US ROUNDTABLE: Fear of the swan

It is a sunny Friday afternoon in early November, three days after the surprise victory of real estate mogul Donald Trump in the US presidential election. With much of the world still recovering from the shock of Trump’s defeat of his heavily-favored opponent, Hillary Clinton, five property executives have gathered in midtown Manhattan to discuss the current state of the US private equity real estate market, with the potential impacts of a Trump presidency being a key topic of discussion.

Sitting around a conference room table on the 16th floor of TIAA’s headquarters building, the group includes Tony Charles, executive director at Morgan Stanley; Randy Giraldo, managing director of portfolio management at TH Real Estate; Iva Klisanin, vice-president at Macquarie Capital; Matthew Scholl, head of investment management for the Americas at Union Investment; and Paul Sisson, head of Americas for the CBRE Global Investment Partners division of CBRE Global Investors.

For Giraldo, one statement post-election is easy to make: “It is amazing, just as a real estate person, that we now have a real estate developer, Donald Trump, in the White House. It’s unbelievable.”

At this early stage, with Trump not due to be sworn in as president until January 20, the group still has more questions than answers. However, Giraldo believes that Trump’s policies are likely to promote growth in the US economy and, by extension, the US real estate market. “It’s an acceleration of what investors have been predicting, in terms of a rate migration upward, coupled with an acceleration in the overall growth of the economy and in commercial real estate,” he says. “So perhaps this is the kickstarter to getting that actually moving.”

Meanwhile, Charles sees two sides of the coin with Trump. “We don’t know what he’s really going to do, but if you look at some of his positive mandates – infrastructure, tax cuts, looser regulations – that will probably help real estate,” he says. “Trade protectionism and immigration policy are probably negatives to real estate. Net-net we expect to see a small positive bump to GDP growth over the next couple of years.”
He adds that the president-elect’s infrastructure plan may take time to pass through Congress and then be implemented, so any major impact from such an initiative may only materialize over the medium to long term.

Scholl also will be closely tracking Trump’s infrastructure efforts in the US. “Infrastructure is a key component to the long-term success of our investments in the core markets we’re focused on,” he says. “Over the long term, it can truly impact an investment and we remain cognizant of that.”

For him, one potential positive of a Trump presidency is the likelihood of less regulation, particularly from a tax standpoint, which could make the US real estate market more attractive, he says. But the president-elect also has possible downsides for Union’s real estate investments south of the border, given Trump’s campaign vow to do away with the North American Free Trade Agreement. “We’re worried about NAFTA, obviously, with the implications there,” says Scholl. “We are going to actively continue our sourcing in Mexico City. That’s the only market we look at in Mexico, and then exclusively office. Next year will certainly tell us more.”

Overall, however, Union is taking a measured approach to the incoming administration. “We’re certainly looking at this in a pragmatic light and I think that’s the only way to do it right now,” he says. “A bit like Brexit, it’s going to be a wait and see.”

Klisanin agrees. “The execution plan of his policies may not be substantive enough to make an informed view or to take a position,” she says. Like Giraldo, she believes that Trump may help to encourage a stronger sentiment towards economic growth, which in turn would help to spur job creation. “That may flow positively to various sectors such as multifamily – as household formation continues to increase – and office,” she says. “You’re looking at the 20-to-34-year-old demographic and they’re probably still living in groups or at home. Markets are expecting stronger wages growth so you might see a break away from that, with smaller groups or people living independently. The momentum already in place might be heightened by an expansionary policy.”

On the flipside, if the US economy were to grow under Trump, it could further strengthen the dollar, which would make US real estate a growth proposition but also more expensive for foreign investors. This consequently could temper impact on cross-border capital flows into the US, says Klisanin.

Part of the uncertainty mix

But while a general feeling of uncertainty continues to linger over the US real estate market, and is exacerbated by the lack of clarity on Trump’s future policies, the executives differ over how much the US election has contributed to that uncertainty.

