Institutional Investors Ride the Wave
Lynn DeMarco and Randall Shearin,Roundtable Discussion
Shopping Center Business and Staubach Retail’s East Coast Retail Investment Team recently co-moderated a roundtable of institutional investors to see what the market is buying, how the changing capital markets are affecting their behavior and what the trends are for institutional owners. The roundtable was held in September at the Westin Times Square in New York City. Attendees were Thomas Caputo, executive vice president of Kimco Realty Corp.; George Fryer, principal of AEW Capital Management; James Garofalo, director of retail asset management for TIAA-CREF Global Real Estate; Richard Coles, principal of Emmes & Co.; Adam Ifshin, president of DLC Management Corp.; Elizabeth Owens, senior vice president of BPG Properties Ltd.; Steve Vittorio, principal of Prudential Real Estate Investors; and Barry Argalas, senior vice president of acquisitions and dispositions for Regency Centers. The roundtable was moderated by Lynn DeMarco, managing director of Staubach Capital Markets, and Randall Shearin, editor of Shopping Center Business magazine.
Shearin: Let’s start by talking about the turmoil in the capital markets over the last 6 to 8 weeks. Has this impacted your acquisition and disposition plans for the rest of the year?
Ifshin: We are going to have to get used to the fact that the fundamental availability of debt capital, at least for the foreseeable future in the United States, has changed dramatically. Last year, there were about $450 billion of commercial mortgages originated in the U.S. The run rate in the first quarter of 2007 suggested that the number might reach $550 billion [for the year]. Some Wall Street conduits that, 2 years ago, were originating $400 million to $500 million of fixed-rate paper per month were originating $2 billion to $3 billion per month in early 2007. It now looks like the total market this year will be about $250 billion. It is roughly a 40 percent reduction in the availability of debt capital for refinancings and transactions. Every property in the spectrum, with the possible exception of the Class A trophy/fortress asset, has been impacted. It has also affected the buy side and the sell side. Refinancing proceeds on transactions have been cut by 15 to 20 percent. All the data points from the last 24 months assume a level of liquidity that no longer exists. Even if you are an institutional buyer or developer who is low leveraged on the front end, your expectation is that you are going to sell it on the back end to the absolute highest bidding buyer. What that buyer can pay is, in most instances, very different.
Owens: We are a value-add moderately leveraged buyer of all property types. There has not been much availability in the permanent debt market lately but we often obtain bank debt when we buy because our properties are normally not stabilized at acquisition. The banks are really aggressive right now in their pricing. They are trying to make up for some of the business they lost because of the residential market. We are not seeing a big problem in acquiring properties. Permanent refinancing has been harder for us right now; the lenders cannot commit to terms.
Garofalo: We are staying pretty active. We have a huge portfolio and three accounts to feed so we have to stay active in the market. What we are seeing that is different is that we are being more selective. We are holding a little firmer on pricing. We are testing the market a little bit. We’re going to wait and see how that develops. As cash buyers, we look at these choppy times and we see opportunity.
Argalas: Our mentality mirrors what Jim [Garofalo] said in that we’re being a little more selective. We’re honing our scope a little bit and not getting outside of the core major metro markets. Fortunately for us, at the time when the turmoil hit, we had closed enough at the beginning of the year that we’re able to meet our 2007 goals. On the disposition side, we were in the market with a number of properties that were impacted. I still think we will be able to transact those. We think there is opportunity out there, but that we must maintain discipline and keep our focus.
Vittorio: As Adam [Ifshin] mentioned, the Class A trophy property might not be hit quite as much. I think it may go a little deeper than that. Most Class A high-quality properties in primary markets are attractive to enough buyers that the cap rates haven’t been affected by more than 25 basis points. It is still pretty competitive for high-quality properties. Get under that, and there has been a lot of price erosion.
Shearin: How has it been to get financing over the last 6 to 8 weeks? Has anyone noticed a change in lenders’ attitudes?
Caputo: It has been very difficult — a bit like shooting at a dartboard. We typically are in the market in our various joint venture programs looking at up to $1 billion in debt at a time. Our treasurer has always been very confident on execution — picking the right lenders and going with the folks we had done business with for a long time. Now, we have far less confidence in the conduit lenders because there is less certainty of execution. We are working extensively with the life companies, who have appropriately moved with the market and raised their spreads significantly. We’re seeing spreads from 170 to 200 basis points over the 10-year. We had an instance last week where we had three different quotes in 3 days from the same lender on the same pool of properties. It is frustrating.
Ifshin: The lenders that we are used to dealing with are not in control of their own destiny. When someone who you have done $200 million to $300 million of business with for years says they can’t your call anymore, things are tight. At the monolithic institutions — the largest on Wall Street and the largest European lenders — is that the risk management guys are in control right now. They have a hard time understanding what their total exposure is. Moodys and S&P maybe completely wrong; but they may be holding paper that they can sell based on certain credit ratings. It is not just real estate; it is CDOs in high yield investments; RMBS, asset-backed, high yield bank debt. They can’t figure how exposed they really are. In the early years, these were giant manufacturing plants for financial derivatives. Billions of dollars originated every day; they were sliced, diced and repackaged, branded by the rating agencies and pushed out. The machine got so big, but it was executing so well. When the music stops, everyone doesn’t know what to do because they don’t know how exposed they are to every sector.
Vittorio: The spreads for construction debt have widened. It is another cost to the deal that has narrowed the development margin. Where rates go, no one is sure, but certainly spreads have widened at least for the time being.
Fryer: AEW is primarily an equity buyer. Even when we do borrow, there is usually a big equity slug underneath. Nevertheless, some of our clients are taken out of the market when “interest-only” provisions are removed and they can’t stomach negative leverage. In our joint venture programs, where we are not accustomed to signing recourse on construction loans, increasing requirements for such may simply prevent us from doing the deal.
Shearin: Will there be a flight to equity?
Fryer: That is certainly what we are hoping. We just opened a new core investment fund and initially raised $450 million of equity, on the way to $1 billion or more. That fund sits ready so we can act when pricing settles out. We intentionally slowed down our acquisition pace back in February, not because of some prediction of this credit crunch, but j