Dennis Desmond
Managing Director, Capital Markets Phoenix

Last night at The Clayton on the Park we hosted 200 clients at our red-hot ULI reception. Fire flames adorned the entrance of our venue making an immediate impact on the crowd. Music flowed throughout the evening while everyone had a great time connecting and discussing the events from this week’s ULI Spring conference.

I want to thank everyone who was able to make our event and please enjoy the photos from the party. See you in L.A. for the fall conference.

-Dennis

The Clayton on the Park: pre-party photos

Benjamin Breslau
Managing Director, Americas Research

I had the opportunity to moderate the opening session of the Commercial Real Estate Roundtable this morning titled “Reading the Commercial Property Barometer”.  Panelists from Prologis, JP Morgan, and Regency Centers all had some great insights about their respective property types – Office, Industrial, and Retail.   

We all know that apartment construction is starting to ramp up quickly, but who would have thought 18 or even 12 months ago that we’d be talking about getting started on other new commercial developments.  While this sounds crazy when you look at the overall space overhang everywhere, there are a few drivers that make some sense.  First, I noted that while overall markets are still suffering from elevated vacancy, high quality large blocks in the best locations are starting to become scarce across property types.  Tenants in some cases are willing to anchor new projects rather than moving to secondary locations even at higher rents.  Second, with pricing for core property skyrocketing and an abundance of capital still chasing, some investors are feeling that their prospects are better to build-to-core and take on development risk (and returns) rather than buy non-core and take on significant quality or leasing risk.  Lastly, debt options have improved and there is finally a trickle at least coming out of the spigot in favor of construction financing for great projects, locations, and sponsors.  

I don’t expect much special construction to ramp up in the near term outside of apartments, but it’s clear the discussion is back on the table earlier than expected in this cycle, and if tenants show interest, developers won’t be shy to put the shovels in the ground where they can.  If new construction soaks up some of the growing demand, it could take even longer before the secondary markets benefit and join in the recovery.  

-Ben

Raj Aidasani
Senior Vice President, Capital Markets

Lee McPheters, Director of the Economic Outlook Center of the W.P. Carey School of Business at Arizona State University, started off one of the council sessions today at ULI.  He began by asking a simple but important question: why has there not been a great recovery after the great recession?  The recession officially ended in December 2009 and yet GDP growth has been 2.8% over the last 7 quarters, compared to a quarterly average of 3.3% over the last 50 years.  The biggest reason for this, according to Professor McPheters, is the consumer.  While there are a number of factors that drive the growth of the US economy, 70% of GDP is made up by consumer spending.  And more than ever, the public is skeptical of the economy and, according to poll after poll, feels that the country is heading in the wrong direction. 

Why is this if there are so many positive data points?  We have had 7 straight months of job growth and are on pace to add 2 million jobs in 2011!  It appears that job growth finally has firm footing and we should regain all the jobs that were lost during this past recession by 2013.  While not as strong as some had hoped, we are in a definite recovery and fears of a double dip recession have been drastically reduced.  Nonetheless, a cloud remains over the public’s perception of this recovery. 

Professor McPheters feels that consumers still haven’t regained confidence to go out and spend and this is primarily because of a handful of reasons: oil, housing and a still-high unemployment rate:

1. Consumers are constantly reminded of how high has prices are because everywhere they drive they see gas prices posted and every week when they fill up their tanks, they see the meter going up and up.  This constant reminder has a huge psychological impact on consumers, even if the differential in what it costs in higher gas prices isn’t that much on the margin in their monthly budget.  Especially given that prices in other products have remained relatively constant and in some cases, have gone down! 
2. Housing prices continue to drop in many markets and should finally stabilize this year.  For most Americans, their homes comprise a large component of their wealth and when they see values continue to decline, they become more cautious with their wallets. 
3. Unemployment remains high overall but especially in certain industries and geographies.  For example, in healthcare, unemployment rates are extremely low but in construction, they remain extraordinarily high.  

This all leads to consumers going at “half speed” and being more disciplined with their money.  This is the “paradox of thrift” – we want people to have less debt and save more, but this actually hurts the overall economy.  He said that a 6% savings rate pulls $660 billion from the spending stream – effectively wiping out the effect of the stimulus program!  In the end, we can continue to have positive data points coming out every month, but the cloud hovering over the public’s perception has to shift for us to get back to where we want to be.

