In the future, successful real estate investors will have to look at the long-term outlook of the credit markets in addition to simply whether an investment can generate cash.
That was the prediction of Adam Metz, CEO of General Growth Properties (GGP), a real estate investment trust that is the second-largest owner of shopping malls in the country. Metz was among experts who spoke November 11 at the fourth annual Real Estate Conference, sponsored by the Chicago Booth Real Estate Alumni Group. The daylong conference included presentations from such real estate experts as Sam Chandan of Real Capital Analytics; Randy Mundt, president and CIO of Principal Real Estate Investors; Ken Riggs ’94, CEO of Real Estate Research Corporation; and Neil Bluhm, founder of Walton Street Capital. Steven Kaplan, Neubauer Family Professor of Finance and Entrepreneurship, spoke about the performance of private equity and its relationship to private real estate.
Metz spoke two days after his company emerged from Chapter 11 bankruptcy protection, the result of not being able to refinance the company’s debt in 2009 despite strong revenue from its 150-plus properties.
“People are good at underwriting cash flows. What people didn’t underwrite is the lending part — the downside of the credit markets, which could be huge,” Metz said. “You need to figure out what margin of safety you need. You need to underwrite a margin of safety, I think, that is pretty big.”
Moderator Joseph Pagliari, Jr., clinical professor of real estate, said GGP’s emergence from bankruptcy set a market standard that would be important for years to come. The company restructured its hard-to-value assets into a separate division in order to keep valuation strong among its core properties. “I really admire what Adam and his team has done, taking GGP through a very difficult process. I think it has changed the real estate market landscape in marked ways; I don’t want to say forever, but for a long time.”
Stories like GGP’s emergence from bankruptcy are a positive sign for a real estate market that seems to be growing stronger after the global economic crisis of 2008. “We’re back at 2005 prices,” said Michael Kirby, ’85, chairman and director of research for Green Street Advisors. “We still think real estate is cheap relative to bonds. The next move is probably up again. Unlevered real estate will deliver a return of, call it, 7.5% today. That’s still pretty attractive, relative to the ultra-low bond environment.”
“What’s clearly happened over the past 12 months is a rush to what we call core real estate, which is well-leased, has lots of term and credit, and, for many people, has become a substitute for fixed-income or bond investments,” said Stephen Livaditis, senior managing director of Eastdil Secured. “We’re also seeing a lot of money coming into real estate as a substitute for other investments.”
However, Livaditis said, the growth “drops off pretty big for anything outside of core.” “Nobody wants to take a risk on these value-added investments,” he said. Also, while deal terms and return expectations have returned to 2005 levels (with top-line income on most investments dropping significantly), lenders are requiring more equity before dispensing loans. Kim Redding, CEO and CIO of Brookfield Investment Management, concurred.
The panelists debated whether real estate investment trusts (REITs) have more volatility than typical private real estate funds. Kirby said he preferred the REIT structure because of the governance that a public market brings along. But Pagliari cautioned that the public markets could bring with it some fluctuation. “You also have to acknowledge there are public market influences on price, which allows price to go up and down more than in the private market.”
Metz disagreed, saying that both private investors and public funds price their investments based on risk. “It’s the same investment; it should be the same risk.”
At the end of the day, Kirby mentioned, it shouldn’t matter to savvy investors. “Who cares?” Kirby asked. “Any investor should think about their investments on a 5- or 10-year time frame, and then volatility goes away.”
The conference concluded with a consultants panel, moderated by Nat Marrs, ’04, and partner at Kirkland & Ellis, that included Bill Foster, managing director at Courtland Partners, Ltd.; Tony Frammartino, principal at the Townsend Group; John Parsons, managing director at MacGregor Associates; and Cate Polleys, principal at Ennis Knupp.