The industry is in the later stages of both economic and valuation cycles, but a downturn will not be like anything we experienced in 2007, according to Blackstone's Jonathan Gray.
Editors' Note: A quote about the Millennials' share of the workforce in 10 years' timeattributed to Anthony E. Malkin, CEO of Empire State Realty Trust, has been updated to reflect Malkin's comments.
Disruption—and investment strategies being pursued to mitigate negative aspects of it—dominated most of the discussions at New York University’s 22nd annual REIT Symposium held in New York City on April 6. Major disruption is taking place in industrial, office and retail real estate sectors, in the political environment, the current unique real estate cycle and new technologies, according to most panelists.
Equity Group Investments Chairman Sam Zell sat for a one-on-one interview at the event. Silverstein Properties Chairman Larry Silverstein paid a surprise visit, sharing updates on the development timeline for the World Trade Center and then introducing Blackstone Head of Real Estate Jonathan Gray for a lunch panel interview.
Here are key takeaways from the event:
- At the World Trade Center, Tower 4 lease-up has been completed and 3 WTC is on schedule to be completed by this time next year, being already 25 percent leased by global marketing firm Group M, according to Silverstein. “We hope to find a major user soon for Tower 2,” he noted, saying the whole project should be completed by 2022-2023. Over the next five years, Silverstein Properties plans to invest $30 billion in additional funds in the site to “to replace what was there.”
- REITs are navigating how to better deliver value to their shareholders at this point in the cycle, and mergers and acquisitions help drive up values, according to Ventas CEO Debra A. Cafaro. There is talk about continued consolidation among multifamily REITs, according to Thomas A. Grier, global head of real estate investment banking at J.P Morgan Securities. However, mall REITs won’t allow themselves to be taken over even if they are experiencing discounted NAVs, said Mike Kirby, chairman and director of research at Green Street Advisors.
- The industry is in the later stages of both economic and valuation cycles, but a downturn will not be like anything we experienced in 2007, according to Gray. As interest rates go up, “my gut is there will be more privatizations in the REIT sector related to sharp upward movement in rates that get the REIT sector scared,” Gray said. In the current market environment, [BREIT] is able to buy debt, which is what we are doing right now as we warehouse capital for new buy opportunities,” Gray noted. He added, however, that if BREIT doesn’t see good opportunities, it will shut off the capital. “What we’re trying to buy is really stable real estate… If we think pricing gets too high we will stop buying.”
- “Suppression of growth” over the last eight years might mean the real estate cycle has extra innings this time, according to Zell, who said his views on where we are in the cycle have changed to some extent. “Most recessions follow a pattern of exhaustion, but that is not the case today,” he noted, citing the significant amount of capital corporate America has on its balance sheets for real estate investment. He added that the Trump administration is instilling a level of confidence in the economy.
- Relatively strong demand for multifamily has differentiated the current real estate cycle from previous ones, according to Zell. “Oversupply? Yes. Catastrophic? No,” he noted. He also mentioned that he’s okay with the Fed finally raising rates. “I hope interest rates go up; overall business doesn’t benefit from low interest rates,” leaving no rush for growth and no penalty for non-growth, he said. “It is very hard today to go out and make a case for buying assets. I don’t think there is any redeeming factor to redeploying capital at today’s interest rates. The cost of keeping capital is cheap.
- Tax reform is a “low probability event that deserves attention,” according to Matthew Lustig, head of investment banking and real estate at Lazard. “I don’t know if it will get done this year, I don’t think so, but if it does, it will be a big deal for real estate,” he said. Zell does not think there is “much in the way of tax reform that would affect REITs,” but moving toward “something with brutal circumstances for real estate is possible.”
- President Trump’s infrastructure plan is well-intentioned, but held back by too much regulation, Zell said. “His intentions in infrastructure are nothing but the best, but we’ve created so many barriers to do everything. It is going to come down to changing the rules.” Citing economic impact studies as one obstacle, Zell used a hypothetical local example. “Let’s assume that the Verazzano bridge, like all other bridges, needs work. You’ve got to put piling into the river to support the bridge. The minute you do, 25 environmental groups want to know what’s going on.”
- Last-mile industrial space was a hot topic for panelists across the board. “What we like most is the last mile,” said Gray. “It is hard not to be enthusiastic around logistics and particularly the last mile. It is clearly a real trend.” Gray cited national industrial vacancy of 5.0 percent, while office vacancy nationwide is at 14.0 percent.
- Besides e-commerce, the biggest disruptors in the industrial space are the “size matters” trend and the increased use of robotics in fulfillment, according to James B. Connor, CEO of Duke Realty. “We’ve seen a 170 percent increase in square footage of industrial facilities over the past 20 years,” he noted. Modern bulk industrial facilities are absolutely huge and state of the art. It’s go big or go home.”
- The fact that department stores are going out of a business is going to be a challenge, Gray added. “Certain parts of the retail sector are probably going to get re-priced a bit.”
- E-commerce will accelerate the trend of retailers’ store rationalization and bring both threats and opportunities, according to Regency Centers CEO Martin E. Stein. Supermarket operators such as Publix, Wegmans, Kroger and Whole Foods are “excellent operators, using tech to their advantage,” said Stein. He shared how Kroger’s technology can tell how many people are in the store, offers customers the ability to order online and pick up in-store, and has allowed its recent experimentation with delivery.
- The ideal regional mall has just one department store anchor and one grocery store anchor, according to General Growth Properties CEO Sandeep Mathrani. The tenant mix at a successful center would put less emphasis on apparel sellers and more on food, entertainment and non-traditional tech retailers like Apple or Tesla, he noted. “I would have only one department store. In the U.S. we are too fascinated by department stores.” Mathrani added that the lines between different types of retail real estate are blurring. Retail tenants are now more concerned with location than with the format they are in.
- Mathrani doesn’t know why retailer bankruptcies are such surprising news. He noted that retailers should have been downsizing their portfolios for the past 20 years. Meanwhile, GGP has been “pre-leasing at our properties in anticipation of those bankruptcies. In 2012, I bought back 100-plus department store boxes, and I have no vacant space.” The spaces have been leased to a mix of newer brands and former online-only retailers: Victoria’s Secret Pink, Warby Parker, Bonobos and Lululemon, for instance.
- Right now, the office market is “dangerous if you are a commodity asset just competing on rent,” according to Boston Properties CEO Owen D. Thomas. Being a long-term investor focused on long-term rent growth for class-A properties in central business districts (CBDs) and ex-urban locations is Boston Properties’ strategy for fighting disruption. “We are trying to take advantage of evolving core-ex locations,” paying particular attention to place-making, Thomas said. “An office located in a place [with] nearby food, services and retail is critical to successful office investment targeting Millennial workers.”
- In addition to technology firms, the life sciences and R&D employers are emerging as the fastest growing occupiers in the office market, according to Thomas. His firm is chasing life sciences occupiers, he notes, using as an example Boston Properties’ 2016 acquisition of Los-Angeles based Colorado Center from Blackstone.
- Life sciences companies and tech occupiers are now competing for the same type of office space in urban clusters, noted Joel S. Marcus, CEO of Alexandria Real Estate Equities. “It is the collision of two industries fighting for the same locations. We are seeing it in Cambridge and San Francisco, and it will continue,” Marcus said. “You’ll see some secondary locations emerge for tech in two to five years. Seattle and Austin just experienced that.”
- When asked about any surprising developments that might occur within the next two years, Anthony E. Malkin, chairman and CEO of Empire State Realty Trust, said people will be surprised about the impact created by the Millennial generation and their household formation. He referred to office investments in “urban-centric environments” as “a good bet.”