-Raj

Matt Handel
Associate, Corporate Solutions

I just finished up a busy day with the Public Private Partnership council. The day’s agenda included a tour of some of the recent Phoenix development projects including: the new Arizona State University campus, the BioCampus University of Arizona Medical School and the mixed-used CityScape project — JLL shout out from RED development who mentioned the importance of a large UnitedHealthcare lease that was signed for the office portion of the project! With local support from a variety of stakeholders, Phoenix experienced an incredible downtown construction boom during the last decade.

Dave Rodrigue, CEO of the Downtown Phoenix Partnership, said the public and private sectors spent a combined $4 billion on new investments in the downtown during the 2000s (a majority of this investment came in the form of Public Private Partnerships). The story of the Arizona State University expansion into downtown Phoenix was particularly interesting. As explained to us by Rich Stanley, the SVP and University Planner at ASU, Phoenix wanted more downtown residents and ASU wanted to introduce an alternative to its suburban Tempe campus. A partnership was formed between the city, ASU and a private developer that allowed all three groups to succeed even during our recent economic downturn. It was a unique partnership; however it seems like the PPP model will play an increasingly important role going forward.

-Matt

Raj Aidasani
Senior Vice President, Capital Markets

A panel on the real estate capital markets brought together some of the biggest names in the industry including Mark Wilsmann, head of real estate portfolio management at MetLife, Dennis Schuh, head of CMBS for JPMorgan, Peter Sotoloff, Managing Director of Blackstone Real Estate Debt Strategies and Ira Schulman, Managing Director and Co-Founder of Walton Street Capital.

Most of the conversation focused on the return of capital to the commercial real estate market.  Mr. Wilsmann from MetLife said that they plan on hitting the $6 billion mark in originations by July 1st, and could potentially double that amount for all of 2011.  As a point of comparison, MetLife originated $6.7 billion of debt in all of 2010.  Mr. Schuh said that JPMorgan alone could hit $10 billion in new CMBS originations in 2011 – almost equal to the entire CMBS market for all of 2010.  Mr. Schulman said that Walton Street has already invested $900 million in commercial property in 2011 with a significant amount going to office, hotel and retail properties. 

The moderator of the panel, David Sonnenblick, asked how life companies have become so competitive given that they haven’t really changed their risk profile.  Mr. Wilsmann pointed to a number of interesting factors reshaping the dynamic of the lending market.  First among them is that the market downturn has created smarter borrowers.  Borrowers he said want relationships again and don’t want to deal with the complexity of highly structured deals and servicers that treat them like numbers.  In addition, life companies can be flexible on structure and can work with borrowers on things like prepayment fees – which are basically set in stone for CMBS loans.  Mr. Wilsmann said that life companies now don’t see mezzanine financing behind their senior as a bad thing – depending on the mezz provider.  He said that if Blackstone provided the mezzanine financing behind one of his loans for example, he would have more comfort and view it as having two strong sponsors and an “equity cushion.”  Lastly, life companies he said can easily do very large loans without jumping through a lot of hoops or worrying about the exit and this gives them a big advantage over CMBS, mortgage REITs and private equity. 

The conversation then moved to leverage and pricing.  Life companies will still be in the 60 – 65% range and CMBS will go up to 70 – 75%, with pricing for both ranging from 4 – 6%.  Blackstone is providing subordinate debt in the 70 – 80% range at yields of 10 – 11%.  On the equity side, Walton Street is still targeting yields in the teens but will go sub-10% in some cases.  Overall the panelists were very positive on the market and were excited about the opportunities available despite the increasingly competitive environment.

There’s a tremendous sense of frustration with investors that our federal and municipal incentives are focused on alternative energy production rather than demand reduction strategies. While it is important that there are subsidies for supply side solutions, many of these technologies have challenging ROIs without the added incentive provided by only a handful of states. However, building consumption reductions of 10%, 20%, or even 30% can be easily achieved by demand modifications such as lighting upgrades, HVAC control modifications and other operational changes.

The difficulty for many owners is around financing.  If the government developed innovative loan programs for building retrofitting strategies that improve existing buildings energy demand, we could see a dramatic increase in this type of work being completed  This type of government program, focused on  short term ROI payback, could finally make energy efficiency projects more accessible to building owners than ever before.

Kristin Mueller
International Director, Retail

I heard an interesting case this morning for increased M&A activity in the shopping center sector.  In terms of balance sheet strength and cost of capital, it’s never been a better time to be a REIT.  Over the past few years, the larger market-cap retail REITs have been very successful — and more successful than the smaller market-cap retail REITS at raising capital.  This capital has been used to strengthen their balance sheets, rather than for growth, in part due to a lack of properties to acquire. 

