Goodwin Insights March 11, 2021

2021 Real Estate Capital Markets Conference Recap

2020 was a challenging year, to say the least. The real estate industry continues to feel the effects of the global COVID-19 pandemic and subsequent economic consequences going into 2021 as industry leaders are still assessing what has been lost, as well as what new opportunities lie ahead as the world slowly emerges from a socially-distanced reality. Although this year’s 14th Annual Real Estate Capital Markets (RECM) Conference, hosted by Goodwin and Columbia Business School, was held virtually, guests were still given the same dynamic experience with a global representation of speakers who led sessions about the state of the real estate capital markets, global capital flows, impact and responsible investing, as well as a market-focused session on the hospitality sector.

After introductions from John Ferguson, a partner at Goodwin and co-chair of its Real Estate Private Investment Funds practice, and Christopher Mayer, the Paul Milstein Professor of Real Estate; Professor of Finance; and co-director of the Paul Milstein Center for Real Estate at Columbia Business School, this year’s keynote speaker Annemarie DiCola, Esq., CEO of Trepp LLC, opened with an update on the current state of the U.S. commercial real estate market on a macroenvironment level. Trepp’s global commercial mortgage-backed securities (CMBS) datasets, which include user-contributed data from banks and financial institutions, provided the audience with a deeper look into mortgage and loan performance in relation to the economic impact of the pandemic. “In addition to the incalculable human tragedy of COVID-19, it has had a major damaging effect on the economy, and the impact on commercial real estate has been specifically severe,” said DiCola, who highlighted key examples including the struggle to host occupants across the lodging industry, the movement away from cities to the suburbs, the decrease in business activity from office tenants, and the sharp decline in gross domestic product (GDP).

In terms of bank loan performance, the industry has seen a rise in commercial mortgage delinquency rates. This varies by property type, but DiCola shared that delinquency has been especially prevalent across retail and hotel spaces. “What’s important when looking at bank delinquencies is that banks pride themselves on relationships with borrowers,” DiCola noted, “so to see these loans having problems is telling that you can’t point to any type of lender. You can point to the fact that no property type is immune to the effects of COVID-19.” When comparing this trend to the 2008 financial crisis, it is clear that commercial borrowers and lenders are in need of relief; in June of 2020, the CMBS performance delinquency rate reached 10.32%, which took less than four months to reach, whereas it took over four years to reach this rate during the 2008 crisis. However, data suggests that commercial properties could begin to bounce back again by the end of Q3 2021, especially in selected lodging spaces.

Occupancy rates are currently lower than usual across all property types, which is defined beyond physical occupancy and includes the existence of lease obligations to pay rent. This drop-off is particularly noticeable in the lodging category, with Trepp data showing occupancy rates are 30-40% lower than the “break-even” point. DiCola pointed out that of all property types, however, lodging will most likely show the first signs of recovery as consumers begin to travel again, especially to drive-to leisure resorts over fly-to ones as comfort levels towards air travel slowly return to normal.

When evaluating the current state of commercial real estate, a common recovery theme is that property owners need to center their strategies around convergence in order to successfully reinvent themselves in a post-pandemic world. “We saw hotels being creative before COVID-19 with the co-working phenomenon and creating designated workspaces,” said DiCola, adding that lodging properties were already beginning to explore convergence by devoting floors for professionals and offering amenities for business lunches and dinners. For convergence in the retail sector, she discussed how grocery stores, for example, may consider restructuring their business models to serve as part walk-in store and part e-distribution center. Additionally, as companies look to appease employees who vacated the cities by providing remote office hubs or conveniences, they will want to think about what amenities they can provide in existing urban offices in order to compel corporate tenants to return.

So, what’s next as we continue to navigate COVID-19? DiCola closed by noting that despite the current state of things, there are still positive sentiments in the industry. CMBS lending is expected to pick back up in the second half of 2021, although with a critical lens on who the tenants are, what type of building or property it is, and what kind of business needs to fill that specific space. “Lenders want to lend, there is capital to be used,” DiCola stated, emphasizing that there is a lot of money to be spent at both the consumer and institutional levels. When reiterating the importance of convergence for commercial properties, DiCola summed up the session and said, “I think the key is that we have to be brutally realistic about each property type and how it will be used as the world comes back from this. It is far more costly to fail to embrace changes that may well need to be made for properties to succeed in the new normal that we fully have yet to uncover.

