During his 37-year career, Harvey Green has been involved in every aspect of the real estate industry, including development, commercial leasing, investment sales and company acquisitions. All totaled, the CEO of Marcus & Millichap Real Estate Investment Services has initiated the close of real estate transactions valued at nearly $6.6 billion. NREI asked Green to put into perspective the evolution of the commercial real estate investment market over the past half century and to gaze into the future.
NREI: How has the real estate investment decision process changed over the past 50 years?
Green: It used to be much more of a ground-up and local process dominated by institutional investors and a few high-net-worth individuals and families. The drivers were based on the knowledge of local markets. And decisions were based on one's limited ability to predict threats from economic downturns and oversupply. Finding available land and analyzing whether it was in the path of growth were the only ways to determine future supply and demand. Investors needed lots of equity, and returns had to make sense to lenders who were quite conservative.
Over time, the number of commercial real estate investors expanded significantly, along with the wealth of the country. The asset class became more sought out because of its attractive returns. By the 1970s and 1980s, real estate emerged as an inflation hedge and tax shelter, which began to move the supply/demand orientation out of balance.
Consequently, we saw overbuilding and over-investing in both decades. Much of that was corrected with the credit crunch and S&L crisis of the early 1990s. Moving into the 21st century, the industry began to evolve into a more transparent, mainstream sector as public REITs expanded and themarket provided ample capital.
NREI: Since there were no broad data sources available 50 years ago, how did investors decide what to buy, where to buy and what to pay?
Green: Investors remained local for the most part, especially passive investors whose expertise was in other professions, but who wanted to invest in real estate to build wealth. It wasn't until the last 15 to 20 years that private commercial real estate investors became comfortable with the idea of investing outside their local markets. Over the past 10 years, investing outside one's market became far more pervasive due to the growth of technology and data.
NREI: Has the growing role of institutional investors helped or hurt the commercial real estate investment market?
Green: Their influence has definitely brought a higher level of transparency, capital and sophistication to the industry, and it partly explains why we have not grossly overbuilt the sector this time. Even the commercial mortgage-backed securities (CMBS) model was a positive factor because it provided badly needed capital and funded many good investments and developments before the market became frenzied.
NREI: Has the growing role of Wall Street in commercial real estate investments been a negative in light of the current financial crisis?
Green: It was largely competition among capital sources and a major investor appetite for yield around the world that started it all. This led to lowering of underwriting standards and conflicts of interest between Wall Street and credit agencies, which in turn enabled speculators to overdo it by making capital ample, cheap and easy to obtain. The CMBS model itself was sound; it was the execution of it that brought on the negative effect. I referred to it as the “capital markets house of cards” in various industry conferences and events as early as 2004 as the market frenzy was beginning to build, not so much because the CMBS model was flawed, but because of the way it was being executed.
NREI: Is the investment sales market totally moribund, or aregetting done?
Green: Most people don't realize that transactions are still occurring. During the first three quarters of 2008, 15,200 transactions valued at $1 million or higher in the four major property types — apartment, industrial, office, retail — had closed. While that figure is down more than 50% compared with the prior year, it is still quite a large market and financing is still available through alternative sources.
NREI: For today's ailing commercial real estate market, what are the mustard seeds to recovery?
Green: Unfortunately, we have gone from a below-trend downturn to a serious recession and it will take time for government intervention and market forces to cause a turnaround. If housing bottoms by mid-2009 as we expect and job losses begin to subside, we should see at least a moderate year of growth in 2010. Commercial property sales should begin to increase by mid-2009 due to narrowing of the gap between buyer and seller expectations. Sellers are likely to become more realistic about valuations, which should result in more deals. A sizable inventory of distressed assets and commercial paper finally will come to market via banks, financial institutions and government agencies. Over the long term, CMBS will likely make a comeback in some form because its benefits in a normal market are so compelling.
NREI: What will the commercial real estate investment market look like in 10 years?
Green: Investing in commercial real estate will be even more common among institutions and private investors. Today's setback aside, institutional investors and foreign buyers will be attracted to U.S. commercial real estate because of its promise of long-term returns. The correction we are in will create great buying opportunities. Also, as baby boomers conduct the largest transfer of wealth in history to echo boomers, many first-time investors will enter the commercial real estate business. Institutional allocations to commercial real estate will eventually increase. Their allocations before the recent stock market correction were only 8% of total assets. The sector will come back into favor.
NREI: How active do you expect foreign investors to be in U.S. commercial real estate?
Green: The current financial crisis and the “flight to safety” benefits the U.S. and hurts the prospects of emerging market investments, at least in the short term. Once the U.S. comes out of this recession with a strengthened financial system and excesses taken out, U.S. assets will once again be comparatively attractive, including commercial real estate. I expect that global demand for investing in the U.S. will increase starting in 2010. The commercial real estate correction will add to the investor appetite. Investing in specific properties by private foreign investors will grow, but fund flows will continue to be dominated by foreign fund managers and institutional investors with U.S. partners.