Core grocery-anchored shopping centers are the most sought-after retail product today.  Demand far surpasses supply, and a lack of new development isn’t helping the situation.  So, while the larger REITs have access to capital, they’re not able to drive desired growth through acquisitions.  Shares of the larger market-cap REITs often trade at a premium to the value of their assets, while the smaller and mid-sized market-cap REITs trade at a discount.  All of this adds up to an environment perfect for mergers and acquisitions.  For the larger REITs, acquisition of smaller REITs is an excellent means for growth and the key is buying portfolios of equal or better quality, so that the portfolio’s value isn’t diluted.

 -Kristin

Scott Melnick
Managing Director, Capital Markets

Robert White, President of Real Capital Analytics, showed that public REIT’s were responsible for over 18% of acquisitions last year and that the trend will continue as the flight-to-core, in-fill assets continue to be rewarded in the equity markets. He referenced that REIT’s have been able to literally raise $300-$400 million of debt or equity “overnight”, and  that it actually is still a form of de-leverage since the most recent acquisitions are generally all cash.

Statistics were presented outlining a 20% increase in cross-border investors and White made specific reference to the large amount of Canadian investment in US real estate. (FYI: JLL’s recent $286 mill multifamily portfolio sale was fueled by a Canadian pension fund). While he projected that only 60% of loans maturing this year will actually get paid off on time, it is a significant increase from last year’s approx. 50%.

According to White, “Multifamily is behaving very differently from all other asset classes” with significant debt, equity and development alternatives. The stability and growth potential of multifamily creates continued investor demand and price appreciation. 

David Clark, Vice President of Northwestern Mutual also expressed a multifamily focus, with a record number of multifamily quotes in the 1^st Q of 2011 and a corresponding high success ratio.  Life Company debt/equity alternatives will continue in 2011 with a projected increase in 2011 volume to $45 billion from last year’s $35 billion.

The general consensus was that buyers of all product types are focused on  long term income. While stable assets in gateway cities are most preferred, they expect to see a bigger push for private buyers to become active in markets such as Minneapolis, Denver and Phoenix. The abundance of capital available for at least the next 24 months will create more opportunities for all assets classes and sub-markets.

-Scott

Steve Collins

While we are all gathering in the American Southwest for ULI, investors around the globe are revealing their appetites for acquiring foreign assets.  Cross-border direct commercial real estate investment volumes reached $37 billion the first quarter of 2011—that’s up 25 percent from a year ago–and it shows no sign of slowing down any time soon.

Of the top 10 city markets in the first quarter claiming the highest investment action, five were in Asia Pacific including Tokyo, Singapore, Hong Kong, Seoul and Shanghai; three in the Americas, New York, Washington DC and Los Angeles; and two in EMEA, London and Manchester.

So who’s buying?  We’re finding the most active purchasers so far this year have been the global funds from Canada, Singapore and Germany.  Tokyo will obviously feel the impact of its natural disasters, while London remains a focus for many cross-border investors and the re-kindling of the U.S. market will bring us back into the top 10.

-Steve

Keith A. Largay
Senior Vice President, Capital Markets

The keynote speaker yesterday afternoon was Brad DeLong, an economics professor from the University of California, Berkeley.  DeLong provided insight into what caused the financial crisis that put the real estate industry and the entire economy into a tail-spin in 2008.  We all know the causes were sub-prime lending, a residential housing bubble, poor underwriting standards, and a lack of understanding risk.  However, all these factors were simply symptoms of the broader cause — a glut of international savings seeking a “safe haven” in the U.S. markets.  As foreign investors sought safety in investment grade securities; yields were driven down and investor risk continued increasing to achieve desired yield.  This created a cycle of ever decreasing credit quality due to the undersupply of quality investment opportunities. 

As we look forward, we must continue to look at global capital flows, not just in real estate, but across the capital markets to understand the implications it will have on our businesses and overall economy.

A very refreshing comment made by DeLong was that like most economists, he was completely surprised by the events of 2008.  He went on to say that often when economist projections are right; their timing is often off by years.  For example, one of his colleagues properly forecast the sovereign debt crisis is Greece and Portugal, though he forecast that they would default no later than 2006, not 2011 like what actually happened. 

Looking forward, DeLong is an optimist.  Driven by population growth of approximately 1.5 million people per year, the U.S. real estate market has to recover.  These new additions to the U.S. population need places to live, shop, and work.   This recovery may be slower and more drawn out than historical downturns, but when the market does turn, it will turn quickly.  And with respect to the housing market, he predicts a major new development spree in more urban locations where people can live close to work and entertainment.

-Keith