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Vol. 16, No. 1

Spring 2012


Table of Contents

Note from the Editors

April 2012

Witold Rybczynski—Scholar, Author, Friend

Personal recollections of a co-editor.
Peter Linneman
Executive Summary

As we end our tenure as founding co-editors of the Wharton Real Estate Review, I tip my hat to my co-editor, Witold Rybczynski, who will be retiring from Penn's faculty at the end of this academic year, leaving a giant void in his wake.

Lessons I Have Learned in My Career in the REIT Industry

The reflections of an industry insider on the evolution and future of REITs.
Jon Fosheim
Executive Summary
Publicly-traded REITs have come a long way from a small backwater of the capital markets. The maturing of the industry began with the real estate recession of the early 1990s, when lenders forced major real estate players to bring in more equity investors or risk foreclosure. Investors, realizing they held the better cards, demanded that the new REIT vehicles be more investor-friendly than what came before. A few issues remain, such as the institutional bias against REITs on the part of the big retirement funds; the excessive pay at some of the REITs; and the expropriation by so-called non-traded REITs of a portion of the goodwill so laboriously developed by the publicly-traded REITS. Nevertheless, publicly-traded REITs have outperformed bonds, the broad stock market, and direct ownership of commercial real estate. The future for publicly-traded REITs does indeed look bright.

The Making of an Asset Class

An overview of the real estate industry's evolution over a quarter of a century.
Roy Hilton March
Executive Summary
With the advent of modern portfolio theory in the 1950s, and its subsequent adoption by institutional investors, commercial real estate went from cottage industry to bona fide asset class. But the obstacles to its ownership made real estate largely inaccessible to all but the largest investors. Twenty years ago, a remarkable transformation occurred: liquidity in real estate brought on by the rise of public REITs, CMBS, real estate private equity funds, and the abundance of capital sources. Today, real estate competes directly with stocks, bonds, currencies, commodities and other financial assets. Understanding the factors that catalyzed the industry's transformation, and the lessons learned along the way, is the key to preparing for the many exciting challenges and opportunities that lie ahead.

The Biggest Problem Facing Real Estate Today

Not only K-12, but also university education in the United States have serious problems.
Peter Linneman
Executive Summary
Real estate values depend upon a strong and growing U.S. economy. Long-term economic growth is challenged by many things, but the biggest challenge is the downward spiral of our education system. This is not limited to grades K-12, but now infects our once-great university system. The absence of a culture of excellence has taken hold and will reduce long-term economic growth, hence real estate values.

What Next for Housing Finance?

There are several proposals to fix the broken housing finance system, but will they be effective?
Adam J. Levitin, Susan M. Wachter
Executive Summary
Since the financial crisis of 2008, approximately 90 percent of the housing finance system has migrated into the federalized auspices of FHA and the GSEs, Fannie Mae and Freddie Mac. With taxpayer money at risk and hopes of revitalizing the private market, policymakers have proposed new ways to transition away from this nationalized system. The central debate rests on the government's role in the long run: Should it continue to guarantee safe, affordable mortgage products, or can market stability exist without taxpayers assuming the tail risk? Of equal importance, but less acknowledged, is the necessity of comprehensive reform, including transparency and standardization for all mortgage products and securities, government-backed or not.

Safety in Renting

Home buyers take risks, but so do renters; it just depends where they live, and if they are planning to move.
Todd Sinai
Executive Summary
A recent decline in the home ownership rate raises the possibility that some people now perceive home-owning as too risky. However, renting is also risky. The author outlines two risks that only owners avoid: low-mobility households can lock in their housing costs, and all households can hedge themselves against changes in the cost of housing from moving. On the other hand, when tenants move, they avoid uncertainty over the sale price of a house. The author shows which kinds of households would best avoid risk by renting or owning. The recent decline in the home ownership rate does not appear to be driven solely by natural renters returning to renting, and the article issues a challenge to landlords to find ways to make renting less risky for natural owners.

The Past, Present, and Future of CMBS

The story of commercial mortgage securitization.
Sam Chandan
Executive Summary
The commercial mortgage-backed securities (CMBS) market has struggled to reestablish itself in the aftermath of the financial crisis. Efforts to reignite securitization have sought to balance shortfalls in credit availability against persistent concerns regarding incentive conflicts in the CMBS structure. While CMBS market participants have made observable progress in addressing several perceived deficiencies, major structural issues may go unattended as activity resumes. Among the key challenges that persist as impediments to the efficient functioning of the market, potential misalignments of incentives between originations, issuers, servicers, and ratings agencies coincide with differences in incentives across securitization and balance sheet lenders. While a resumption of CMBS issuance may be interpreted as validation of reforms already undertaken, the failure to address incentive conflicts with practical and implementable remedies leaves open the possibility of costly disruptions to credit flows in the future.

