Upcoming Speaking Appearances

Upcoming Speaking Appearances:

November 19, UW Madison Graaskamp Center for Real Estate

December 4, Distressed Real Estate Summit, Minneapolis MN

December 11, Distressed Real Estate Summit, Milwaukee WI

New Initiative

I am working on a new white paper "A Case for Real Estate in 2010". Looking for contributions - specifically fact related trends, charts, and indicators. Email me for more info.

Todd

Comments from Dealmakers: Opportunities

This is the final of six installments of my notes and comments from Institutional Real Estate, Inc.’s Dealmakers Summit (Sept. 14 – 16, 2009). This section describes some of the opportunities that will likely get traction over the coming quarters.

OPPORTUNITY IN CRISIS

Consensus is that this might be the best opportunity for buying real estate in our lifetimes. However, the early mover advantage this time is fraught with peril.

The economic downturn may have been caused by a credit crisis, but the collapse of credit created real problems for the economy and in turn for real estate. Not only are most deals gasping for capital like a fish out of water, now we are dealing with deteriorating fundamentals. In some cases it is a sharp decline. Therefore, it probably goes without saying, but current deals need to have a distress component to attract any capital at all.

As evidenced by the enormous amount of capital flowing into the public REIT space, however, capital will not sit on the sidelines forever and deal making should begin once investors feel values are at the bottom.

POTENTIALLY HOT SECTORS

Given that there is a consensus that there is a once in a lifetime buying opportunity forming, it makes sense to gear up, but there is no consensus on where opportunity will strike first. Given that multifamily has held up well, most people are viewing those buys as core. Given that retail was likely overbuilt in most markets, that sector is likely the most opportunistic. The other classes are likely somewhere in the middle and heavily dependent on where the economy starts to rebound first.

Sector – What to Watch

Retail – Consumer Spending

Office – Jobs

Multifamily – Housing

Industrial – Consumers and Inventories

It will not be uncommon to hear entrepreneurial investors state that their goal is to control as much real estate as possible through 2015; especially when coupling the idea of a buying opportunity with almost certain inflation on the horizon. Therefore, real estate professionals should stay positive – the future is likely bright.

The most confounding part of the next few years will be how difficult each and every deal will likely be. Buyers will likely be negotiating with several parties including the seller and the seller’s bank, but also lien holders, tenants, and other people with interests in the property. Deals are going to be messy – and those who are good at dealing with messes should get the lion’s share of the opportunities.

Because of this messiness, mezzanine and/or senior equity may be the best opportunity over the next 12 months. Given that there is a capital vacuum in most deals right now, a group could control a lot of real estate for a low investment.

WHAT TO DO NOW

It is time to get ready, time get your house in order and build relationships. There may not be a tidal wave of deals over the next few years, but there is strong consensus that volume will pick up from where we are at now. Your old relationships are not the ones you need in this new environment.

The best advice is to choose your opportunities and create a three to five year plan. One person at the conference commented: “If you are not at the table, then you are on the menu”

New Commercial Real Estate Website!!!

Real Estate Professionals - Look!

The newest commercial real estate website:

Real Invest 2.0

www.realinvest20.com

The site is still in Beta mode, please let me know your thoughts and comments. I am working with the creators to make it an extension of my linkedin group, Commercial Real Estate Professionals, which is now closing in on 10,000 members worldwide.

Todd

Comments from Dealmakers: Equity Outlook

This is the fifth of six installments of my notes and comments from Institutional Real Estate, Inc.’s Dealmakers Summit (Sept. 14 – 16, 2009). This section regards the state of commercial real estate equity.

INSTITUTIONAL EQUITY

Earlier in the year, Institutions’ investment allocations were out-of-whack. A quickly falling stock market made real estate appear over-allocated. Real estate values have subsequently dropped and equities have recovered. It appears as though allocations have been repaired and may now be in line for institutions to start investing in real estate again. Given that even the least savvy investors can infer that bond values will drop in the near to mid future (hard for treasuries to go below zero), then there would seem to be a case for allocating even more to real estate.

There is evidence of this happening – small pockets of pensions are announcing increased real estate initiatives. Nearly everyone, however, is targeting at least second quarter of 2010 (if not later) for getting serious about putting capital to work.

New equity funds will likely be smaller, with fewer investors for two reasons: Limited Partner issues (read: too many cooks in the kitchen) and scarcity of debt for really large deals. Although in my opinion, there is a play in buying all cash today and leveraging up with non-recourse financing when debt markets recover. Complex waterfalls are likely gone in favor of more simple (and investor-friendly) models.

