Over 140 board members, faculty, students and guests gathered on April 3-4 at the Four Seasons Hotel in Chicago to discuss the current industry outlook and where it's headed for the future. As the real estate industry continues to respond to the economic recovery, the theme "Back on Track" was both relevant and timely, and the range of topics and expert views of our panelists made this conference one of our best programs yet!
Dinner Keynote with Jeff DeBoer
In his keynote address at the board dinner on April 3rd, Mr. DeBoer provided an overview of key policy initiatives that may have a direct effect on the real estate industry:
- Foreign Investment in Real Property Tax Act (FIRPTA) discourages the investment of foreign capital in U.S. real estate by treating a gain or loss by a foreign investor from the sale of a U.S. Real Property Interest (“USRPI”) as if such gain or loss were effectively connected with a U.S. trade or business. Mr. DeBoer contended that this law currently reduces the global flow of foreign capital investment into the U.S. by assessing a significantly high exit tax on the disposition of real estate assets, if owned by a foreign investor.
- The EB-5 Program is a highly beneficial permanent residence option for the wealthy, foreign investor which enables a foreign national to obtain permanent residence status in exchange for their U.S. investment. The EB-5 category requires an investment of $1 million (or $500,000 in a high unemployment or rural area) in a commercial enterprise which will employ 10 full-time U.S. workers. Mr. DeBoer explained that this program unilaterally provides an advantage to foreign capital over domestic capital seeking EB-5 funding in exchange for U.S. visas. This program’s juxtaposition with FIRPTA seems to present a glaring conflict in policy priorities concerning the general flow of capital and the laws surrounding foreign capital investments.
Policies around Energy Efficiency may reward tenants who exhibit exceptional commitments to green and sustainable design by compensating tenants who are mindful of their energy usage. Mr. DeBoer also mentioned policy discussions around single family home owners potentially receiving tax deductions for creating and improving their building’s energy usage.
- The Terrorism Risk Insurance Program is currently up for renewal this year, which may present potential real estate value implications if the program is not extended. Especially as it relates to CMBS pools which could see mass downgrades if this particular insurance program is not present on the assets within the loan pool.
- 1031 Exchanges and Carried Interest were also briefly discussed. Mr. DeBoer contended that 1031 Exchange rules could potentially be on the chopping block while tax implications for carried interest could significantly affect capital flow.
With an overview of key policy concerns from the White House, guests were eager to delve into the panels scheduled for the following day, which would highlight the primary trends within the real estate industry.
The CEO Outlook
The CEO panel gave attendees a high-level insights into the challenges and opportunities presented by the economic recovery. LaSalle Investment Management CEO, Jeff Jacobson, was pointed out that, “History always repeats itself, but differently.” His belief is that cycles will never change. In that belief, he questioned whether the risk/return balance is in line, given the industry’s rapid price escalation. Heitman CEO, Maury Tognarelli, expressed the importance of recognizing a cycle’s current state and employing specific goals and strategies for capital placement that can generate outcomes with a high level of certainty, given that position. Ryan Companies CEO, Pat Ryan, stated that he tries to always recognize the geographic focus of that capital and works to initiate projects in those areas ahead of the demand wave.
Mr. Tognarelli sees a change in the overall size and landscape of the industry. There are more long-term investors buying core real estate to put into a vast portfolio with other investment vehicles. Mr. Jacobson agreed but made two distinctions. He noted the bifurcation of investment, with long-term capital following expensive, safe assets and short-term capital chasing big IRR pops through opportunistic investing. Mr. Tognarelli generally believes current trends will move towards assets with short-term leases, which allow for more frequent rent adjustments, as the economy improves. Mr. Ryan sees an increase in speculative development on the horizon, starting with industrial and shifting to office over the next 18 months.
Equity Search For Value: Where is the Opportunity
During the Equity Search for Value discussion, panelists discussed strategies towards deploying the excess capital within the market, especially from an increased number of foreign investors. In light of this, Ms. Collete English Dixon, head of Principal Transactions at Prudential Real Estate Investors, discussed the company’s PRISA fund to further ease capital placement. Due to FIRPTA regulations, which Ms. English Dixon believes can place up to 30-40% tax on foreign investors, sophisticated public market investors like Prudential have moved toward creating alternative avenues for foreign investment. However, the panel did place caution on the flow of excess capital within the markets, as it likely places additional pressure on investments and acquisition goals. With a strong push to get money placed and a search for value via risk and yield, this could adversely affect the implementation of sound real estate decisions.
