38th Annual Cornell Real Estate Conference: Insights on Real Estate Capital Markets from Leaders on Wall Street (Jeffrey D. Horowitz ’86, Warren de Haan ’97, Sherry Rexroad, and Ralph Rosenberg)

Image result for cornell real estate councilAs part of the 38th Annual Cornell Real Estate Conference, Cornell remotely hosted Ralph Rosenberg, KKR’s Global Head of Real Estate; Sherry Rexroad, Senior Product Strategist for Global Real Estate Asset Securities at Blackrock, and Warren De Haan ‘97, Head of Origination at ACORE for a discussion on Real Estate Capital Markets.  The round table was hosted by Jeffrey Horowitz ‘86, Head of Global Real Estate, Gaming, and Lodging at BofA Securities. The discussion covered topics from thoughts on the general macro environment, to views on asset classes, and capital structures.  Overall, while there are still many challenges ahead for real estate assets, there remains plenty of opportunity in both public and private markets.

The divergence in the performances of the real economy and capital markets is stark. At the time of writing, the S&P is up 62.62% from the lows in March while unemployment rates have nearly doubled from 3.5% to 6.9%, with a local high of 14.7% in April.  Despite the poor performance of the real economy this year, Mr. Rosenberg views the current investment environment as strong.  This view is driven by an accommodative Federal Reserve whose forward guidance suggests short-term rates will be “lower for longer”, while quantitative easing (QE) and low inflation expectations have helped to keep the yield curve flat.  This has led to borrowing rates of roughly 2% to 2.25%, while current cap rates on high quality core to core plus assets range from roughly 4% to 5%. However, the divergence in performances is not contained to real economy versus capital markets. The panelists said that they have also seen a clear divergence in valuations between public and private markets.

Mr. Horowitz has seen more public market activity from typically private players, such as KKR, than at any point in recent memory.  Part of this is due to the fact that private markets are valuing assets at a higher level than public markets.  For example, Mr. De Haan noted that while public real estate companies with high quality assets and low leverage are down 29%, private market assets are only down 5% – 10%. For this reason, much of the dislocation trade has been executed in the public rather than the private markets.  Ms. Rexroad believes part of this divergence is due to the increased headline risk public companies face as well as stock price pressure driven by $10bn of outflows year to date.  Additionally, as primarily a public markets player, Ms. Rexroad has seen a wider dispersion of outcomes and increase in market volatility.  This has generated a wealth of investment opportunities leading to relatively easier alpha generation.  While there has clearly been a dispersion of individual outcomes within asset classes, it is also apparent that asset class performance, from industrial to hotel, has varied widely through the onset of the COVID-19 pandemic.

On the debt side, Mr. De Haan views the “darling” asset classes as industrial, multifamily, single family rentals, and life science. Debt capital has steered well clear of retail and hotel assets, especially as the second wave of forbearance requests come in, particularly for hotels.  The strong interest in multifamily is primarily driven by demographic trends including millennials hitting household formation age, government stimulus subsidizing unemployed renters, an increasing savings rate, and the limiting of new construction (which has been exacerbated by COVID-19 related shutdowns. Office assets are more of a dark horse as nobody can reliably predict how workplace behavior will change after the crisis.  Life sciences, while in favor, presents difficult underwriting challenges as buildout costs and weaker tenant credits will result in some projects failing. The risk/reward as a lender is challenging.

In terms of real estate’s risk spectrum from core to opportunistic, Mr. Rosenberg has found the lower risk end of the spectrum most attractive—with borrowing costs low and high quality, high cash flow, low leverage assets available at cap rates in the 5% range.  While there is certainly opportunity to go further out the risk curve, Mr. Rosenberg does not view the valuations of opportunistic properties as sufficiently cheap to account for the high level of uncertainty.  His view is that nobody ever lost their job generating money at the expense of IRR, especially when 10 year UST yield less than 1%.  Levered returns in the high single digits on high quality real estate assets are very attractive by comparison to UST and investment grade corporate debt.

In line with his views on the most attractive part of the risk curve, Mr. Rosenberg also believes that, due to real estate’s cyclical nature, capital structure is key.  Currently, KKR’s real estate funds are running relatively low leverage (ranging from 65-70%) with slightly more leverage on high conviction investments in industrial assets (where leverage creeps up to the low 70% range). In concurring with Mr. Rosenberg, Ms. Rexroad believes industrial companies’ 30-35% leverage is appropriate, and has put them in a stronger position than heading into the financial crisis.  Furthermore, Mr. Horowitz does not think that public companies are incentivized to run higher leverage in the same way that private companies are, partially evidenced by the increased stress seen in the public versus private markets.

All in all, these leaders of industry, from debt to equity and public markets to private markets, view the investment environment as strong given accommodative monetary policy and the possibility of further fiscal stimulus. This is further enhanced by elevated market volatility and the dislocation of high quality, low leverage assets—particularly in the public markets.  However, not all real estate asset classes are created equal. The poor performance of the real economy and behavioral uncertainty have pushed investors away from retail, hotel, and office assets, while industrial, residential, and life science assets have been quite enticing.  Due to elevated uncertainty and real estate’s cyclicality, appropriate capital structure has continued to be essential, and lower risk investments have generally been most attractive —particularly given borrowing rates in the low 2% area.  While there are plenty of uncharted waters ahead for real estate, those who can safely and innovatively navigate will likely come out of this crisis as stronger than ever.

We thank Mr. Rosenberg, Mr. De Haan, Ms. Rexroad and Mr. Horowitz for sharing their valuable insights with the Cornell real estate community.

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