Real Estate Portfolio recently asked Jacques Brand, managing director, global head of real estate, lodging and gaming for Deutsche Banc Alex. Brown, to share his thoughts on the capital markets for publicly traded real estate and the industry as a whole.
Portfolio: Given everything that has happened in recent months, what is your assessment of the state of today’s real estate capital markets?
Brand: In short, the real estate capital markets are fundamentally healthy. We see a well-functioning capital market that is readily accessible, even in the wake of an underlying economy that is clearly worsening, and in the face of our national tragedy. These two factors have caused the capital markets in some other industry sectors to shut down completely.
In the equity market, there have been a number of public real estate companies that have raised capital since September 11, including a $328 million equity offering by Vornado Realty Trust and a $200 million offering by Westfield America Trust—the latter an offering on which Deutsche Banc Alex. Brown was lead manager. Public real estate, gaming, lodging and leisure companies have raised approximately $6.2 billion in public equity in 2001. At the same time, the CMBS (commercial mortgage-backed securities) market is experiencing record volume this year, on the order of more than $75 billion, which is on track for its second largest year. The same holds true for the unsecured bond market, where we have seen approximately $8 billion in issuance as of mid- November 2001, exceeding the previous year’s volume of around $6.2 billion.
What we are observing is that there continues to be strong investor demand in both the equity and debt markets for well- capitalized real estate issuers accessing the market who have compelling stories—and management teams with good track records.
Portfolio: What about the real estate marketplace itself?
Brand: The healthy real estate capital markets reflect the strong underlying fundamentals of today’s real estate markets, which are good in the absolute sense, and very strong in comparison with other industry sectors.
I believe we are in an environment where the real estate business is in the best shape it’s ever been in. First, there is significant financial transparency due to the increasingly public nature of how real estate is fundamentally owned. This in turn has driven public companies to be moderately leveraged and fairly well capitalized.
Second, real estate markets overall continue to enjoy a very good supply-demand dynamic. We have not experienced the overbuilding situation of the early 1990s in part due to financial transparency. Although real estate is an “old economy” business, investors continue to be attracted to it since it has very good earnings and cash flow visibility, stable current yields, and has been one of the best performing investment sectors of late.
Real estate stocks have become both a vehicle to minimize risk and optimize return. In volatile markets, investors looking to minimize risk have found safety in REITs. Many investors have “rotated” out of other sectors into real estate as a defensive strategy, and they have not only enjoyed downside protection as the market as a whole has gone down, but have also realized an investment that has strongly outperformed most of the major market indices. Publicly traded real estate companies as a whole, for example, have outperformed the S&P 500 by some 20 percent over the last two years.
Portfolio: What are your feelings regarding the various property markets?
Brand: In the U.S., we believe that the overall strongest real estate markets are in New York City, Boston, Washington, D.C. and major markets along the West Coast. In general, these markets enjoy fairly high barriers to entry, and their recent supply growth has been below that of other regions.
As far as property sectors, we believe the best office markets now are in New York and San Diego, while the best warehouse markets are Denver, Ft. Lauderdale, FL, Los Angeles and Palm Beach, FL.
Overall, we sense some weakness developing in the nation’s office and retail sectors, although investors should look closely at supply-demand fundamentals in the submarkets in which each company operates and the credit worthiness of their tenants. The entire “telecom hotel” sector, of course, has been hit hard by the correction in the markets. This sector started out as a compelling real estate play, and now represents one of the more challenging sectors to access capital among the property markets.
Portfolio: Back to the office sector for a moment, what impact do you see the current reduced demand and increasing sublease space will have on certain markets?
Brand: Office vacancy rates continue to be historically low, although sublease space continues to come back in certain cities. For example, the vacancy rate in the San Francisco Bay Area has recently surpassed 15 percent and will more than likely rise further. This reflects the fall off in the high-tech sector and the current economic downturn. Clearly there is a growing amount of sublease space as the economy weakens.
Portfolio: One of your focus areas is the lodging sector. What do you see happening in that market?
Brand: Of course, the lodging sector has taken a significant blow as a result of the events of September 11—the impact of obvious concerns among travelers about the safety of air travel combined with the economic downturn.
But this situation should turn around in mid to late-2002, principally because there is virtually no hotel supply coming online in late 2002 and certainly none in 2003. The nemesis of the lodging sector has always been excess supply. Therefore, with virtually no visible [new] supply, and with demand historically growing with GDP, the industry should be poised for growth in 2002 and certainly in 2003. As the U.S. comes out of this economic downturn over the next year, I expect the lodging sector to fare extremely well.
What we are observing is that there continues to be strong investor demand in both the equity and debt markets for well-capitalized real estate issuers accessing the market who have compelling stories—and management teams with good track records.
—Jacques Brand
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Portfolio: Are you seeing any special real estate opportunities outside the U.S.?
Brand: There are huge buying opportunities in the European markets, as European corporations continue to restructure and monetize their non-core assets—including real estate—in order to raise capital and increase shareholder value.
One good illustration of this trend is British Telecom. The company is selling more than $3.5 billion in real estate assets to the largest property company in the U.K, Land Securities, in a venture with a third party.
In addition, the Australian equity markets are incredibly robust. Approximately 50 percent of the investment-grade properties in Australia are owned in the public markets, making it the least fragmented, most consolidated public real estate market in the world. And as a result, the market is bidding up investment-grade acquisition properties in Australia—which means that companies like Westfield and Lend Lease U.S. Office Trust are looking to Europe and the U.S. for opportunities.
Portfolio: In closing, can you give us your outlook for the real estate capital markets in 2002?
Brand: The good news is we should continue to enjoy a healthy, fully functioning real estate capital market, with ample access to capital across the spectrum of debt and equity.
As the U.S. economy recovers—as we believe it will—the real estate markets are in the best condition they have ever been in. That fact alone would argue that we should come out of the current economic downturn in very good shape.
From a public equity perspective, dividends in the industry are fairly stable, so those who have been looking at real estate as a defensive play have certainly selected an investment sector that has given them precisely that.
The flip side of this is that we know there has been rotation by investors out of other investment sectors into the real estate public markets. This would suggest that there are now a number of non-dedicated investors that are really “momentum players” who may gravitate out of real estate into one of the “hotter” sectors as other sectors of the economy begins to heat up over the next year.
This “rotation” challenge facing the real estate market is balanced by the added dimension of new liquidity created as more and more real estate stocks are included into the S&P 500 and real estate companies in general become a staple of a well- diversified equity portfolio.