Real estate historically produces strong, positive cash flow which will continue to make it attractive when compared to other investments, especially when combined with a potential for appreciation.

Institutional equity owns roughly $450 billion in real estate (give or take depending on whom you talk to). Of this, there is another estimated $45 billion of committed capital sitting on the sidelines as a leftover from the previous buying cycle.

Institutional trading capital (short term) is somewhat active, but long-term investor capital is still on the sidelines. There simply is no perception in the institutional community that tomorrow will be better than today. Until that changes, expect most of this equity to stay on the sidelines.

ENTREPRENEURIAL EQUITY

Although there were very few entrepreneurs at the conference the general perception was that this group would be first to act and will likely profit the most from this buying cycle.

In my experience, this is a uniquely challenging market for entrepreneurial real estate investors. Many of them are dependent on the debt market for at least a portion of their capital.

Compounding problems for the entrepreneurial crowd was their previous appetite for recourse loans during the previous cycle. Most of these buyers are dealing with workouts in their existing portfolio and are, at the very least, having to de-leverage properties with debt maturities. Deleveraging requires a great deal of capital which is difficult, if not impossible, to raise (can’t sell properties, can’t refi, and can’t attract outside investors).

I think that we’ll see only a handful of these investors active until the debt markets recover.

PUBLIC REITS

Public REITs have been the lone bright spot for real estate in 2009. Public REITs have had their best year of raising capital on follow-on offerings since REITs were first conceived. Through the second quarter, REITs have raised nearly $16 billion. It is generally understood that most of this capital will be used to repair balance sheets versus invest in new deals. However, once there is consensus that a REIT’s balance sheet is healthy, they will be given the green light by investors to start acquiring distressed deals.

What remains to be seen is whether this frothy equity market will carry over to IPOs. It certainly did in Starwood’s case, but their new REIT is a mortgage REIT. Other mortgage REITs are rumored to be in the works, but no one has been brave enough to launch a fresh property REIT.

PRIVATE REITS

Private REITs enjoyed a big run earlier in the decade. It remains to be seen when this will rebound. It would make sense that once public REIT IPOs start to come online, that there would be a spike in demand for private REITs.

The second quarter for private REITs were a stark contrast to public REITs. Private REITs (and LPs/LLC s) had one of their worst quarters on record. There are two major drivers for this, (1) the private REITs on the market had spent a year or more ‘on the shelf’ and thus they have real estate acquisitions from the last cycle (aka legacy assets) and (2) due diligence officers have spent the better part of 2009 clearing old unsold REITs off the shelf rather than adding new offerings. Those REITs from the 2007 / 2008 vintage that are still open have been heavily discounted, but that isn’t helping them sell.

Once the public REIT market looks sustainably healthy and B-D’s have cleared their bench, I think we will see this market spike similar to the public REIT market in the second quarter.

Comments from Dealmakers: Debt Outlook

This is the fourth of six installments of my notes and comments from Institutional Real Estate, Inc.’s Dealmakers Summit (Sept. 14 – 16, 2009). This section regards the state of commercial real estate lending.

COMPETITION

Supply and demand factors have a very large affect on the debt markets. During the last cycle, there was an enormous supply of debt capital and competition was fierce fueled in large part by the growth and abundance in the CMBS market. Today, not only has CMBS dried up, but the other more traditional sources of capital have problems of their own / and or have abundant opportunities outside of commercial real estate. Therefore, it should not be a surprise to anyone that supply of debt capital has all but disappeared.

In order for debt markets to return, competition on the capital side of the equation must first return.

SECURITIZATION

After listening to a number of experts, I think the question is when securitization gets resurrected versus if there is ever securitization again.

There are many positive arguments for loan securitization. Many in the public have a current perception that leverage is bad, however, we know leverage is not bad. It is simply a bifurcation of the risk and allows the most efficient use of capital. One presenter at the conference astutely pointed out that “the goal of any functioning financial system is to bring to bear the most efficient capital to the user.” Not only does debt itself do that, but to have a healthy securitization market, complete with tranching, further accomplishes that. So, while it is hard to say if tranching is gone, but there is a valid reason to have it.

Too much leverage comes as a result of out-of-whack perceptions of risk. For example, a first mortgage of 85% priced as though there is little to no risk, is clearly out of touch with the reality of economic and fundamental cycles. But if the 85% was tranched to different parties with an appropriate risk-reward distribution, then the same loan may make sense.