“It wasn’t so much a longstanding issue about the elections,” says Klisanin. “It would come up in conversation but it probably wasn’t until the eleventh hour that we started to see a pause and reflection of, ‘What’s going on, is this really going to happen?’ The feedback that I’ve been receiving from various investor groups, it was more like, cap rates have compressed significantly, do we put our money in now? Are we nearing a downturn?”

CBRE GI’s overseas investors similarly viewed uncertainty in the US as being tied to the real estate cycle, says Sisson. “I don’t think I saw any investors hitting pause because of the election,” he says. “There were considerations about whether it was time to sell certain assets and where to allocate. It was more about whether you should be tactical about certain markets; should you go to places other than the gateway cities, should you be tactical about asset classes, is multifamily attractive or is it a defensive strategy? Those types of decisions were more important than the election.”

Giraldo, however, takes a different view. “I feel that the election, whether or not it was stated as a rationale for hesitation, was in the mix as part of it,” he says. “We had a lot of transaction activity in the first half of this year, and we definitely started to notice a marked drop-off in the different categories of buyers on a lot of the assets that we were selling. The layers of capital sources started to peel away as we got into the latter half of the year, and I was ascribing part of that to uncertainty about what happens in November, just as a natural event to get past.”

Sales of commercial properties totaled $32.1 billion in October, down 43 percent year-on-year, according to data provider Real Capital Analytics. Year to date, total transaction volume was 12 percent down from the aggregate volume through the same period in 2015.

Although Trump’s trade policies could have the potential to impact countries like Canada and China – which are two of the largest sources of foreign capital for US real estate – investors from those countries would likely not retaliate by refusing to deploy capital in the US, Charles points out. “I think they will still see the US as an attractive market with strong underlying fundamentals and returns and that would trump any potential retaliation they may feel,” he says.

“While there might be a short-term pause in capital flows coming into the US given the uncertainty, I think that foreign investors will continue to be attracted to the strong underlying fundamentals of the economy and real estate markets,” he adds. “Relative to other parts of the world, the US still looks to be a good bet.”

What is clear is that the outcome of the US election has not altered global investors’ view of the country’s real estate market.

When the group is asked whether their real estate assumptions have changed as a result of Trump’s election, Scholl answers: “For us, it’s a clear no. The US, with the depth and the transparency of the broader market, is a must for our global allocation, and it will remain amongst the top markets on our list in 2017. This would have been the case with a Clinton victory as well.”

Scholl adds that the impact of a Trump presidency on the private real estate market would be less significant than that of Brexit. “The Brexit phenomenon is one that we continue to monitor very closely,” he says. “We certainly see opportunities in the UK as a market, but our view is to wait on the sidelines a while longer to see how this all plays out.” He adds: “With the German bund now, today it’s 25 basis points and it’s been negative as recently as two months ago. Our investors need a place to get sustainable returns and we are accommodating just that in our investment approach.”

Sisson also believes his clients’ allocations to the US – which represent on average 25 percent of those investors’ overall property portfolios – will not change as a result of Trump winning the election. “The US is the cornerstone of every global investor’s portfolio, and I think that’ll remain the same,” he says.

Seeking out new opportunities

Investing in US real estate at this stage of the cycle, however, is a tricky proposition, with some executives feeling the pressure to deploy capital.
“For us, it’s a big issue,” says Scholl. Union Investment opened its global real estate fund, Unilmmo: Global, for a week in May and raised enormous liquidity over the course of five days, which compelled the firm to close the fund for additional unit sales.

“That gives you a sign of the pent-up liquidity that’s looking frantically for return. While we do have enormous pressure to source appropriate product, we are going about it prudently.” One way to address the challenge has been to seek out new types of opportunities. For Union, whose bread-and-butter strategy in the US has historically been office investments, the firm is now increasing both its footprint in the retail and hotel sectors. With the latter property type, in which it made its US entry about a year ago, Union has been focused on lease contract hotels – in which the hotel operator leases the property from the owner and consequently assumes the financial responsibility of running the hotel – and intends to buy more such assets over the next 12 months.