Global Flows of Capital

Despite being a virtual experience, the silver lining of the 2021 RECM Conference was that everyone could essentially “get together” from anywhere, as this year’s attendees and participants were more global than ever before. David Sherman, the senior advisor and co-founder of Metropolitan Real Estate and co-director of the Paul Milstein Center for Real Estate at Columbia Business School, highlighted this fact with the panel’s moderator David Hodes, the founder and co-managing partner of Hodes Weill & Associates, when introducing the Global Flows of Capital panelists speaking from the Americas, Europe and Asia. Before jumping into the main discussion, Hodes presented his company’s findings from its annual survey for global institutional investors in respect to their outlook on global capital. Key takeaways include a continual rise in target allocations since the last financial calamity in 2008, a shift in allocations towards “home country” investments amid the global pandemic, and an increased appetite for high-return strategies as institutions shift their focus to distress.

Hodes moderated the discussion between panelists Anar Chudgar, Managing Director and Head of the Income and Growth Fund at Artemis Real Estate Partners; Ric Lewis, Executive Chairman and Chief Investment Officer of Tristan Capital Partners; and John Pattar, a partner and Head of Real Estate at KKR Asia Limited. When Hodes initially asked how each panelist has handled the COVID-19 pandemic over the past year, the consistent response from all three speakers was first and foremost making sure their employees, investors and partners were healthy and taken care of. From an investment standpoint, Chudgar explained how Artemis played a combination of defense and offense with its portfolio in 2020 to take advantage of situational volatility.

When asked how one builds conviction in an environment where future demand trends are being debated, Lewis responded that the answer depends on the country and sector; it not only comes down to a macro basis, but what’s also happening on the ground which, in non-pandemic times, enables his team to truly look ahead. “What we already know is that there’s a near and insatiable appetite for the incoming duration,” Lewis remarked on investors looking to place their money into alternative assets. He also added that one of the biggest challenges during this unprecedented time is not giving into recency bias when looking at trends. “We are betting on human nature. We believe there won’t be an elimination of office space.” This concept especially applies to the Asian market, which Pattar says has its own unique sectors and demands that are different than other markets such as smaller, denser living spaces. “In Asia, if your boss goes to the office, I guarantee that you will go to the office,” Pattar joked, indicating that the desire to return to the office is especially strong among the younger Asian workforce.

Hodes pointed out that global flows of capital are not limited to one sector, especially as some investors want to explore distressed properties but not take the risk with hotels and empty retail buildings. When he asked panelists about the entry point for the core portfolio during a narrative that implies distress, Chudgar said she believes core plus is in demand but that a lot of people desire opportunistic and distressed investments. Pattar’s response, on the other hand, demonstrates the geographical differences in availability of core versus opportunistic investments since Asia does not have much core to sell, as he explained, “The only real core markets that show steady growth are in Japan and Australia. We occasionally see core assets trading, but it’s a tough product line because of lack of availability and stock.”

As the world embraces an environment with greater access to data and analytics, the future of commercial real estate faces new opportunities and challenges. When asked about what this future looks like, Chudgar commented, “We are very close to it. We are using technology to be more efficient in how we invest and our own portfolio management internally.” Pattar agreed, adding that while they have never been more inundated with information than now, the element of instinct can never be replaced with technology. “The analytical part helps us, but doesn’t replace the ‘feeling’ you get from seeing a site in-person.” Lewis acknowledged tech’s advancements while emphasizing the importance of conducting ground-up observations, a practice that his European firm also misses as the world waits out the pandemic storm. “Our business is both high tech and low tech – you better be good at the low tech part too or you’re going to lose a lot of money,” he added. Despite the nuances of the capital markets around the globe, one thing it seems that the industry agrees on is wanting to get off of Zoom calls and onto the ground.

Burst I: Market Focus – Global Hotel Sector and Potential Recovery Paths

Faced with the unprecedented impact of the coronavirus pandemic, the global hotel sector is in the midst of recovering and repositioning its current business models. This has left many with questions about what’s next, and Robin Rossmann, the Managing Director of STR and leading its operations across EMEA, APAC and LATAM, addressed them during his deep dive into the industry’s latest and transformative attempts for recovery.

Before sharing his industry learnings from 2020 and predictions for 2021, Rossmann gave the audience a relatable analogy; the hotel industry is more perishable than milk. “A pint of milk can sit in a fridge for a week before it goes bad. Similarly for a hotel room, if you can’t sell an available room on a given night, you forever lose the ability to sell it.” Keeping the fragility of the hotel business in mind, Rossmann is able to help hotels assess and analyze their financial performance in order to make better decisions using STR data that is aggregated and shared with hotels, along with a STR-coined model that determines “RevPAR,” or revenue per available room.

