Building the Firm of the Future
- Feb 10, 2011
Shekar Narasimhan on Real Estate, the Government and Finance
Beekman Advisors managing partner Shekar Narasimhan spoke with editor-in-chief Suzann D. Silverman about the real estate and real estate finance markets. An icon in commercial and multi-family real estate circles, Narasimhan has spent the past 30 years in the industry, working in nonprofits, property management and real estate development before moving into banking and the mortgage business. In December 1997, he took WMF Group public, selling it to Prudential Mortgage Capital Co. in 2000. In 2003, he started Beekman Advisors, which serves as a strategic advisor to real estate firms in the United States and a principal investor in India. For more on his views of government policy, click here.
Q. Given your industry experience, what lessons have you learned and how have you been applying them?
A. I’ve learned two lessons, and I think they both are relevant to today’s times. The first really is, if you’re in this business, expect the unexpected. Because (with) the things that you know, you can plan, you can measure, you can quantify and you can evaluate. It’s the things you don’t know and don’t expect that are actually either the best opportunities or the biggest pitfalls. And so it’s important to plan for what’s on the other side of the door that’s unseen, as opposed to what’s obvious and seen. And that distinguishes true leadership and vision from just operational excellence. That’s important in real estate today and real estate finance. And the second is something people don’t want to hear, and in real estate particularly because it’s entrepreneurial … which is that government policy affects everything.
Q. Among government initiatives, what do you agree with and what are you concerned about as it relates to real estate?
A. What had to be done was done with TARP. … Many years from now, when all the histrionics are over, people will gauge that it was both necessary to have done it when it was done, and then it was executed actually rather well in a crisis; and No. 2, that the net result was that it did save the system at the lowest possible cost that one can imagine. … The biggest negative is the government has introduced over the last several years a high degree of uncertainty—uncertainty about how you’re going to get taxed, how much intervention there’s going to be, which sectors of the economy, of the marketplace it will support or not support. The more uncertainty there is in the system about what government policy is going to look like, what tax policy is going to look like, where government intervention may or may not occur and to what degree, the less it is desirable for someone to make a long-term investment. And the difference between real estate generally as an asset class and most other asset classes is that we’re making pretty long-term commitments. …
I would argue that the support for the financial system, the conservatorship of the GSEs, the introduction of TARP, the stress testing of the banks, the getting the plumbing of the system right, the re-start of securitization—all of these are results of actions that, when we look back upon them in later days, we’ll say, “You know what? There was a cohesion here. Yeah, it might have been done by bootstraps. But at the end of the day people did what they were supposed to do, and our system actually worked.”
The flip side is that what happened during the period of extraordinary growth is there was excessive spending by everybody—the federal government, the state governments and the local governments. And you look at the budget deficits, and you start to wonder how could they have done that. That was pretty profligate. When you make money, you’re supposed to also save money. Nobody did. The federal government didn’t, state didn’t, local didn’t, the household didn’t, and most companies didn’t either, by the way. So we all participated in this period of extraordinary consumption for it looks like probably close to a decade and a half. And then it came back home to roost. …
I would suggest that the biggest thing we have to think about (regarding) policy and government in the future … is where is the job growth going to come from, in what sectors and what markets, and for what reason. … In real estate, we are heavily dependent upon the fact that there are jobs being created and workspace is needed and housing is needed. Otherwise, we don’t have work to do.
Q. What are the key characteristics of finance companies that have stood out in your work in recent years, and do you see any patterns emerging among the finance companies that you’ve been advising?
A. We went from essentially balance sheet only to a form of contingent balance sheet where I still needed a balance sheet but I could sell it. And this is the evolution of the Fannie Mae DUS program, for example, or bank loan participations or syndications or so on. I leveraged the balance sheet more—to securitization, which was essentially a way to sell off balance sheet, but in some cases with some residual risk, with some operating risk, with potentially, as we’ve learned, some buyback risk.
And now we’re sort of reverting back to a form in which you say you do need a balance sheet, but given the changes that are occurring in accounting rules and the world at large, how do we find capital players of different kinds to do one deal? … And then how do you aggregate this and do this? You’re going to need an extraordinarily interesting company that has capacity to hold some paper, to take some off-balance-sheet risk, and has capital market savvy to become the finance company of the future. And one of the most important things about that company is—and it will be a new hybrid—that it will have to have really strong risk management and control systems to be able to survive.
Q. Do you believe many companies will be able to achieve that model?
A. Sure. In the market as it is emerging, you have a private market and you have a public market. … The private market is most of the finance companies, most of the mortgage banking companies. You then have different kinds of capital in these companies. You have private equity, which has a particular focus. While many people in private equity say they are long-term thinkers and long-term planners and long-term doers, the fact is they all need an exit some day.
