Here are a few notes from the SIOR Fall Convention 2015 that was held in Chicago this past weekend, October 8-10.
National Industrial Perspectives
This session was moderated by Jim Costello from Real Capital Analytics who brought excellent research slides and five superior panelists including Roy Splansky from the sidelines. The primary emphasis was to contrast different strategies based on the type of capital being used. There was a REIT specializing in secondary markets; a buyer of NNN assets who also does joint ventures and pre-sales; a buyer of value-added industrial; and a mortgage broker.
For instance, one buyer borrows from Life Companies to finance new industrial construction with long term credit tenants in major markets. In addition if you have an investment grade and long term 20-year lease, it is possible to take cash out, in excess of replacement cost, as in a Credit Tenant Lease (CTL). In contrast, a different buyer relies on CMBS finance, now available in greater quantity, to finance older buildings in secondary locations with weaker credit. Yields are of course higher. Additionally, CMBS will lend on older product at 75% of appraised value even if the deal price is lower. The common thread shared by all buyers is they are looking for at least a small advantage that boosts returns.
Real estate portfolios were a strong topic. Cash makes large institutions nervous. Real estate is a secure yield and offers safety. Large Buyers need to deploy cash in very large chunks. They can’t do that in one-off transactions. Portfolio Sellers receive better pricing than if they sell a single LLC and can include difficult properties at the same time. In particular, Sovereign Wealth Funds have a different profile than most other investors. Sovereigns rely on low amounts of debt and very long holding periods, but they won’t purchase single properties. For others, portfolios are a strategic way to spread risk over many buildings while taking on lower credit and shorter lease terms thereby mitigating overall exposure and retaining their own high credit rating.
In this low cap rate environment, many look to build. The market is ripe for new construction because of historically low vacancies, especially in Class A space. Because of the space shortage, large users have no other option than new buildings. Speculative construction is well rewarded in most parts of the U.S. The choice these panelists face is either to pay up for for existing product or take on development risk. Normally developers are receiving 150 to 200 bps for taking on the additional risk of speculative development. Texas has a lot of product in the pipeline, whereas the Southeast has supply shortages and good demand fundamentals. Developers naturally seek out markets with strong population growth. In order to obtain financing on new construction developers need one of three things – pre-leasing, a guarantor, or equity.
In terms of finance, Moody’s Corporate B yields are a good precursor to the movement of cap rates. Recent market turmoil has caused CMBS to increase by 80 to 90 bps; Life Companies are only up by 20 to 30 bps. In terms of interest rates, Life Company spreads are 180-200 bps over 10-year treasuries for 65% leverage. CMBS spreads are 245-275 bps over 10-year swaps for 75% leverage.
There was a lot more to this session and I thank the remaining panelists, William Barry, Draper & Kramer; Don Pescara, Griffin Capital Corporation; Ryan Stoller, Venture One Real Estate and Brad Sweeney, STAG Industrial.
Technology Disruption in Commercial Real Estate (CRE)
Steve Weikal from MIT ran two sessions focusing on industry disruption from many new CRE technologies. One session began with Brandon Weber of Hightower who pointed out the commercial real estate business is rapidly institutionalizing and these acquiring entitles require new tools for reporting, transparency, metrics, analytics, and prediction. He also posted a quote from Marc Andreessen, “software is eating the world” foretelling how the real estate industry will evolve.
During the presentation, Mr. Weikal divided the technology applications into two major categories, Workplace and Workspace. Within these categories he named almost 50 applications out of hundreds more that are available. Up until this point, most of the “app economy” has been targeted at residential real estate but the sights are now drawn to commercial. There will be a lot of niches to exploit once you put together the right technologies.
While I won’t list all the products that were named, the categorization alone was enough to gain a sense of where the industry is headed. Each sub-category shows how the industry is splintering and different vendors are carving out areas to master. Under the Workplace category came Data Visualizing, Find and List, Analyze, and Manage the Process. Under the Workspace category, we looked at Workflow and Traffic, Sharing Economy, Virtual and Augmented Reality, and Big (small) Data. My personal favorites are the apps that help me do more transactions.
In a follow up program, I hope to learn how quantitative data is serving large buyers and developers to make big decisions. As in other industries, technologies like those discussed, directed to the business of commercial real estate, will have disruptive consequences to the status quo. It’s now our turn.
During the presentation, Mr. Weikal made the following additional points: There is a strong city focus with millennials looking for the urban experience for creativity and energy. If not 24 hour cities, at least ones that are open 18 hours. “Urban Burbs”, live work and reduced car ownership are parts of the new development patterns. He also reiterated more data and better transparency; analytics and decision making; and decreased transaction friction underlie many of the new technologies.
I was happy to hear that the brokerage business would not disappear like travel agents. Commercial real estate is a complicated business that benefits from experience. However, those that take advantage of new technology are the ones who will prosper.
The premier real estate economist, Dr. Peter Linneman, closed the conference. His first point was the troubling gap in GDP from a normal growth pattern is attributed almost completely to weak housing production. We are producing only 65% of what would be expected under historical conditions.
Consumer spending at “Brick Retail” is flat because of increasing internet sales. However if ecommerce ran under normal revenue assumptions, the price of goods would need to rise 25%-40%. How long can companies afford to pay for growth?
Other factors that weigh on the economy include average Consumer Confidence, below average Small Business sentiment, and low rents in suburban office. One surprise was that industrial construction is at the highest levels ever, and while not by itself a cautionary signal, if demand falls, we could be facing excesses. Still, the overall market continues to have very low vacancy rates.
It was an excellent conference. Many major developers and investors attend on a regular basis to get access to the finest brokers worldwide. Social activities are an important part of the conference where we can personally meet our peers and clients. Meanwhile SIOR is embarking many new initiatives and ventures so we can continue to provide relevant and effective services to our clients. Next year we will be in San Diego, London and New York City.