Goodwin Insights February 28, 2020

2020 Real Estate Capital Markets Conference Recap

The convergence of technology into all aspects of the economy is more critical than ever as markets continue to face evolving political change and environmental challenges. The particular influence of technology on the real estate industry continues to inform Goodwin and Columbia Business School’s 13th Annual Real Estate Capital Markets (RECM) Conference, which took place on January 31, 2020 in New York City.

Owen D. Thomas, CEO of Boston Properties (BXP), joined Guy A. Metcalfe, a Managing Director and the Global Chairman of Real Estate at Morgan Stanley, to open the first session of the conference in a conversation about property trends, the supply and demand of capital and growth being spearheaded by specific sectors. “I came in as an orange among apples,” he joked as he told the audience about his experience joining BXP as a brand new employee surrounded by leadership that had been with the company for numerous years. “Although the company was doing well, I wanted to get the lay of the land, build trust and figure out what was going on in the marketplace in order to make changes that needed to happen,” Thomas said as he explained his approach for the big task of taking over for two iconic founders.

One of the biggest changes Thomas witnessed when he became CEO of Boston Properties was the change in their customer base and, within that, what sectors are demonstrating growth over others in an increasingly technology-driven world. Technology and life science customers have been key players in this real estate cycle and spearhead much of the net growth that the industry sees today. Metcalfe noted that, in 2019, while most property types showed positive price performance by the end of the year, shopping malls fell into negative territory and are still trending that way.

Thomas and Metcalfe discussed how these trends all contribute to modern real estate investing practices. There are numerous avenues available for accessing capital in the real estate market. Thomas posed the way he questions and thinks about raising capital to the audience: what is the company using the capital for and where are they getting it from? Developments, value-added acquisitions and stock repurchases are BXP’s potential uses of capital, in current order of attractiveness. Likewise, potential sources of capital in order of attractiveness are company cash flow, unsecured debt financing, asset sales and public equity. Ratings impact the amount of leverage that can be used.

When speaking about his theory on supply and demand of capital, Thomas stated historically the real estate investment trust (REIT) market has been seen as the “canary in the coal mine,” or a predictor for private market values. That has changed as REIT dedicated investors are suffering redemptions and index and generalist investors represent a much larger segment of the marketplace. Institutional REIT dedicated investors experienced material portfolio volatility during the 2008 financial crisis and today are opting instead to allocate real estate investment capital to the private real estate market.

Metcalfe asked Thomas what he has learned as the landlord to some of America’s most prominent companies amidst changing space needs. Referencing innovative workspace projects such as Hub on Causeway in Boston, he replied, “I think the most important driver of the development business is our customers’ war for talent. They are competing to get the best talent, and one way to do this is to give the best offerings with office space.”

Global Capital Flows

The following session focused on how investors can manage risk while strategically allocating assets in a diverse market. When asked about the themes for real estate heading into 2020, Craig Leupold, former CEO and current Strategic Advisor to Green Street Advisors, said, “I expect some deacceleration, but that said I’m still positive about the market. We’re starting to see a convergence of cap rates across spectrums and a favoritism towards gateway markets.” He added that there is a heightened awareness of managing risk among greater political and global uncertainty, along with regulatory changes that play into the public and private market’s response.

However, investors are practicing a degree of discipline as they explore alternative assets, according to Jackie Brady, Executive Director at PGIM Real Estate and a member of the U.S. Business Development Group. “There always needs to be evolution of what will generate steady income for a core asset or fund – life science and data centers are niche strategies that can have core implications,” she stated as an example of how portfolio managers and investors are rethinking asset classes and their place within a core strategy. Brady also sees this discipline in the debt market, where there is still competition but not the level of excess lending that the industry has seen in the past.

Major themes highlighted include the transition from retail stores to e-commerce, the growing interest in new geographical markets and regulatory changes. Offering his perspective on the continued strength of critical gateway markets, Nick Bienstock, Managing Partner at Savanna, said while places like Seattle, Austin and Nashville are picking up, he has seen extraordinary growth and diversification of the business base in New York City. “Just a year ago, Amazon backed out on its commitment to place a headquarters in New York City in our building in Queens. But in the months since they left, we have signed leases or term sheets for about 750,000 of the one million square feet of space Amazon was going to take. And, while they are not coming to Queens, Amazon has nonetheless signed hundreds of thousands of square feet of leases in Manhattan and is looking for much more. The biggest and most profitable companies in the world, the Amazons, Facebooks and Googles, are coming to NYC in mass because New York is among the only markets where they can access the talent pool on the scale they need to grow.” Bienstock has seen the continued appeal of the NYC market, adding, “The depth of the market is still growing and has a lot of diversity in its people and industry sectors, generating continued demand for quality office space in NYC.”  

Burst I: Perspectives on Europe

Keith M. Breslauer, Managing Director and Senior Partner of Patron Capital Advisers LLP, provided a timely macroeconomic view of Europe in the wake of Brexit. As the European markets have changed, private equity real estate funds are advising investors to consider new assets that accommodate the shifting economic environment. The biggest market driver for European real estate today? Unemployment, according to Breslauer, which has dropped significantly and together with low interest rates, supports the European housing market.

While a decrease in unemployment has been a positive factor for the European real estate market, Breslauer cautioned that there are potential risks that need to be considered. “The biggest risk would be a populist government, a rise of the far left or far right,” said Breslauer. Now that Boris Johnson is the new prime minister of the UK and Brexit has occurred, Breslauer noted, this risk has significantly decreased. He added that overall, the actual risk of Brexit itself is a lot less than what was perceived. “Europe is all about the U.S. and China in terms of determining performance – it’s all about how its economy works in the context of the global environment.”

