2002 Fall Members’ Meeting Summary
This year’s Fall Members’ Meeting once again provided an extraordinary forum
for our members, faculty and students to share their expertise and discuss relevant
The Max M. Farash Real Estate Roundtable discussion took place at the Rittenhouse
Hotel on Tuesday evening, October 15th. Dr. Anthony M. Santomero, President
of the Federal Reserve Bank of Philadelphia
was the guest dinner speaker.
Prior to joining the Federal Reserve, Dr. Santomero spent 28 years in various
academic and managerial positions at the University of Pennsylvania’s Wharton
School and as a finance professor turned policymaker he was able to give a unique
perspective on the Federal Reserve and its role in the economy.
As a voting member of the Federal Reserve Open Market Committee Santomero explained
how the Fed interprets and responds to economic developments. He also addressed
the broader questions of monetary policy’s capabilities and limitations in today’s
complex and uncertain economic environment.
It was both an enlightening and inspirational evening. The Research Sponsors,
Executive Committee members, faculty and guests also took the opportunity to
commend the excellent dinner created especially for the Farash Roundtable by
Rittenhouse chef Jean-Marie Lacroix who was personally introduced by David Marshall.
The University of Pennsylvania’s Houston Hall was the venue for Wednesday’s
Fall Members’ Meeting. Members who enrolled in our Career Mentor Program started
the day early, meeting with students over breakfast. The real estate majors
who have been paired with industry leaders enjoyed this unique opportunity to
acquire insights gained from their Mentor’s professional experience. The Zell/Lurie
Real Estate Center would like to take this opportunity to express sincere thanks
to all members who have volunteered their time for this most worthwhile and
much appreciated program.
Following breakfast, over 280 people packed the Bodek Lounge to be welcomed
by Advisory Board Chair, John Bucksbaum, and to hear Center Director Joseph
Gyourko deliver the State of the Center address.
Wharton Real Estate Professor Peter Linneman moderated the first panel. “When
you walked in, did you think you’d hear about the Eisenhower years?” he
asked. That was just after they heard a speaker’s allusion to the former president’s
time in office. Other such insightful nuggets from industry veterans were liberally
sprinkled throughout the meeting. I think you have to look to the late 1950s
to find the same kind of markets, the same kind of spreads — the Eisenhower
years,” said William Mack, managing partner of Apollo Real Estate Advisors.
He was participating in a panel discussion entitled “What Does the Future
Hold for Real Estate Private Equity.” “We have a combination of 1973-74
and the Eisenhower years. We had a couple of mini recessions, very flat, slow
growth, very, very, very low interest rates, [and] some opportunities, but not
a huge boom. If we combine that with the stock market of 1973-74 in the downturn
— the Nixon era — we had the same distrust and we had the same questioning
about exactly who we are and what we are. We now see some of that same distrust
right now of all kinds of corporate earnings, including real estate.”
Mack spoke about the Eisenhower years as Linneman prodded his panel members
on the outlook for the real estate industry and the opportunities ahead. Painting
a picture of what’s in store for the industry was the theme of the Zell/Lurie
Real Estate Center’s Fall Meeting’s four panel discussions. These included “Are
House Prices Sustainable?: Implications for Investing in High Price Markets,”
“Real Estate in the Post-Bubble Economy: The Institutional Investor’s View,”
and “Does Good Design Pay and What Works.”
“Our goal is to provide thought leadership to the real estate community with cutting edge research and to facilitate a partnership between the industry and Wharton faculty and students,” said Joseph Gyourko, Bucksbaum Professor of Real Estate and Finance at The Wharton School, who opened the Meeting with a State of the Center address, to be fully reported in the next issue of our E-newsletter.
In putting together a panel for the discussion on the future for real estate private equity funds, Linneman chose three people to represent differing shades of investor behavior. While Mack represented a large but private real estate investment firm, Stuart Rothenberg represented Goldman, Sachs & Company, the huge, public investment banking firm. Neil Bluhm provided the perspective of a boutique investment house, JMB Realty Corporation.
