Tuesday, December 15, 2009

Probitas Partners published an excellent white paper this week, "Real Estate Private Equity Fund Investing: Profound Changes for the Road Ahead." These are the primary trends they see:

• The real estate sector has not yet reached bottom and will not until perhaps late 2010 or early 2011, with capital markets “normalcy” returning perhaps by 2013.

• No new development will materialize in the foreseeable future.

• New acquisitions will occur at discounts to replacement cost, many at deep discounts depending on the physical condition of the assets and leasing.

• The downturn will be significantly deeper and worse than the 1980s/Resolution Trust Corporation (“RTC”) crisis; many fund sponsors will restructure or disappear. And like the RTC era, successful groups will persist and new groups will emerge, with some of the most successful teams taking full advantage of these market dislocations.

• Investors will return to an emphasis on fundamentals and a focus on operational expertise; initial strategies will include debt repurchases, asset rehabilitations, releasing, debt restructuring, acquisition of fund interests or general partnerships, etc.

• There will be attractive investment opportunities — in direct investments and secondaries —
but investors will need to focus on fundamental asset valuations and stable teams capable of executing on operational business plans to achieve the return potential, since this will take some time.

Another piece just published is in the current issue of "RICS Property World" magazine, Marc Louargand, of Saltash Partners writes in an article titled, "Are We There Yet?":

  • The outlook for the near term is not better.
  • We will again have a flat bottom for an extended period as we enter a period of mixed results.
  • It could take as many as five years to regain the jobs lost to date.
Falling Cap Rate Scenario or Rising Cap Rate Scenario?

"It will likely be both. Persistent high cap rates for a period of at least 12 to 24 months, followed by cap rates falling on a relative basis to Treasuries. The initial phase of recovery will see few if any jobs created, thus investors will lack confidence that they will be able to fill empty space in the short run so that they will rely on in-place revenue and be subject to reduced leverage opportunities. At some point, however, the massive liquidity created by stimulus packages around the world will escape the liquidity trap and inflation will come roaring back. Monetary policy response will lead to higher reference rates from central bank actions or from investor pricing....So, after a period of persistently high cap rates investors will come back into the market in sufficient volume to put downward pressure on cap rates and force them to price inflation into their expectations rather than into the cap rate."

This kind of stuff definitely gives us food for thought but as with all input, it's up to us to absorb, ponder, inquire and come to our own conclusions. For the past 18 months or so, a number of long-term real estate investors have just decided to sit on the sidelines rather than venture out in uncharted waters. My question is: Will the sea be any calmer or more predictable in 2010 than it has been and who really knows the answer?

From what I hear, debt is back, in a big way. But then again, competition for 'good' properties has heated up also. Hmmmm. Are we back to 'things as usual?' Not quite and maybe not for a long time. Don't forget that the key to income producing real estate is.....income. And the way it looks, it's getting harder and harder to keep properties fully leased (or even leased enough to generate any cash flow). I don't think anyone really knows how things are going to begin shaking out in 2010 but I'm hearing from too many institutional investors that they can see themselves pretty much sitting on the sidelines through 2010 and are talking about 2011 as being the year they get back into new allocations to real estate. Having said that I also believe that there's still a lot of investors who are unhappy with how the managers of commingled funds have handled themselves and are looking at that structure with very critical eyes going forward. It seems that there may be more interest from investors in club deals (where they feel they will have more say at the table aka more control) or one-off transactions.

We have all paid tolls to cross bridges or go through tunnels. It could take us from one part of a city to another, across state lines or from one country to another. Tolls (apologies to the infrastructure investment community) don't go down: they go up, sometimes, as New Jersey did with it's Garden State Parkway and Turnpike, dramatically. And, while sometimes we pay tolls to go to and from work or school, or on holiday, the fact is is that there is always a price to pay to get from here to there. But, "there" may be a new job, a girlfriend, a new home. Or it could be that we are taking the bridge or tunnel to get away from our past or a life that has changed for the worse. Taking flight does not always involve boarding an airplane and today, in the United States, there are a lot of people who have run or are ready to run to the nearest bridge and tunnel and hope that there's something better on the other side. Even in our industry, with all the talk about hoping that 2009 would end so that we can get cross that bridge to 2010 when things will be 'back to normal' is popular talk. But I am here to report (sounds official doesn't it) that things in the institutional real estate world have and are changing right before our very eyes. And the changes are not minor nor are they temporary (whatever that means). Some investment management firms will disappear. Others will merge. Investors will be much slower to come back to the game than we'd all like to think and when they do they will be talking a different talk than before. Sometimes tolls require small change and those tolls are easier for us to accept but others, perhaps most tolls, require big change and those tolls cause us to mutter, "Whathfok." But change is what life is about and we can either choose to change or be left out in the cold or left behind, choose your saying. Sometimes, in the day to day effort to grab the brass ring or even to meet the goals (some reasonable, others unreasonable) that have been established for us to achieve, we do not take time to step back to actually see what is going on. But some folks that I speak to are big picture people and when you combine that attribute with them having been around the industry for a while it's worth listening and learning from them because even though the bridge we're all crossing may look like a bridge we're familiar with, it's a lot different.

Last week I had a real treat. A joined a group of friends from Real Capital Analytics to go see "Memphis" on Broadway. Charlie Williams, son of Steve Williams of RCA is in the show. First of all, the show is really fun. But it was especially special to see Charlie, dancing, singing and simply having the time of his life on that stage in front of a sold-out house. The proudness and joy that his Dad felt was something we could all feel as well. Your son on Broadway: Priceless!

Lots of us say we'd like to write a book. One of our industry friends did just that. Craig Thomas, formerly of Torto Wheaton Research and currently with PNCBank has recently released, "Econosphere." I've read it and really like it. Here's a random comment on the book on Amazon: "As someone who has read his share of economics books, I can tell you that its seldom if ever you can find a book on the subject as well written and entertaining as the Econosphere. Even more rare is a book that can be enjoyed by professional economists and economic newbies alike, but this is it. Craig has a natural gift for explaining complex issues in a clear, concise and engaging manner. Well done!!!" A nice holiday gift (for yourself or someone else) can be found here.

Getaway find of the week: Vacation rental in San Diego (La Jolla), California (72 and sunny all year 'round). Owned by a friend. Very special. Check it out here.

Photo: Rockefeller Center Tree

These are my views and not that of my employer.

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