs more.
Everything we try to replace costs more. Inflation is a big concern for us." Edens also noted that the problems with financial institutions have not really started yet.
Behravesh also noted that commercial real estate is starting to see signs of weakness, although the problems are not as big. The problems in residential, however, attracted thorough attention.
A record number of attendees listened to Sheridan Schechner, managing director of Lehman Brothers, as he summed up the root of the current problems succinctly, when he said that the prevailing ethos, up to August last year, was "if you can make a loan and sell it, make it".
There was agreement that the indicator to look at, both locally and nationally, was excess, as existing home sales is not reliable since many sales do not complete contract. Problems with residential foreclosures are also very localised, pointed out Frank Nothaft, vice president and chief economist, Freddie Mac, with 20% of excess nationally in Florida alone and other clusters in southern California, Phoenix, Las Vegas, and the Great Lakes area.
It is important to note that, despite the international focus on sub-prime delinquencies, sub-prime lending amounts to only 7% of the overall residential market. As Doug Lyons, managing director of Transwestern Investment Company maintained, "sub-prime didn't take the market down".
The high leverage mindset that was at fault is now changing, according to many panellists, replaced with a ‘back-to-basics', relationship-oriented way of doing business. "Relationships were dissolved by securitisation," said David Maki, head of capital markets, North America, at RREEF. "But today, if you do not have a relationship, you're out of business."
Despite economic volatility, the opportunities are not necessarily in distressed deals, according to the CEO panel. Dean Adler, CEO and co-founder of Lubert Adler Partners, warned that, "a lot of the distressed deals out there are really toxic". He has found some deals by working with regional homebuilders or developers, who know the local banks and the local execution, to step in to complete unfinished residential developments.
Jeff Blau, president, Related Companies, also has seen some distressed construction opportunities. He said that while with legacy partners there is some hesitation on new deals, an appetite to invest still exists.
Adler stressed the importance, in this market, of being a strategic buyer. "There's never a better time than now for strategic buyers. Their biggest competitors were the financial buyers, and they are not in the market anymore. A strategic aggregator is going to have a field day in this environment."
While commercial mortgage-backed securities (CMBS) is still stalled, Susan Merrick, managing director, Fitch Ratings, sees very little default risk in CMBS, although there is some refinance risk. However, she pointed out that over the last six months, 99% of maturing loans have refinanced, either with regional banks or insurance companies. In 2010-11, there will be significant amounts or maturing loans.
Interest in emerging markets was a notable theme at the spring meeting this year. "There was a time that you invested abroad because there were not the opportunities domestically," said J. Bruce Flatt, managing director, Brookfield Asset Management. "Now there are opportunities here."
Jonathan Gray, senior managing director and co-head of the real estate group at Blackstone, agreed. "There are more favourable risk-adjusted returns in the US today than there were a year ago."
But there is still a commitment to look overseas. In an informal poll of delegates, 58% were actively investing in emerging markets. Of those not yet invested, 47% were actively considering doing so. Of the plan sponsors present, 27% invested less than 5% of their total real estate portfolios in emerging markets; 22% invested between 5-10%, 12% invested between 10-20%, and 7% invested more than 20%.
While more than two-thirds of the delegates saw politicals as the most significant emerging markets risk, the lack of leverage in emerging markets is an attraction, according to Gary Garrabrant, CEO and co-founder of Equity International. Michael Pralle, president and chief operating officer, JE Robert Companies, emphasised that investors do not have to make ‘perfect' real estate decisions in emerging markets as they do in developed markets, "in the same way as falling cap rates and rapid growth forgave a lot of mistakes here in the last few years".
There was much talk of ‘decoupling' and analysis of the significance of the US economy globally, and it was agreed that regional influence, especially in Asia, had become more significant over the last decade.
Asian markets are attracting many US investors - 33% of the delegates perceive India as offering the highest returns, and 28% see that as the case for China. With Brazil, which was rated as offering the highest returns by 22% of delegates, there is some concern that it is an overcrowded marketplace. "There is more capital trying to get into Brazil than there are opportunities," said Timothy Hoeppner, managing director, real estate, for the MacArthur Foundation.