Where's the Money Going in the Real Estate Market?

More than $40 million in institutional money is waiting for the right moment to begin investing in real estate bargains, said Joseph Pagliari Jr., clinical professor of real estate. “Part of what’s going on in the marketplace is that the big accomplished players are raising money, whether or not they’ve had some big gaffs in their portfolios,” Pagliari said.

In the last half of 2008 and during the first 10 months of 2009, publicly traded real estate trusts have raised about $30 billion in new equity and $10 billion in senior debt capital, said Pagliari, who moderated a panel during the third annual Real Estate Conference presented by the Real Estate Alumni Group at Gleacher Center on November 4-5.

“Admittedly, some – maybe half – of this equity is going to recapitalized over-leveraged balance sheets,” he said. “But the other half represents money presumably available for this buying opportunity that we’re about to experience.”

Meanwhile, for the first 10 months of 2009, the top 10 funds investing in private real estate equity have raised or are in the process of raising $16 billion, Pagliari said. “This is for opportunistic, value-added, and distressed debt deals,” he said.

In the third quarter of 2009, global sales volume for commercial real estate rose to $90 billion, up 40 percent from the second quarter and almost double the first quarter, said Dan Fasulo, managing director of Real Capital Analytics. “When we look back in a couple years, we’re going to see that the first quarter of 2009 was really the low point in the transaction cycle,” Fasulo said.

After rising for two straight years, Real Capital Analytics has finally recorded the first downtick in global capitalization rates, he said. “We might have called a global inflection point, but there is certainly a different story developing by mega-region,” Fasulo said. Among those regions, he said:

• Asia is very much displaying “V-shaped” recovery fueled in great part by $90 billion in property sales in China – half the global total this year. “They had a real stimulus,” Fasulo said. “When Bejing said lend, all the lenders actually lent.”

• Europe is showing more of a “U-shaped” recovery with cap rates falling in some Western European cities. “If you talked to anybody in London or Paris, they will have confirmed that for you,” he said.

• The Americas, dominated by the U.S., are experienced somewhat of an “L-shaped” recovery. “Unlike in other regions, we definitely haven’t seen cap rates fall yet in the U.S.,” Fasulo said.

Opportunity funds are currently addressing the market in three different approaches, said Brian Newman, ’00, managing principal, Ceres Real Estate Partners, LLC:

• Get portfolios under control and keep limited partners happy. “It’s not a question of what the returns are, but a question of what they’re existing portfolio looks like,” Newman said.

• Move up return targets substantially. “Even though rebalancing is going on, many LPs (limited partners) still feel over-weighted to real estate or, more importantly, don’t have the liquidity to make fresh capital currents,” he said.

• Hold returns at 18 to 22 percent, but underwrite very conservatively. “This is an IRR of 20 that doesn’t require growth in the economy, lets employment fall, and lets governments raise real estate taxes,” Newman said.

Whether or not the commercial mortgage-based securities market is broken depends on how you define the market, said Kent Born, ’91, senior managing director of PPM America, Inc. “I couldn’t disagree more with the idea that the CMBS structure is broken or that it is a failed experiment,” Born said. “The spread volatility we’ve experienced in the CMBS cycle in the past 12 months was technically driven by things largely unrelated to commercial real estate.”

However, these structures will be tested soon, he said. “We’ve bumped along with limited loan delinquencies for a very long time, but now we’ve gone from 1 percent to about 4.5 percent 30-day-or-greater delinquencies,” Born said. “The primary market, where the new deals come from, is broken. We have not had a new issue CMBS for 16 months. But the secondary market has gone from death’s door about 12 months ago to quite vibrant. Super senior AAA spreads have tightened up to 800 basis points this year.”

Many recent newcomers to real estate investing made large amounts of money in structuring and pooling transactions, but knew very little about real estate, said Heather Goldman, ’99, partner at Brookfield Financial U.S., LLC. “They never really developed evolved underwriting, structuring, and strategic decision-making skills about an asset and real estate’s role in a portfolio,” Goldman said. “Much or most of the layoffs in financial services or real estate have come from the capital markets side. Many will not find there way back into the market, certainly not at a comparable compensation level.”

If they want to work in real estate investment, MBAs should carefully pick the right employers, she said. “I’m cautious to give anyone advice, but real estate is not going away,” Goldman said. “If there is a word to the wise, my advice would be to focus on the experience, the people you work with. There is a flight to quality in management. Underwrite who you’re talking to. It’s so much more critical than it was before. Pick good people first, and the rest will follow.”

                                                                                                                    — Phil Rockrohr

 Read about professor Kevin Murphy’s explanation of forces driving U.S. growth at the Real Estate Conference