Perspectives on the REIT Industry

In a prescient 1993 NAREIT address, a legendary real estate figure looked back and ahead.
Sam Zell
Executive Summary

A discussion of the evolution of the REIT industry since the original 1960 REIT Act, and its various iterations: mortgage REITs, the revival of REITs in 1985, and the emergence of a REIT structure in 1991-92, when the structure and the pricing for the first time really represents a scenario where it is a fair deal to both the buyer and the issuer. The author argues that REITs need to get larger, and that the real future of the REIT industry is going to emanate from the creation of very large mega-REITs that give sophisticated investors the opportunity to make a real bet on real estate as an asset class, and have the liquidity to both enter and exit.

Twenty Years of Opportunistic Real Estate Investing

Real estate funds have many investment opportunities around the world.
Joanne Douvas
Executive Summary
The history of real estate opportunity funds is a twenty-year search to take advantage of cycles of distress and the scarcity of capital. Opportunity funds identify dislocations and illiquidity in real estate markets that have historically shifted geographically over time based on where the market is in the real estate cycle. The availability of excess returns for those managers that know what they are doing and that possess the requisite skill set to execute opportunistically is expected to continue. The opportunity for funds to achieve higher returns has become truly global in nature and these geographical shifts can also be expected to continue.

The Proposed Lease Accounting Standards

New accounting standards mean major changes to lessee compliance and implementation.
Josh Leonard, Robert T. O'Brien
Executive Summary
In August 2010, the Financial Accounting Standards Board (FASB) issued an Exposure Draft (ED) containing major revisions to accounting for leases, including real estate leases, from the current FAS 13. To comply with the proposed standards, lessees will be expected to fundamentally change how they account for real estate and equipment leasing transactions, providing more extensive financial statement disclosures than ever before. Standards-driven lessee accounting changes and associated operational issues are the focus of this article.

Mind the Liquidity Gap

Capital flows to the global property markets are changing rapidly.
Jacques N. Gordon
Executive Summary
The flow of capital to international real estate vacillates between risk aversion and risk tolerance. As 2012 unfolds, low-risk core assets in the most expensive districts of the world are in great demand. Assets with more complexity or in less central locations are placed on the other side of a great divide. The debt crisis in Europe highlights the stark contrast between pricing on either side of this "liquidity gap." The emerging markets of the world continue to have very active development pipelines. However, credit is also being squeezed in China, though infrastructure spending will continue as part of the government's "go west" policy.

The Sustainability of China's Residential Market

James Macdonald, Francesco Mussita, Rand Sobczak Jr.
Executive Summary
China's residential real estate market has grown substantially since its privatization in the late 1990s. Many argue that its development has been built on a number of structural flaws and a housing bubble may be on the verge of bursting. Rapid price growth has resulted in a large proportion of the population being priced out of the market and the economy dependent on the industry's stability. The authors assess the short- and long-term sustainability of the Chinese housing market by examining the economic, social and political elements that have shaped it. The findings suggest that despite the short-term risks that have emerged from recent government regulations, these policies have addressed many of the factors that have brought an industry in its infancy to a possible bubble. As fundamental drivers of the industry fade, the overall health of the sector rests on the successful execution of these initiatives.

Creating a New Suburban Town Center

A public-private partnership produces a novel solution that blends retail, commercial, and educational uses.
Witold Rybczynski
Executive Summary
Despite the current fashion for lifestyle centers that mimic the Main Street environment of small towns, the suburban centers of the future will not necessarily resemble the downtowns of the past. The Surrey Central City project in suburban Vancouver is an example of how out-of-the-box thinking--and a public-private partnership--can produce an innovative solution to a complicated problem. The project combines a 680,000 square-foot shopping mall with one million square feet of new development containing a university campus, and a twenty-five-story commercial office building. This paper discusses the complicated negotiations that produced this unique mix of uses, and the design strategies that have produced the nucleus of a successful town center.

Power Center Meets Lifestyle Center

The Edgewood Retail District in Atlanta is an interesting combination of retail types.
Brett K. Bannor
Executive Summary
The Edgewood Retail District in Atlanta, Georgia, is a mixed use urban development that includes retail, commercial, and residential space. Developed in 2005, Edgewood combines aspects of both a power center and a lifestyle center. In spite of the shaky economy, Edgewood has been a strikingly success. Occupancy stands at over 99 percent, and several of the chain retail stores exceed any other units in Georgia in volume of sales. When the project was announced there was significant local opposition, but through a series of community meetings and negotiations between the developer and the neighbors, tension was minimized.

Two Decades of Design and Development

Evolution and change in American urbanism and architecture.
Witold Rybczynski
Executive Summary

The author reviews changes in the world of urbanism and architecture over the last two decades. Some of these changes are substantial and lasting, others driven by fads and fashions will likely be of short duration, but all have altered the environment in which the real estate industry operates. Urban design has been greatly affected by the new urbanist movement. Developers today play a central role in large urban projects. Mixed-use developments are touted as a universal solution but since they are more complicated to design, build, and manage than traditional shopping malls, they require a special skill set on the part of the developer. The challenges for the future include not only developing successful models of mixed-use, but also increasing housing density, both in urban centers and especially in the suburbs.

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