March 18, 2013
Interviewed by: David Snow
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The Real Estate Rebound

Real estate was battered in the financial crisis, but according to Dan Vene, head of real estate capital raising at Fir Tree Capital, and a veteran of the institutional private fundraising market, investors are showing renewed interest in the once-toxic sector.

Real estate was battered in the financial crisis, but according to Dan Vene, head of real estate capital raising at Fir Tree Capital, and a veteran of the institutional private fundraising market, investors are showing renewed interest in the once-toxic sector.

What’s driving the renewed interest in real estate investing today?

Dan Vene: Largely speaking, I would say investors today are looking for some form of yield. And I think there’s a couple of reasons for that, many of which date back about a decade. If you look and think about it, we sort of had a lost decade in stocks. If you look at a 10-year treasury rate today of…I think it’s about 183, with an inflation rate of three percent, you still have a negative real rate of return in the fixed-income market. So most investors that are looking at real estate today are looking for some form of yield and some conservative underwriting, because several of them got burned in the last downturn, when you had kind of unrealistic assumptions built into these models, which allowed them to pay, you know, somewhat higher prices than they probably should have been paying for those assets. So I think when we really think about what the market is looking for, clearly they’re looking for more stable managers, less financial engineering. They’re looking for both operators who can actually go in and have an expertise in an asset class, do some repositioning, try and move away from the trophy asset classes, which are being bought by international buyers who have much deeper pockets and, frankly, are much more accepting of maybe a four or five percent overall total return because they’re looking at it as a flight to safety, to the same extent that they would a treasury, but with another 200 or 300 points of spread.

How does that focus on current income differ from the past? And what impact does it have?

Vene: Yeah, I think that’s right. They… When we look at real estate from the decade of, I would say, about 1985 to 1995—I’m sort of parsing decades there, but you saw about 75 percent of the total return came from income and only 25 percent from residual appreciation or capital gains. That was completely flipped. Those two numbers were inverted from the period of ’95 to 2005, when you had all sorts of momentum investing. And people weren’t even all that worried about the current income being thrown off the property. We’ve now seen sort of a retracement to looking at real estate as a coupon-generating instrument—although ironically we are in the 200-year interest-rate-low environment. So almost nothing is offering yield. And so, you know, even real estate which should be offering yield today is being driven down by, again, that kind of global search for a yield, in the absence of it in the fixed-income market.

Can you describe how investors are looking to invest? Is the interest more in commingled funds or direct opportunities?

Vene: It’s really fascinating when you sit down and speak with one of the partners today. And, of course, there’s not a blanket statement, because each have their own sort of liability streams they need to attend to. And they also have different resources at their disposal within their team. I would say they have generally looked at JVs and direct real estate ownership as an additional vehicle for them to explore. What tends to happen, though, when the rubber meets the road is you tend to see an offering or a project that’s put in front of them. And they have maybe two or three weeks to decide if it’s suitable for them, if they want to move forward. And that takes a lot of work, to actually make those decisions. And I think they start to remember again why they did like the fund model. And so I think what we saw, probably, in 2008, 2009 was a little bit of a knee-jerk reaction, saying, “I’m not going to invest in funds for the time being. I’m going to look at other ways to get exposure to the real estate asset class.” While what happened in reality, they realized that these fund managers, many of them did make mistakes. But there’s also a tremendous number of high-quality managers that did exactly what they said they were going to do. And they continued to perform. And so those managers are now prevailing and easily raising capital, while others are probably having a bit tougher time.

You’ve been a placement agent for many different strategies. How does fundraising for real estate compare to other alternative asset classes?

Vene: Real estate was certainly hit, probably hardest of the major alternative asset classes. So if you look at the landscape, private equity always was the largest. That would be everything from your large firm to your middle-market lending funds—everything in between. In the real estate world, any highly levered asset was forced to de-lever. And so you had upside-down capital structures, and there was a lot of pain there. And so people completely pulled back from that market sector. You saw, basically, an asset class that was generating about $150 billion, $160 billion a year of new capital inflows, through ’05 to ’07 time period. And that went down to about $35 billion a year in the 2009–2010 time frame, and just, maybe just a little bit above that in 2012. So it really hasn’t recovered very much. You’ve had a little separation of the top-tier managers who, again, did what they said they were going to do, used modest leverage, used modest or realistic underwriting assumptions. And those are able to raise capital today, whereas the groups that were getting a little bit out over their skis or using too much leverage or doing momentum trades, they have largely been wiped out of the system. And I think that’s generally a good thing.
Have you found that real estate is viewed as an alternative to fixed-income investments?

Vene: Interesting question. And we have certainly seen that happen. I think, at the trophy end of the asset class, there has been a huge appetite for U.S. central business district, you know, prime properties, and those yields have fallen dramatically. Assets have traded in the three-cap range there. And the only explanation, really, there is again flight to quality and looking at it as a fixed-income surrogate, because a similar-term asset might only have a 1.5 percent yield in the treasury bond. But at least you can get three percent or maybe four percent. And you hope that as NOIs you’ll have a sale on the residual. I think a major concern with that strategy—or just, even more broadly, considering real estate as a fixed-income surrogate—is that there is no CAPEX involved with U.S. treasuries, right? Your tenants don’t walk out of the building every day like they do in a real estate asset. And so it is a bit of a dangerous approach to consider it. And then, of course, also your exit. If you get back par on a bond, all you have to worry about is the coupon you’ve clipped while you’ve held the asset. In real estate, if you’ve paid a three-cap for something, the only way to really make money is to grow NOIs fairly dramatically and hope that someone buys it from you in five or seven years, also for a three-cap. If they’re going to buy it for a four or a five, you’re going to lose money, unless you’ve had fairly significant NOI growth over that time period. So we do think there are some concerns with that sort of an approach.

Alternative investment fundraising has long been viewed as an inefficient process. Is progress being made in making it function better?

Vene: I think there are some approaches that are making a lot of sense in the marketplace. It is an incredibly fragmented business. And really, if you go back to the dawn of private equity and the dawn of private equity real estate, you’re looking at—there used to be 200 or 300 managers out there. Today, there are over 6,000 managers of institutional quality, and at any given time you probably have 1,800 or 1,900 new funds in the market trying to raise capital today. So how does the limited partner look at that landscape and try and make some sense of it? Are there any systematic ways to profile funds and find out what might be a suitable place for me to spend some time? And of the, excuse me, of the hundred or so investable opportunities, the three that I’m really focused on: How do I get the market to generate and to show me those leads where I can actually spend my time, versus just thumbing through all 1,900? And so I think some of the businesses out there have done, made, some interesting approaches. I think some of the more proactive placement agents have thought about ways to use technology. And I think we’ll see a lot more of that in the future. It’s simply born out of necessity. The industry was so fragmented, and it was so…such a cottage industry. And now it’s really become more mainstream, as limited partners have moved up the alternative allocation from, say, five or 10 percent to, in some cases, 30 or 40 percent of their portfolio. It’s not only a much bigger driver of returns, but it’s a much more important asset class that they get right. And they have to find those suitable opportunities.

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