More than 450 members and their guests attended the 2011 Zell/Lurie Spring Members’ Meeting on Wednesday and Thursday, April 27-28 at the Rittenhouse Hotel in Philadelphia.
It has become a tradition for Research Sponsors to gather for a round of golf before the meeting at the Merion Golf Club, hosted by the Center’s associate director, Asuka Nakahara. This year saw a great turnout of 12 Research Sponsors on a gorgeous day.
Wednesday night’s dinner program at the Rittenhouse was a celebration on two fronts: The evening recognized the Center’s 25th anniversary, presenting a video chronicling the Center’s history and significance. Approximately 50 former Executive Committee members and founding members of the Center were in the audience, recalling old times and networking. Research Sponsors and special guests had an opportunity to meet for cocktails and reunite with old friends at a private colloquium before dinner.
The evening also honored Peter Linneman with a video starring him and documenting his career and contributions as he retires from Wharton’s faculty. Joe Gyourko announced the formation of the Peter Linneman Real Estate Fund for Teaching, Research and Industry Outreach, “in recognition of Peter’s outstanding accomplishments in real estate education and his many contributions to the industry.” A number of industry leaders—including Dean Adler, Tracey Applebaum, the Count and Countess Arco, Albert Behler, John Bucksbaum, Michael Fascitelli, Lizanne Galbreath, Spencer Haber, Lewis Heafitz, Chaim Katzman, Christine Kwak, Eric Larson, Robert Lieber, Roy March, David O’Connor, Douglas Shorenstein, David Simon, Keith D. Stoltz, Alfred Taubman, and Sam Zell—have each pledged $25,000 to launch the fund. Learn more about this initiative.
Continuing the evening’s festivities, Gyourko bestowed lifetime achievement awards upon Linneman and former Wharton Dean Russ Palmer, citing their continued dedication to education and the real estate industry. Todd Sinai presented student awards to some of the University’s best and brightest students.
At the dinner, it was announced that Michael Fascitelli, President and CEO, Vornado Realty Trust, is stepping down after two terms as Center chairman. Gyourko expressed his sincere thanks and noted Fascitelli’s dedication and outstanding leadership. Gyourko presented Fascitelli with a commemorative book of photographs and other memories of his tenure. Robert Lieber, executive managing director of Island Capital Group is the board’s new chairman; the new vice chairman is Roy Hilton March, CEO of Eastdil Secured.
Opening Thursday’s meeting, the outgoing chairman of the Zell/Lurie Real Estate Center, Michael Fascitelli of Vornado Realty Trust, noted the size of the audience, and wondered if the large turnout was proof the market has returned.
The first panel, “What is in store for property markets and the economy?” also delved into that topic, setting the tone for the rest of the day. Jacques Gordon, Director of Investment Research at LaSalle Advisors, moderated the panel comprised of Wharton faculty.
Gordon began by reviewing Federal Reserve chairman Ben Bernanke’s first-ever press conference a few days earlier, including charts, graphs, and forecasts. The panelists agreed that QE2 has helped the economy, although panelist Jeremy Siegel, Russell E. Palmer Professor of Finance at Wharton felt the Fed was merely putting a hold on the situation.
Panelist Joseph Gyourko, the Center’s director and Martin Bucksbaum Professor of Real Estate, Finance, and Business and Public Policy, didn’t think the GDP will get much better than the 1.8 percent it was during the first quarter. In a year he predicts it may reach 2.5 to 3 percent, but it will be a “long slog.”
Gordon questioned panelist Peter Linneman, Albert Sussman Professor of Real Estate, Finance, Business and Public Policy about his prediction at last year’s Spring Meeting that the public was underestimating companies’ hiring abilities over the year, and asked him for his views on inflation for the coming year. “I don’t see how we’ll miss inflation… this is the most obvious inflationary situation we’ve seen in a long time,” Linneman answered, citing the rise in oil prices, apartment rents, and healthcare costs.
