The Long View: The return of the real estate gambler

Uncertainty is back - and with it a chance of fat profits (and fat losses)

Feb.February 16, 2017 08:30 AM

From the New York website: To get a sense of how private equity is feeling, look no further than Steve Schwarzman’s birthday parties. In 2007, near the height of the pre-Lehman bubble, the Blackstone Group chief reportedly spent $5 million on his 60th birthday bash at the Park Avenue Armory. This past weekend, Schwarzman celebrated his 70th at his estate in Palm Beach, and it was another ostentatious affair, with fireworks, trapeze artists, camels and Lady Gaga.

His birth and wealth aside, Schwarzman had another reason to celebrate: The return of market uncertainty, something opportunistic investors like Blackstone have sorely missed in the past couple of years.

It may seem counterintuitive, but plenty of so-called opportunistic real estate investors depend on a certain degree of uncertainty to do what they do. Firms like Blackstone, CIM Group and Carlyle Group had a field day between 2009 and 2011, when no one seemed to know where property and capital markets were going and trophy skyscrapers could be had for a bargain. But as the Manhattan market matured, risk-averse institutional money flooded in, prices rose and opportunities to buy buildings and make a 60-percent profit in three years became scarce. Professional risk takers piled up unspent cash, also known as dry powder. At the end of 2016, real estate funds’ combined dry powder stood at a record $237 billion — up from $136 billion in 2012 — according to Preqin.

It’s possible that these opportunistic investors will soon find more real estate bets to make, and that has a lot to do with Donald Trump’s election victory and the uncertainty it has added to an already slowing real estate market. Economic growth could leap – or not. Interest rates are also likely to rise faster. Will that make mortgages unaffordable and push up cap rates for trophy properties? Will trade disputes break out, and will they hurt foreign capital flows into New York real estate? What will Congress and the White House do with taxes and financial regulations? The answers to all these questions matter a great deal to Manhattan property prices, and no one’s got a good answer. Enter the gamblers.

“I think it does create opportunities, it just has to,” said Ronald Dickerman, head of real estate fund manager Madison International Realty. In June, when Britain voted to leave the European Union, investors panicked and property prices fell. But Dickerman saw a chance to benefit from the turmoil and buy properties on the cheap. His firm has since acquired two London properties, he said. Now, New York could hold a similar appeal.

If uncertainty creates openings to bet on the real estate market, it also encourages investors to bet against it. Last week, Deutsche Bank analysts recommended shorting commercial mortgage backed securities (CMBS) amid a weakening retail market. Meanwhile, real estate investment trusts rose to the third-most shorted sector within the S&P 500 stock index (up from seventh in August), according to Sandler O’Neill’s latest short interest report, behind only retail and apparel. A hefty 7.2 percent of all hotel REIT stocks were held in a short position as of Jan. 31.

In a survey by law firm Seyfarth Shaw published Tuesday, real estate executives ranked rising interest rates as their top concern for 2017. Higher rates could take an “immediate hit” on real estate lending, said Savills Studley chief economist Heidi Learner. They could also push down prices of Midtown trophy properties. After all, few investors would accept a 2-percent cap rate on an office building if they could get 4 percent on a virtually risk-free Treasury bond.

Vornado Realty Trust, which invests heavily in Manhattan office and retail properties, seems to think there may be some bargains on the horizon. “The easy money has been made for this cycle,” the firm’s CEO Steve Roth said during an earnings call Tuesday. “Now is the time in the cycle where the smart guys build cash.”

(Read more of The Long View here.)

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