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2008 Fall Members’ Meeting Summary

The annual Fall Members’ Meeting began this year with an elegant dinner for Research Sponsors and guests at The Rittenhouse Hotel the evening of Thursday, October 23, with Kathleen Hall Jamieson, Elizabeth Ware Packard Professor of Communication, and Walter and Leonore Annenberg Director of the Annenberg Public Policy Center, University of Pennsylvania, discussing “What the Rhetoric of the 2008 Campaign Reveals and Conceals.”

The following morning, Friday, October 24, members who enrolled in our Career Mentor Program joined their mentees for breakfast at The Inn at Penn. The mentorship program provides a unique opportunity for students to acquire insights from their mentor’s professional experience. The Zell/Lurie Real Estate Center expresses its sincere thanks to this year’s record number of members who have volunteered their time for a most worthwhile and much-appreciated program.

Joseph Gyourko, the Martin Bucksbaum Professor of Real Estate and director of the Zell/Lurie Real Estate Center, opened the meeting, welcoming more than 400 Center members, faculty and students, and presented his annual State of the Center report.

The first panel, “Commodity and Oil Prices: What Do They Mean for Real Estate?” moderated by Peter Linneman, concluded that the lessons taught by high oil prices will be stickier than the prices’ subsequent decline. In the retail sector, expect many empty storefronts, unless they are in top locations. According to Cynthia Cohen, president, Strategic Mindshare, a retail consulting firm, high gas prices were accompanied by a decline in the value of investments and many consumers reaching their credit limit. “They got used to driving less and they’re still driving less,” she said. “What they’re saving is going to pay down credit cards.” Preoccupation with the election drove down store traffic, but Christmas also promises to be poor.

Retailers ordered merchandise in which high fuel prices were imbedded, said Cohen, and will work hard to avoid discounting and maintain market share. But expect pre-Christmas bankruptcies and consolidations. David P. O’Connor, president, High Rise Capital Management, noted that little capital is being invested in retail. “Frugality will be chic for the next decade,” he said. “It is going to be a long row to hoe for retail.” Oil prices will be volatile, noted Robert Raymond, principal of the investment firm RR Advisors, and corporations remain hunkered down, reluctant to do deals and committed to the presumption of high oil prices. “Wal-Mart trucks are not allowed to go more than 55 mph,” he said. “Long-term, oil price volatility will mean shortages and higher prices by discouraging current exploration and drilling. Energy companies will proceed with projects to which they’re committed,” said Raymond, “otherwise, they’ll be cautious and so will investors.” Construction will also slow, said Colin Parkes, senior vice president of Bovis Lend Lease. Quoting prices is difficult because the cost of supplies is volatile and clients are waiting for prices to decline. “It’s also taking longer to get (materials),” he said. “Steel, piping and electrical manufacturers are behaving like car dealers-they’re not carrying inventory.” Speaking before the election, panelists predicted than an Obama victory would mean more federal construction projects. “Democrats’ philosophy is to use government projects to stimulate economy,” said Parkes. O’Connor predicted a modern version of the Depression-Era WPA. Cohen foresaw that an Obama victory might produce a short “euphoria” of consumer spending.

The Farash Distinguished Lecturer, Kenneth S. Rogoff, Harvard professor of economics, examined “Financial Crises and Bailouts: An International Historical Perspective.” Based on precedent and the political climate, he said, it is likely that there will be a re-regulation of the financial services industry. His concern was that the federal government may go overboard. “The financial system needed reining in,” said Rogoff. “If you look at its share of corporate profits—30 percent—it was not sustainable.” At the Harvard Business School, he added, 42 percent of 2007 graduates went into the financial sector-investment banking, hedge funds and private equity. “That’s a lot of human capital and resources and it needed to shrink.” Yet he sees intervention as essentially negative, noting that FDR’s New Deal may have prolonged the Great Depression. “It wasn’t over even by 1940,” said Rogoff. This time around, intervention could produce another “slow decade” like the 1970s or the one Japan experienced after its government intervened in its economy in the 1990s. Left alone, the economy would probably right itself in about two years. “A plain vanilla recession rarely goes over a year,” said Rogoff. “A recession accompanied by a credit crisis lasts longer.” In retrospect, the crisis could have been averted. Fannie Mae and Freddie Mac were too large and mismanaged. The Federal Reserve pursued an “ultra soft money” policy. And the Bush administration denied the problem. “It would have been better for the government to buy up some debt earlier,” said Rogoff. “By waiting, we let this downturn turn into a bank panic.” On the other hand, he acknowledged, if the administration had requested a trillion dollars in early 2008 to solve the problem, it would likely have been laughed at.

