The annual ULI McCoy Symposium on Real Estate Finance was held last week. As in prior years, the symposium was attended by a wide array of real estate industry participants including: public and private owners and developers; conventional and securitized lenders, institutional investors, investment bankers, real estate investment advisors and managers, economists, as well as the leadership of various real estate industry associations.
While titled “Adapting to a New Realty,” a more apt title could have been Antifragile: Things That Gain from Disorder, the title of the recently published book by Black Swan author Nassim Nicholas Taleb, as the majority of participants appeared to believe that 2013 would be a year more to their liking and better than 2012. One also had the sense that participants felt that their companies were well positioned to benefit from shocks as well as volatility.
Topline findings include the following:
- Participants were more optimistic about the future than in recent years.
- Record liquidity is available in the equity capital markets and the liquidity in the debt capital markets is not abundant, but at least sufficient.
- While interest rates remain at record lows, now is the time to begin planning for higher interest and capitalization rates, as well as the impact of potential inflation.
- Everyone is chasing yield; equity investors buying debt proves it.
- Some investors are becoming aggressive in their underwriting.
- Today’s uncertainties—the "fiscal cliff," The Euro-Zone, China’s economy—will be with us in one form or another for an extended period of time and we will have to learn to operate somewhere between uncertainty and extreme uncertainty.
As in prior years, the symposium was divided into a number of panels. Topics included: politics, economics, and real estate markets; equity real estate capital markets; debt real estate capital markets; and global real estate and real estate investors. As Chatham House rules (providing anonymity to speakers so as to encourage openness and the sharing of information) applied to the discussions, the following is a summary of the key findings and themes of the symposium.
Politics, Economics, and Real Estate Markets
- Economy is performing better than expected with job creation increasing.
- Real estate is benefitting from improving fundamentals combined with a 50 year low in new construction.
- Gross Domestic Product is projected to increase 2.0 percent in 2014 as the economy adds 2 million jobs.
- On a relative value basis, real estate remains the best horse in the glue factory.
- Global economic growth slowing with “uncertainties” (the Euro-zone, China’s economy, the Middle East) affecting corporate investment and spending.
- In regard to the fiscal cliff, the consensus was that a deal, but not a permanent solution would be reached; unfortunately, that was on Tuesday and the landscape has changed considerably since then.
- There is plenty of equity and debt available…for the “right” deal (not defined).
- Participants agreed that now is the time to borrow for as long a term as possible as interest rates and capitalization rates have no place to go but up.
- The improvement in the housing market is positively affecting consumer confidence.
Equity Real Estate Capital Markets
- While fundamentals are improving, and liquidity has reached record levels, the real estate industry remains forced to grind it out, waiting for clear signals that the general economy is improving.
- Participants do not (finally) expect to see a replay of the early 1990s when institutions and the government liquidated property acquired on a wholesale basis; this has proven to have been the correct decision as banks (for example) have achieved significantly higher recoveries levels than they would have had they participated in wholesale liquidation of properties.
- Core property is clearly “priced to perfection” with investors willing to accept record low rates of return (IRRs) as the price of entry into the market.
- Best bet: overwhelming majority of participants thought best risk-adjusted rates of return were in the value-added, mezzanine, preferred equity space.
- 20 percent remains unattainable for most investors; 15 percent a more realistic target.
- Participants noted “assumption creep”, “pro-forma” underwriting, and projected continued capitalization rate compression among some investors as evidence of a “desperation” to get money out.
- It was noted that while REITs remained strong competitors, driven by their low cost of capital, for core assets in the gateway markets, they could not compete with private equity in the secondary and tertiary markets or value-added space.
- Fundraising remains challenging for all private funds except those that are very large (and global in investment strategy) or are considered the local sharpshooter.
Debt Real Estate Capital Markets
- Cautious construction lenders
- Some recourse required
- 60% - 65% loan-to-value
- Spreads equal to 200 to 300 basis points
- Floors have disappeared (for the moment)
- Size remains an issue with most large loans syndicated
- Non-U.S. based banks not competitive; regional banks “aggressive” and “competitive”
- Not a good source for general purpose type of real estate loans
- Focus on transitional, value-added assets in mezzanine or preferred structures
- Low loan-to-value
- Highly competitive with focus on core property in gateway markets
- Recent tightening of spreads has allowed securitized lenders to compete with life companies for core assets in gateway markets
- CMBS are providing substantial liquidity for transactions outside the gateway markets
Global Real Estate and Global Investors
- At first, “everyone” decided their home market was overpriced; now, everyone seems content to stay home, and play defense
- U.S. remains a safe haven to international investors, a trend that is likely to continue
- Offshore investors will continue to focus primarily on core property in gateway markets, thereby putting a floor on property pricing
- FIRPTA regulations make it more difficult, but not impossible, for foreign investors to invest in the U.S.