Global Conference 2008

Global Conference 2008

Real Estate: Where Is the Bottom?

Monday, April 28, 2008 / 9:35 am - 10:50 am

If the audience anticipated blunt discussion, this panel did not disappoint. Moderator Lewis Feldman opened with a discussion of current real estate market dislocation, fueled as it has been by a combination of low prices, easy credit and a resulting high demand. Lending standards retreated as Wall Street's use of collateralized debt obligations (CDOs), with highly profitable transaction fees and potential returns, had "investors consuming them like sumo wrestlers at a Las Vegas buffet line." Problems began to emerge by 2006, and now the losses are piling up. "So where, asked Feldman, is the bottom?"

All eyes turned to iconic Sam Zell of Equity Group Investments, who stressed how crucial it is to recognize that the real estate market is "heterogeneous," with impacts varying by market sector. "The single-family residential (SFR) market is dead," he said, noting that the cause of death can be traced to failed federal policy. "For forty years, every single time the federal government has tried to increase home ownership above 62 percent — and it went up to 69 percent this decade," he added, "the policy fails, and home ownership retreats and a recession ensues.

"Buy all the SFR you can at 40 cents on the dollar," he added, "because there is a huge oversupply."

In the commercial real estate (CRE) market, strong demand exceeds supply for assets like Class "A" office buildings. This market is in relatively good shape, Zell said, adding, "I have seen the numbers on losses and they are overstated in this area." Still, he warned, construction could effectively stop by the end of this year. Why? Because a loss of confidence has frozen lending since July 2007, and it takes about nine months for CRE work to start drying up due to a lack of capital.

Brian Fabbri of BNP Paribas noted that banks are tight, but with reason: "Builders are still building more SFR than people are buying," he said. "We should be concerned because all the losses to date incurred at full employment absent a recession. If we lose 1.5 million jobs in a recession, it is going to get worse." He predicted that the SFR market won't bottom out until well into 2009.

Current federal programs support a bunch of people who never should've bought houses,"interjected Zell. "They should not be getting our sympathy because they have no equity invested in the property and got loans without financial means tests. They must be cleared from the SFR market for it to return to good health. They can liquidate their asset or choose the foreclosure process." The federal government, he said, "is hurting the SFR market by helping those who never should've got their house in the first place."

"This housing bubble fed itself through borrowing from the pool of future homeowners for the next 10 years," noted Bobby Turner. "The market incentives encouraged overbuilding in suburbs in outlying areas, where land was cheap and transportation costs were 9 to 14 percent of disposable income." Now that transportation costs are hitting 25 percent of disposable income, he said, people can't afford to live in outlying areas and commute to work, and this is making urban areas more attractive.

Michael Van Konynenburg of Eastdil Secured spoke of the great run CRE investors and bankers did enjoy from 2002 to 2007. Throughout this period, he said, commercial lending didn't loosen its standards, as the SFR market did. But the SFR impact on the CRE market, along with the declining dollar, a recession and not much CRE to sell, has a chilling effect on CRE lending: down 80 percent from 2007 to the first quarter of 2008. If the CRE investment market doesn't recover, he predicted, there could be material stress in CRE by late 2010. "We have a recession, and investors are waiting for the federal government to show its hand," he explained. "Does the government take steps now to make matters worse? Or does the federal government give clear signals that enable the markets to unfreeze themselves?"

The panel was pessimistic that foreign investors will "save" the real estate market. "There are always opportunities," said Zell, "but there isn't always scale. While there's a demand for high-quality office buildings, there is excess supply in houses. There simply is no scale to buying up SFR. This is compounded by the fact the U.S. liquidity problem is not a worldwide problem. There is plenty of investment going on external to the U.S."

Investors in the Middle East would be the most capable investors, said Fabbri, noting that they are savvy and invest wisely. While they have invested big in the past, they like to visit to see what they bought. U.S. politics (visa and security challenges) make it much more difficult to come to the country relative to travel ease in EU countries. The U.S. tax regime is also somewhat unfriendly, he continued.

"The domestic challenge," said Bobby Turner of Canyon Capital Advisors, "is getting current investors, most notably pension funds, to focus on opportunities and not on current problems."

The panel's discussion was specific to asset prices, not rents, and their shared belief that the country is in recession. Feldman asked each to pick one opportunity for investing, and Fabbri picked international investments for the best returns. Turner opted for domestic urban rental housing that benefits from immigration trends. Van Konynenburg said he likes major hotels in urban infill, while Sam Zell stated that he's bullish on Brazil, suggesting it may exceed China as an economic power in 30 years.


Lewis Feldman

Partner, Goodwin Procter LLP


Brian Fabbri

Chief U.S. Economist for North America, BNP Paribas

Steven Green

Former U.S. Ambassador to the Republic of Singapore; Managing Director, Greenstreet Partners

Bobby Turner

Managing Partner, Canyon Capital Advisors LLC

Michael Van Konynenburg

President, Eastdil Secured

Sam Zell

Chairman and President, Equity Group Investments LLC; Chairman and CEO, Tribune Company

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