New light on a cloudy market
The most disconcerting but pleasurable thing for any European attending the Winter Forum on Real Estate Opportunity and Private Fund Investing at Dana Point in California in January is the sunshine. Attending investors from the US opportunity sector, however, were more concerned with the metaphorical climate for real estate in the US and beyond – seeking rays of light in what has been a cloudy environment in the past year or so.
Dennis Yeskey, national director, real estate capital markets at Deloitte and Touche and chair of the event, started proceedings brightly, announcing the focus on opportunity funds where the returns are still “attractive” in what has become: “a preferred asset class for institutional investors”.
And opening the discussion with an evaluation of the current economic bedrock in the US for real estate investing, John Koza, principal at Koza & Co and chairman of PREA, the Pensions Real Estate Association, noted that there were signs of recovery in the US, albeit via an unfamiliar “jobless recovery” that would make for interesting times ahead, with real estate normally tending to prosper on the back of more usual job-oriented growth.
Koza then introduced a group of some of the premier dealmakers in the US opportunity sector, to flesh out how the market was shaping up.
Mark Halle, principal at Prudential Real Estate Investors, began by explaining why he believed it was a good time to invest.
“We appear to be at the bottom of the cycle, so things are looking up. On top of that we are seeing increased investment from plan sponsors, strong cap flows and signs of recovery in the market.”
Halle also pointed out that flows into REITs had also been “interesting”, although he raised the question as to how much institutional money would “stick” with the asset class or flow out should equities start to recover strongly.
In terms of sectors, Halle said he saw potential going forward in offices, adding that now could also be the time to invest in hotels and lodging. The prospects for retail investments, however, were “not so good” he claimed.
In a talking point that was raised and discussed on numerous occasions throughout the conference, respected macro economic analyst, Charles Wu, managing director of Charlesbank Capital Partners in Boston, warned that inflation was the most perplexing prospect on the horizon for US real estate investment. Wu said there were clear signs to suggest the US economy was heating up and that the only way to “let off steam” would be through inflation.
Citing underlying economic similarities between the current US war on terror/homeland security concerns and those of Lyndon Johnson and Vietnam in the 1960s, Wu suggested that the US government was at “full tilt” and using all possible stimuli to boost the economy. “There have been 13 rate cuts in recent years. What does that say about the levels of credit and money greasing the system.”
Unlike the 1960s, however, Wu pointed out that the current US budget deficit when looked at on a per capita basis came out to around $2,000 per person: “five times what it was in the 1960s”
He also presented what he called some “remarkable” statistics to back his inflationary fears: “Oil prices stayed high after Iraq, while gold prices have grown 40% in four years. This suggests a pretty high inflation rate, which is good for real estate but not so good for bonds and equities. Is the US facing inflation and what does this mean?”
Russell Appel, president of the Praedium group, countered that he was less worried about inflation than he had been two years ago and was now looking to invest.
“I believe this year will be pretty strong and in an election year there will be increased monetary stimulus to the economy.”
Mike Happel, principal of Westbrook Partners, which invests real estate funds in the US, Europe and Asia, moved on to the subject of real estate pricing, noting that in the last couple of years the fundamentals for real estate had deteriorated to the point that it was difficult to see where the bottom of the market was; a quandary that he noted had been “particularly difficult” in the US.
To this end, he advocated a widening of the risk spectrum based on imaginative deal-making: “There are opportunities out there if you can increase your risk profile and be more creative. As an example, we made a bet on hotels and are now seeing signs of recovery there.”
Nonetheless, Happel stated that some of the pricing problems encountered in the US market had prompted the firm to focus more closely on overseas opportunities.
“In the US real estate fundamentals are starting to look good, but what is happening to the capital that is chasing these deals?
“By contrast in Europe, EU interest rates will rise and capital will be less aggressive, so we predict greater investment activity overseas, where it has been tough in the US.”
The audience grilled the managers on the kinds of returns that they were expecting in the opportunity arena. Significantly, most stated that they were still looking for returns in the high teens, early 20s, although almost all pointed out that it was not easy to get these kinds of returns today.
In another panel entitled: ‘Is this the time to buy?’ Kurt Roeloffs, managing director and head of Asian/American real estate opportunities at DB Real Estate, posed a searching question as to whether the US real estate market, particularly the office sector, would fundamentally change as a result of increased tertiary job outsourcing to countries like India.
He also raised the highly topical concern about currency implications, with the dollar at record lows against the euro.
“Does this mean there is an opportunity for European investors in North America due to the low levels of the dollar?”
The answer, he said, was yes, but more important was the fact that long-term average returns for investments were more than 200 basis points higher than in Europe. “Our German colleagues are actively looking for deals in the US.”
For US real estate managers, the Asia-Pacific region remains an opportunity play, although as Mark Grinis, managing partner of Ernst & Young Asia, explained on a panel entitled ‘Uncovering opportunities in Asia’ each market is “distinctly different depending on the product structure used”.
More specifically, he noted that China was a market arousing considerable levels of opportunity interest, which was not yet being translated into activity: “Investors are asking themselves what the prospects are in China but there is weak real interest at present. This is not a question of will, more an uncertain perception of asset valuations, laws on ownership and buyers perceptions.”
For the institutional investors (plan sponsors/insurance companies) speaking at the conference, a round-table event featuring US pension funds Calpers and Lacers (see page 34) gave the occasion to state what exactly they were looking for as capital providers to the industry.
Howard Fields, portfolio manager at insurer Allstate Investments, used the platform as a chance to remind real estate managers that institutions were looking to address the balance of returns: “We don’t like it when we lose money and you make money, or when you make a lot of money and we make a little. We like it when we make a lot of money and you make a little!”