Conference Notes, Councilors of Real Estate, April 2013 Meeting, New York City.
Primary macroeconomic section.
There has been significant job growth from the new US energy boom, as well as in several tech centers throughout the country.
Of the $12 trillion in lost single family residential value, about $7 to $8 trillion has come back.
The fed should accommodate with low interest rates for the next 18 months.
Commercial real estate is doing okay as an asset class because of the limited new supply in the past 5 years.
David Levy of the Jerome Levy Forecasting Center, who used to be a hedge fund manager, had the following points to make.
He considers the past 5 years as a “contained depression” and expects the next 5 years to be very similar. There is a substantial amount of balance sheet correction ahead that needs to be done and that private debt is very high.
Between World War II and 2008, total assets and debt grew faster than the economy did, which turned out not to be a good thing. There will be little growth in household assets over the next 4 to 5 years.
The private economy cannot generate larger profits without balance sheet expansion.
Containment of the recession/depression was due in part to the government becoming the lender of last resort and quickly developing a much larger footprint in the economy.
He thinks we have another 5 years of relatively slow growth and “contained depression.” He would not be surprised to see a second recession sometime in the next 5 years, as well as to see some asset price deflation. He says that stock market rallies that are driven by low and zero interest rates are not sustainable. The possibility of a recession within the next 5 years is significant, given the amount of deficit cutting required at all government levels and given that the fed has not much left to cut on interest rates.
On the good news side, he sees pent up demand starting to expand and become a long term boom in 2017 and after, much like the period between 1946 and 1970. He says one should maintain a defensive and patient posture and be ready to take advantage of strong growth 4 to 5 years down the road.
Owen Thomas, Chief Executive Officer, Boston Properties.
Growth is no longer a coastal story anymore. Boring, stable, second and third tier markets are important to look at. Stay away from government leases and look for private investment, especially that which promotes productivity and efficiency. Look at global warming as an open opportunity for new development and changes in types of real estate development.
Invest in hard assets that produce income like REITs and avoid fixed income bonds as well as dividend stocks.
Europe will be suffering for the next several years and will not produce strong export demand from the US. India, China and Brazil all developed fairly quickly and took advantage of export growth and cheap labor, but now need to work on productivity and domestic consumption within their economies.
Emerging Markets Section.
Emerging markets look better on paper as investments than they do in reality. Exit strategies are very difficult. There is significant corruption and markets are not transparent. It is also the case that GDP often outpaces equity markets and equity investments. i.e. connected locals are getting the best returns. Look for inefficiencies where you can supply unmet demand.
If developing today, there are some strong arguments to prefer Texas over China. In many of the emerging markets, new development requires either political connections or that you are the politicians. The entitlement process is open for abuse, can continue throughout the project, and often doesn’t get resolved until the final stages of construction.
China is starting to see a functional commercial real estate financing market, but India has a lack of entitlement guarantees, a lack of experienced managers and experienced developers. The big thing to think about emerging markets is risk versus return. 7% always sounds worse than 15%, but that 15% may never be realized; Or may be a loss.
Practitioners and Dealmakers Section.
The dealmakers see the market awash with free money.
A number of long term New York real estate families and investment companies bought distressed or low priced assets over the past several years. Many of them have been cleaned up and re-tenanted. These were originally planned to be 20 year holds, but prices have escalated so rapidly, many of these long hold owners have decided to sell at 100% gains over their initial acquisition prices just a few years ago.
Part of this is a strong growth in the New York City office market. Many of the corporations in New York want their tech providers in New York, not in California, and many sections of Midtown have become in demand for office users as opposed to secondary neighborhoods.
Urban retail is a favored asset class and is often worth many more times what the office space above is. It is also, in the New York City market, in such strong demand that the landlord needs to provide no tenant improvements and often gets long term leases. Urban ground level retail has also been in strong demand by medical users and as much as 15% of ground floor retail is expected to be medical related over the next several years.
Especially on the apartment side, some dealmakers are saying that there is a large gap between the overall rates of return and treasury yields/mortgage rates and that the market has already priced in a 200 to 300 bump in treasury rates. Some buyers are also looking at getting longer term financing, 10 years and beyond, or even HUD loans, and then reselling 5 years down the road with the accretive, long term loan. That has not been in fashion for some 20 or 30 years.
The more conscious buyers and brokers say that it is important to understand that the buyers who win the bidding war for an asset face 3 possible outcomes.
Number 1, free money persists, in which case they will do okay;
Number 2, interest rates rise, but rents also rise, in which case they will do okay;
Number 3 has interest rates rising, but no inflation in rents and that may be a significant problem especially if they are getting 5 and 7 year mortgages.
Some investors are choosing to try to get the longest term debt they can and to shorten amortization schedules in order to pay down debt quickly. That, of course, reduces the amount of current cash flow.
Single Family En masse
There was a lecture section on hedge fund and REIT purchases of massive amounts of single family homes as rentals. The presenters were uniformly optimistic about this type of investment, but many in the audience were much more pessimistic. Typical houses being purchased are in the $100,000 to $150,000 range, with 5% to 6% capitalization rates and these typically require $15,000 to $50,000 in renovation. The houses that are getting purchased are those that are in too poor of condition for the buyers to be able to get FHA financing. But one of the investment advisors I talked to in private, who has a management company that also has a single family residential portfolio, indicated that management of dispersed individual single family houses is much more expensive over the long term than apartment management is, and that many of these new single family rental entities have not yet fully reflected those higher management costs in their pro formas.
We got to hear Larry Silverstein talk about the redevelopment of the World Trade Center. He is not a shy and meek individual, and he has a very impressive and massive development project under way.