Linneman noted that real estate private equity funds have matured over the past decade or so since the 12-14 years ago when they came into existence. “Prior to 1990, you had a giant LBO industry,” he said, adding that the equitization of real estate came in the 1990s, chiefly with the real estate investment trusts for low risk profiles and the private equity funds which equitized higher risk investments.
Real estate private equity funds have collectively raised some $110 billion since the early 1990s, according to Linneman. He estimates that another $14-15 billion is available “as dry powder — undrawn but committed equity”; that would translate into about $42 billion with a 2:1 debt:equity ratio, he added.
Linneman wanted to know what opportunities exist today for such money. “Leverage the hell out of your assets with very cheap debt, try to buy good assets,” said Bluhm, “because I don’t think we may have another opportunity like this.” Bluhm was discussing how the market components are teeing up. “Today you have some very distressed markets where you are starting to see a few opportunities, but nothing like what you saw in the early 1990s,” he said. “That’s because sellers and owners are very well capitalized, interest rates are low, and you are not seeing a flood of those transactions.” He added that in the 30 years he has been in this business, “I have never seen a situation where you could borrow money so cheap and get such a great cash flow even though the underlying rental markets are not strong.”
Mack had a dismal view of the road ahead. “If I look at the macroeconomic basis, I believe we will have sub par growth based upon not historical standards, but based upon what the economy should absorb, and can absorb, with the productivity levels we have today,” he said. “With the kind of productivity we have, I don’t think we are going to get out of this situation very fast because job growth will be rather anemic over the years. There will be some stress and there will be some opportunities…”
Mack said that “with judicious purchasing or redeveloping, you could probably get the high teens or 20%, but you are not going to get the 25% returns [as in earlier years].” He said that considering present yields and the cost of funds, investors would be well advised to lower their return targets by up between 300 and 500 basis points. And he felt these were “highly acceptable returns” compared to present inflation rates. His experience: “The spreads are about the same, and may be on a risk adjusted basis, if you look at the bottom when we made these investments, it might be even a little more favorable.”
Rothenberg noted it is difficult to spot opportunistic investments in today’s markets. “In hindsight, the opportunities in the early 1990s were clearly ones where we thought we were making the money in the purchase — it was all about buying right,” he recalled. Today, he is compelled to revise earnings expectations. “The Whitehall (a Goldman, Sachs fund) type returns of north of 20% are very few and far between,” he said. He said returns in the high teens are “still very acceptable, opportunistic type of returns,” involving mezzanine investing or selective asset classes that are not pure real estate development projects.
If the U.S. markets seemed to lose some appeal, windows of opportunity have sprung up in Europe. Mack said the U.K. is “somewhat of a mirror image” of the U.S., but he said he has seen “very stable, good business” in France, “okay” opportunities in Spain, the Netherlands and Belgium. He was particularly attracted to openings in the emerging central European countries such as the Czech Republic, Poland and Hungary. “Overall, although demand is a little weak, there is still a lot of money to be made because there continue to be divestitures by government, corporations and institutions,” he said. He also noted that many of these properties are typically undermanaged, “so there is room for improving management, improving the leasing, and making some money.”
Rothenberg is disappointed with the way opportunities have shaped up in Germany, but he sees “great opportunity in Italy and to a lesser extent in Spain; France has been very stable where we have been able to buy and sell.”
But Mack and Rothenberg didn’t have too much company. “It’s easier to lose money in Europe than in the U.S.,” said Bluhm, adding, ‘I don’t know if any of these guys have ever lost money there, but I have.” He said that although pension funds want to go there and there is a lot of real estate available for sale, the risk of the economy tanking is greater in Europe. He recalled a Barton Biggs’s comment: “Don’t bet against the U.S.” About present times, he said he’s “never seen the U.S. get clobbered for an extremely long period of time, unless you think it’s 1929 again.” He believes that when the global economy does start to turn around, the U.S. “will come back better than Europe.”
Bluhm felt the biggest opportunity around today was to refinance existing real estate assets. “If I owned an asset myself, I would refinance it,” he said. “But we promised our investors that we would sell, so we are selling and getting good prices.” He also felt it was a good time to buy real estate, “because rates are so cheap.” In addition, according to Mack, these are great times in the U.S. to sell stabilized properties, which typically mean buildings with quality tenants and long lease tenures, among other features.