So that’s what I call … patient equity with a clear objective. And you have regulated capital, which is the market in which banks operate, and where to a large extent how much capital they have to hold and what they can pay in dividends is dictated by regulatory standards. And then you have people who have a balance sheet—a permanent balance sheet—and those who do not. So three broad characteristics. …
Personally, I’ve always felt that the best model would be one where you had a true mortgage banking company where you accessed multiple sources of capital for your clients, and those sources of capital both shifted and changed over time, but you also had an investment management model inside of it where you raised third-party capital that was discretionary and potentially proprietary and you could actually utilize that to benefit your clients by helping in enabling them to be more successful. … A number of people are trying it. I tried it 15 years ago. Large-balance-sheet companies try it; non-balance-sheet companies try it; regulated capital companies try it. But the entrepreneurial model with a source of stable capital and a limited balance sheet strikes me as the best one. Because if you have a real balance sheet and you can keep growing it, you tend to, in my view—just over time—become less disciplined. … What this kind of company needs, where it can both create capital and deliver it itself … is it has to have a culture of its own. It has to know and believe this is a good thing and that’s not a good thing. The discipline of knowing that and managing that, in an environment where growth is seen as the only sort of driver of value, is a very, very difficult thing.
All our systems—compensation systems, the kind of people we usually have working in these kinds of enterprises—are driven by growth—and often by growth of volume, of business, as opposed to just simply growth of profitability or recurring earnings. So to the extent that we have mismatched in real estate finance and not created these companies, it’s because we haven’t measured them properly. And so my biggest pitch to companies, and (where) … we might be able to help the most is trying to help them do strategic planning out of the box and giving them metrics to measure performance that might not be the logical things that they would look at, and saying how do you now build a rigorous financial model, a way to measure this so that you can actually start to export it and create a culture.
Q. Do you see some of the types of lenders that have historically been active, especially some that have dropped out, staying out for the long term rather than making these shifts?
A. I sold WMF Group in 2000 to Prudential. Starting then, for the next 10 years essentially, we had this evolution of entrepreneurial companies that became midsize and then sold to larger institutions. … Some of the entrepreneurs stayed and most didn’t. Now we have the reverse phenomenon, because we have this confluence of events going on … (a) combination of Dodd-Frank, Basel III, FASB 166 and 167 and the introduction of international financial reporting standards. … Any one of them alone could have been dramatic and somewhat Draconian. The combination of those is kind of a cocktail mix. If you take enough pills, unless you’re incredibly smart and have a general physician who knows this, you don’t know whether three of those neutralize the other two or create side effects for which you need a sixth. I feel like we’ve created an interesting cocktail mix, and I’m not sure there’s anyone out there that can fully tell you what the impact is and what the world is going to look like five years from now. Except, it’s pretty volatile out there. …
What kinds of businesses are these entities going to be in? How are they going to look? I think that what happens is, a lot of the parts that they might even have bought within the last 10 years start to go back into the private market. So I do see the pace of M&A quickening; I do see that there is going to be now another level of the private market that will be the “major market.” A number of things we’ve been involved with in the last two years point to this: that it’ll be larger capitalized, better capitalized private players in the commercial real estate finance business playing this role of both mortgage banker as well as investment manager, and in some cases finance companies with a balance sheet. …
Where do I think the vacuums might be? … A vacuum, as you know, by definition is a place that gets filled. So it’s (really), where are temporary vacuums? And one place that really worries me as I think about commercial real estate is construction lending. … The country has to have construction. … How is that sector going to come back? One of the things is, you’ll see in the FHA multi-family program, even though they’ve been very cautious, a big spurt in their construction lending and multi-family, because no one else is doing it.
Q. What’s your outlook for the coming real estate market?
A. I think we’re through the worst. And it’s probably partly because the crisis wasn’t really created by us. Obviously, we did overleverage real estate pretty heavily in ’06, ’07 and even ’08. And then the economy tanked, and then there were capital shortfalls and withdrawals. But now we have better-capitalized operators, the capital structures of the properties are much more rational and I think we’ve learned complexity is the enemy of the problem. … People will actually pay you more for a simplified structure than a complex structure, if they have a choice. So I do see, for the capitalized operators and with capital structures being more rational, lots of upside in commercial real estate. I do see capital re-entering; I do see a more robust market. But I gave you three caveats: How do you maintain discipline, who’s going to do construction loans, and how do we avoid having a seriously bifurcated market of haves and have-nots? We’ll muddle through this, and yes, the next generations of companies will address those vacuums and find creative strategies with discipline to employ.
And then the one other thing they’ll all do, which I think will be extremely helpful to the industry, is … people are going to do the right thing in investing in their own businesses in the future. And I therefore tend to be … not optimistic … just sort of cautious and positive.
I think there’s more information, more transparency, higher-quality people entering the business. In the 1990s, when we came out of the last downturn, we lost a whole generation of people who would have normally come into real estate and finance. So by the time you got into the 2000s, it was like building a bench. We have that bench today. It’s the strategic thinking and the thoughtful leadership that there hasn’t been enough of. And I strongly feel now that we have more of it than we’ve had in 25 years.
That’s why I tell you I’m cautious and positive. I do believe that all the indicators are right, and if the real estate industry would turn its sights with its leadership now to government policy and job growth and really thinking about the macro issues and how we can support those, I think we’ll be in pretty good shape for another 10 years. Before the next whatever.