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Jan 10 2013

The 2012 Kellogg Real Estate Conference, “Searching for Yield: Dealmaking in Opportunistic Times”

The Kellogg Real Estate Conference was held November 7, 2012 at the Museum for Contemporary Art in Chicago.

By Sean O’Grady '14, David Smith '14, Daryl Quick '13


The Kellogg Real Estate Conference was held November 7, 2012 at the Museum for Contemporary Art in Chicago, hosting an attendance exceeding 220. The theme, “Searching for Yield” focused on the aggressive pricing across core asset classes and the moves investors throughout the industry are taking to find opportunity at this stage of the real estate market recovery. The day’s events began with an alumni luncheon, followed by three panels and a keynote address from Ms. Debra Cafaro, Chairman and CEO of Ventas.

Panel 1: “Viewpoints throughout the Capital Stack” – Capital Markets
The conference kicked off with a lively discussion about the current state of the real estate capital markets. This year’s panelists brought a depth of knowledge and experience as both debt and equity stakeholders. Jason Choulochas, Managing Director of Ares Management, moderated the discussion. The panel consisted of Joseph Geoghan, Global Head of CMBS Closing & Structuring at J.P. Morgan;
Stephen Quazzo, CEO of Pearlmark Real Estate Partners
Stephen Quazzo, CEO of Pearlmark Real Estate Partners
; and Don Suter, CEO of M3 Capital.

Mr. Choulochas started the discussion by asking the panelists to describe their outlook on the current investment environment. All panelists agreed that we are still in a “defensive and cautious environment”, as Stephen Quazzo phrased it. “Until the fiscal imbalance is fixed and while the European debt crisis remains undetermined, investors will remain risk-averse”, said Don Suter. As a result, investors are continuing to pursue core assets in primary markets with strong fundamentals. Simultaneously, the current low-interest-rate environment has left investors “Searching for Yield”. The panel agreed that both factors have combined to lead to a compression in capitalization rates in core markets.

The discussion centered on the relationship, if any, between capitalization rates and interest rates. When asked about his thoughts on the recent compression of capitalization rates, Mr. Suter responded “it depends entirely on your view of long-term interest rates. The popular view is that rates will go up, and if that is your view, then sub-5% cap rates for multifamily properties are probably too low.” However, he went on to describe a contrarian view: some real estate investors may believe that the US could be looking at a new norm of long-term slow growth, similar to Japan’s “lost decade” or “two lost decades” since the 1990’s. If this is your view, then rates, along with economic growth, will remain compressed and today’s capitalization rates can be substantiated.

Mr. Choulochas then asked, “So where are the current opportunities for yield?” Mr. Geoghan volunteered the success of his platform and the reemergence of the CMBS market. Investor demand for CMBS paper has revitalized as evidenced by both competitive pricing and a strong pipeline of issuances. “CMBS issuances totaled $33B in 2011. We expect the total issuances for 2012 to come in over $40B, and that number is expected to be over $50B in 2013”, said Mr. Geoghan. New competition in CMBS issuance is emerging as well. While traditional CMBS issuers like J.P. Morgan are maintaining conservative underwriting standards, smaller-sized competitors have begun to not only compete on rate, but they are also taking on additional risk by allowing “pro forma underwriting” or giving ground on term, structure, or asset quality.

Despite the return of competition to the CMBS market, overall underwriting standards are still conservative when compared to pre-2007 standards. Therefore, Mr. Quazzo sees an opportunity for mezzanine investors due to the impending “tidal wave” of maturing pre-2007 vintage debt. “There is still a substantial gap in the capital stack” he said, and distressed borrowers will either need to contribute additional equity capital or seek proceeds from mezzanine sources. Mr. Geoghan agreed, and he is also seeing new players in the mezzanine space such as yield-focused pension and hedge funds.

Mr. Choulochas then moved the topic to raising capital in today’s environment. While there is pent-up demand for yield, Mr. Suter stated that it is taking longer to raise capital and there’s been a transition to a “spoke structure”, where limited partners are demanding more governance over general partners. Furthermore, the larger fund managers are reaping the benefits of a flight to perceived quality among institutional investors. However, Mr. Quazzo maintained, “I still think real estate is a local game, and the boutiques will be able to differentiate themselves through local relationships and unique market knowledge.”

Greg Kennealey ’03
Moderator by Greg Kennealey ’03
Panel 2: “View from the Street” - A Market Update by Asset Type
Panelists for the recurring “View from the Street” panel were cautiously optimistic in their outlook for the real estate recovery. The panel was moderated by Greg Kennealey ’03, Portfolio Manager at KSL Capital Partners, and included speakers Keith Anderson, Chief Investment Officer of Equity Office Properties; Jason Lewis, Vice President of Investments at Capri Capital Partners; and Jim Thurston (’10), Chief Accounting Officer of General Growth Properties. Panelists provided an update on the current financing, supply and demand drivers, and rent and sales markets for hotel, office, multifamily, and retail product types.