That view was endorsed by several other participants at panel discussions throughout the day, including Martin Cohen, president of Cohen & Steers Capital Management, a leading manager of real estate securities portfolios and real estate mutual funds. “The office building market is really a tale of two cities,” said Cohen, who was on the panel that discussed real estate in the post-bubble economy. “If you have a property that has a reasonably diverse or strong tenancy with no expected or material rollover for the next five years, you’ve got a property that will sell for a cap rate that will make your head spin,” he said. “On the other hand if you’ve got a prime quality building with a lot of rollover risk and some questionable tenancies, you’ve got a serious marketing problem on your hands.”
The subject of the real estate market’s strength entered territory that was more speculative when participants spoke about the housing market. When Chris Mayer, a Wharton professor of real estate who moderated the session on home prices wanted to know how this cycle was different from others, he got a rash of data. “We had a 10-year expansion in the 1990s — the longest in American history, and the strength of that economy was hard to overestimate,” said Karl Case, founding partner of Case Shiller Weiss and a popular commentator on housing prices. “We pushed the unemployment rate down to 3.9%; we created 24 million jobs; the stock market went up $8.5 trillion. All the factors that favor expansion of demand were there.”
But in response to Mayer’s question about what makes the current cycle different,
Case said, “What’s unusual in the downside now is the enormous strength
of the housing market, in the face of the recession that started two years ago.”
He said that one of the obvious reasons was an expansionist monetary policy
with low interest rates. He noted that housing starts were strong in this year’s
second quarter at 1.6 million, while existing home sales this year have hit
an all-time record at 5.3 million.
Bruce Toll, co-founder and president of Toll Brothers, the country’s largest builder of luxury homes, said he has seen the downturns of 1979-81,1989-93 and others in his 35 years in the business. “This cycle is different, it’s been better,” he concluded. “Everybody keeps hollering bubble; we don’t have a bubble,” he said, pointing to reducing land availability throughout the U.S. and the constraints of securing building permits from municipalities.
“To have a bubble, you need two things, particularly in housing — one is inelastic supply and the other is bad information,” said Robert Van Order, chief international economist at Freddie Mac. “If something is elastic in supply, it’s going to be hard to bid the price up and get a bubble out of it.” As for “bad information,” he cited the experience with tech stocks or even the Tulip Mania in 19th century Holland where “people didn’t know how to project future income.”
Case said that while it is true “we’ve had an extraordinary period from 1995 till now” with housing values and investors have received returns of 30% of more, it was time for caution. “None of these things are sustainable over the next year or two; we are going to have a reduction in housing prices,” he predicted. Mayer, too, had worries on this front. “If the credit markets have made it so easy for people to own homes, what if there is a pullback in that?” he asked. “We could see the opposite problem.”
Toll said he did not give up on the housing markets easily. He believes that “housing markets go down regionally but they’ve always come back within a few years.” Van Order pointed to the $100 billion or more of equity that was taken out in cash last year by homeowners through refinancing. “Quite often, when people take equity out of their homes, it’s because they are in trouble, and they have some problem,” he said.
Case recalled “the only complete housing crash” he has seen — in Vancouver, Canada, during the 1979-81 recession. And he had an explanation for that. He said that unlike the U.S., Canada didn’t have fixed rate mortgages. In the 1979-81 recession, the San Francisco market didn’t see a huge lot of homes coming to market even as interest rates climbed because homeowners had locked themselves into 30-year fixed rate mortgages at low rates. But in Canada, “when the rates went up, they couldn’t afford the payments,” recalls Case.
In a concurrent breakout session, Asuka Nakahara, Associate Director of the
Zell/Lurie Real Estate Center
, moderated a panel that attempted to answer
the question “Does Good Design Pay and What Works?” Joe Denny of Liberty
Property Trust, Tom Farrell of TishmanSpeyer, MaryAnne Gilmartin, Forest City
Ratner, and Marilyn Jordan Taylor, Skidmore, Owings & Merrill, brought their considerable
and diverse expertise to bear in an interesting attempt to discern just what constitutes
good design, and how much buyers and tenants will pay for it. An interesting part
of the session was the give and take between the panelists and the enthusiastic
audience discussing how the concepts defining good design would probably change
Just after lunch, in an ‘off-the-record’ speech, the Honorable Laura S. Unger,
former members and Acting Chairman, Securities and Exchange Commission, and
the current Regulatory Expert for CNBC, delivered the Farash Distinguished Lecture.