According to Rossmann, the year 2020 gave us three main lessons; it was a shut and open case, life is unfair and we cannot panic. When looking at what happened to the hotel industry from COVID-19, it is clear that the scale of closures that took place in hotel markets across the world was unprecedented. With minimal to no people staying at hotels, countries like the U.S. experienced around a 20% closure rate; meanwhile, Europe saw closure rates of up to 70% in April and May of last year. Second, life isn’t fair and doesn’t discriminate based on age, where you live and, in this case, what industry you are in. While the general sentiment is negative, Rossmann noted that there have been regional variances in the velocity and type of recovery. For example, cities that are more reliant on national and/or international tourism have been struggling the most, with luxury hotels having been more impacted than economy class hotels, a stark and previously unseen performance difference between individual assets. Finally, although the news can seem dire, Rossmann reassured the audience not to panic. “There are strong signs that the industry will recover because it has actually happened in many places already,” he confirmed, discussing how China is already starting to stabilize room rate pricing as domestic business and leisure travel returns and Dubai is leveraging the international demand for travel by not mandating a quarantine period.

Now in the early stages of 2021, Rossmann shared three mantras for recovery and future success: patience is a virtue, recovery is uneven like his baking, and the practice of “extending and pretending” will come to an end. While we are certainly facing difficult times, there is a light at the end of the tunnel: vaccines. “It’s an incredible miracle that we can’t take for granted,” said Rossmann. With science and the “ketchup effect” of pent-up demand for travel soon to be released, the lodging industry will start seeing more business in the books. Rossmann humorously used the analogy of his baking to explain how recovery will be more like a “W” shape than a “V” shape with more ups and downs over the next few years, especially due to restrictions removing capacity from international travel and budget cuts in marketing and other promotional expenses since businesses are trying to financially recover. Rossmann expanded on the last mantra by sharing that the harsh reality of the dark economic turn we have seen is that any business suffering from a 50% or greater loss will struggle to meet its financial requirements, leading to many assets in distress. With that being said, many owners haven’t pulled the plug on their businesses because of the uncertainty of the shape of recovery, so hotels that are still holding on may sharply recover in 2020 when housebound consumers are able to safely journey again.

Rossmann wrapped up the presentation with key takeaways, including that good brands and operators can make a huge difference, recovery will come but be uneven, and the second half of 2021 should present significant opportunities to help hotels in financial distress catch a break. On a personal note, Rossmann struck a communal chord and emphasized, “It is important as individuals and business leaders that we are a part of the solution, not the problem.”

Burst II: Impact Investing

Impact investing has shown explosive growth and popularity as a sector where many institutional investors are deploying capital to directly benefit people and the planet while generating significant market returns. Rekha Unnithan, the co-head of Impact Investing at Nuveen, talked to RECM attendees about the natural synergies between real estate and impact strategies and what her firm has been focusing on to help address issues like climate change, geopolitical tensions, social justice demands and the global COVID-19 pandemic.

Unnithan started by saying how impact investing is now a topic discussed beyond small circles as it is increasingly viewed as an important growth sector. “Typically, the businesses we target are growth businesses as well as real estate, an asset that lends itself nicely to impact investing,” Unnithan stated, adding that Nuveen sees potential in companies that understand the problems at hand and follow a business model that addresses the needs of overlooked demographics. “We are thesis-driven investors. Every investment has an impact, whether positive or negative, so how we act as investors has a material manifestation,” Unnithan added, and on this note she posed a few questions to the audience that impact investors need to consider: What are the big challenges in the world? How can an investment practice contribute to solving them? And, how can we measure its impact?

With one in four U.S. households lacking access to affordable housing, this topic is a specific focus for Unnithan and Nuveen, especially in terms of accessibility and comfort. “We think affordable housing can be enforced beyond a place to sleep and serve as a place of identity and stability,” Unnithan said, and underscored the importance of these efforts enabling tenants to take pride in where they live and, consequently, have that trickle down positively towards their education, nutrition and sense of community. Beyond affordable housing, Unnithan added that other real estate-related impact issues include financial exclusion, early childhood education space and healthcare infrastructures.

Unnithan stressed the importance of showing impact by the numbers to hold investing firms accountable for what is accomplished over a period of time by having goals from the outset. “When we evaluate investment opportunities, we have a specific framework around what we’re trying to achieve. We consider what real estate projects can help us achieve a goal, if they are sustainable and scalable, and if the impact and financial stability are mutually reinforced.” In relation to affordable housing, an example of this framework is making sure properties are truly affordable while being sustainable, which can mean keeping costs down through benchmarking heat energy, controlling waste management and reducing carbon emissions.

As innovative companies alongside impact investors continue to make a difference in the world, Unnithan is confident that impact investing is here to stay. This momentum on the private side is also supported more and more by the public side as the U.S. government focuses on the environmental, ethical and social issues occurring in our country. In reflection of the coronavirus and current social environment, Unnithan concluded, “Impact investors will have a role as well in addressing racial inequality, how capital is channeled, and what decisions are made to reflect diversity.” Despite the many challenges that 2020 has posed, a silver lining is the increased focus on these critical topics, which is a positive for everyone coming out of this pandemic.

