The inventor of CMBS is back and he’s raring to go.
Many industry observers credit Ethan Penner as the inventor of the modern-day commercial mortgage-backed securities (CMBS) market. In the 1990s, Penner built the Japanese-based Nomura Capital brand into a Wall Street powerhouse. But then, just as abruptly in 1998, the firm folded its tent and left the business after an aborted attempt to spin-off Penner’s Capital America division.
Penner, now 47, quietly took his millions and virtually disappeared for the better part of 10 years. Now he has resurfaced in what many view as the most unlikely of venues. In April, Los Angeles-based CB Richard Ellis Investors hired Penner as an executive managing director and member of its executive committee. But the official three-paragraph press release only deepened the mystery about exactly what it is Penner will be doing for the world’s largest real estate company.
In this exclusive interview, Penner sheds some light on the state of the present-day markets and hints at his future role.
NREI: What led you to the CBRE opportunity? What are your next steps, building a business there?
Penner: First, I spent about 10 years of searching for who I was and redefining my life. Then I spent the better part of the last two years meeting with people getting ready to come back. I had a sense that we were approaching a major market turn, that the excesses of the previous cycle were about to unfold and create opportunities that were reminiscent of the 1990s.
I was anxious to find my seat at the table. I found there are a lot of new players. The hedge fund industry when I was on Wall Street was a minor industry, and now they are the big kahunas.
I had a very good vision about what I wanted to do and how I wanted to express myself in this market. One of my main beliefs is that a brand is extremely valuable. I think I was successful in creating real brand value during my time at Nomura Capital America. My main reason was when you have a great brand that people think of as where they want to go to do business then you don’t have to be the smartest guy in the market every day. It’s a big challenge to have to outsmart the market every day. If you’re a great brand, then people with the great ideas and entrepreneurial instincts will come to you to get their business done.
Once you have the taste of that and the value of that, you realize that’s the only way to do business. That was my main criteria. After meeting with tons of people and flirting with the idea of putting together my own private group, I ended up spending time with the CEO of CBRE [Brett White], the parent company, someone I’ve known for quite a while and we met socially. We met in December, played a round of golf, had lunch and we exchanged our beliefs about what the current market looks like, where the opportunities were, and how one might address those opportunities. Low and behold our ideas of how to address things were pretty much aligned.
It dawned on both of us that maybe there would be a good fit for me here. I have an incredibly high regard for the franchise that has been built here. If we could come to terms, I realized this place already had what I wanted already and would give me an incredible running start. I wouldn’t have to take a brand that had no value, like Nomura, and recreate a brand from scratch. Here I was starting with among the best names in the world.
I fancy myself as a guy who knows how to make a brand work financially. My goals are reasonably ambitious, and the really cool thing about this place is that I can’t say I’m any more ambitious than the guys running the place. That is very refreshing for me.
Any idea I come up with is taken seriously and pursued intellectually. I’m going down one main path, which is to create a version of what I created and had hoped to create with Capital America here, with this brand. Every initiative that I seek to undertake in fulfilling that mission is met with enthusiasm and I just love it here.
NREI: What is your plan exactly?
Penner: I can’t give you the specifics or telegraph my intentions right now, but to give you an executive summary, there is a similar void in the real estate finance space today that I was able to respond to at Nomura in the early-1990s. It’s very similar, although times are different, but the theme is quite similar. I will endeavor to create a company that is responsive to that opportunity that exists because of that void.
NREI: You spent much of your career on the residential side of the business. Is that involved in your new position?
Penner: I can fulfill a lot of my potential here, including that. The residential aspect of the opportunity is massive today, and I think we will partake in creating a response to that opportunity as well. We are looking actively at it right now.
NREI: What do you think about what’s happening on the residential side with the subprime mess?
Penner: There were obvious excesses there in hindsight, but it wasn’t just subprime. Every aspect of finance in this country was taken to excess. The cracks became visible earliest in the subprime market because that was the borrower class that had the least staying power or margin for error. It’s natural if you think about it that the stresses in the market would show up there first.
But there is not an area of finance in this country that wasn’t taken to extreme excess, and the cracks in the system are going to be rippling through our financial system for years to come.
NREI: You’ve said that “market dislocations” have a way of working themselves out over time. When will this market correct itself and how much pain will be inflicted along the way?
Penner: [Market dislocations] tend to work themselves out best when the government doesn’t get involved. Take your two extreme examples of how to deal with a dislocated market — Japan in the early-1990s and the U.S. in the early-1990s. In the U.S., the government came in and said, ‘Look, you’ve got losses, and if they’re big enough, you’re out of business and we’ll take over your assets and sell them to whoever will buy them at whatever price the market will bear.’
From that experience, the opportunity fund industry was born, which includes hedge funds. So the cleaning up of the mess took a few years and that set us up for a bull-market rally that went on for about 14 years. In its wake we also now have an organized system of opportunistic capital, which is a buffer to our entire financial health. That didn’t exist before — organized, professional managers managing billions if not trillions of dollars, all of which means dislocations can be moderated.
In Japan, their response was to pretend they had no losses. They didn’t force any banks out of business and allowed forgiveness accounting, and the country is still not out of it — they never had their bull market. They’ve been in a malaise for the last two decades and they don’t have organized pools of capital like we have in the opportunistic world.
In my mind, the free market works. That juxtaposition of those two experiences justifies that when free markets, left to their own with intelligent government intervention that facilitates the free market response rather than obstructs it, [it] sets the stage for a much healthier financial system.