She discussed the “Politics and Economics of the Current Crisis in Financial
The Fall Meeting’s attendees got a glimpse into the future in the final session of the day. Everybody wanted to know if real estate would draw more investments in times to come. “Real estate has been the best performing asset class for two years, maybe three,” said Bernard Winograd, CEO of Prudential Real Estate Investors, one of the largest institutional investors in the marketplace. “That has meant it has gained a new level of respect. But has not translated into a lot of cash, frankly,” he added.
Winograd said that what is holding back the hands of many institutional investors is the “denominator effect.” William Mack explained that succinctly in an earlier session. He recalled meeting somebody from an institutional investor who said his firm had raised its allocation for real estate from 8% to 10%. “But the stock market went down 20%, so we are at 11.3% in real estate, and [therefore] can’t invest [any more] in real estate,” Mack recalled the other person saying.
Even so, real estate has seen the entry of several new players in recent years, such as pension funds, especially corporate pension funds, according to Winograd. But he said “they are looking for a one-stop solution; a single fund they can invest in which is broadly diversified [in real estate].” Also, he said they don’t show a lot of appetite for risk. He compared the interest real estate is evoking among investors to the hedge fund industry, which according to him is being “swamped by capital.” He said that was because of the general “cultural bias” against investing in real estate. “Until the industry finds ways to make itself more congenial…the number of people who are going to participate in it is going to remain somewhat restricted,” he said.
Some movement is visible, and may be a pointer to a longer-term change of heart.
Marjorie Tsang, assistant deputy comptroller for real estate investments for
the New York State Common Fund, a big retirement fund, said that she is seeing
“a greater respect for real estate” and that a number of pension funds
are formally and informally increasing their real estate allocations.
Philip Ward, managing director of CIGNA Retirement and Investment Services, said foreign banks and foreign investment banks are the ones driving liquidity these days. But he’s worried when he sees the fundamentals getting worse and cap rates (a measure of income from a property to determine its market value) going down. “It makes me nervous that we will do what we did the last time with real estate (referring to the 1989-92 recession which saw massive overbuilding and distress sales by investors and landlords), which is to bring everybody in at the wrong point in time,” he said. “Two years later they’ll all be unhappy and they’ll go away for 10 more years.”
Serious problems persist. Winograd said liquidity problems dog acquisitions of large-scale properties because they are tied to terrorism insurance issues. “It’s very, very difficult to put together a deal of any size where the building has what we call ‘postcard risk’ — that is, they sell postcards with the property’s picture on it, which is not a good thing.” He said concentration is another issue they didn’t have to bother about till last year: investors these days are also studying how many buildings they have “within four blocks of each other.”
That said, it is true that lots of high net worth individuals want a piece of the action in real estate. As Winograd noted, foreign money, especially German, is crowding the industry; newer investors such as corporate pension funds have arrived; and, many existing institutional investors have increased their allocations.
If there is one message that rang out loud and clear that day, it was that real estate now has a rare opportunity to win a place in the hearts of investors. And its players must not squander this away, but treat it with care. Tsang, whose real estate allocations are now so low that the “four top stocks” in her Fund eclipse all its real estate holdings, says, “I can see how these board members who don’t have a history in real estate would be easily swayed once the rug is pulled out from under them, to say, ‘Here…real estate has done it again,’ and put it on ice for years.”
Tsang asked participants at the meeting to imagine what it would be like for a pension fund or corporate fund that has never been in real estate before. She said people like her make their case to their board members, projecting returns and the anticipated risks; her fear is when “two or three years later, you say it wasn’t there,” and faith is lost. “Credibility takes a long time to build up,” she told the audience. “It’s easy to damage. These are investors who’d so much more easily run back to the domestic markets. Because it’s easy; you pick up the phone and place the order for Microsoft [shares].”
Posted November 2002