Besides a lower unemployment rate and stronger liquidity, key takeaways for the European property market include less opportunity for non-performing loans, a lack of supply in most products to lack of significant development post the GFC, transactions driven by private equity and large international sources of capital and uncertainty for retail. Core asset pricing is at all time high levels, driving by low interest rates and yield hungry capital “the idea of the American investor going to Europe to invest in core real estate now is insane, the opportunity is finding pockets of low level of supply and good demand and filling the need” explained Breslauer. He concluded that investors should keep investment duration short and play the micro cycles that exists across each of the Western European countries where significant risk adjusted returns can be made.

Burst II: Smart Cities

“Growth begets more growth,” Marc Ricks, COO and Head of Corporate Development at Sidewalk Labs, stated at the forefront of this session. In other words, cities need to grow in order to prosper and where cities thrive, residents benefit and real estate values rise. This is part of Sidewalk Labs’ mission around the “virtuous cycle” theory inspired by its CEO Dan Doctoroff, which theory asserts that catalyzing inclusive large-scale development for a better quality of life will recapture returns in communities, their economies and revenue that can fund more innovation to keep the cycle going.

However, growth begets common concerns across cities, particularly around affordability and sustainability. Ricks discussed three ways that Sidewalk Labs is looking to make real estate development more affordable: (1) the use of mass timber as a highly malleable and more economic material, (2) implementing factory construction methods that help with both scale and customization, and (3) other innovations such as dynamic interior technology like Goodwin client Ori, a company in which Sidewalk Labs co-invested. Many of the same approaches that contribute to greater affordability also will increase sustainability. Using a "cradle-to-cradle" material such as Shikkui plaster, for example, instead of regular drywall is not only easier to work with in an automated factory setting but is also more environmentally friendly.

“The hope is that strategies like these can help reignite the virtuous cycle. There’s a lot of appetite for this in the real estate market, and we are really looking to partner with developers and owners as capital goes towards these initiatives,” Ricks said. Through a combination of innovative developments, technology and venture investments, Sidewalk Labs aspires to develop more projects like “Sidewalk Toronto” that will help shape the cities of tomorrow.

Burst III: Climate Change: Changing Ice, Changing Coastlines

Climate change will have implications on development and existing real estate assets over the coming years and decades as sustainability becomes more and more of a global priority. In this session, Dr. Robin E. Bell, a PGI Research Professor at Lamont-Doherty Earth Observatory of Columbia University, discussed the ramifications of our warming planet from a scientific standpoint and how these changes will impact real estate investment and development.

“Ice is like mozzarella cheese,” Bell stated using a relatable analogy, explaining that polar ice is spreading, stretching and losing mass as the surface temperature increases. This, in turn, contributes to the uneven rise and fall in sea level, resulting in our changing coastlines. Using “Superstorm Sandy” as an example, Bell explained how coastline properties are becoming more susceptible to these intense storm surges as a result of the domino effect from Earth’s melting ice caps.

What Bell has learned is that there is no single solution when it comes to addressing sustainability in the real estate industry. Her advice? Investors and developers should be considerate of where properties are located, how they are built and what the long-term climate impact will be. The advantage is the power in knowledge; now that science has progressed, we have the resources and understanding of our changing climate to have the important discussions with industry stakeholders in order to become a part of positive environmental practices. “Changes are global – the goal is to connect the global to the regional,” Bell concluded with a provocative discussion about real-time issues that impact not only real estate, but every living thing on this planet. 

Keynote Session: A Conversation with Stephen A. Schwarzman, Chairman, CEO and Co-Founder of Blackstone

How did Blackstone grow its assets by eight times in the past decade and become one of the largest real estate investors in the world? CEO Stephen Schwarzman shared the secrets to the firm’s success with Wall Street Journal reporter Miriam Gottfried and highlighted anecdotes from his new book What it Takes: Lessons in the Pursuit of Excellence.

Schwarzman attributes Blackstone’s success to its decision-making processes. The first process, he explained, is building firmwide awareness of what’s going on across the businesses and in the macro environment by openly discussing news, politics, markets and more in each major business’s Monday morning meetings. “Everyone who works at the firm should know everything we are doing to make them empowered and to lead by example,” Schwarzman said. By seeing what’s happening with existing portfolio companies and properties, he continued, decision makers across the firm can adjust how they view future investments. The second process is laying out and analyzing everything that can potentially go wrong in an investment. The audience laughed when Schwarzman advised, “never lose people’s money,” but he went on to explain how the firm’s meticulous focus on the risks of a deal has contributed to their success.

Gottfried and Schwarzman discussed some of Blackstone’s notable deals and key investment themes. When it comes to deal making, Schwarzman offered straightforward advice: always live to fight another day, and if you don’t have a great plan that’s easy to execute once you’ve made an investment, you’re going to get yourself into trouble. When asked about his thoughts on the real estate sector today and whether he is concerned about high prices, Schwarzman talked about Blackstone’s thematic approach – such as how the rise of Amazon and ecommerce has made warehouses and logistics assets worthwhile investments. “This has been a wonderful thematic investing thesis for us. As retailers try to do one-day delivery, warehouses near cities are useful for proximity.”

Recently, the U.S. signed a deal with China as a step towards resolving the ongoing trade war. Schwarzman, who played a role in the discussions, explained the importance of the initial deal and the easing of tensions between China and the U.S. “China makes up 40% of the world’s economy along with the U.S., so imagine this huge portion of the economy at odds with each other,” said Schwarzman. “It was a lose-lose situation for every part of the world.”

In closing, Gottfried asked Schwarzman how he learned how to “dunk” in Blackstone’s holiday video featuring a proposed mascot, “Mr. Stone,” for the firm. Schwarzman joked that he learned from the best at the firm – although added that his basketball skills may not be as strong as his real estate investing skills!

View photos from the conference.