Spring EO 2017 Meeting Report: How Can We Succeed in this Kind of Market?

Posted on August 30, 2017 in Viewpoints by admin

_L2A8289“ Never permit the pressure to exceed the pleasure.”
– Joe Madden, Chicago Cubs Manager

(for a print version, click here)

The goal set for the 2016 Chicago Cubs was almost impossible to meet: break a 108 year losing streak by facing down 29 highly competitive teams and win 162 times. But they did it – and each year baseball teams approach that same goal, and only one succeeds every year. Real estate investment managers are confronted with a similar task: face down incredible obstacles– and perform above average for investors. Fortunately, real estate investment managers don’t have to beat every other firm in order to be considered successful, but the pressure is tremendous – and just like the Chicago Cubs it’s important to keep that pressure from exceeding the “pleasure” of investing.

2017 is a year of incredible pressure. The market, interest rates, cap rates, politics, and regulations are in flux, the rules are changing and everyone must adapt process and strategy to thrive in the months and years ahead. Meanwhile, a growing pool of capital requires continued, predictable, and reliable yield even as markets tighten, cap rates compress, and good acquisitions seem scarce. How can anyone succeed in this kind of market? NAREIM members gathered at San Diego’s Rancho Bernardo Inn last Spring to discuss just that. This report includes just a few of their insights.

How should investment management approach industry consolidation?


Jeffrey Dohrmann“Consolidation has been going on for a very long time,” commented Geoffrey Dohrmann, President and CEO of Institutional Real Estate, Inc. “On the investor side, there is a pattern of expansion and contraction. When we are in a period of expansion, no one pays attention. It’s only when we hit a period of contraction that everything seems to change all at once. But this is just a natural pattern of life. We breath in, we breath out.” Larger companies have bigger staffs to manage their larger and more complex portfolios, but smaller companies, that have more potential for growth spurts, tend to be in a position of making more with less; less capital, less assets, and most importantly, less staff. “What tends to happen in these smaller companies is their portfolios out grow their managers. They can very quickly get out over their skis.” The obvious solution for investors is to streamline and really focus on the major positions so they can get control of their investments. “The current path of consolidation coming out of places like CalPERS is a natural outcome of the financial crisis 8 years ago.” Once they get everything under control, they will likely begin to expand again.

What if the time has come to merge or sell a firm? “There are a lot of options to create a liquidity event,” explained Dohrmann. “There are recapitalizations, leveraged buyouts, employee stock ownership programs (ESOP’s).” Not all options have to result in a traditional sale of one firm to another. “ESOPs are particularly interesting because they have a lot of tax advantages.” But they also may not give you the highest valuation. “But the important number is the after-tax number. You can’t look at it in a vacuum.” In addition, many clients look favorably on an ESOP because it transfers ownership within the company and technically isn’t considered to be a change of ownership. It also means that the firm doesn’t have to focus on managing the transition period nearly as much.

Whether a firm considers changing ownership or merging, Dohrmann pleaded that everyone never say the following to their clients: “Gee, I can’t believe how well the two cultures are coming together!” Managing a change process is, without question, “the most difficult thing you will ever have to deal with. No matter how similar two companies may look, you will never know how different they are until you go through this process.” Clients want the truth. Don’t spin it, don’t sugar coat it. Instead, it behooves everyone to tell them something like, “this is a challenging process, but we are working through it.” Never lie or hide challenges from investors…never.

How is the new political landscape impacting commercial real estate?

Chip RogersThe Trump administration has been difficult for anyone to predict in its first year. One of their stated intentions has been to change how the government operates. Transforming an operating model is difficult and unpredictable for any organization, and doing so in clear view of the world could only be more challenging. As congress, the courts, and other arms of the government begin to adjust to this new operating system, the rest of the world, including commercial real estate, is in a kind of holding pattern, waiting to find out just how this new government will change the economy, risk, and the “rules of the road” in the years to come.