Robert Landin, CEO of Milestone REIT, a U.S. based REIT listed on the Toronto Stock Exchange, also presented his company’s unique strategy. Milestone REIT affords Canadian investors’ access to U.S. public real estate markets, presenting one of the few opportunities of this kind in the market place. With a primary focus on multifamily real estate assets, Milestone REIT’s strategy closely follows the ‘middle-income’ renter as 50-60% of all U.S. renters fall within this demographic. Targeted assets for this investment priority are a mix of downtown urban developments and multifamily housing within 25 miles of a local job center. The primary demographic targets are blue and grey collar American households which generally place a high value on multifamily housing near great schools and within strong gateway markets.
In general, equity’s search for value maintains multifamily investment at the core of its continued success, especially in ‘gateway’ markets. Similarly, a ‘build-to-core’ strategy within gateway and urban core markets has proved to be successful. Panelists discussed that this multifamily focus is not without cost of capital concerns. Cost of capital decisions are essential to multifamily housing, but panelists believe that economic fundamentals will continue to outweigh cost of capital concerns especially when rent growth potential could hedge against capital costs.
Development in High Gear
Fred Cooper, Senior VP at Toll Brothers, and a great friend of the Graaskamp Center, led the lively Development in High Gear panel. Chicago-based developers Dan McCaffery and Jim McShane poked fun at one another, while sharing their insights on the current development climate with the rest of the panel. The overall outlook was fairly cautious, as Mr. McShane indicated he is “more submarket conscious than ever,” and Mark Tennison, EVP at Equity Residential, suggested that the “low hanging fruit has been plucked.” Mr. Tennison added that today’s potential projects require more time and/or money, and that developers need to be wary of construction inflation during the time between initial underwriting and obtaining entitlements. Dan Rosenbloom, Managing Director at GEM Realty Capital, provided another perspective as an equity provider to developers. Mr. Rosenbloom is seeing less upside from a multiple perspective, and his focus is on forming relationships with developers in hopes of doing multiple deals over time. Mr. McCaffery also commented on the developer/equity relationship, with hopes that the two sides become more like partners over the long run.
Lending Markets in an Improved Economy
After lunch, Jack Cohen, CEO of Cohen Financial, kept the crowd engaged while actively moderating the Lending Markets in an Improved Economy panel. The general consensus of the panel, consisting of Chris Duey of Principal Real Estate Investors, Steven Myers of AEGON Realty, and John Petrovski of BMO Harris, was that the capital markets are ahead of real estate fundamental, and risk retention practices should be considered, particularly in the CMBS sector. The likelihood of an increase in cap rates as interest rates rise was also discussed. Mr.Cohen stated that because the abundance of capital in the market is seeking a scarce group of real estate assets, he still expects cap rates to compress further, even as interest rates rise. Other panelists noted that the directional shift in cap rates is hard to predict in a rising interest rate environment. However, as interest rates rise, NOI should increase in kind, and the overall effect should theoretically be net zero at a minimum.
Underwriting parameters were also a well discussed topic. The overarching theory was that, over time and as competition among lenders increases, it will not be leverage ratios that lose discipline. It will be other features of lending, specifically the location and quality of assets, that will bring greater risk to the lending environment.
The Public Markets Crystal Ball: Insights, Picks and Pans
The final panel of the day was led by David Toti, Senior Managing Director at Cantor Fitzgerald. This panel focused on the world of REITs, with the panelists discussing their approaches to REIT investing, as well as the sectors that are currently both in and out of favor. The potential impact of interest rates on REIT share prices is a hot topic, and Louis Conforti, Sr. Managing Director with BAM/Colony Capital, kicked things off by explaining that all REIT shares typically go down when interest rates increases, but the great companies bounce back quickly. Joseph Fisher, Portfolio Manager at RREEF America, and Joshua Klaetsch, Analyst at Advantus, both suggested that the industrial sector is currently their favorite sector based on the present demand for new product from high-quality tenants and quick construction times. Their least favorite sector was healthcare, given that healthcare REITs do worse than other sectors in a rising interest rate environment as a result of their longer leases.