A Conversation with Sonny Kalsi and Joe Margolis: Private and Public Perspectives on the Market

Minta Kay, a Goodwin partner and chair of the firm’s Real Estate Industry practice, introduced the conference’s final keynote speakers, Joe Margolis,  CEO of Extra Space Storage, and Sonny Kalsi,  CEO of BentallGreenOak (BGO), for a conversation on their views of the market from private and public perspectives. Starting with the provoking topic of 2020, Kalsi asked Margolis how Extra Space Storage has managed the pandemic. Margolis joked, “Mike Tyson says everyone has a great plan until you get punched in the face,” and highlighted that throughout the chaos of adjusting to a remote world, his first priority was making sure his employees were safe under this stress as well as the company’s customers since self-storage was deemed as an essential business. Despite the challenges, Margolis said his company still managed to have a strong financial year since the demand for self-storage is driven by life events, whether they occur during good economic times or bad. In particular, he observed the trend of emptying bedrooms and storing those unneeded items in order to make more room for a home office.

Margolis turned to Kalsi to ask about opportunities and trends on the private side in lieu of COVID-19, to which Kalsi responded, “COVID-19 has changed everything about real estate; the question is what’s cyclical versus what’s secular.” For example, what’s happening with the hospitality industry is cyclical due to the pandemic, while Kalsi views industrial, self-storage and cold storage facilities as trends that will likely stick around. These themes relate to the concept of customer behavior as well. When Margolis asked Kalsi about what he’s noticed, Kalsi said he believes that some of these behaviors are temporary while others may be more permanent. “I call this our current abnormal. We just have to get back to where we were again,” he explained, noting that the shift in behavior towards being in the office is more of a response to the current environment while the decline in retail may not ever return to the strength and influence it had ten years ago, especially now with the pandemic adding further injury.

Margolis continued to focus on the topic of real estate assets and whether the private sector has seen any shifts. When directed to Kalsi, he said, “Overall, it’s our view that there are some pretty good tailwinds still in the sector,” and provided two main reasons: one, private real estate is less volatile and gives investors a way to be diversified in a low interest rate environment, and two, there are a lot of asset classes that are still in the early market stages, so BGO often looks to other industries to see what they’ve been doing.

Next, Kalsi brought up environmental, social and governance (ESG) as a prevalent focus among both private and public businesses. Margolis expressed that Extra Storage Space certainly prioritizes doing the right thing for the planet and has retrofitted almost all of its locations with energy-efficient lighting and placed solar panels on the roofs. He also talked about the importance of prioritizing diversity, especially from a governance perspective as his board is becoming more diverse in terms of experience and other key metrics. “We were woken up by the stark reminder of racial injustice and that we can all do better as individuals and as companies,” Margolis added, and when he asked Kalsi the same question the response was similar. For BGO, Kalsi said the company is especially passionate about social justice issues and making all employees feel taken care of, pointing out that these responsibilities have fallen on private companies in the past few years. “We need to make sure we’re using whatever leverage we have as a company and hold service providers to those same expectations.”

The topic of technology is a popular one as it continues to find its way into mainstream real estate conversations. In terms of how BGO incorporates it, Kalsi said they put together a group of people at the firm to spearhead initiatives around accelerating technology to be a better, more efficient company and exploring investment opportunities related to technology. “I think real estate as an asset is in its early days of technological disruption,” and Kalsi further joked that if we don’t think about the past year and how that has changed things, “we will be like the dodo birds.” From a public company perspective, Margolis emphasized that, “technology will change the ways companies and customers interact with each other,” and mentioned how Extra Storage Space developed an online leasing option to help make for a more seamless customer experience when employees can’t help them in-person.

Both Kalsi and Margolis acknowledged that debt is deep and available, thus impacting portfolio construction. “The challenge of the debt markets will be when some of the securities come through,” Kalsi said. “I joke we’re at the time of the great forbearance – that’s going to end at some point. The day that ends is the day we have herd immunity in the U.S.” Wrapping up the conference with a question from the audience, Kalsi and Margolis were asked what is it this year that “keeps them up at night” now that we’ve gone through the initial challenges of the pandemic. Margolis responded, “The things that keep me up at night are not so much about industry-shifting risks like COVID-19, but about how we retain our workforce,” and added, “People are a real challenge for us since a lot of companies are moving to Utah and want to entice them. So how do you keep the best engaged and diverse workforce?” He accurately pointed out that just because you’re the leader today doesn’t mean you’ll be the leader of tomorrow. Kalsi feels that being a purpose-driven company is now more important than, which also resonates with investors as the focus on doing good becomes more and more important. On this note, Kalsi posed a question to the audience. “Where do we put capital to work? And how do we make an impact from an environmental and social perspective?”