In general, the panelists thought the current state of recovery was bifurcated, with the coastal “gateway” and “core or A” markets performing much better than suburban or “B” markets. The San Francisco office market is already performing above the last cycle’s peak pricing and occupancy levels, and Equity Office expects Southern California to return to strength in 2-3 years. Strong job growth is driving multifamily demand and pricing in Seattle, San Diego, and Washington DC, although investors should monitor the effect of the impending “fiscal cliff” on DC’s job market. As always the case in real estate, Capri believes multi-family investors and developers should focus on the strongest locations, down to the individual neighborhoods of submarkets. On the retail side, REITs are focusing on their core portfolio and are recycling their capital by selling B assets. All panelists agreed that in today’s new real estate market, firms should be disciplined about leverage, underwriting, and location. If more firms stay focused on their core strategy and don’t overlever or overpay for assets, the recovery will occur faster and stronger.

Panel 3: “Thinking Outside of the Box” – New and Alternative Asset Classes
Peter Stelian ’88, Managing Principal at Blue Vista, moderated the day’s third panel, a survey of asset classes or subclasses not traditionally included in the core real estate conversation. James Goldman, Vice Chairman and Chief Investment Officer of Green Courte Partners, represented the manufactured housing sector. Thomas Scott, Chief Executive Officer at Campus Acquisitions, spoke for student housing. Michael Lincoln ’88, Executive Vice President of Lillibridge, represented the medical office space.

The first common thread drawn between these varied sectors was deal size. It was noted that, for different reasons, the typical asset size is small and, therefore, portfolio level transactions are required to quickly allocate large amounts of capital in each space. This makes the sectors comparatively attractive and viable for smaller, specialized firms. In manufactured housing, Mr. Goldman cited the limited number of communities which can be considered investment grade, which Mr. Goldman estimated at 25%, and a $20 million average asset value. In student housing, Mr. Scott noted a typical $40-$50 million development cost and the need to identify the appropriate location based on school growth and student population, academics, and core infill. In medical office, Mr. Lincoln estimated an average asset size of only 50,000 SF.

The second common theme was fragmentation. Mr. Goldman referred to manufactured housing as a “small but inefficient” real estate sector. Mr. Scott noted that student housing represented only 10% of the multifamily housing sector as a whole. Mr. Lincoln stated that REITs hold only 6% of all healthcare real estate. Potential for consolidation was a common theme among the speakers.

The third commonality discussed was vertical integration. All three sectors are comparatively operationally intensive with respect to other asset classes, which Mr. Lincoln positioned as an opportunity to create competitive advantage through scale and experience rather than as a challenge. Mr. Scott noted that some campus housing investors do manage by contract, but Campus Acquisitions views the management of student housing as specialized and prefers to maintain the operational component in-house.

Keynote Address: Debra Cafaro, Chairman and CEO, Ventas Inc.
Debra Cafaro, Chairman and CEO of Ventas Inc. delivered the final presentation of the day, discussing trends in healthcare real estate and recent Ventas acquisitions.

Ms. Cafaro touched on multiple transformational themes in the healthcare real estate industry, including a senior population growing at three times the rate of the rest of the population, healthcare reform bringing 32 billion newly insured, a transition to general practice physician employment, consolidation of off-campus operations among providers, and a transition from focus on inpatient to outpatient facilities – all leading to increased capital access for healthcare real estate investment.

Ms. Cafaro also highlighted the contrast between her early days at Ventas in the late 90s and the past three years. She illustrated the sector’s late 90s status as a real estate “afterthought” with a tale of her fight to have healthcare REITs listed in the NAREIT Index. She compared that to the period from 2010 to 2012, which saw Ventas, the sector’s second largest REIT, double in real estate value and make $13 billion in acquisitions in the past year alone. Ms. Cafaro attributed the change to investors’ acknowledgement of the sector’s demographically driven demand growth, the less cyclical nature of its revenues, and strong dividend returns. Ventas’ investment positioning, she stated, was that of healthcare real estate in the early 21st century as “core-like characteristics with non-core returns.”

Turning to the subject of dealmaking, Ms. Cafaro focused on the current preferred mode of growth at Ventas – corporate acquisitions. She touched on the several acquisitions across both the senior housing and medical office markets, and presented the recent Cogdell Spencer acquisition as a case study.

The keynote address was followed by a networking reception within the MCA gallery area.

About the Author

This article was written by Sean O’Grady '14, David Smith '14, Daryl Quick '13.