A&I 2017 Meeting Report: If the Rules Change, Can the Game Stay the Same?
“ The secret of change is to focus all of your energy, not on fighting the old, but on building the new.” – Socrates
Today’s investment management companies have some issues: The data is a mess, information doesn’t flow, and we tend to spend a lot of our time fixing stuff that happened in the past. A long time ago, way in the past, Socrates knew that the secret to change was in the focusing on the future, in building the new. So why aren’t we focused on that? Because we have no idea what is going to happen. That may have always been true but it feels especially true today. Things are feeling particularly uncomfortable right now but as Gunnar Branson put it in his introduction, “The challenge of life, is in learning how to get comfortable with being uncomfortable.” We are at a crossroads. “If we’re not feeling uncomfortable it means we’re not paying attention. It means we are making too many assumptions.” But maybe this is a good thing. Maybe the economy is about to teach us something. Maybe we’re about to learn more than we ever have before and that may be scary but it’s also exciting.
What is driving CRE right now?
“We are now eight years into the current expansion,” said Doug Herzbrun, Global Head of Research for CBRE Global Investors, “which doesn’t break any records in terms of length, but it does break some records for pace. It’s been incredibly anemic.” Employment growth has greatly outpaced GDP growth. Growth has been just good enough to generate demand for real estate product and moderate gains for ongoing investments, but not good enough to generate any real inflationary pressure. “The stock market is up roughly 12% since the global financial crisis. However, since our most recent election it’s up roughly 17%.” So, there is a glimmer of hope, it seems, that we may see some more aggressive growth than the past eight years. Proof that people believe the new administration may be able to make good on their promise of “better than Obama.”
“There is a lot of talk right now about the disconnect between hard data and soft data,” according to Herzbrun. Soft data is survey based. Mostly having to do with how people feel about the economy. “Consumer confidence indices are at the highest level they have been since the dot com boom.” That is a 16-year high. “Conversely, business confidence is down from just two years ago per the weekly Moody’s survey. Businesses hit a high in 2015 but since then profitability has been down.” “The first quarter of 2017 has seen a meager .7% GDP growth,” which is troubling. “This isn’t quite as bad as it seems because the first quarter of most years is the worst. Actually 60% of the time the first quarter exhibits the least growth.” Logically it should be 25% of the time by the law of averages. “The number that has been consistently positive is job growth.” Over 30 years old we are effectively 100% employed. “My worry is that we are going to run out of skilled people to employ because of the rhetoric around immigration.” The U.S. has always used immigration as an engine of growth.
If you are moving or improving your office space, “it is mostly to attract millennial’s.” It used to be unthinkable to move to midtown. Now companies are flocking to Hudson Yards which is some of the most expensive office per square foot. “If new construction is always at the top of the “most desirable” list, that is going to greatly accelerate obsolescence in current portfolios.” Older office buildings are now being converted into hotels and multi-family buildings because they are not desirable anymore. “Industrial is doing well largely because retail isn’t.” The growth of e-commerce means that warehouses and distribution centers are in high demand. “We at CBRE are expecting industrial to exhibit the most growth in the coming years.”
How is CRE accounting evolving?
“I remember the days before the personal computer,” reminisced Karen Gillen, Director at RealFoundations. “The days when the accountant was the personal computer. Then the personal computer allowed us to write purpose built programs to collect and deliver data more efficiently. But ever since the iPhone fell into our pockets there has been absolutely no patience for technology.” The accounting professional within commercial real estate has a massive job to do.
“In today’s economy, we need an accountant that is less an accountant and more a project manager,” commented Hillary Shine, Founder of Shine Associates. Because of automation the CFO spends very little time with ledger sheets these days. “We used to be 80% numbers and 20% strategy. It’s flipped completely these days.” There are a lot of CFOs coming out of operations and capital markets though they need to have a strong base in accounting of course. “We are also seeing a lot more people reporting to the CFO. IT and HR used to report to the CEO, not anymore.” Even JVs are reporting directly to the CFO much of the time.
“It’s very important that you work closely with your joint venture partners,” said Jim Strezewski, CFO of Blue Vista Capital Partners. “Be frank with them upfront and this will help form a lasting relationship of good data provision.” As we move to a greater concentration in institutional investors, there is a demand for greater transparency and more control, and therefore, some joint venture partners may decide to part ways. Another issue is that, “some investors are using indexes as benchmarks which they are not designed for. If you start basing compensation agreements on those indexes, you’re likely to run into problems.” A large institutional investor just announced that they are no longer using the NPI as a benchmark. “These days there’s so much data out there that you can use that data to prove out multiple perspectives. I’ve seen the same data set to prove and disprove the same point.”
Are people trying to steal our data?
Some firms in the financial sector spend $250 million on cyber security and IT. Our sector has never really had the same sense of urgency on the subject. But we should. There are more threat–actors out there than ever before and their toolsets are multiplying in ways we’ve never seen. It has been said, and proven, time and time again, that if you have not been hacked yet, just wait, you will be.
Building management systems are particular pain point and drive a lot of the cost associated with doing business. Many of these systems were put in place when the building they service was built and haven’t been upgraded in any comprehensive way since. The analog systems out there are actually beneficial because they are inherently resistant to a cyber-attack. The more recent systems that are vulnerable need updating and the costs can be significant. So how do we justify that expenditure? The Target debacle is often quoted in these instances. In addition, J.P. Morgan was hacked in late 2014, about 175,000 client names and associated information were compromised because one person’s credentials were stolen. Thankfully that information did not include account information.