The panel members continued to discuss the cost of capital and what consumers are going to do. They agreed that there is global liquidity and money is available at good rates that investors should take advantage of, if possible. Real rates have gone down dramatically, according to Siegel, in part because of a growth slowdown and in part because of an increase of risk aversion causing people to flock to Treasuries.
“You should not underestimate the tremendous increase in risk aversion on the part of investors. The truth is people just want their money to be safe, regardless of low rates… they’ll tiptoe in once they are tired of getting nothing, and then actually losing when inflation goes up,” Siegel said.
Linneman added that private industry may have to carry the bulk of responsibility for new hiring because state and local governments have seen their budgets shrink, disallowing much new hiring. “Each area of the country has its own microdynamics, and the bounce-back will be faster in certain markets than in others.”
The panel agreed the recovery will vary by market, and that all will be constrained by employment numbers and the supply of rental units. In areas with plenty of supply and little demand, rents can’t be raised much, versus those areas where jobs are more plentiful and people are clamoring for apartments.
Discussion then centered on the rate of new MBAs who leave the United States, some to return to their home countries, even if employed by an American company. Emerging market economies are critical to the world economy, Siegel noted. Younger people in those markets will be the prime purchasers of the assets of retiring baby boomers, he said. And it was these emerging markets that bounced back the best from this global recession—the deepest in more than 50 years—in part because they were not as overleveraged as the United States.
Linneman added that as those countries’ capital markets become as safe as those in the United States, people there won’t need to bring their money to the United States for safe investments. “Suddenly, our office building or shopping mall does not look as enticing. This would reduce the flow to our assets… political, property, market… they’re all bundled.”
Gordon wondered if it’s a benefit or a curse that the United States is viewed historically as offering the least risky assets in times of turmoil. Gyourko felt it is both, given “how badly we’ve behaved economically… but the bond market will make us pay this liability eventually,” he added.
An audience member posed a question about the residential marketplace and why it is still in a recession, given the improvements in the stock market and the economy. Gyourko blamed it on the fact that the industry overbuilt single-family homes, glutting the market, and creating a supply “overhang.” In addition, there is still a fear of unemployment and people don’t want to make the capital expenditure, leading to a weak market for the new home and entry home market.
The second panel was moderated by Asuka Nakahara, associate director of the Center. The panelists were Andrew Farkas, chairman and CEO of Island Capital Group; Michelle Felman, a consultant to Vornado Realty Trust; John Pelusi, executive managing director at Holliday Fenoglio Fowler; and Dean S. Adler, CEO of Lubert-Adler Management. The topic was “Capital Markets—which way is up?”
When asked for an overview of today’s capital markets, Pelusi divided them into three distinct divisions. The first consists of a core asset in a core market, such as Los Angeles, New York City, or Washington, D.C. In those cities, pricing is back to levels seen in 2006 and 2007. “It’s frothy and aggressive, with a deep pool of investors. What a difference a year makes,” he said. The second type is within cities perceived to be distressed. And the third is a shopping center or office building in the Midwest, rust belt, or plains states, where it’s hard to find equity and lenders.
Farkas compared today’s situation to that of the mid- to late-1980s, when equity could be pulled up by working with lenders, when whole loans were held by institutions, and deals were being made. “Today it’s harder to find product, and the ability to take assets back and the strategies being used are also different today,” he said.
Adler reminded the group that major transactions do occur outside of the gateway cities and asked if anyone remembered the strategy of buying distressed property and refurbishing them. “I see value added business coming back… starting to see balance sheet lenders who will finance that for operating partners and entrepreneurs… we will see more transition there,” he predicted.
Felman was asked to comment on what the other panelists had said so far. She said Vornado is performing well in New York and Washington as the largest owner of both office and retail spaces there. It’s a good news/bad news situation, however, because, she said, “…everyone wants to be there, which causes competition and pricing pressure. You can’t just walk in through the front door anymore. You have to be creative in getting to the point where you think you can make some money. Dean’s point about repositioning is a good one. You need a variety of skill sets to make money in this business right now,” Felman added.