“We have the beginnings of a new economic leadership team,” observed Chip Rodgers of The Real Estate Roundtable. “The new chairman of the banking committee, Mike Crapo from Idaho, is conservative but is great at reaching across the aisle – which is essential for getting anything passed in the Senate. Gary Cohn the director of the National Economic Council seems to be taking the economic lead for the Trump administration.” But apart from some very visible leadership positions, very few jobs are filled yet. “The third floor of the Treasury Department building is very thinly populated. It’s just empty office after empty office.” Filling those offices is a very slow process that is just beginning to take shape. But as those offices fill, the stated economic goals of the new administration will begin to be felt throughout the various parts of the government. “As this moves forward you’re going to see a lot of anti-regulation, reform minded people appointed to key leadership posts at The Treasury and key regulatory agencies like The Fed, The OCC, The FDIC and The SEC.”

The administration’s stated goal of generating 4% growth may be a stretch. The growth rate has gone from around 1.6% to .8% currently. “This is the slowest post-recession growth in post war history.” Theoretically, since Republicans are the majority in both branches there should be less resistance to GOP initiatives. “Not only do Republicans control both the House and the Senate, they also control 32 out of 50 state legislatures.” And yet, the Republicans are less than a united front on the specifics of economic governance. This dynamic means that the democrats have more influence than one might expect. For example, despite stated plans to repeal and reform Dodd-Frank, with the specific dynamics and priorities of different members of congress, “It’s going to be very hard to achieve a full-scale rollback of Dodd-Frank in the Senate.”

“As a self-proclaimed outsider with no political record, Trump came into the job with a minimal political network and organization.” Filling all the seats that need to be filled and effecting wholesale change is a tremendous task and “most regimes that come in have built themselves an apparatus beforehand.” The new administration is building a new government from scratch, and whether it’s congress, the judiciary, agencies, or any other branch of the federal and local governments, this alteration of the “operating system” will take time to come to full fruition as almost 22 million government workers alter the day-to-day details of regulations, priorities, and methodologies.

Long term, government change may appear to bode well for commercial real estate with a former real estate developer in the white house, but at present everyone is faced with an extreme amount of ambiguity. The operations of our government continue to be in transition and this is likely to continue for some time.

What is the economy doing?

Brian Bailey“We are 92 months into this cycle,” said Brian Bailey of the Atlanta FED. “The average recovery period is 60 months and the longest was 120.” That average takes into account the last 70+ years and many would argue that our economy does not really compare to the manufacturing economy of the pre-1970’s. “I tend to think that a comparison to the last 4 cycles may be more applicable where the average today is 94 Months.”

Consumers seem to be plateauing on spending. “Residential investment in the last three quarters show two down and one up.” Unemployment is nearing 2007 levels. Bailey argues that “in 2007 we were in a state of virtual full employment.” The numbers were not 0% but they never will be. “Under that rationale, we see that in 2007 unemployment was at 4.6% and today we are at 4.8%. We are arguably getting closer to a state of full employment again.”

Job growth, however, is a different story. At the county level in April of 2016, 540 out of 3,100 counties showed negative growth. “This was largely due to low energy prices. However, if we look at December of 2016 we start to see what I would call a contagion.” Counties showing negative job growth have grown to 37% and can no longer be attributed to oil. “The headline number still looks good but significant growth is only happening in localized areas. There are many areas of the country that are experiencing some substantial stress.” Auto loans are also an important area to consider, “one-third of people with auto loans were underwater on their old loan and rolled it over.” Delinquency in auto loan payments is way up and banks are offering auto finance products as long as 96 months.

“The longer we go on the cycle, the more risk we always see in the marketplace,” warned Bailey. As an example, “I was talking to some bankers who mentioned to me that the bank lending (in certain markets) is getting so competitive that they have been putting $250,000 unsecured additions on top of small commercial loans.” This is just one anecdote of more risky debt behavior than we have seen in the last 8 years. Correction is inevitable, but it is impossible to know when.