The threat actors out there are more creative then we are. While our main focus is generating value and return on investment for investors, their main focus is finding vulnerabilities and our aging IT infrastructures and exploiting them. But why? Because there is money to be made. Last year there was a ransom-ware attack on a fairly high end pair of buildings in Finland. The building management company refused to pay and as a result the tenants were left without heat for two weeks in the middle of winter, in Finland. They eventually paid up. Another money-making venture is a basic wire transfer email scam. Threat-actors have been known to mask their email addresses as someone in the target company and from that email address request a wire transfer to support a transaction. This is known as “CEO emulation” and it is the most damaging form of cyber security today.
There are top floor and the bottom floor elements to the cyber threats. If two competing companies have designs on the same property, one might pay somebody to hack into the other’s system to get their valuations. That gives them a competitive advantage. This is known as “top floor.” The bottom floor category focuses mainly on building systems management vulnerabilities.
One of the best deterrents is basic training. We need to teach employees not to click on suspicious links in their emails. One bad link and the whole system is cracked wide open. And while phishing is the greatest single threat, many security breaches come from simple carelessness resulting in a physical loss of sensitive property.
Has the SEC changed their examination system?
Acknowledging what we’ve all known was the case for many years—that the vast majority of registered investment advisers can go several years without experiencing an SEC examination, the SEC has been shifting resources from its broker-dealer examination teams over to its investment adviser examination teams. This means that examination teams come in two flavors, according to Adam Kanter, Associate at Mayer Brown, “experienced investment adviser examiners who have spent the past several years since the Dodd-Frank Act steadily building up expertise in examining private equity fund advisers and real estate advisers and tend to know where the bodies are buried,” and exam teams that used to examine broker-dealers and often don’t know the first thing about CRE, and accordingly will need to be educated—by you—about your business.
On the subject of data, the SEC has shifted to be much more data focused now than they have been before. “They are looking for discrepancies in the data they find in their examinations and the data that you have submitted in the past—and not just data you’ve submitted to the SEC, but also any data floating out in the ether that the SEC can access.” There is also a “whistleblower” rule written into the Dodd-Frank Act. “They have essentially enacted a bounty program where a whistleblower will get a portion of the penalty exacted from the company if any wrongdoing is discovered.” That portion can be up to 30% which could be a fairly lucrative business if you were to become a repeat whistleblower. “If the SEC shows up unexpectedly? You will never know who brought them there.” It puts compliance consultants in a very suspicious position.
“In a perfect world, you would find the problem yourself or your compliance consultant would bring it to your attention,” says Kanter, “because if you can show that you have remedied the problem yourself that looks pretty good to the SEC.” Conversely, if you knew about the problem and didn’t rectify it, that looks worse.
How can we attract the best talent?
“The hiring process is really important because we have all experienced the results of bad hires,” says Angela Castellani, Senior Managing Director at Ferguson Partners. But how can we predict who will be good and who will be bad? “Nobody is perfect. Everyone brings some weaknesses to the table. The perfect candidate does not exist.” It’s more about finding a fit and finding that fit has a lot to do with how you interview people. “If you are a ‘fun’ company, your interview process should reflect that.” Interviewing outside the work environment can be a great way to disarm people. “A lot of what an interview is about for me is how I feel when I walk away.” Sure, we can get a lot of information about a person’s skill set, but what might be more important is how human they are. Emotional intelligence and someone’s ability to read the landscape is critical. “I like to look for positive disruptors; people who will come in with new ideas and ways of working without alienating themselves from the team and culture.”
“A problem I have run into is that a lot of people will take a job just to take a job,” added Josh Anbill, Senior Managing Director at FPL. He likes to utilize a test. “We give all prospective accountants a basic test. If they can’t pass it, they really shouldn’t be accountants.” How well someone can write is incredibly important to how well they organize their thoughts, and ultimately how successful they will be in their jobs. “We use the same test for everyone so we can look at an employee’s performance and then go back and see how they did on their test.” It may be an old-fashioned tactic, but it’s effective. Just because it’s on their resume doesn’t mean a candidate actually possesses those skills. “Passion is something that no one puts on their resume, but it might be the most important trait on which to hire.”
Great companies are said to be “fully optimized entities,” operating at the highest and most complete level possible. To be a great employee, “we need to be fully optimized human beings,” said Gunnar Branson in his conclusion, “so it is no wonder that we want to hire fully optimized candidates. What are doing is not rocket science, but it is not without difficulty.” It requires detail management. Cyber Security and the SEC both demand extreme detail management. Every vulnerability needs to be checked to prevent a leak, and every disclosure needs to be comprehensive to mitigate the risk of a conflict of interest or any seemingly duplicitous action. And what’s worse is while we are dotting our i’s, crossing our t’s, and focusing so much on the unintended loose ends, we are constantly pushed to take greater risks. To push on into that great unknown. To focus on building our future on what might turn out to be sand.← A&P 2017 Meeting Report: Is Doing it Right…Enough? 20/20 Investor Summit Report: Walking into an Unknown →