In “Challenges and Opportunities in the Problem Sectors in Real Estate: Where Do We Go from Here?,” moderated by Asuka Nakahara, panelists described a market disaster of “epic proportions” that also presents opportunities. Now, said Jeffrey M. Gault, CEO of Landcap Partners, the real estate sector “is in complete chaos, and that’s where the opportunities are. As soon as sellers can tidy it up, then prices will stabilize and increase.”

According to Gault, now—in the middle of panic and many unknowns—is when sellers are most likely to sell cheap. Which, of course, means opportunity for buyers. “You have to buy it cheap, like less than half of today’s value,” he said, “and probably keep it for a couple of years.” Specific opportunities will be “situational,” said Stephen G. Haggerty, president of Global Hyatt Corp. “We see the best opportunities in markets where there are high barriers to entry.” Opportunities will feel risky, observed Cia Buckley, partner, Dune Capital Management. “The problem with waiting is that you lose feel for the market.” Conversely, said Buckley, whose firm was looking to buy, waiting until you’re comfortable will probably mean that recovery is on the way-and the best opportunities have escaped.

Resurrecting the market will require direct federal stimulus, according to Ara K. Hovnanian, president, Hovnanian Enterprises. Housing starts have fallen to an annual rate of 850,000, he noted. In 1975, when the nation experienced a six-quarter recession, housing starts fell to 1.1 million—in a much smaller economy—and triggered legislation that created tax credits and lowered interest rates. “In many markets, new homes are selling below the replacement cost of the bricks and the sticks,” said Hovnanian. “That’s not a correction—that’s dysfunction.” In retrospect, said panelists, mistakes that were ignored now seem obvious. “Everyone knew what they were doing,” said Buckley, who credited a business culture that forced even clear-eyed investors to act rashly. “If you didn’t jump into the game, the analysts would go crazy because your earnings weren’t as good as everyone else.” That said, Hovnanian discouraged excessive tightening of underwriting standards. “We need to get buyers off the sidelines,” he said.

In the final session, “Where Will the Capital Come From?” moderated by Joe Gyourko, panelists looked abroad because that’s where the liquidity is. “Over the past 18 months, everyone was looking at Asia,” said Ron Sturzenegger, group head, Banc of America Securities. “Now, they see the United States as distressed and want to get in on that.”

Sturzenegger reported hearing comparisons of San Francisco real estate with high rises in Singapore. “If you’re sitting on cash, you’re licking your chops,” said Jeffrey S. Quicksilver, managing principal, Walton Street Capital. “Yes, you have to be patient and careful, but there will be some terrific investment opportunities.” He said he is already seeing some owner “capitulation” on price.

For buyers, the good news is that the market for real estate space is strong. “This is not a supply-driven collapse,” said Quicksilver. “Demand will overtake supply and rents will increase.” Sturzenegger concurred: “Take residential real estate out of the market and Banc of America’s portfolio is performing really well,” he said. Spencer Haber, CEO of H/2 Capital Partners, described the real estate market as a patient “without a pulse,” which would not be revived without big changes. “The notion of separating underwriting from the person who has to live with the risk” will be one thing that changes, said Haber, who called for renewed attention to the concept of “moral hazard.”

Mike Fascitelli, president of Vornado Realty Trust and chairman of the Advisory Board of the Zell/Lurie Real Estate Center, closed the meeting by reminding members the Spring Members’ Meeting would be Tuesday and Wednesday, April 28-29, 2009 with guest speaker Fareed Zakaria.

Members: If you would like to listen to audio clips of the meeting, please contact Ron Smith.

Posted November 2008

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