Conflicting currents of cautious optimism and imminent doom were on display during the Real Estate Investment Securities Association’s (REISA) annual conference, which took place October 18-20, 2009 at the Bellagio Hotel in Las Vegas, Nevada. Approximately 700 attendees-about half of which were registered representatives-enjoyed a record-breaking 45 educational sessions and engaging keynote addresses by Alison Levine, team captain of the first American women’s Mount Everest expedition, and Dr. Mark Dotzour, chief economist and director of research for the Real Estate Center at Texas A&M University. As evidence of the new energy and interest in the organization emanating from its recent rebranding from TICA to REISA, conference organizers estimated that nearly fifty percent of conference attendees were either not members of the organization or were new members attending their first annual conference.
While I was not able to attend every breakout session, I managed to attend quite a few, and set forth below are my top five highlights from the conference.
1. The Commercial Real Estate Market-More Bad News. The general consensus among industry experts who spoke at the conference is that the commercial real estate market will get worse before it gets better. The lack of liquidity in the debt markets will continue to paralyze the commercial real estate market. Job losses continue to hurt market fundamentals and few businesses are reporting plans to hire in the next six months. Commercial real estate pricing is down 40-50% from its peak in 2006-2007 (dubbed a “fairyland” that we are unlikely to see return anytime soon) and may not show significant signs of turning the corner until 2012-2013. Key economic indicators to follow are (i) the personal savings rate (this rate flattening out will mark the end of the recession) and (ii) corporate profits.
2. The Capital Markets Remain Frozen. Lenders remain reluctant to lend due to regulatory and risk management concerns. The CMBS debt market has yet to resurface, but there have been some positive developments in recent months that offer some sense of optimism for the future. In September the IRS issued guidance in Revenue Procedure 2009-45 that may facilitate the modification of CMBS loans by providing relief from tax regulations that would otherwise prohibit loan modifications. CMBS loan servicers now possess some measure of added flexibility to work with borrowers before a loan goes into default. With $150 billion of CMBS debt scheduled to mature between 2010-2012, this flexibility could have a meaningful impact, but loan servicers and borrowers will still face a variety of obstacles to reach mutual agreement on a loan modification.
Multi-family properties are still being financed through Fannie Mae, Freddie Mac, and HUD financing, but the agencies, while remaining active in this down market, are not expressing much interest in either TIC or DST structures at this time.
There is a premium in today’s market on so-called “relationship banking.” Some sponsors are finding success developing relationships with regional and local lenders.
3. New Products and Deal Structures Present Opportunities. Conference presenters such as Keith Allaire predicted that syndicated debt programs will remain popular while a variety of sponsors are promoting: (i) opportunity funds that will invest in distressed debt, discounted debt, or CMBS paper; (ii) preferred equity and mezzanine debt funds that will provide short-term gap financing; (iii) oil and gas programs; and (iv) equipment leasing programs, not to mention the growing amount of money being raised by registered, non-traded REITs. A common theme of these programs is that sponsors are forgoing up-front fees and compensation so as to better align their interests with those of their investors.
4. RIAs Present an Untapped Distribution Platform. Sponsors are increasingly looking to distribute their programs through investment advisers as a complement, or in some cases an alternative, to the independent broker-dealer network. The benefit to the sponsor community is that this network represents a relatively new and untapped distribution network for their programs, not to mention a more favorable compensation model that, at least at the front end of an offering, can save 6-8% on the up-front sales load. For the investment adviser community, the challenge from a regulatory compliance perspective is structuring their compensation from these illiquid Regulation D securities. The key issues relate to management, valuation, and liquidity. Some investment adviser firms are comfortable with their policies and procedures in this regard. Other firms less comfortable given the lack of definitive guidance on these issues have encouraged REISA to pursue a formal request for guidance from the SEC, and REISA has responded by forming a special task force to explore these issues to clarify how RIAs can be compensated in connection with Regulation D private placements.
5. The Bar for Sponsors Has Been Raised. The economic downturn has not surprisingly brought with it an increase in litigation, arbitrations, bankruptcies, loan defaults, breaches of contract, sponsor failures, and in the most egregious cases, criminal prosecutions. Regulators and industry associations promise greater scrutiny on Regulation D private placements and the industry professionals involved with these transactions. Industry surveys suggest that it will be difficult for new sponsors without a proven track record to successfully enter the private placement market, as prior performance and a niche investment or management strategy will be critical to a sponsor’s efforts to raise capital during these challenging times.
From a disclosure perspective, sponsors are leaning toward more disclosure and transparency, with greater attention being given to investor relations and reporting. At the same time, however, sponsors are facing increasing pressure to control costs, particularly up-front offering expenses (sales commissions, legal expenses, etc.) and to develop structures that better align sponsor interests with those of their investors.
Favorite Quote: Keynote speaker Dr. Mark Dotzour set the stage for a very informative-and often hilarious-presentation by starting off with the following zinger:
“I am not a motivational speaker…I don’t have any self-esteem so I don’t care if you do when you leave here.”