This brings up the notion that loan originators need to have skin in the game, that is, the should be required to keep the most risky first loss position. This would align the interests of the syndicating group with the investors. As a result, securitization may be very profitable, attracting more players back into the market.

There was also a great deal of speculation that securitization may be further solved by a regulatory ‘standardized blue-print’ for inter-creditor agreements and securitization agreement. Right now, owners of these pools have found themselves in a confusing environment with little or no documentation and lawsuits to unfold the mess will likely take the better part of a decade to work through.

At the end of the day, the argument can be made that securitization is good because it took an illiquid business (traditional lending model) and created a liquid market. The problem was that the industry, just like all fledgling industries had not run a full cycle yet. One commentator compared it to running a marathon. Where an individual who typically runs short distances who tries to run marathon, typically finds their weakness (bad knee, toe, etc.) over the long haul. Now that securitization has run a full cycle, many believe it can be fixed and come out stronger and better than before.

BANK LENDERS

The consensus is that banks need to earn their way out of their balance sheet stress. How long that will take varies greatly bank by bank. Many banks are in denial or simply haven’t devoted resources to deal with CRE yet, most are still focused on their residential real estate problems.

Again, the experts say, while banks appear to be better capitalized now than before, don’t look for them to be aggressively quoting loans until (a) they have cleaned up their own mess, (b) there is competition among lenders and (c) the fundamentals of commercial real estate rebound.

Comments from Dealmakers: Deal Flow

This is the third of six installments of my notes and comments from Institutional Real Estate, Inc.’s Dealmakers Summit (Sept. 14 – 16, 2009). This section regards the state of ‘deal flow’ for commercial real estate.

DEAL FLOW

It is no secret that deal flow is off more than any real estate professional would like. Many in the real estate industry are highly dependent on deal flow for their livelihood. We should not be shunned for this, in a functioning system we need dealmakers, we are the fabric of the system. I don’t know if most professionals have come to grips with just how much deal flow is off, however. Many experts at the conference calculated that deal flow is off 90% or more; some are saying 95%. Ouch.

The general perception is that real estate still hasn’t been squeezed enough. The ‘kick the can down the road’ mentality is prevalent right now. Therefore, most experts aren’t predicting the tsunami of deals in 2010 like some had hoped.

WHAT KIND OF DEALS ARE GETTING DONE?

The deals that are getting done have one of two components: either they are “orphaned assets” (missed CMBS pool) or they have a “capital vacuum” (deals that can’t be fully refinanced and where there is not enough equity). A common theme of the conference was that “distress sells best.” Which leads me to conclude that every viable deal probably has a distress component to it.

Because of the distress, more deals will be done with structure. That is, it likely won’t be just the seller and buyer at the closing table; rather you’ll see the existing lender, a mezzanine lender, senior equity and possibly subordinated equity to boot.

Also important to note, is that industry players are going to have a strong desire to keep their ‘lumps’ out of the public so most deals will be off-market.

This tells me that dealmakers need to: (1) make new relationships, the old ones aren’t going to be enough, (2) learn as much about structure as possible, and (3) figure out how to get off-market deal flow going.

EARLY INDICATORS

Banks are still in workout mode on commercial real estate as compared to foreclosure mode. Add to that the fact that some foreclosures can take up to two years at it may be a while. Most of the deal flow is residential right now. The FDIC is still dealing with $15 to $20 billion of distressed residential deals and there is likely more to come (CA arms to blow up in 2010). As a result, commercial deals appear to be on the backburner at banks and the FDIC right now.

Banks will, on the other hand, sell management intensive and high-risk properties, e.g. hospitality (management, liquor licenses, etc.). Syndicated bank loans will also be sold early because of a lack of consensus from various stakeholders. Most experts agree that the 4^th quarter will start to show more commercial real estate deals and it should start with syndicated loans and hospitality. But this won’t go away anytime soon, deal flow from lenders will continue for four to five years.

Consensus among the institutional investors is that entrepreneurial ultra-high-net-worth (UHNW) investors will be first actors and will likely make the most money.

A leading indicator to watch for is institutional investors buying core. They will start with core because it is cheap from a price per foot perspective and will only buy vacancy after the core opportunity dries up. Although logic would dictate that it should make sense to dollar-average into this market (i.e. no one is really capable of timing the bottom), we probably won’t see that materialize.

Therefore, if you are watching for early signs of a return to deal flow, watch the UHNW investors, the banks for selling hospitality and institutions starting to buy core assets.