Interest rates need to rise if real estate investors are to put cash to work, says Sam Zell.
The Equity Group Investments chairman told delegates at the Chicago Council on Global Affairs this week that an interest rate rise would put an end to investors sitting on large liquid balances.
He said business decision-making under prevailing low rates was akin to the way professional basketball was played before the introduction of a limit on how long a team could possess the ball before taking a shot.
“Interest rates should go up,” said Zell. “In a way, interest rates, and where they are, is like not having a shot clock – there’s no sense of urgency,” he said.
Zell, referencing Grant’s Interest Rate Observer, which contends that positive real interest rates above the rate of inflation force investors to put cash to work, said increased interest rates “would help”, with no harm to property markets.
“Do I think we’re going to see a significant increase in interest rates?” Zell asked. “No. Do I think rates could be raised 100 basis points and have no impact whatsoever? Yes.”
A rate hike after a sustained period of near-zero rates would “nudge rates back towards a normal footing”, Zell said.
“They’re beyond the point at which they are impactful in the decision-making process, and, once that’s the case, they’re no longer an instrument of change,” he said.
“Extraordinary excesses of liquidity” around the world, he added, meant “people are paying preposterous prices” for some commercial properties.
US property markets are benefiting from Chinese exports of capital, but foreign investment in the US could slow.
“Probably the strong dollar is a little discouraging,” he said.
On investing in China, Zell said: “I don’t think it’s a place where I particularly want to have a big footprint.”
China benefits, he said, from being “semi-totalitarian, and, therefore, people get things done.”
But “the Chinese are primarily for the Chinese”, he said.
“There’s a limit to a foreigner’s success there.”
Equity Group’s experience was illustrative.
“We invested in China early and did very well,” Zell said. “We invested later and got our ass handed to us.
“When we were early, they couldn’t wait to hear our ideas and implement them accordingly. Later on, they didn’t understand English.”
The experience highlights a key risk facing investors in emerging market property sectors.
“You trade growth for the rule of law,” Zell said.
Success requires having the right partner in each country, he said, “someone local and powerful” who is taking the same risk.
“If there is some kind of a political problem, reading the documents is not going to tell you much,” he said.
While admitting there is always risk from sector-specific factors – such as office space redeployment – Zell said US property fundamentals were “sound” and that institutions would continue to allocate greater amounts of capital to the asset class.
The financial crisis, he said, “was the first time since World War II that the US entered something where commercial real estate was not in oversupply”.
“So we took the economic hit, but we didn’t have empty buildings anywhere in the country,” Zell said.
The strong performance of property in the past several years demonstrates “real estate’s ability to move from there and to be an even more attractive investment”, Zell said.
Multifamily housing in the US has a particularly bright future, as households are formed later and home purchases are delayed.
“The most significant demographic event of the last 30 years has been the deferral of marriage,” said Zell.
And that trend will not change soon.
For millennials, he said, the American Dream is “freedom, not buying a house”.
