In the Keynote Address of the 2009 Kellogg Real Estate Conference, real estate entrepreneur Sam Zell shared his thoughts on the current state of the real estate industry, bluntly telling the audience that “the next 36 months are not going to be particularly fun.” Zell added that he is as upset as anyone about this reality, because for the so-called “grave dancer,” these should be especially opportune times. Unlike the last downturn of the early 1990’s, during which Zell became well-known for purchasing properties from distressed sellers at steep discounts, he predicted the next few years will be marked more by “hope certificates” and “tranche warfare” than by distressed buying opportunities.
|“In the end, liquidity equals value,” keynote speaker Sam Zell said at the 2009 Kellogg Real Estate Conference. “I’ve never seen that proven more in the first half of this year.” |
|Photo © Dan Dry|
Zell, chairman of Tribune Company and numerous real estate entities including Equity Group Investments and Equity Residential, began the address by commenting on what brought about “The Panic of ’08.” He likened the CMBS-fueled spike in real estate transactions to a game of Old Maid, in which everyone was trying to get their merchandise in and out as quickly as possible. One of the key problems, he noted, was the attitude that “you don’t have to do much due diligence as long as you don’t keep the paper too long.” He went on to point out that the problems were exacerbated by bailouts being given to some but not others, as inconsistency does not lend itself to creating confidence.
Zell then addressed the problems facing the commercial real estate industry going forward: first, the wall of debt maturities scheduled over the next several years. By his count, 60% of the institutional quality real estate in the U.S. has traded and levered up since 2000, and much of this debt is about to come due. Although most of these properties have declined in value and cannot be refinanced at the same debt levels, Zell does not expect a run of foreclosures and distressed sales on these assets. Instead, he predicts a lot of “pretending and extending,” with owners and lenders exploring an array of options before turning to foreclosure.
Faced with the threat of losing their properties to lenders, owners will be inclined to pursue their best available option: dilution. Similar to the spate of REIT IPO’s in the 90’s and new issuances in the past year, owners will be forced to give up the benefits of leverage to obtain liquidity and the value it provides in today’s world. As an alternative to turning to the public markets to source new equity, some owners may be best served partnering with institutional investors to help reduce their debt levels in exchange for preferred returns on the property. The owners may only be left with management fees and a chance to recoup their losses down the road, but many would be wise to dilute and “live to play another day” rather than risk foreclosure. To those in denial about their need for such help in the coming years, Zell offered this bit of advice: “You all ought to come clean by ’13.”
In a bit of good news, “The occupancy scenario will be better than today’s ‘savants’ predict.” Zell said. Pointing to the lack of new construction starts since July 2007, he argued that we currently only face a “demand recession,” unlike the “supply recession” of the early 90’s. Because of this, he expects to see a massive re-leasing of space as owners try to stave off foreclosure. The downside, however, is that the space will be re-leased at significant discounts- 30% below the peak, according to Zell.
Unfortunately, two sectors Zell was candidly less optimistic about were hotels and retail lifestyle centers. He expects hotels to be hit as hard as the general industry was in the early 90’s, as “a lot of the high-end hotel development was massive over-improvement, like the late-80’s, when we emptied all the marble in Italy to build office buildings in America.” As for the retail sector, “There are a lot of hybrid lifestyle centers that will find future value as churches.”