Earlier this year, a panel of real estate experts joined moderator Roy Black, Professor in the Practice of Finance and Director the Real Estate Program at Goizueta Business School to discuss the state of the real estate industry.
Although it’s been a full three years since the bottom fell out of the real estate market, the panel noted that not only have the wounds yet to heal, any inklings of an all out recovery are few and far between.
A pair of recent market reports back up the sentiments of the panel
While there are pockets of growth and a long line of well-capitalized investors hunting for quality property, the commercial real estate market remains burdened by a lethal combination of toxic assets, foreclosures and continued stagnation on the jobs front.
According to a report compiled by Jones Lang LaSalle, a global commercial real estate firm, there is some good news.
Global direct real estate investment volumes in the second quarter of 2011 topped $101 billion, an increase of 7 percent over the previous three months and nearly 50 percent from the second quarter of 2010.
But along with the good news comes the not so good news.
Deloitte & Touche’s latest commercial real estate (CRE) outlook report concludes that more than $1.7 trillion worth of commercial real estate debt will come due between 2011 and 2015 — and that an estimated 60 percent of those loans, held by banks and other lenders, are underwater.
“All our problems are because of leverage. We just moved that from the private to the public sector. We’ve still got to fix that,” panelist Arnold Whitman, CEO and Co-Chairman, Formation Capital told the audience. “I don’t see things getting better any time quick.” Whitman joined fellow panelists Clay Adams, Acquisitions Director and Chief Investment Officer, Jamestown and Felix Figueroa, Director, Northwestern Investment Management Company, LLC for a cautiously optimistic discussion.
The event was sponsored by Goizueta’s Alumni Mentor Program.
“There is an enormous amount of capital slushing around the world,” noted Adams. “We’re starting to see two things: real estate prices escalating and escalating quickly — especially in top markets.”
Since mid-2009, U.S. commercial property prices have increased by nearly a third as capitalization, or “cap,” rates declined across all property types. High quality office properties with stable net operating income experienced the sharpest declines in cap rates and, as competition remains fierce for these type properties in primary markets such as New York City, San Francisco and Chicago, the panelists expected cap rate compression to continue. These declines in cap rates have sent investors fishing for higher yields in secondary markets; as a result, cap rates in those markets, including Atlanta, Miami, and Charlotte, N.C., have been declining as well.
For deals industry insiders deem sound, there is a bevy of well-capitalized competitors ready to pounce. Often times, the frontrunners are heartily-funded real estate investment trusts, or REITs.
“As a lender,” noted Figueroa, “the deals that I like everybody likes — lower leveraged, good properties with good cash flow.”
Whitman agreed, but added that it’s “hard to compete as a private investor” when the competition is swimming in cash. “There’s very little supply coming into the market and a lot of demand,” he said.
Figueroa explained that Northwestern is “back to full allocation” on both the debt and equity sides of acquisition deals. The company is concentrating on the “four major food groups” of office, industrial, multifamily and retail although Figueroa admitted “on the equity side, there are very few retail” opportunities available. (According to the National Association of Realtor’s commercial research publication, Commercial Real Estate Outlook, retail vacancy rates are forecast to decline a mere half a percentage point to 12.6 percent by Q2 2012).
An area of CRE that appears to have all but by-passed the ongoing recession is the senior living and assisted care facility segment. Just weeks before “all hell broke loose” in the real estate market, said Whitman, he closed a $1.6 billion deal — at the time the largest asset in the company’s portfolio. As things went south, everyone involved in the deal — especially the lender — got nervous.
But since inking the deal, operating income has improved 10 to 12 percent per year and “we’ve gone from $190 million in cash flow to $300 million in cash flow,” explained Whitman. He attributed the growth to the nature of the senior housing market.
“We’re the only real estate asset class where you can get amazing cash flow dollars to rent dollars without arbitrage,” he added.
Though not solely a real estate asset (assisted living facilities are also business operations), this segment continues to see substantial growth. The National Investment Center for the Seniors Housing & Care Industry estimates the investment in properties alone is between $245 and $275 billion. Part of the reason Whitman is so bullish on assisted-living is that it’s need-driven.
“People aren’t choosing to go into facilities, they need to go into facilities,” he said.
With numbers like that, one might think investors would be flocking to opportunities in senior living, but they’re not. This is due, in part, to the fact that the industry is heavily regulated and that many facilities receive government funding. Dealing with the government adds a layer of complexity and uncertainty that some investors won’t tolerate.
In terms of the CRE job market, of interest to several members of the audience who were current and past students of Black’s, Adams predicted “growth on the acquisition side.” The reason, he noted, was that assets keep changing hands and those who own them need analysts and operations people to manage them.
“Knowing how to read leases and understand assumptions,” he said, are coveted skills.
According to Figueroa, shops that didn’t do layoffs did reorganize and they’re reorganizing again. “Those guys are getting back on the deal-making side. That leaves a gap on the operations side,” he said.
And while it’s not breaking news, green building and sustainable technologies are seeing increases and are becoming de facto standards for new buildings. While the number of buildings in development is significantly lower than it was before the bust, the Deloitte & Touche report does dub the pipeline for commercial mortgage-backed securities (CMBS) “encouraging,” stating that 2011 totals will range from $35 billion to $50 billion — up from $15 billion in 2010. Not surprisingly, the report notes investors will remain hard-pressed to secure funding for transitional or higher-leveraged deals.
Although there is a sizeable amount of capital pacing the sidelines and firms licking their chops to invest, Figueroa suggested investors remain mindful that there is still a tremendous amount of risk lurking in the market.
“The reality is that CRE debt has been pushed off to the future,” he explained. “That’s a reality people ignore when they’re paying five percent cap rates.”
– Allison Shirreffs