What’s Your Next Move?
- Sep 01, 2008
The real estate landscape has changed drastically since the middle of 2007, and economic conditions are unlikely to permit improvement in the near future. The minimally active finance market, corporate cutbacks and other fallout make doing business difficult at best and have affected some companies gravely. Of course, many a real estate executive has found opportunity in such markets, but timing is everything, and the national economy is volatile enough to throw off even the most seasoned economist’s predictions.Fortunately, there is more than a little truth to the old axiom that history repeats itself, suggesting it is possible to draw on past experience to help predict when to take advantage of market shifts. After all, the industry and the country have been through downturns before.Just how much real estate players can draw on past experience to help them shape effective strategies this time around, though, is a subject that engenders debate.“Real estate goes in cycles, and no matter how good it is for five and six years running, real estate is a cyclical business,” declared Barry Barovick, a former CEO of Grubb & Ellis Co. and a partner in The Schonbraun McCann Group, the real estate consulting arm of FTI Co. “Everybody overestimated the strength of the cycle we were in.”Yet significant differences can make it tricky to relate today’s economy to that of the late 1980s and early 1990s, the last slowdown comparable in size and severity. “We’re in a new era,” argued Arden Realty Group founder Richard Ziman, whose enterprises include AVP Advisors L.L.C., which manages private funds for institutional investors. For instance, the CMBS market was a decade away from its rise to prominence back then, and REITs were still in their relative infancy. In addition, the unprecedented access to information made possible by the Internet was barely on the radar.And while wide-scale overbuilding proved the chief culprit of that downturn, today’s fundamentals remain sound by contrast because developers have generally avoided overdoing it in recent years. More than a year into the current slowdown, the consensus remains that the situation stems from dysfunctional capital markets rather than from an imbalance of supply and demand.In fact, investors now covet real estate as an asset class rather than disdain it, as many did during the downturn of 20 years ago. That explains why otherwise eager investors are waiting patiently to pour untold billions of dollars into real estate until they feel assured that they will be investing in a sounder economy.Differences notwithstanding, consensus is emerging among a diverse array of longtime real estate professionals that the basic rules still apply. In fact, now may be a good time to refer to some timeless themes that many ignored during the most recent boom: attention to sophisticated market knowledge, understanding of the company’s goals and good old-fashioned horse sense.Mr. Buffett’s Three ‘I’sMarcus & Millichap Real Estate Investment Services Inc. CEO Harvey Green suggests that real estate decision makers would do well to ruminate on investment guru Warren Buffett’s oft-quoted theory that all business cycles divide companies into three ‘I’s: innovators, imitators and idiots.Innovators in a real estate cycle, Green said, are those who are looking early for value-add transactions. Next come the imitators, who try to follow in the innovators’ footsteps. They may be on the right track, but the absence of a genuine long-term strategy and perspective on economic and demographic trends may limit their success, he cautioned. And tagging far behind are those unfortunates who carelessly throw money at assets without really knowing what they are doing. “They’re the ones who got caught at the end of the music without a chair to sit on,” Green argued. The moral of the story: “Always think about the exit strategy.”Furthermore, success requires a willingness to take bold but smart risks. Observers point out that a number of industry leaders have historically thrived during adverse times for that reason. “They didn’t let the fear in the marketplace deter them from starting a business,” noted CB Richard Ellis Inc. global chief economist Raymond Torto.That can take patience, too.For instance, Hamid Moghadam launched AMB Property Corp., the giant industrial REIT, during a slow economy in 1983. The company finally hit its stride a decade later, as the economy was pulling out of the downturn. Then, as now, investors were reluctant to put capital into real estate, and pulling the trigger on investments was extremely difficult, recalled Eugene Reilly, president of the firm’s Americas region and a 25-year industry veteran.