C&I 2016 Meeting Report: Are we ripe for disruption?
(For a print version of this report, click here.)
“The sources of our capital and the desires of capital are changing,” stated Gunnar Branson, President of NAREIM as the meeting began last December.” Crowd funding, electronic syndications, continued separate accounts, venture capital and strong investments from global investors are impacting investment managers’ capital raising, reporting and operations. “We need to understand that, not only are the investors changing but the channels through which we receive capital and the ways we communicate with those investors are changing. Investors demand more and investment managers have no choice but to respond.”
Challenging everyone still further, the economy in the final years of an unusual recovery presents an abundance of uncertainty. How can investment managers best rise to the challenges of a transformed process and a transforming economy?
What should we be worried about?
“How many financial scares have we had since the GFC?” Asked Doug Herzbrun, Global Head of Research for CBRE Global Investors. “There has been the European debt crisis, Brexit, fears about hard landings in China, the downgrading of US sovereign debt, the oil meltdown. There have been a lot.” But have any of those significantly shifted state of the US economy? “Absolutely not. The US economy has been incredibly resilient.” There seems to be just enough growth to keep everything moving in the right direction, but not so much that it significantly shifts capitalization rates or inflation. The recent presidential election, however was a fairly major shock to the system. “Can this end the recovery?” It’s impossible to tell, but it’s also possible that this anemic period of expansion could extend beyond any previous recovery because “the market hasn’t been exhibiting any excessive behavior that tends to lead to a downturn.” However, it is still unclear whether the new administration will have a positive or negative effect on commercial real estate.
The new administration may represent the most impactful variable this year, but what about beyond 2017? “There are some longer term trends to consider such as: The way companies use office space, the continued expansion of the “sharing economy” and its negative pull on demand and the retail and logistics impact of continued eCommerce growth.” And there are more disruptors on the horizon, “You can’t look at a newspaper without seeing an article on autonomous vehicles or the automated manufacturing revolution. The intersection of 3D printing, robotics, and artificial intelligence could make the changes we have experienced over the last few years seem like nothing,” said Herzbrun.
Despite the threats to individual businesses and jobs, in aggregate the signals are very positive for continued growth. “Every time there is a whiff of inflation the market has a little tantrum, but the economy is generally up across the board. Consumer confidence is at a 9 year high,” said Herzbrun. We are almost at pre-recession levels. But there is a bit of a disconnect between the market and business confidence. “Some of this is due to the fact that the one thing that has really gone up since the election is uncertainty. CEO’s now live in fear of waking up to a little tweet in the night.” The consensus in the near term is cautiously optimistic. “The republicans are going to work as quickly as possible to show that they can create better growth for the economy than 8 years of Obama.” That means cutting taxes and regulation, stripping bloat from the system in seemingly shocking ways, increasing defense and infrastructure spending, and repatriating capital. “All of which should create a rise in the stock market.” But tax cuts at this point would also likely create a sort of economic sugar high. “The last time we saw that kind of market fervor was 2006 and we know how that ended.”
What are LP’s looking for now?
“Two major challenges in the marketplace are high asset prices and fierce competition,” commented Geoff Regnery, Principal at Harrison St. “So what gets LP’s excited?” Is there an asset class or strategy that is performing better at the moment?
“Smaller is better,” replied Peter Braffman, Managing Director at GCM Grosvenor, “We are a middle market investor. If you look at capitalization rates on larger deals, over $75 million, the average is around 5.2%. If you look at middle market, $50 million or less, you’re closer to 6.7%. Our portfolio is averaging at 7.2%.” Everyone is carving out their own niche, “no matter if it’s a bigger or smaller deal, there is always a way to find something interesting.”
“That’s exactly how we look at it,” agreed Mike Moran, Managing Director at Allstate. “We particularly like class B multi-family. But it’s idiosyncratic; sometimes you go into a market where a local operator has a unique deal with a low basis and great growth potential. That’s a story we can get behind. We prefer to invest with friends but if there is a fantastic opportunity we are always looking for it.”
“There is nothing that makes me go ‘wow, we have to get into that tomorrow,’” commented Brian Boyer, Director of Equities for Wespath. “Most of our vehicles have been through co-mingled funds and we haven’t done much with separate accounts. However, we have been trying to shift our model to doing more joint venture projects.” No matter the structure, LP’s continue to apply considerable pressure regarding fees and returns. Like everyone else, they demand more for less.
How will investment managers get paid?
With a crackdown on fees, increased costs of regulatory compliance, tightening yields, and LP demands, it’s hard to know precisely how to pay for the talent required. And yet, 2016 was a record year for compensation.
“It may mean more of a plateau than a downward trend,” explained Josh Anbil, Senior Managing Director at FPL associates. “The past few years have seen 3-4% wage increases which is not sustainable. Bonuses are seeing a wider variation within companies.” As of five or ten years ago the compensation structures were fairly formulaic. “The last few years, clearly everyone is not moving in the same direction or at the same pace.” A larger share of the money is going to the transactional people. “It is less of a standard sales commission and more of an executive bonus.”
At the same time, demand for capital continues to rise. According to Tim Kessler, Principal at FPL Associates, right now “there are 94 firms that have raised $56 Billion. There are 350 firms trying to raise $172 Billion. That’s roughly 3/1.” So for every dollar available there are roughly three people fighting for it. In 2007 that ratio was closer to 1/1.
Is there a future for radical data transparency in private commercial real estate investing?
What if an LP could, at any given moment, access the fund accounting information and drill down on each property’s data in real time? What if LP’s didn’t have to call managers to order special reports? What if they could access their data at any time, and organize it any way they needed to see it?
