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April 20, 2009
Real Estate Finance Panel
Looking Back at Signs of Trouble, and Ahead to Recovery
By Jim Schroder, WG’09
Looking Back at Signs of Trouble, and Ahead to Recovery
On the evening of Wednesday, March 25, the Wharton Real Estate Club convened its annual Finance Panel. Moderated by Professor Peter Linneman, the panel opened with a discussion of how the industry should have acted differently in 2006-2007, at the height of the real estate boom. Across the board, the panelists -- Joshua Benain of Square Mile Capital, Neil Amin, W'00, WG'01 of Shamin Hotels, Jared Kushner of Kushner Companies (and The New York Observer), Mark Streetcar of JP Morgan, and Peter Sotoloff, W'00 of Blackstone -- wish they had purchased fewer properties and sold more. Any commercial acquisition from 2006-2007 was inherently overbid, they collectively agreed. For real estate professionals to openly acknowledge mistakes does not happen often, but these are interesting times.
The deeper discussion ensued when the panel focused on what signs they should have noticed. Streetcar pointed out the warnings he noticed when major real estate companies, such as Simon Properties, would issue Commercial Mortagage-Backed Securities (CMBS) deals with a credit rating of AA- or A+ when the underlying assets had 65% LTV, even though the company itself was rated BBB with 50% LTV as a firm. Though Streetcar argued this inherent problem with investors at the time, he regrets that he "did not raise [his] voice louder or bang the table harder."
For Kushner, he pointed out that his family's firm purchased billions of dollars of real estate in a span of 30 days in 2007. The coverage ratio was less than 1.0, and the debt had an effective zero coupon. The banks were not underwriting on the fundamentals of the cash flows but on the assumption that the properties would appreciate in value. Peter Linneman responded by commenting, "I have seen these types of [zero coupon] deals four times in my career, and each time is followed by a recession within two years." Even so, as Kushner pointed out, hindsight is always 20/20, and it is easy to get caught up in the bidding frenzy.
As the discussion progressed to the current markets, all panelists agreed that they have a better understanding of risk. Yet none was willing to conjecture on when the credit markets will unfreeze. Bernstein pointed out that both debt and equity remain on the sideline because "stress has not turned into distress." The "slow bleed" of companies such as General Growth Properties has promoted the formation of opportunity funds, but no one has been rewarded for jumping in to acquire such companies, or even the distressed debt.
Consensus held that firms are still waiting for the government to figure out how to treat the troubled assets on companies' balance sheets, and that Treasury Secretary Geitner's announcement of TALP and PPIP would move the markets in the right direction.
Streetcar emphasized the importance of the AAA CMBS tranches as the key indicator of when the bottom has hit. "When AAA CMBS returns to 7-8%, we will see a return to normalcy," he stated. When the conversation concluded on the job market and prospects for graduating students, the comments echoed the words the Real Estate Club has been hearing all year: focus on asset management, government (FDIC and OCC, in particular), and workouts. To lighten the somber mood, one panelist joked that "working for JP Morgan is basically like working for the government these days, right?" Kidding aside, another panelist noted that workouts are "painful, adversarial, and [it is] never fun to break someone's dream" when you foreclose a property. Yet, all panelists agreed that the skills you can learn from operating an asset on the property level will become an invaluable experience later down the line.
After all, this is when the less committed people leave real estate, and those who persevere will become the highly successful real estate professionals 10-15 years from now.
From my perspective as a student listening to the panel, yes, it was brutally painful to hear the lack of job opportunities. Yet for those of us who are committed to real estate, we will get jobs -- maybe not exactly what we were hoping for, but we have long careers ahead and this is only the first step. And while I continue recruiting, you can be sure I will be watching the AAA CMBS for signs of light at the end of the tunnel.
This article was reprinted from The Wharton Journal.
