2010 Real Estate Symposium: Macro Trends Panel
By David Kwitman,’11, CFA and William Behuniak ’11
Although each city, sub-market and building has its own unique fundamentals, the influence of the broader economy has a significant impact on the world of commercial real estate. The common theme of this session was uncertainty, both on the speed and strength of the recovery, as well as on the impact of inflation and the actions of the Federal Reserve.
Panelists included Michael Acton, managing director of AEW Capital Management, Michael Gilberto, former managing director at JP Morgan Asset Management and an adjunct professor at the School, and Dan Heflin, CEO and chief investment officer of Torchlight Investors. Moderated by Chris Mayer, senior vice dean and Paul Milstein Professor of Real Estate, the panelists explored topics including interest rates, inflation, economic growth, and unemployment and the impact these factors have on the real estate market.
Overall, the panelists expressed a belief in a “constrained recovery” with a “drawn-out recapitalization process” that would be characterized by longer lags between fiscal stimulus and economic response than what might historically have been observed. As it relates to real estate, this lag would mean a longer period between economic growth and increasing employment, and subsequently positive absorption of vacant space. Gilberto predicted “subpar growth” in the vicinity of two percent going forward and added that we are more likely to see a downside scenario with one percent growth than an upside scenario three percent growth and noted that small business demand for growth capital and labor was weak given the still tenuous state of the economy. Acton indicated that he did not foresee a double-dip recession given the Fed’s willingness to inject money to whatever extent necessary.
The discussion then moved toward the motivations behind the increasing popularity and prices of core assets. Heflin thought it was hard to be a fundamental investor in the current environment when many key growth and leasing assumptions remain contingent upon the expectation of continued Federal Reserve support. That said, he did see better relative value in real estate vis-à-vis other asset classes despite the tightening of cap rates for core deals amidst strong demand and low supply. Investors have been willing to buy Treasuries at a yield of two percent and core properties at valuations rates increasingly reminiscent of pre-crisis levels due to a desire for safety.
The panel reflected that while most of the industry is underwriting rent and occupancy growth, this may be optimistic. Heflin further explained that near zero interest rates mean that asset prices are artificially high and absolute returns are artificially low, requiring purchasers to underwrite growth in order to make acquisitions attractive. This contrasts with the serious concern about a meaningful recovery with job creation, as it is unclear where such jobs might come, in addition to the threat still posed by external events, such as Ireland’s continuing fiscal woes.
The panel concluded with a discussion of inflation and the protection provided by commercial real estate. Mayer explained that historically real estate prices move with inflation, but this does not take into account the capital required to maintain the asset. While real estate has been marketed as inflation protected asset, Acton expressed that because the United States has not seen significant inflation in nearly thirty years, this may or may not turn out to be true going forward. The panel agreed that the importance of supply and demand outweighs the impact of inflation – in a tight market, inflation helps landlords push rents, but it does not have the same impact in a market with high vacancy. Heflin added that the potential coming of inflation will be beneficial to commercial real estate owners, especially those with fixed rate debt, but it remains an issue of timing, as investors are forced to speculate on the actions of the Federal Reserve. Finally, Gilberto concluded that there are opportunities for investors, especially in supply constrained markets, but ultimately it is a story of asset selection and market selection.