“One of the things you’ve got to learn is that you need to participate (in the market) throughout the cycles,” explained Reilly, who joined the company in 2003. “It was the people who had the courage to buy into the market in the early 1990s that really built strong enterprises.”AMB Property did just that from 1989 to 1995 by focusing on savvy investment in industrial and retail markets. Soon after its 1997 IPO, the REIT took further advantage of an improving economy by exiting retail to focus exclusively on the industrial sector.The company continues to stick to long-term goals in the face of a tough cycle and has added another element to the mix: It has diversified, its six-year-old global expansion strategy gaining clout from sluggish growth in the U.S. industrial sector. Last month, an alliance with Cyrela Commercial Properties S.A. Empreendimentos e Participacoes established Brazil as the 16th country in which AMB operates.No history lesson is complete without a look at Sam Zell’s strategy. His $39 billion sale of Equity Office Properties Trust to The Blackstone Group L.P. in 2007 will stand as the peak of this decade’s market. In retrospect, it also signaled the start of the industry’s descent. Setting a record for a public-to-private buyout, the Equity Office deal will be hard to top for its timing and scale. But Zell has long made history, and both that deal and his moves during the 1990s downturn offer valuable lessons for any investor.Aggressive at obtaining top dollar for his assets, he also showed, while building the empire that included Equity Office, a knack for acquiring assets in multiple sectors at discounted prices, earning him his “Grave Dancer” sobriquet. In addition to his uncanny ability to read the market, his success can be attributed to an exceptional attention to detail. “He knows his portfolio very well. He knows his capital sources,” Barovick said.Zell’s ability to read the market has also contributed to a strong sense of timing, something he and Ziman both have historically made a specialty. “The first three rules … in the real estate business are timing, timing, timing,” Ziman said.Generally speaking, experienced investors emphasize that the best strategy is not to target the market’s height or bottom for the sale of assets, portfolios or even companies, as those milestones are illusory at best and impossible to judge.In addition, as Ziman has found throughout a 35-year real estate career, during which the observations on which he based his own watershed decisions have varied as widely as the circumstances, a successful market strategy can run counter to conventional wisdom, as long as it is grounded in shrewd market analysis.With one of the most successful office investment programs of the past generation, Arden Realty got its start partly on account of a newspaper story. In 1993, Ziman read an article in The Wall Street Journal that reported that Southern California was leading the nation in the formation of new businesses.That got him thinking about the demand for office space that those new businesses would create. He formed Arden Realty to invest in the office sector. Long before the local economy hinted at the long-term value of office properties, the firm started by identifying small yet well-leased office properties in good locations.Given the relatively weak Southe
rn California office market, he encountered a good deal of skepticism at first. But over the next several years, population growth and an improving economy enhanced the value of Arden Realty’s office holdings. By the middle of the 1990s, Wall Street was clamoring for Ziman to take the company public. He did so in 1996, and by 2005, its portfolio encompassed 20 million square feet of office space.A hunch informed by experience and close attention to the market prompted Ziman to make his next big move. He found it disquieting that investment banks would inundate him with e-mails touting multibillion-dollar CMBS issues, and he wondered about the true value of those securitized assets and about the ultimate impact of securitization—whether of debt or equity—on market values. Feeling that the firm was significantly undervalued, he decided it was a good time to get out, and he sold to GE Real Estate for $3.2 billion in 2005.Not everyone harbors such instincts, however. A good safeguard, Torto suggested, is what he calls “old timer’s wisdom”: Investors make their money on the buy side, not the sell side. “Don’t overpay, which is what happened in the last few years,” he advised.As leaders look ahead to the next several quarters, Ziman recommends keeping a close eye on third-quarter earnings reports from commercial and investment banks. He predicts that the trends indicated by those reports will be the bellwether for the economy and for commercial real estate. “If it’s bad, it’s going to be really bad.” On the other hand, if banks fare better than expected in the third quarter, that would be the long-awaited signal that those institutions have finally tallied up their losses.Ultimately. timing major moves in this climate will continue to be the key, and some executives caution against taking too many lessons from the past without noting the differences this time around. “It is a better cycle (during which) to move into the market earlier,” Green argued. After all, whether the commercial real estate market’s comeback begins in a couple of quarters or a couple of years, plenty of capital is waiting for the right moment to pounce.That, in turn, suggests one more principle: Be flexible and expect to hold on to your hat.