Weathering the Crisis
[July/August 2008]
Top executives discuss managing through the credit crunch and a slowing economy
By
Christopher M. Wright
When Portfolio asked REIT CEOs a year ago what most concerned them, the impending tightening of credit and slowdown in the economy was at the front of their minds. (“View from the Corner Office,” May/June 2007). A year later, those concerns have become stark realities. The good news for REIT investors is that CEOs are always thinking ahead of the curve. They are executing their previously laid plans to tap funding in dislocated capital markets. They also are focusing on executing strategies crafted for the back end of the business cycle while they look forward to 2009.
Portfolio sat down with six REIT executives to get their thoughts on managing in the current economic environment: Debra Cafaro, chairman, president and CEO, Ventas, Inc. (NYSE: VTR); Art Coppola, president and CEO, Macerich (NYSE: MAC); Laurence Geller, president and CEO, Strategic Hotels & Resorts (NYSE: BEE); Mitchell Hersh, president and CEO, Mack-Cali Realty Corporation (NYSE: CLI); Connie Moore, president and CEO, BRE Properties (NYSE: BRE); and Jeffrey Schwartz, chairman and CEO, ProLogis, Inc. (NYSE: PLD).
Portfolio:How has the credit crunch affected your company, and what are you doing to prepare for the next turn of events?
Art Coppola: Not surprisingly, the credit crunch has affected businesses across the board. However, we are in an excellent position to weather the crisis. Regional malls are traditional darlings for insurance company lenders, who have replaced the CMBS lenders that dominated until the subprime credit crisis hit. Our borrowing strategy has been to utilize 10-year fixed-rate mortgages, so we have a small percentage of our debt maturing over the next two years. Our 2008 and 2009 maturities approximate $850 million and, at conservative underwriting levels of 60 percent loan-to-value (LTV), we can easily refinance these loans with the insurance company marketplace at roughly double the levels of the expiring debt.
 |
"Shareholders are focused on liquidity and the ability to meet all obligations, especially for companies like BRE with large development pipelines. Early in 2007 we took the steps necessary to ensure we had the balance sheet and the capital to execute our business plan, allowing us to weather the current market turmoil."
- Connie Moore
|
Connie Moore: Fortunately for BRE, we raised our capital in early 2007 before the debt contagion took hold. Our borrowing strategy continues to favor unsecured corporate debt. However, with 90 percent of our assets unencumbered, we have the ability to tap the secured market to fund our development pipeline if the credit crisis continues for an extended period of time. For multifamily companies, Freddie Mac and Fannie Mae provide an attractive financing alternative that other property types do not enjoy.
Laurence Geller: As for Strategic Hotels & Resorts, we are comfortable with our extended maturities on our debt, as well as with its more than 80 percent fixed component. We feel our original and long-established strategy is sound. I agree with Connie’s comments, although, like the other panelists, we must modify our tactics in line with the markets.
Jeffrey Schwartz: There is a significant amount of private equity capital available, seeking best-in-class operations. It is incumbent upon us as an industry to provide the highest quality of operations and performance for all of our customers and investors.
Portfolio: Now that we are halfway through 2008, let’s look forward. What is your outlook for REIT industry fundamentals through 2009?
 |
“The effects of the credit crunch have caused
office space users to delay decision-making due to uncertainties in their
businesses. REITs that have long-term leases, predictable earnings streams
and strong balance sheets, such as Mack-Cali, are in the best position to
be opportunistic as the nation's economy strengthens.”
— Mitchell Hersh
|
Mitchell Hersh: At Mack-Cali, office sector fundamentals in our Northeastern and Mid-Atlantic markets remain sound, with generally stable rents and occupancies. We’ve seen several markets served by our portfolio—such as properties like the Jersey City waterfront—strengthen in the past year as a result of rapidly rising Manhattan rents. That said, we’re keeping a close eye on the overall economy.
The effects of the credit crunch have caused office space users to delay decision-making due to uncertainties in their businesses. REITs that have long-term leases, predictable earnings streams and strong balance sheets, such as Mack-Cali, are in the best position to be opportunistic as the nation’s economy strengthens.
Debra Cafaro: Fundamentals in the senior housing and health care market remain strong because they are driven by the aging of the U.S. population such as the over-75 population and the baby boomers.
Ventas’ assets are defensive in another way: most of our rents come from long-term triple net leases with creditworthy tenants, which should provide us with predictable, growing cash flows despite near-term economic changes. These highly structured leases to care providers in hospitals, skilled-nursing facilities and independent/assisted living communities also provide downside protection to our shareholders.
Coppola: We are still enjoying strong tenant demand across the nation for our regional malls. Tenants generally opt for the sure thing and focus their expansions on the most powerful properties. Given that our top 50 assets average more than $500 per foot, tenant demand remains strong.
Portfolio: In your opinion, which REIT industry trend will have the biggest impact on your company through 2009
and why?
Moore: The ability to shape a business that can permit private and public capital to co-exist may be the greatest trend currently impacting the industry. Few REITs have been truly successful in this regard, which provides not only a challenge, but an opportunity
for success. The disconnect between public and private valuations underscores the need to develop alternative and private sources of equity capital to drive business models and strategies.
BRE believes there is a manner in which we can exploit the abundance of private capital to scale our public business model.
Coppola: I agree with Connie that there remains a major disconnect between private and public valuations. This is, and has been, a consistent theme with regional malls for years.
