Real Estate Investing Makes a Comeback

Real estate is showing some early signs of a revival as an attractive investment destination compared to other opportunities like corporate debt, but the equity and debt markets have to open their wallets with more confidence to resume a normal flow of deals. That was one notable assessment by panelists at the fall conference of the Samuel Zell and Robert Lurie Real Estate Center held at Wharton recently. They also offered insights on lessons learned from the supervisory gaps that fueled the recent collapse of the financial markets and ways to fix them. “Real estate looks like a better value [proposition] relative to other alternatives than it did six months ago,” said David Twardock, president of Prudential Mortgage Capital, which manages the insurance group’s real estate finances. He was speaking at a panel session titled, “Where Will the Capital Come from and How Will It Be Used?” He said benchmark securities like single A-plus corporate debt today offer returns that are a third of what they were at the end of last year. “So, as an alternative, making loans to real estate looks like a better place to be than it has in a long time, relative to those benchmarks.”

Twardock, however, lamented that while debt capital is available, equity investors are still holding back. That phenomenon is not helping the process of deleveraging, or reducing the share of debt in portfolios, that banks and other lenders must undergo before a more normal deal flow can resume, Twardock and other panelists said. “The difference is very few people are writing equity checks to buy property,” Twardock added. “What we need is equity to take this deleveraging process along.” Wharton real estate professor Peter D. Linneman told panelists in a later session that between September 2008 and February 2009, banks deposited as much money with the Federal Reserve as they had done in the previous 50 years. Lending those funds will cause inflationary pressures, but he and other panelists said the economy needs some of that liquidity to finance growth. Peter E. Baccile, vice chairman of JPMorgan Securities and a fellow panelist, said the investment sentiment has improved significantly recently, and that “the capital markets have been wide open this year.”

Between January and August this year, public real estate investment trusts (REITs) issued $18 billion worth of securities, “which is more than what was issued in any single year in the 1990s when we had the big IPO (initial public offering) wave.” The bond markets for investment-grade debt from REITs have also opened up, with issuances totaling $8 billion so far this year. All that “has given more confidence to the market participants and propels new opportunities,” he added. Those confidence levels will move to a higher plane only with deleveraging of investment portfolios, according to Twardock. He said banks hold about half the $3.4 trillion in private debt. Another 20 per cent is in the commercial mortgage-backed securities (CMBS) market and the remainder is split between insurance companies and agencies of Fannie Mae, Freddie Mac and the Federal Housing Administration. “There is money for new loans; we have more money to invest than we can find the loans for, but the problem is deleveraging as a process is going to take time,

” Twardock said. Still, while some glimmers of confidence are returning to some sectors, the positive signs are distributed unevenly. Activity is at “historic lows” among the roughly 600 private market funds that invest in real estate, said Terrance R. Ahern, principal, founder and CEO of The Townsend Group, a real estate consulting company that services pension funds, endowments and foundations. “Few, if any, funds are closing [deals], and managers who have capital are not executing deals,” he noted. Aggravating that situation: Institutional investors were seeing “dramatic losses” at the end of the second quarter, with the prospect of that continuing. Insurance companies wrote $40 billion in loans in their peak years but they “are not going to solve the problem on their own,” he said. The market needs capital flows from banks and agencies such as Fannie Mae and Freddie Mac, as well as a revival of the CMBS market. “Everybody else, excluding insurance companies, took money off the table in the second quarter; you need some new form of capital.