A few years go FedEx asked a similar question. Before implementing their package tracking system, the belief was that customers would not really know what to do with the information. “There was a fear that giving this information out was going to generate a whole lot more questions than answers,” according to John D’Angelo, Managing Director at RealFoundations. “In actuality the opposite happened.” Of course, shipping packages is much simpler than institutional investment but it illustrates a phenomenon that happens when implementing new systems: fear of blow-back.
LP’s tend to ask the same questions in different ways, over and over. And GP’s tend to try and answer those questions over and over in different ways as well. But if the same questions keep getting asked, were they ever really answered? “I think the bottom line is, something’s got to give,” says D’Angelo. The requests to fill out forms and questionnaires keeps increasing and every LP has their own template, which is maddening for GP’s. “They complain about fees, but filling out all these forms doesn’t lessen the workload.”
Radical transparency is a bold concept and something that will take time. I think to get there, we need to ask ourselves more basic questions like, “does the industry have the tools they need to do their job?” In it’s earliest day’s, the restaurant reservation booking tool wasn’t what we know it as today. If Opentable went to restaurants and said, give me all your available tables, the worst restaurants with the worst tables at the worst times would have participated. Instead, Opentable met the industry where the industry was. They took the reservation process out of notebooks and brought it online, as a result, they got widespread adoption. This is what the real estate industry needs. Not only does this create a better business process but it meets the ever changing and more demanding needs of investors. Investors want information and they want it to be accurate and timely. It is important to keep this in context when we think about “radical transparency” as a long-term goal, there are many shorter term tactical steps we can all take to be better at our jobs.
“Our industry still operates in Excel,” Says Sedloff, “which is a great tool for ad-hoc analysis but is not a system of record, yet that is how GP’s use it to track capital accounts and is often the true source data for transactions.” The non-real estate financial world has figured it out with up to the minute market reports and eventually someone will do the same with properties and funds.
John D’Angelo asked, “Would the ability to provide real time, instantly accessible data help to raise funds?” The answer is almost certainly yes. If we could get consultants and industry professionals to agree on some sort of standard form for data delivery across the board it would vastly lessen the workload, thereby allowing managers to charge lower fees. But that necessarily means there might be less work for people to do in general.
One member commented that, “There is very little real incentive to share all the data or to standardize it because there is job security in keeping that information.” Just like lawyers writing in legalese, sellers keeping their “market price” knowledge to themselves, or buyers keeping their top price a secret until necessary to disclose – private information gives one an edge. The less the customer understands, the more they need an advisor. But eventually, institutional investors will demand direct access to data, “it’s a question of when, not if,” posited D’Angelo. The first firms to adopt and sell data transparency as part of their service will have a distinct advantage.
Will new technology help investment managers? Will it challenge them?
Three presenters from the world of technology and venture capital spent some time with the group exploring how new developments may change the way investment management works.
Rajeev Ranade is the Founder of Source Central, a web platform that connects institutional GP’s with real estate and other real asset LP’s. Their system works to benefit both parties by giving access to comprehensive data – a significant change from more opaque and laborious process for capital aggregation now. “There are many pain points but change takes time in entrenched industries. There is a much simpler way to go about the process that a new generation is demanding. If people see a dramatically better, simpler, and more accurate way to share information – adaptation happens quickly. It took the media industry led than 10 years to completely transform in the face of relentless software, maybe real estate can too.” Could a better interaction platform for GP’s and LP’s transform commercial real estate that dramatically?
Zach Ware helped get Zappos off the ground and is now working with VTF Capital. They do early stage investing and are currently with ShopWithMe – a compelling bridge between on-line retailing and in person shopping that retail real estate companies like Macerich are using to re-imagine how to transform their existing malls. “The value of the supermall real estate industry is $1 Trillion plus and that industry is being reconfigured overnight. We need to rethink how this space performs. The storefront is becoming a showroom rather than a marketplace.” More and more, people enter a store and interact with it, but then go and buy the items they want online. “If we don’t figure out how to do this, shopping center REITs could collapse.” Ware and his team’s mission is to figure out the correct path to take to make sure that doesn’t happen. “I don’t believe that all that real estate is just going to evaporate and turn into parks.” It can and will succeed as retail, if real estate and retailers understand how to better serve the new internet enabled consumer.
Mike Latiner is President of Treehouse Investments. Treehouse is on a mission to revolutionize construction and they are making good headway. A current service that they are providing is drone camera footage of construction sites. Not only can this provide unprecedented vantage points to developers and investors without having to be on site, the drones can be programmed to detect anomalies and mistakes when they are made, not when they finally cause major problems. It can create 3D real time models of the buildings so that oversight and troubleshooting can occur from anywhere in the world. But they have a competitor: “Google is heavily investing in construction. They feel like if they can move the needle just a bit, that’s a big deal,” said Latiner. Drones are capable of a lot more than just taking video. “They are working on a way to have drones actually do the building, not just photograph it, and if they don’t figure it out someone else will. If you don’t think this way, you are kidding yourself.”
So Google wants to build buildings? We better step up our game quite a bit.
“We are most certainly in an unstable environment and the future is uncertain. However, it is clear that what we will be doing next year will probably not be the same as what we did last year,” said Gunnar Branson in his closing remarks. In this new landscape we will be forced to think harder and do more than we ever have before. The central task for business has always been: do more with less – but that isn’t getting any easier to do. “We all have pitfalls and habits that we fall into, and it’s always easier to assume the way we did something before will work again in the future. It won’t. It’s time now to take on the more difficult path of uncertainty and change, before someone else forces change upon us.”← L&C 2016 Meeting Report: What do we do now? Report: Survey re. Transaction Database →