“The lease contract model is attractive because it’s a lease, so there’s guaranteed cashflow for 15 or 20 years or as long as the lease will be,” he says. “We’re buying these in the Downtown Crossing of Boston, or the Central Loop of Chicago – so, Class A hotels in defensible locations.”

For CBRE Global Investors, one strategy where the firm has been deploying more capital is real estate debt. “A lot of foreign investors want exposure to debt, and viewing that as a defensive way to access core markets,” says Sisson. “There seems to be more and more of that appetite popping up from various countries like Korea. So investors feel like they don’t have to depend on outsized growth in a gateway market to achieve attractive returns. It’s a tax-efficient way for them to get a yield and they can still invest in an office building in New York or some other trophy asset.”

More specialized or niche strategies also have grown in popularity – in fact, four out of the five executives say their firms are investing in alternatives to the traditional four property sectors. The CBRE Global Investment Partners team recently closed on an on-tarmac air cargo portfolio and is looking at opportunities in senior housing, student housing and self-storage. “We’re going to asset classes that we think are less competitive and have higher yields but still strong fundamentals,” says Sisson.

TH Real Estate has likewise been investing in storage and medical office, life sciences and student housing – in the last of which, the firm currently has a dedicated closed-ended product. Niche strategies are a significant enough part of TH Real Estate’s real estate investment strategy that the firm is currently aggregating its alternative real estate investments to potentially create a fifth vehicle within its US Cities Real Estate Fund series, which includes one master fund and four sector-specific funds.

“They generally have higher cap rates than the traditional four property types, less correlation to the four property types and they usually have less of an appreciation component to their total return,” says Giraldo. “So they’re yield enhancers for portfolios.”

Meanwhile, Charles sees emerging opportunities where there are pockets of distress within the US. “With the US being the furthest along in its economic cycle, we’re beginning to already see pockets of distress and dislocation emerge, with opportunities both on the core and the opportunistic end,” he says.

With New York high-end residential, for example, there are about 1,000 high-end condominiums – units that are priced at $10 million and above – currently for sale, and about an additional 400 units in planning. With high-end residential sales averaging about 60 units per year, there is about 10 to 20 years of inventory that needs to clear, according to Charles.

Hotels is another sector that could yield investments in markets that are oversupplied. “Some of the commodity-linked markets, for example – Houston is beginning to gap out a little bit in terms of pricing, so there’s some potential plays there,” he says. “And even with Trump coming in, there may be pockets of illiquidity that may emerge, and
opportunity funds will take advantage of that, dive in and try to get decent returns.”

The elephant in the room

As the executives seek out opportunities in US real estate, however, several major concerns loom large in their minds. The prospect of another global financial crisis, for example, remains a lingering threat. “To some extent, real estate investors expect one big downturn,” says Sisson. “They’re kind of worried about it, because it’s fresh in everyone’s minds, even though it was 10 years ago.” The reality is that the downturns have been much more local, and are limited to only certain markets at the present time, he says.

However, Giraldo points that the recent memory of the crisis has overall made the majority of institutions act more prudently, which actually lessens the likelihood that another catastrophic event would occur. “There’s scar tissue that can help us extend the duration of this recovery longer and longer,” he says. “We still have that fear of the swan.”

Meanwhile, Charles worries a little about US interest rates, which are expected to normalize at a quicker pace. “To what extent is that going to start putting pressure on cap rates, and at what point do we need to reach before we see the reallocation of capital out of real estate into fixed income?” he asks. He is hopeful that Trump will help to stimulate economic growth through his proposed tax cuts and infrastructure spending, and that growth in turn would help to offset any cap rate expansion. If growth does not keep pace with rising interest rates, however, then a recession could be triggered, he notes.

For Scholl, the biggest concern is over geopolitical risk, particularly in the aftermath of Brexit and Trump’s presidential win, both of which were driven partly by rising populist sentiment. “It’s the elephant in the room that we can’t think about enough, how it affects every single region of the world at the moment,” he says. “As a cross-border investor, of course we worry about this protectionist theme or trend that’s going around in markets that we have traditionally considered a must for our allocation. That’s a real concern.”

