Real Estate’s Seismic Shift

Technology, demographics, urbanization, retail investors—real estate investing is undergoing seismic shifts in a number of ways. However, Colony Capital, Dune, and LaSalle all warn it’s vital to keep an eye on market cycles, not least in the U.S.

Zoe Hughes, Privcap: As you look ahead at commercial real estate and to what your portfolios will become, how does that compare to the changes you’ve seen during the past decade?

Dan Neidich, Dune: It’s a different world. The main thing about [our] portfolio is the way we think about leverage. We think about de-risking—the different ways we can manage risk, whether it’s selling assets early or doing financing early—and the way we control leverage. We grew up in a world where a developer could get 85, 95, 105 percent financing. Today that’s really 60, 65 percent financing in the bank world, depending on other layers of capital.

Jeff Jacobson, LaSalle: An area that’s been growing for us, particularly since the financial crisis, is listed global real estate securities, which is $13B of our total. Our bias is towards core-plus. We’re trying to make sure we can go through the cycles. As you’re investing later in a cycle, it’s more about protecting yourself if the world starts to change. Right now we’re skewing towards that when we have to make trade-offs.

Kevin Traenkle, Colony: Ten years ago we were much more focused on the opportunistic equity end of the spectrum, shooting for 20-percent-plus rates of return. Today we’re skewing towards the conservative end of the spectrum. A lot of our clients didn’t necessarily need real estate to deliver a 25 percent return in their portfolio, and when you get to managing tens of billions [of dollars], it’s just too hard to pull that rabbit out of the hat year in, year out.

How has the globalization of capital changed your game?

Neidich: Capital flows have been global for a long time. Everyone has a little bit of a short memory—even the people who pull back—so there’s always an ebb and flow. All of us remember when the Japanese were here. Now it’s the Chinese or the Koreans, and the Middle East has been here for a long time. The German banks are starting to look at coming back to the U.S. Even the Japanese are coming back to the U.S.

Jacobson: Real estate is becoming more and more a global financial asset. What continues to change is where real estate capital is going to come from. Look for where the money is: in markets where they don’t have the ability to invest in their home market. And a portion of that will go into real estate. A tremendous amount of global savings over the last decade has come into commodity-rich countries—the Middle East, Norway, parts of Africa, Australia, and Canada—and countries with a big current account surplus. So Germany is going to be big.

Traenkle: Colony is raising even more capital from international sources. Those capital sources have gotten a lot bigger in the last 10 years, and liquid capital is looking to find safer places to invest. The world today is volatile, and the U.S. offers a pretty safe environment relative to other big markets. When you think about preservation of capital, you probably think about U.S. dollar-denominated assets that will at least keep up with inflation. Real estate does a really good job of that.

And how will you be raising capital in 15 years’ time?

Traenkle: One of the things we’re starting to see is capital coming into institutional real estate from retail sources. Some banks are giving their clients access to products and services that had only been available to the biggest of institutions. Technology has made it feasible and efficient to provide what we offer to individual investors. The amount of capital coming through those channels is growing exponentially.

Jacobson: Individual investors are coming in, and there are a lot of people, ourselves included, trying to put together lower-fee, higher-quality products with greater liquidity. If you come up with the right product, there will be huge demand. A lot of us are also focusing on the defined-contribution space. There is a lot of complexity, but 15 years from now that will be a big source [of capital].

How will demographics, technology, and urbanization impact real estate investment in the next decade?

Jacobson: Those trends are secular, and within those long trends we get cycles. Technology is driving the market today. There will be a year where we’ll all forecast office absorption in San Francisco is going to stay at the current level, and there’s going to be a year where it goes negative and everyone will say, “Oh no, rents have fallen!”

So where should investors be betting big today for tomorrow’s returns?

Neidich: We wrestle with emerging submarkets in the gateway cities. The one question I haven’t really heard a good answer to is, what happens with schools? What happens when all these millennials have families? Can the schools accommodate them? For urbanization, we’re all going to have to make bets on schools.

Traenkle: I don’t see trends changing anytime soon. People are putting off getting married, household formation is slowing, and people want to live in more urban areas than suburban. People are renting more. Home ownership rates are down, and it looks like they are going to continue to go down. So they are not going to buy the house out in the suburbs, they’re probably going to be in an urban core. I’d rather make a bet in urban retail than in a suburban mall anchored by a JCPenney and a Sears.

So where are we in the real estate cycle in the U.S.?

Neidich: Seventh inning. My concept of the seventh inning is that on one hand you think you’re near the end, [and] on the other hand, you just had six innings of great experiences, so it gives you a confidence that probably shouldn’t be there, given you are late in the game.

Jacobson: Everyone says seventh inning, so it’s probably wrong. We do a lot of scenario planning. But the fact that we all think it’s good… We’ve had a great run, but going to extra innings is probably unlikely.

Traenkle: It feels a lot like 2005. Everything is going really well; it looks like there are no roadblocks in our way. But in two years’ time, 2007 hits, and it all can come to an end.