Managing Risk After the Credit Crisis

Today more than ever, real estate investment is all about interpretation of risk.

Keynote speaker Jonathan Gray, of The Blackstone Group

Today more than ever, real estate investment is all about interpretation of risk. That was a strong message during IPD’s U.S. Real Estate Investment Forum, which took place on Thursday at the Grand Hyatt in New York City. The conference marked an unveiling of the new PREA/IPD U.S. Property Fund Index, really two indexes focusing on open-end funds and core diversified open-end funds.

“For us, it really starts and ends with the global credit crisis,” said keynote speaker Jonathan Gray, global head of real estate for The Blackstone Group, who launched the day-long event.

For consummate acquirer Blackstone, the crisis has created opportunity, in the true sense of the Chinese proverb. Gray listed a range of options, from the huge amount of distress in the market (with 40 percent of real estate debt in trouble) to equity assets trading at a discount to replacement cost. And the lack of new construction has only helped the market, he pointed out: With office construction down about 80 percent from 2007, Blackstone’s portfolio occupancy has risen from 80 to 90 percent over the course of the past four years. The falloff in retail construction has been even more significant, dropping from 200 million square feet in 2006 down to a mere 8 million square feet in 2012.

While investors have shied away due to fear of the credit crisis, or “hyper risk aversion,” Gray predicted that will soon change and more investors will even start to follow his company into suburban markets. Most visible among them are likely to be the sovereign wealth funds and public companies.

But other groups are starting to step up as real estate investors. While chief investment officers have been cautious, demanding justification for real estate investment, their perceptions are starting to improve, noted Doug Poutasse, executive vice president & head of strategy and research for Bentall Kennedy, during a discussion on alternative investments valuation. And a panel of portfolio managers generally agreed that while they have a responsibility to manage risk for their clients, that doesn’t necessarily mean not assuming risk, even for core investments.

“We’re still all in the business of taking risk,” said Cathy Marcus, managing director & senior portfolio manager for Prudential Real Estate Investors, who suggested “having a more broad and creative view of taking risk.” Specifically, she noted, the real risk is that of not being able to provide investors with the cash flow they are looking for (she later specified “cash flow” as being total return and income).

Indeed, core risk is the security of the cash flow, agreed Glenn Lowenstein, founding partner of The Lionstone Group, while opportunistic cash flow is the ability to get it back.

During the discussion of risk that followed, Lowenstein noted that to him the biggest risk issue is how you manage through the down cycles so you can control asset performance. Kevin Howley, managing director at RREEF, put in, “Income matters and how you manage debt matters. You want to survive the cycle.” And Marcus recommended paying attention to other types of risk factors, such as demographics. The danger there lies in too readily dismissing the preferences of the 20-somethings, the next generation of tenants and consumers, she noted.

Overseas, Gray also recommended that U.S. investors pursue product in China and India. “You want to get more exposure in these markets because there will be growth over time,” he added. And while they carry risk, “volatility is a new fact of life in a global world,” he concluded. “You want to make sure you’ve got staying power on your assets.”

The new fund revealed some performance trends in U.S. real estate. Apartments outperformed the overall index based on one-year, three-year and five-year returns, according to Jim Valente, director of performance and risk analytics for IPD North America, as did super-regional malls, while other property types produced a drag on the index. Geographically, the outperformers were the Mountain and Pacific regions, with only the Pacific coast topping the benchmark across all three time periods. The Northeast and East North Central regions came in below benchmark during all three periods. At a more granular level, Denver, Houston and San Francisco were all outperformers, with Seattle showing a more recent strong performance and Washington, D.C., performing well at the three-year and five-year marks but down in one-year returns.

Valente announced the company will be launching a global fund index on March 21.