The element of unanticipated events – first with Brexit and then with Trump’s presidential win – has heightened overall nervousness within the industry, according to Klisanin. “We feel comfortable about the fundamentals generally across regions. However, we are seeing a tremendous amount of unforeseen political changes and there are more elections to come that may surprise us, particularly in Europe. Certain countries within Europe still endure economic hardship. Our concern is about the black swan that could come out of Europe,” she says.

When the group is asked whether Brexit or Trump’s election would be examples of black swans, Giraldo quips, “they’re brown swans,” to the laughter of the group.
Scholl, however, acknowledges that the Trump election could give steam to other populist risings in other countries, particularly France and Germany, which are both scheduled to hold federal elections in the next 12 to 18 months. Meanwhile, Italy is due to hold a referendum in December on constitutional reforms to increase the power of its parliament.

“If there is a black swan, there’s multiple ones at work here,” he notes. “Do we call Brexit the kickoff? I don’t know. I think these will all have an effect on what’s happening in Europe in the next 12 months.”

Indeed, given these highly unpredictable times, the black swan event is no longer the rarity it once was.

Tony Charles
Executive director and global head of research and strategy
Morgan Stanley Real Estate Investing
Charles conducts research on global real estate markets to identify products and investment opportunities to meet clients’ investment goals. He develops global macroeconomic, property sector and capital markets updates with his research team and serves on fund investment and valuation committees.

Randy Giraldo
Portfolio manager, TH Real Estate
Giraldo is a managing director and the lead portfolio manager of the US Cities Fund, TH Real Estate’s flagship core open-ended fund in the US. Since joining in 2008, he has held acquisitions and portfolio management positions in the US and Latin America.

Iva Klisanin
Vice-president, Macquarie Capital
Klisanin has over 10 years of experience across banking and corporate finance, working in both the private and public capital markets in Australia and the US. She joined Macquarie Capital in 2015 and is responsible for developing institutional investor relationships across North America.

Matthew Scholl
Executive director in the Americas
Union Investment Real Estate
Scholl is responsible for strategic development of the real estate portfolio in the Americas. Union Investment is on target to invest $2 billion over the next three years in North and Latin America on behalf of its open-ended real estate funds.

Paul Sisson
Head of Americas
CBRE Global Investment Partners, a division of CBRE Global Investors
Sisson has responsibility for both debt and equity investments in the Americas for CBRE Global Investment Partners, the division of CBRE GI that focuses exclusively on investments with operating partners/managers. Investments can include primary funds, secondaries and co-investments across sectors and the risk spectrum

The tech disruption

Of the many game changers in real estate, one disrupter of particular interest to the speakers has been the impact of technology on the sector. This is particularly the case with online platforms like Uber and AirBnB, which have provided alternatives to traditional taxis and hotels. “Technology has exposed overcapacity in a lot of different industries,” says Giraldo. “Technology is going to continue to expose that excess, and that’s a downward pressure on space usage, and demand for space over time. Technology is great for consumers and makes things more efficient, but for certain industries, it can be headwind for demand.”

Then there is WeWork, a shared workspace provider that is now seeking to raise its own fund to buy its own buildings. “They’ve realized that they’ve added so much value through their presence,” he says. With such a company, the investment model would be to buy a building, raise its profile and value as an occupant, and then subsequently capitalize on the enhanced value by selling the property.

But while real estate owners may view the company’s intended transition from tenant to landlord to be a threat to their own businesses, Scholl prefers to think of WeWork as a firm to learn from. “WeWork has been very creative in how they’ve connected with their tenant base,” he says. “This community network is something that has made them incredibly successful, too. As an asset manager of traditional core office, I think you have to be cognizant of that in your own technology platform, how can you implement some of that for your own tenancy, to not be irrelevant. That’s a disrupter that we have to be aware of.”