Felman also said that all investors have to worry about risk, no matter the market. Her suggestion to mitigate that risk is to look at great assets in great locations, don’t over-leverage, don’t have great expectations, but “buy a product you believe in and have the ability to create value.”
Nakahara then asked the panelists for their predictions: “There are a number of places where risks are individualized by asset class, property type, etc. and the overlay could dwarf economics of individual deals if interest rates blow out. Things have changed so quickly in real estate’s capital market. What do you think will happen by the end of the year?”
“People are starting to move out on the risk spectrum,” answered Pelusi. “Interest rates and cap rates will work until they don’t. They go down slowly and go up incredibly fast… you have to be on top of it.”
Farkas said there is not enough product or availability. “Everyone wants to buy large assets in better markets, but there is a dearth of product. If you can mark to market and fit new financing structure to deteriorated value to where it was before, so if you’re buying something that’s the right size and right interest rate, you’re good.”
Felman added that value-added product may be in secondary or tertiary markets, while Adler suggested a way around lack of buyers for hard-to-sell products in distressed markets might be to create a pool, of limited service hotels, for example.
The panelists then agreed that 2011 could be a good vintage year, and Adler added the question is, “How do I buy it, reposition it, and ride it up in next few years?” They also agreed that interest rates would be higher three years from now, and cap rates would as well. Only Felman felt cap rates would not be higher, and when asked to explain answered that she felt there were too many different scenarios to predict accurately.
The day’s keynote speaker was Ronnie C. Chan, chairman of Han Lung Properties, which invests and builds world-class commercial complexes in Hong Kong and major cities in mainland China. His company reported a 2010 net profit of $2.87 billion, U.S. In his introduction, Joe Gyourko said that Chan founded China’s counterpart to the Zell/Lurie Center and is a man who “works hard at reaching across cultures.”
Chan spoke on “The Future of China and Its Investment Risks.” “In the late 1800s and early 1900s, the United States was the best place to invest. It’s safe to say that the best economic opportunity in 21st century is China. We have 1.3 billion people in China… we’re large and moving fast. Ninety-five out of 100 investment opportunities in China are good, and real estate is one of the best,” Chan began.
China is experiencing a long period of relative prosperity and stability, making it the best time in 20 or 30 years to live there. Due to the fast-changing nature of the society, however, there is risk. Social unrest is real and can happen at any time. Political overlay is an important part of any business in China, and people can expect some difficulty related to all that growth.
Understanding Chinese culture is critical for any foreign investor. “The differences are humongous, and you need to understand them,” he said, adding that ignorance of China is profound in America.
Unable to project what China will be like in the next five years, in addition to how quickly the market is growing, provides ramifications and risks. Competition is stiff and regulations are not well developed, with a certain “backwardness” and rules that are constantly changing.
According to Chan, the major real estate “players” are those from Hong Kong who have local knowledge, with foreign developers being mostly ineffective. Residential properties are expensive because of high land costs, although their prices are cheap compared to Shanghai and New York City.
Hang Lung doesn’t invest in residential real estate, a decision made years ago because of government intervention and the amount of competition from large developers. “Taxes are high. Markets are volatile. The flour is more expensive than the bread it makes,” he said.
His strategy for accruing $5 billion to $6 billion in cash with zero debt is to “stay away whenever there is competition. The market is huge and there’s plenty of room for everyone.” So he builds high-end commercial properties with retail and hotels, if necessary. “Build the right product in the right place with the right management, and basically, no one can dislodge you.”
In reply to a question about whether the Chinese government will change its policy regarding pollution, Chan said that the Chinese government is more conscientious about environmental concerns than the U.S. government, although private citizens in this country are more conscientious. “China is undergoing the biggest urbanization mankind has ever seen,” he said, adding the country has to find a way to balance this huge growth in cities. He then explained that all his projects meet LEED standards, but reminded the group that the United States went through the same period of growth and improved environmental awareness that China is now going through.
After lunch, members of the third panel took a look at the topic: “Déjà vu all over again. Does real estate ever really learn?” The panel was moderated by Michael Fascitelli and panelists were J. Ronald Terwilliger, chairman emeritus of Trammell Crow Residential Company; Matthew J. Lustig, CEO of Lazard; and Richard Mack, Managing Partner of Area Property Partners.