Portfolio: What do you see as your shareholders’ top concerns moving forward?
 |
“Investors’ major concerns today are the absence
of liquidity in a non-functioning debt market, and the impact of a potential
recession on real estate cash flows...companies must be certain that they
have sufficient capital available to meet their debt maturities and other
commitments to avoid dilutive equity deals and/or a cash crunch that could permanently destroy value at the firm.” — Debra Cafaro
|
Cafaro: Investors’ major concerns today are the absence of liquidity in a non-functioning debt market, and the impact of a potential recession on real estate cash flows. Regarding liquidity and debt, companies must be certain that they have sufficient capital available to meet their debt maturities and other commitments to avoid dilutive equity deals and/or a cash crunch that could permanently destroy value at the firm.
Ventas spent the last 12 months building liquidity to be well capitalized to manage through a dislocated debt market. Additionally, investors are favoring the health care and senior housing business, because it has the best demand drivers in a slowing economy.
Moore: I couldn’t agree more with Debra: shareholders are focused on liquidity and the ability to meet all obligations, especially for companies like BRE with large development pipelines. Early in 2007 we took the steps necessary to ensure we had the balance sheet and the capital to execute our business plan, allowing us to weather the current market turmoil.
Hersh: Debra’s assessment of the credit markets and the weakening economy is right on target. Mack-Cali has implemented portfolio and balance sheet strategies over the past year similar to what she describes. However, unlike the health care and the senior housing businesses, our ability to increase earnings is more dependent on the vitality and expansion of the global companies doing business in the United States. Therefore, drivers of our earnings growth would certainly include the development of new office buildings, which we are ready to do as demand dictates, as we own a land inventory capable of supporting 11.5 million square feet of office development.
Portfolio: Where do you expect to find your best opportunities in the next two years?
Schwartz: We have become cautious on our outlook for the United States in 2008, given the impact of both the housing slump and credit crisis. However, ProLogis continues to experience strong occupancies and significant demand in our build-to-suit business. We continue to see strong growth opportunities in Central Europe, China, India, Japan and the Middle East.
In the long-term, we foresee sustainable development gaining additional momentum and expect that an increasing number of our customers will request such facilities. As such, we have made significant commitments in this area and are dedicated to accelerating the prominence of reliable, economical sources of renewable energy such as solar panel and wind turbine installations.
Geller: Adding on to Jeff’s views, we believe strong opportunities will and do exist internationally and we foresee opportunities to build on our successful Mexican and European platforms.
Additionally, our experience with joint venturing in the past may well give us opportunities bridging today’s apparent disconnect between private and public capital in volatile environments.
Moore: Our outlook for our core markets remains generally good. We have areas of weakness; those that have been most impacted by the single family housing crisis, causing a shadow market for rentals. It will likely take the next 18 to 24 months to absorb this supply, resulting in muted revenue growth in these markets. However, we continue to see strength in the Bay Area and Seattle, which are arguably the best markets in the country.
We also are beginning to see a few more land opportunities, especially from broken condo transactions. However, patience is key because land sellers have not adjusted their expectations. If market liquidity issues continue, we may see more opportunities.
Schwartz: I concur with the group that well-capitalized diversified business models should fare best in the coming year. The importance of multiple streams of income, including asset management fees, rental income and other forms of profit, when combined with geographic and global diversification, has never been so important.
Portfolio: What do you expect REIT share prices to do through the end of 2009 and why?
 |
“There is some economic ‘light at the end of the
tunnel’ in the foreseeable future: we assume REIT stock prices will show commensurate improvements. There has been little trading of lodging
assets to demonstrate the declines in property values that appear to be
priced into stocks. Therefore, it is reasonable to assume there is substantial upside in REIT stocks which should narrow the significant NAV gap.”
— Laurence Geller
|
Geller: Clearly, REIT stocks are linked to gross domestic product (GDP) and consumer confidence. There is some economic ‘light at the end of the tunnel’ in the foreseeable future: we assume REIT stock prices will show commensurate improvements. There has been little trading of lodging assets to demonstrate the declines in property values that appear to be priced into stocks. Therefore, it is reasonable to assume there is substantial upside in REIT stocks which should narrow the significant NAV gap.
However, a conclusion cannot be drawn regarding the timing of such a recovery. Uncertainty in the credit markets will likely continue to discourage trading in the near-term and share prices will likely rebound only when some increased clarity in asset values returns.
Hersh: Over the last year or so, we have seen extraordinary volatility in REIT stocks, due in part to short-selling by ‘traders’ as well as to the strong correlation to financial stocks that are interest rate-sensitive
and have been pressured by subprime write-downs. What I can say with reasonable certainty is that the REIT industry is generally composed of professionally managed and well-capitalized real estate operating and development companies that should perform well over the long term. As the economy improves and liquidity returns to the market, REIT total returns should strengthen accordingly.
Coppola: While the broad indexes may remain flat over the next year, I do believe this will be a year of differentiation between sectors and companies. This is partially driven by the large influence the hedge funds are exerting. More importantly, there will be a bifurcation of valuations driven by the investor’s perception of the balance sheet strength and liquidity of individual companies.
This is not unique to REITs and will be reflected across all companies dependent upon capital. I am optimistic about our prospects in this environment.
Cafaro: REITs with strong balance sheets, secure dividends, and reasonable cash flow growth should outperform the broader market as a safe haven.
Christopher M. Wright is a regular contributor to Portfolio.
|
