WHAT THE BIG BRAINS ARE SAYING

About 1,200 of my closest friends and I recently attended the “Real Estate 2006” conference on March 13 at the Hyatt Regency in Century City that is organized annually by Real Estate Conference Group. A great guy named Marty Stolzoff started this event many years ago. He built it into the leading real estate conference in the market (I should be politically correct– UCLA and USC also do a good job with their real estate conferences). Real Estate Media, the company that publishes some very savvy publications like Real Estate Southern California, Real Estate Forum, and Globe St.com, bought Real Estate Conference Group a few years ago. They have continued delivering great meetings. Boy, after that pitch, I had better get my endorsement check. The annual conference brings together some of the smartest people in the business. They spend a whole day telling us what is going to happen from their perspective. You should make a point to attend the next one. They also host an annual Apartment conference that I reviewed in an article last year. Be looking for that in September. Attending is money well spent.

The country singer, Kenny Rogers, had a popular song about twenty-five years ago with the line, “You got to know when to hold ’em, know when to fold ’em, know when to walk away, and when to turn and run.” The song’s words became a mantra for just about everything in life. I think Kenny should have listened to himself before opening those roast chicken restaurants, but that’s another story. My goal for attending the “Real Estate 2006” conference was to have the speakers tell us whether we should “hold ’em or fold ’em” this year. Have we had enough “irrational exuberance” as former Federal Reserve Chairman, Alan Greenspan, was fond of saying, or was there more on the horizon? It is always easy to give advice when the signals are clear or we are in the middle of a normal 4-6 year cycle. It is when conditions are extended– one way or the other– that we go look for the proverbial guru on top of the mountain to tell us what to do. Remember how long the bull market of the Ronald Reagan presidency lasted? It lasted the entire decade of the 1980s, and was one of the longest sustained periods of growth in our country’s history. After about five or six years, the experts kept on saying it cannot last much longer, but it did.

Well, after listening to panel after panel of people with large brains at the conference, I feel that we are in somewhat of a similar situation when it comes to real estate. Specifically, the speakers would like to tell us to take some chips off the table, but they did not quite go that far. Why, you ask? Well, to quote Everett Dirkson, who was the Majority Leader of the United States Senate back when Lyndon Johnson was President, “A billion here, a billion there, and pretty soon it adds up to real money.” You guessed it, the overriding theme by the panelist was that money, money, and more money is driving the market. Moreover, it is not just a billion here or there, rather, it is hundreds of billions here and hundreds of billions there. “Where is the money coming from?” you ask. It is money from pension funds, money from oil producing countries, and money from Baby Boomers.

Now let’s move on to some direct comments by a few of the speakers and panels. This will give you a flavor of the day.

Sam Zell,
Chairman of Equity Office and Equity Residential

As the head of two real estate investment trusts (REITs), Sam Zell is the largest owner of office and apartment buildings in the country. That makes him someone we need to pay attention to. In Wall Street lingo, he can “move the market” by his words and deeds (and he does have a
lot of deeds… a pun occasionally necessary just to make sure you are paying attention), so you know his comments were not off-the-cuff. He was the keynote speaker of the event.

Here are a few of his pearls of wisdom:

• The law of supply & demand is the most important thing to know in order to understand the status of the market. There is an oversupply of capital in the world, and it will take 5-7 years to work through it.
  
• As an example of the abundance of capital, Saudi Arabia has been pumping 10 million barrels of oil a day for the past ten years. When the price of a barrel was $20, they had a cash flow of $200 million a day. Now, oil is $60 a barrel. They have an additional $400 million a day to deal with.
  
• The true cost of capital is 3% over the rate of inflation.
  
• He is bullish on real estate. There is a widening gap between replacement cost and economic value. Basically, investors are settling for lower yields than in the past.
  
• Regarding the principal of “are we in a bubble,” he stated that assets with no intrinsic value (basic value) are what cause bubbles because their worth can go to zero. As an example, in the 1600s, there was a tulip craze that drove the price of them sky high. However, once a tulip is gone, it is gone. The dot-com frenzy of the 90s is our most recent “bubble.” Most of the firms had no revenue stream or hard assets. Real estate, on the other hand, has the intrinsic value of land and building.
  
• Capitalization rates will remain low for high quality assets that generate reliable streams of income.
  
• Anticipate a strong commercial market for the next two years. The most important thing will be the availability of capital (liquidity).
  
• It may be a long time before actual returns meet expectations.

Finance Panel

This was a panel of leading lenders, ranging from those that handle “every day” deals, to the very largest of situations:

• Long-term rates will rise, but they will not subdue market activity because there is great deal of capital to invest.
  
• About 1/3 of all condo-conversions will fail and revert back to apartment use due to over supply in the condo market.
  
• There is a growing market divergence between single-family residences and condos. Single-family residences may see a small adjustment, but condos will adjust in value more steeply.
  
• Regarding condo conversions, lenders are very focused on reserves, sponsorship, contingencies, and time-related market risk.
  
• Markets should remain liquid through 2006. Variable rate loans will be pushed.
  
• The condo market is in trouble in many parts of the country due to speculation. Los Angeles is on the radar screen.
  

Investment Panel

This panel was consisted of investors ranging from pension fund advisors to major private investors:

• The debate is whether we are in a typical market cycle or a new paradigm, which would mean all bets on historical market behavior are off.
  
• Individual investors are showing weakening demand, but institutional investors are still strong.
  
• Pension funds are all cash buyers and are flush with cash that must be invested.
  
• High prices for quality assets have raised the value of lower grade assets.
  
• Current CAP rate spreads between such assets have narrowed and no longer represent the true risk of owning lower grade assets.
  
• Investors are receiving diluted returns. They are now relying on appreciation to achieve desired returns.
  

There were also other great panels dealing with Tenants In Common investments, special topics, development, and general economic conditions (which are good, by the way).

Therefore, as you can see, the big brains think we are “good to go” in 2006, and maybe beyond that. Again, the fuel is money. Yes, there will be caution (no one wants another 1990-1995), and we may have already experienced the peak in prices, but the signs appear to be good for property owners.