The panel agreed that single-family detached housing is “bouncing along the bottom” with no rebound in sight. Several factors have played into the existing scenario, he said. Overbuilding was unprecedented, people who didn’t deserve mortgages were getting them anyway, and demand fell. He said residential real estate is “not doing its part… it’s weighing us down” and slowing down recovery.
In contrast, Mack commented on the multifamily market, which has rebounded and said it may be time to build, “but it’s just a matter of time before we ruin this market with overbuilding.”
Using a baseball analogy, Lustig agreed that the industry is well into recovery. “We’re about in the sixth inning, from a restructuring cycle point of view,” he said.
But Mack disagreed, saying he expected the market to “bump around” for a while when it comes to most product types. He thinks more volatility is coming into the system, and all the distress has yet to be digested. Lustig argued that the government is pushing large amounts of liquidity through the system, which is propping up all asset classes, allowing problems to be addressed faster.
Terwilliger reminded the audience that what really matters is supply and demand. Multifamily is rebounding because nothing much has been built for a couple of years, and some jobs are coming back, as is demand for that housing. Some markets are pretty healthy already, such as Denver and Washington, D.C., where land now is at about 2007 rates.
As for the debt markets, large loans for trophy properties with multiple lenders are difficult, but the markets are functioning to 70 percent of where they were, according to Lustig. “The bank market is strong for certain types of credit and borrowers,” he said. “For better markets, there are choices.”
The day’s final panel was titled “A conversation with Steve Ross, Steve Roth, and David Simon: The outlook for business, investing, and real estate,” and was moderated by Peter Linneman.
Linneman wondered how the three men-Stephen M. Ross, Chairman and CEO, The Related Companies; Steven Roth, Chairman of the Board, Vornado Realty Trust; and David Simon, Chairman and CEO, Simon Property Group-were doing, and how the consumer has come back. Simon said the tourism markets are “back strong, especially international.” The Midwest is “chugging along” and didn’t have the same ups and downs as the rest of the country. Northern California is strong; San Diego is pretty good; in Orange County, “residential is squishy;” and the Florida market is soft everywhere. Ross agreed with that assessment, quoting unemployment at 20 percent in Palm Beach County.
According to Roth, retail has gotten to be a dangerous, intellectually challenging industry. “America is grossly over-stored,” he said. “Competition between tenants is ferocious…”
Linneman wanted to know how the panelists are planning for increases in taxes and interest rates and the possibility of inflation or not. Simon said his company is anticipating higher rates and doing as much as possible on the refinance front. He complained about the increase in taxes for business like his, while Internet businesses get sales tax exemptions, which is having a huge impact on other retailers.
Roth said the “rules of the game are difficult to follow,” suggesting it’s important to try to act “counter-cyclically.” Then he quoted the amount of real estate taxes Vornado paid in New York City last year. “It was $260 million, more than twice what it was seven years ago… taxes are $25 to $28 per square foot in New York.”
Ross noted one of the biggest unknowns to affect real estate prices: taxes. “Look at the condition of state and local governments. Where are they going to get money? A lot will come from these taxes.” He said 33 percent to 35 percent of his firm’s gross income goes to real estate taxes. “Where is the money for the rest of things? Capital expenditures? How can you build anything new?”
The panel agreed that a passion for a challenge and their competitive natures are what keep them working. In the coming months and years, they will continue to use that passion to work for balance, growing business wisely and soundly, looking for opportunities for growth, learning how to make technologies work, and determining the best way to structure their businesses while dealing with a lot of unknowns that haven’t existed previously.
All members of the Center are invited to listen to audio of the panel sessions, view photos of the meeting and watch the dinner video presentations. For more information regarding access or for membership opportunities, please contact Ron Smith for more information.
The 2011 Fall Members’ Meeting (members only) will be on Penn’s campus on Wednesday, October 12, 2011.
Posted May 2011