Attendees at the 2010 Urban Land Institute Fall Meeting in Washington, D.C., found plenty of actionable information and a slight upbeat note compared to the depths of the 2008–2009 recession. Among the usual high-level panels and research that are typical of ULI meetings was an extra ounce of top-ranking current and former government officials who broke away from their day jobs to come to the convention center.
Banking System: On the Mend
Sheila Bair, chairman of the Federal Deposit Insurance Corporation, opened the fall meeting with a reality check of the nascent recovery. Commercial real estate being recycled quickly, such as the Resolution Trust Corporation process of the 1980s recession, is not going to happen. “We are focused on helping banks work out problem loans and portfolios,” she said. “It is almost always better that property with cash flow get a chance to continue, versus closing.”
As for the bank closures of the past two years, Bair said that “losses will be lower this year [by total dollars], although there have been more banks closing because they are smaller banks.”
“As the economy continues to heal, we anticipate the banking system will be in a better position to provide credit and capital for expansion.”
When asked about her biggest ongoing concern, Bair said, “It’s interest-rate risk. We’ve been extolling banks to prepare themselves and have asked, Can you absorb a several-hundred-basis-point ‘hit’ if one should occur?”
Housing Industry Reshaping, Rebounding
While housing sector problems are widely seen as fueling the deep recession, the sector is also one facing major structural change, and, in some views, for the better. A keynote panel of leading private and public sector veterans held that federal housing policy in the 21st century needs to strike a better balance between homeownership and renting, to foster ownership opportunities for families ready for homeownership while also encouraging rental housing that is appealing, affordable, and accessible to others.
“Housing has played a key role in every market recovery, and it has to play a role now,” said Henry Cisneros, former secretary for the U.S. Department of Housing and Urban Development. “It was 30 percent of the most recent recovery and is a major part of the economy.”
Going forward, it is highly unlikely that the federal government’s involvement in the residential mortgage market will be as extensive as it currently is, wherein 90 percent of the home mortgages now available are ultimately with government-sponsored enterprises (GSEs) including Fannie Mae, Freddie Mac, and the Federal Housing Administration. Could the GSEs disappear entirely?
“I’m confident the private market could create a replacement for the GSEs because a mortgage is not a difficult instrument to create and manage,” observed Steve Preston, another former HUD secretary. “Regulators could create the guidelines to outline such a private-sourced system, and the government should still perform a role of last-resort backstop” with layers of protection to cushion taxpayers against losses.
“There has to be a way to realign interests,” said Bart Harvey, former chairman and CEO of Enterprise Community Partners. “Today, the majority of the mortgage [interest] tax deduction is helping people who make over $200,000 a year, a group that hardly needs it.”
Achieving the right balance is key, said moderator J. Ronald Terwilliger, founder of the ULI Terwilliger Center for Workforce Housing and chairman emeritus, Trammell Crow Residential. “The private sector cannot address all the housing needs that the population has,” he said. Rising housing and transportation costs for families in urban areas nationwide constitute one area that could benefit from federal involvement, he noted.
Spelling Relief: Demographic Trends and Job Drivers
A large, packed room gleaned opportunities from analyst/researchers Richard McLemore of MetLife Real Estate and Craig Thomas of AvalonBay Communities speaking on “Where and When Will the Jobs Show Up?”
“Job gains are still not countering the job losses we’ve experienced across U.S. markets,” said McLemore. “People have been out of work longer in this recession than in prior ones,” he said in reference to a stark chart on the average number of weeks people have remained unemployed.
McLemore offered three takeaways on the nascent recovery: The “new normal” is long-term lower job growth from declining U.S. manufacturing and cheaper offshore alternatives; the tentative cyclical recovery of recent months has moderated and remains fragile; longer-term cyclical trends will tend to inhibit broad expansion including shrinking public sector payrolls and demographic trends among the workforce.
His upbeat note: Cities with high percentages of young people such as Austin will experience higher job growth.
McLemore’s harsh reality—"I’m more conservative, even pessimistic, compared to others"—was countered by Thomas’s data-mining approach that found slices of markets and sectors showing growth.
His approach is to combine the “inherently flawed look back at data” with “real estate people on the street.” From that basis, Thomas pointed to several cities where industry-specific job growth in the first half of 2010 indicates opportunities.
The largest micro-trend was an 8.6 percent rise—17,000 jobs—in “information technology” jobs in Los Angeles, primarily in content production for movies and entertainment.
Elsewhere, Washington saw a rise in retail trade employment of 5 percent; retail trade jobs also rose 3.6 percent in New York; professional and business services went up 3 percent in Indianapolis; and the education and health care sectors rose 1.3 percent in New York.
On the downside, Thomas cited industry-sector declines as well: construction jobs dropped 15 percent in Las Vegas and 7.8 percent in Chicago; financial services, down 3.6 percent in Atlanta; and local-government employment, down 2.1 percent in Los Angeles.