Now we have another revisiting of it where excesses occurred, with plenty of blame to go around, and the free market will have a great response. Companies that made terrible mistakes and were poorly managed will go out of business or out of certain lines of business. New companies that perhaps are better equipped to handle the risks and manage the risks that were poorly managed in the past cycle will emerge. Hopefully I’ll be running one of them. That’s what the free market is about.
NREI: How has Wall Street changed the commercial real estate industry?
Penner: There are unquestionably hundreds of billions of dollars that are available to the real estate industry as a result of the Wall Street participation in that industry post-1990 that were not available before. That has a material, positive impact on the cost of capital, and having more capital is a good thing. The real estate industry has Wall Street to thank for the introduction of and facilitating of all that capital.
Clearly there have been excesses and mistakes have been made, but that’s part of any system. It goes through its fits and as it starts to figure itself out, modifies its regulatory and oversight functions. But the system itself has been an unmitigated success over the last two-decade period.
Look at pension fund allocations. U.S. pension fund allocations to real estate were closer to 2% pre-1990 and now they’re close to 10%. That’s a massive shift. Foreign institutional investment in U.S. real estate was very close to nothing pre-1990 and now real estate in the U.S. is considered a safe haven by foreign investors.
The REIT industry didn’t exist. The fact that there is a big public market for real estate serves as a safeguarding benchmark for people to ascertain values. If you’re a Norwegian pension fund and you want to put money in the U.S. real estate market, you may not want to buy a REIT, but it’s a good check and balance. The REIT industry is not only valuable to the industry because of its presence directly, but indirectly as well.
Wall Street did all that. Now, did the last cycle of 2006-2007 go to extreme excess and is Wall Street partially to blame for that? Absolutely, but that will correct itself in a natural way.
NREI: You have been highly critical of the rating agencies’ role over the past few years.
Penner: Look, it’s one of the things the industry itself has to reexamine. In 1995, $16 billion of new issuances was rated. Last year, $230 billion was rated last year. That’s a dozen years and the same three rating agencies that rated $16 billion rated $230 billion last year.
While I was at Nomura, a lot of people asked me if I thought this would ever be as successful as it has become. I did think that. But did I ever dream that a single year of CMBS issuance would exceed $100 billion? No way would I ever have guessed that. Two hundred billion? Impossible. The industry was a victim of its own success. It just wasn’t ready and with the rating agencies being asked to underwrite $230 billion of credit in a year it’s not a stretch to say they might have been stretched too thin. Even if they were geniuses and attendant to their jobs and responsibilities, that sheer volume of underwriting is beyond the scope perhaps of any one, two or three institutions.
Take the largest institutional investors in the country, like Prudential or MetLife. Maybe they do $3 billion or $4 billion in loans and have an entire underwriting staff around the country. Who’s staffed to do $230 billion of lending? Is it a surprise that they missed a lot? Nobody could have done that volume, and that’s a big crack in the system. How it will all settle out remains to be seen. Does it have a place in the market? For sure.
NREI: You sound like a financier, but many people know you consider yourself a real estate person.
Penner: The people who are in the field of real estate are the most entrepreneurial people I’ve ever met in my life. I enjoy that. I consider myself an entrepreneur, I like entrepreneurs, it’s very revitalizing to be around entrepreneurs.
Second, I love real estate as an asset class for an investment. Over the last decade I did a lot of private investment, in real estate and not in real estate. I always did much better in real estate. A bad manager can really screw up a company a lot worse than a bad manager can screw up a piece of real estate. And a fraudulent and dishonest manager can destroy a business, but you can’t walk away with an office building.
To me, it’s a safer business, for a lot or reasons. The management and the human element is one of them. Another is tenancy. Fashions change and businesses come and go, but the real estate is indifferent to the tenant, right? So if you’re getting virtually the same return owning the equity of a single company or the equity of a building where companies are tenants, it’s a no-brainer. From a mathematical perspective, it’s a better bet. So I’m a huge lover of real estate for all those reasons.
NREI: What do you think the bulk of the industry thinks of you?
Penner: When I hear that someone says something negative about me, I always say that person’s never met me. If somebody’s met me and had something to say negatively about me experientially, I take that seriously. We all find ourselves engaged in idol gossip and passing on stories third hand that we don’t even know, right? Clearly being a public figure I learned that people like to talk about people, especially people who are successful and they don’t know.
I have heard negative things and it’s disheartening, but categorically it’s based on complete untruths. But I take responsibility for that, too, and I understand the calculus of being successful. I feel good about my record. I never did anything to hurt anyone. I always operated with the highest integrity and the people who know me know that, and fortunately for me that’s a lot of people. I think most people regard me as having made a significant contribution to this business. The few people who might view me negatively I would love to have the opportunity one day to convince them otherwise, but I’m not too worried about that.
NREI: What will be your mark in the coming months and years? What do you hope to accomplish?
Penner: The majority of my time off was connecting with my family. I got divorced and thought it was really important for me to spend time with my two kids from my first marriage. I was fortunate to have another child and was able to spend every day of her first five years with her. So that is very precious to me. So I don’t need to do something in the public arena to earn their respect.
I would like to do something in the public arena that sets a good public example for them. I’m very conscious that a parent can only influence their kids through their actions and not their words. I do feel like I want to produce something of value to the world and show my kids the fruits of hard work.
NREI: You’ve said that you manage down better than you manage up. Is that a problem now that you’re with a large company like CBRE?
Penner: Let me put it this way — I like people and the fact that there are a lot of people here is good for me. It’s not an issue. I’m a different person than when I was 32-years- old. There’s a little bit less of the rebel in me, and a more mature version of me. I have an edge but it’s not the same counter-culture person I might have been.