What is the current mood of investors?

Marc Reynard“As investors, the single most important skill set you need is the ability to gauge changes in the risk appetite of one another at any given time,” said Marc Reynard, Executive Vice Chair of Capital Markets at Cushman & Wakefield. “Those changes in risk appetite trump all other impacting forces on the market.” With stock markets and indices hitting record highs, “that’s generally a risk-on scenario.” However, the psychology in the market right now is one of not wanting to make a bad decision. “We sold the land under Cal Plaza One and Two at a 2.8 cap rate at the end of last year.” This is a very safe bet and arguably better than the 10-year treasury yield. “However, we’ve been marketing 38 acres on the Vegas Strip across from Mandalay Bay and I cannot give this property away. I’ve been begging people to insult me with an offer.” This shows that, even though we should be in a period of high risk bets, investors are feeling quite risk averse. “People are adopting a defensive stance. There is a transition away from Core because of concerns of short term supply to suburban/urban for higher rent growth.”

“The current buyers are what we refer to as ‘unicorn buyers,’” according to Reynard, “They are generally high net worth individuals or overseas buyers.” And they tend to hold on to what they buy just like a pension fund would. “Once a deal closes, you can expect that property to be off the market for a very very long time.” Asia represents about 44% of the incoming dollars, Canada is about 24%, Europe is 14%, and the Middle East around 9%. All this foreign investment is extending the cycle but, “there is some evidence that we may have already gone through a small recession in 2016.”

“Everybody is income growth oriented instead of cap rate compression focused right now,” said Reynard. As far as interest and cap rates are concerned, “everyone always asks me what impact interest rates will have on cap rates and it comes down to three things: what’s the magnitude of the increase, what’s the risk premium associated to real estate, and most importantly what are income growth patterns. But the most vital thing that has been documented as having a significant impact on commercial real estate is GDP growth. There is a direct correlation.” Trump has said that he will increase GDP to 4%. If that is possible, maybe there is room for growth in values in the coming years with some tax cuts.

How do things look to the institutional investors?

Jennifer Stephens“It’s all about political and financial uncertainty right now,” according to Jennifer Stevens, Principal at Townsend Group. “With Brexit, Trump, and the European elections coming up there is an obvious trend towards populism.” The IMF puts out a study called the global economic uncertainty index. “It surveys 19 developed economies and currently is at an all-time high. That is since 1987.” Buoyed by strong growth expectations, “we still think that the US will be the best choice for investments globally but just about every property type is priced at an all-time high.” That is creating some serious trepidation among investors and many are keeping as much liquidity or “dry-powder” as possible. “We aren’t doing many blind pooled investments funds these days for fear of getting caught in a correction. We don’t want to be locked up for 10 years.” Townsend, one of the most discerning firms around, is looking to, “buy into portfolios with pre-specified assets.” They are trying to come in a bit later rather than the being first money. As far as Europe is concerned, “there is no growth forecasted there so we feel we are in an overweight position.” They are also looking closely at industrial property in China but have yet to make a commitment.

Elizabeth Crisafi, CIO of San Diego City Employee’s Retirement Fund, finds herself in a similar positon. “Right now, we are involved in liquidating our separate accounts.” Many firms have invested heavily in separate accounts to gain control of assets. “We got to a place where we had over 50% of our real estate allocation in those funds.” This allowed a lot of small cap firms to become real players, “which we did not want.” Because prices seem to be maxed out, “we thought this was a good a good time to exit.” They are going toward more traditional core open ended funds and debt investments.


There is no question that the world – and therefore real estate investors – is facing a time of great uncertainty and change. Determining what will happen over the term of any investment made today has never been easy, however, even in times of relative stability. In many ways, that is the “pleasure” of real estate investing, and no matter how much pressure there is to succeed, this business can and should be tremendously interesting, challenging, and ultimately rewarding. Good luck, learn from mistakes, and as Joe Madden once said to Cubs infielder Javy Baez, “Try not to suck.”