Broadly, Thomas said to look for “eds and meds” submarkets where university and health care sectors combined to provide significant local boosts not only in New York but also in Dallas, Philadelphia, Chicago, and Washington, D.C. New York should see strength in retail as well as leisure and hospitality, he said, while Washington—everyone’s favorite market these days—would also enjoy retail gains. Gateway cities of San Francisco, D.C., Boston, and New York would continue to benefit from immigrants and global commerce.
Thomas’s sleeper opportunity: the Midwest, where low land and wage costs combined for a “screaming bargain.”
From the panel “New Models to Meet Changing Consumer Demand,” attendees learned to watch both the numbers and their TV.
“If you want to know how people will live in the next decade, look at what people are watching on television,” said Federal Real Estate Investment Trust’s senior vice president for development, Donald Briggs. “People want the lifestyles of those on their favorite shows. Developments and cities that provide those opportunities are the ones that will thrive.”
Timothy Sullivan, principal of John Burns Real Estate Consulting, stressed the need to understand what consumers are willing to pay for. His company’s market research found that despite the housing crash and economic downturn, people are not as disillusioned with homeownership as developers might think. Some 90 percent of the population believes it is a good time to buy a home and 55 percent say that they would buy a home if the product was in accordance to their preferences. Sullivan also discovered that 78 percent of the population wants a master plan and are willing to pay homeowners association fees.
Global Opportunities: World Gateways and . . . U.S. Distress
On the world stage, the deep recession is making a decidedly mixed impact, though globe-trotting real estate opportunists face daunting local-market challenges, according to panelists speaking on “Characteristics of Global Capital.”
Accessing global institutional capital is a long-term strategy that can be well worth the effort, said Stephen Barter, CEO of Qatari Diar UK. “Understanding international capital is key to attracting that capital, and it’s not only about returns but is also [the investor’s] long-term goals and the relationships you develop.”
Added Simon Treacy, group chief executive for MGPA, formed from the management buyout of the former Lend Lease global property fund group, “We’re seeing a return of the arbitrage opportunity of private capital being able to slip in below the public and REIT investors who have to buy property that’s immediately accretive [to earnings].”
Fundamentals of the given property are paramount no matter the market, versus the “financial engineering” of prior cycles, said moderator Robert O’Brien, partner and vice chairman of Deloitte & Touche.
Added Barter, “We’re most focused on the underlying property fundamentals, but that being said, we don’t ignore currency risk [of cross-border investment].” While the panelists agreed on the importance of focusing on the local, in-market characteristics of a property, the cross-border movement of capital can’t be ignored. “For Japanese investors, America looks like a ‘20 percent–off’ buying opportunity,” he said.
Treacy said MGPA’s approach to an investment is based on the original assessment of the property or its replacement cost. “But even that is sometimes challenged,” he said, “such as in California, where we’re getting reports that land deals are valued or trading at essentially zero.”
Chandler’s group is buying in “non-glamorous cities, places outside New York, Boston, and San Francisco where local fundamentals are improving,” he said. “We’re buying on jobs.”
Treacy joined a subsequent panel titled “Global Distress” that cited a number of offshore opportunities competing for capital.
“Asia in general is very healthy and distressed deals are rare, but the lack of transparency and the shear size of the China market indicate there is more distress than one might think. It will present itself over time,” he predicted.
The perceived opportunities for distressed real estate in Greece, Portugal, and other troubled economies in the European Union simply are not there. “Just like the U.K. and elsewhere, banks are reluctant to just take the hits they may need to take,” said Robert Peto, president of RICS, the Royal Institute of Chartered Surveyors. “In Spain, the only deals are in sale-leasebacks with solid, long-term tenants.”
What are the top markets attracting capital? “A year or more ago, it was London, the U.K., Paris, but for global investment funds today, the great white hope is right here in the U.S., primarily in debt platforms,” said Treacy.
A Long, Slow Trip It’s Become
The fall meeting’s closing keynote by Donald Kohn, former vice chairman of the Federal Reserve, stressed a “long, slow climb out of a deep hole,” and then gave hints at what could fill the economy’s half-full glass. Kohn expects growth will pick up next year, with inflation remaining very low. Households are rebuilding net worth while stabilizing their savings rates; the financial sector is rebuilding capital; problem loans are being addressed; productivity growth from employee cutbacks is slowing in favor of hiring gains; pent-up demand is driving an increase in business spending on equipment and software; and consumer durables are wearing out, so they will need to be replaced.
A consistent message for fall meeting attendees was the challenge and opportunity in the return of fundamentals to the real estate industry: Identifying demand drivers and meeting those needs. As speakers pointed out over three days, there are any number of opportunities along this long, slow trip, ranging from stabilizing U.S. gateway cities and global distressed markets as well as niche plays among submarket slices and narrow demographic drivers.
Read extensive coverage of ULI’s 2010 Fall Meeting sessions at urbanland.uli.org/fallmeeting.
