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For New Projects, the Sky’s the Limit -- to a Point

Oct 8, 2015

Although the Chinese Zodiac connects 2015 with the sheep, co-leader of EisnerAmper’s national real estate practice group, contends it’s actually “the year of the crane” in New York and the United States.

While the private equity panelists at the EisnerAmper Real Estate Private Equity Summit at New World Stages on Sept. 30 seemed to largely concur with Ken as he moderated a session titled “The Sky’s the Limit: The Private Equity State of the Market,” they demonstrated one common opinion regarding investments and new projects: If you’re going to reach for the skies, do it from your own backyard — at least for the next 10 years.

The industry giants held this view, it seemed, to preemptively avoid the too-rapid expansion and mistakes that contributed to the market crash of 2008.

Acadia Realty Trust president and CEO Ken Bernstein perhaps summed it up best when he said that due to the riskiness in the market, now is “probably not the right time to dabble” and to avoid transactions in secondary markets you don’t understand just because a deal has a higher yield or slightly more potential. “We’ve been through that trouble before and it’s painful. What you’re best at is probably where your best opportunities are.”

A completely different macro-environment has opened the possibilities of rising interest rates, which can be underwritten, noted Dean Adler, CEO and co-founder of Lubert-Adler Partners. A focused strategy for a property is key in order to be successful in 2016.

What it leads to, as a positive, is that real estate execution and entrepreneurship is now going to be a premium, he continued; if you can take a building and have a plan to apply real estate skills and reposition management, you can still make money in this market. He warned, however, that “the days of being the broad engineer and just buying things and riding with the wave are behind you.”

Urbanization was also on the panelists’ minds and radars. Cushman & Wakefield vice chairman James Nelson noted that with an influx of tens of millions of millennial workers replacing baby boomers, cities and neighborhoods once thought undesirable are now where the action is, both for residential and commercial use.

“We have all this new workforce coming, and they want to be working and living in the cities,” he said, adding that the Big Apple is an example of the correlation between the increase in job growth and occupancy rates. “In the last five years, there have been over 500,000 jobs added in New York City, which is more jobs in a shorter period of time than we've tracked in decades.” 

The retail sector was explored during the session as well. With the suburbs basically at its limit regarding major retailers, Bernstein noted that he’s seeing better top growth in urban areas because owners are realizing their growth can be in cities as well.

Richard Mack, CEO and co-founder of Mack Real Estate Group, said aggressiveness paid off in retrospect when he pushed into cities and neighborhoods.

“We got paid more going out, and the returns were generally better as I look back at my history,” Mack explained. “It's very tempting to chase these 7% yields, but I'd still rather build at 5.5% in a great location in an urban market.” 

Time could cure a low-yield problem, according to Reid Liffmann, co-portfolio manager of Angelo, Gordon & Co. New construction leaves little wiggle room and lots of clock-watching, particularly in urban environments, he noted.

“We have to get in, develop it, and get out in one cycle.  Two cycles can be a very successful project, but that's not what our investors want us to do,” Liffmann said. It’s for those reasons his group has avoided most ground-up construction. Additionally, “it is such a relatively thin spread between development yield and exit caps, and you are really at the mercy of capital markets and flows and interest rates.” His strategy: Class-B product and urban infill.
While Liffmann didn’t break in to Houston as he’d hoped, for example, he’s still watching that market and learning about it before his next jump. His faith in pairing up with building operators may aid success there and in other primary and secondary markets. “I like an operating partner who has mud on his shoes, who is walking the property and working the real estate,” he quipped. “It's a skill set that a lot of times loses emphasis.”

Ultimately, selectiveness should be ingrained in the modern dealmaker’s DNA. Adler, who was perhaps the most vocal advocate of that stance, stressed the importance of seeking high-quality transactions even if it means fewer overall deals. The risk of aiming for 17% to 20% IRRs in the U.S. would be “extraordinarily difficult,” he said — especially if rates go up and new supply comes in, those IRR projections may be very far off. “This is the time to stick to your basics. Necessity items are what you should be investing in today.”

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