Stanley Iezman, president and chief executive officer of Glendale, Calif.-based American Realty Advisors, has worn enough hats to complete a fine collection. But each of his careers has been connected to real estate. A lawyer by training, he started off as a partner and rainmaker specializing in real estate and security issues. He moved on to work as a chief administrative officer for one of his real estate development clients. Along the way, he became an adjunct professor at the University of Southern California's School of Policy, Planning, and Development.
In 1991, he bought the real estate advisory business of Glendale Federal Bank, a casualty of the savings and loan crisis and created American Realty Advisors. Since then, the firm has expanded its offices — adding Atlanta; Santa Fe, N.M.; Orlando, Fla.; Chicago; and Cincinnati. It hired on Equity Office Properties' research department and instituted environmental investment policies. What Mr. Iezman hasn't changed is his investment approach: an alternative to bonds with low risk. The firm continues to invest solely in the U.S., sticking to what he describes as a “nuts-and-bolts” approach to real estate investment.
The result is that the firm closed a number of deals in the second half of last year, when the market was beginning to fray. In the face of the credit crisis, its mezzanine business has also picked up. At the same time, Mr. Iezman still manages to moonlight as a real estate asset management professor in the master of real estate development program at the University of Southern California, Los Angeles, where he earned his law degree.
How does this cycle compare to other similar cycles? The last four years of exponential growth in the value of both the commercial and residential real estate market was driven in large part by the remarkable growth in global liquidity as well as falling interest rates coming out of the 2001 recession, culminating in a fed funds rate of 1% in 2003. The cost of money was so low that it was in essence free to the borrower, and this stimulated behavior we have seen before. Investors who could access capital at such cheap rates were like my 12-year-old daughter in a clothing store with a credit card and no parents around!
Of course, everyone knew that arbitraging between the cost of debt and the return on investment could prove to be reckless, but it was also quite profitable — provided that you could sell before the music stopped.
Today's cycle downturn is definitely demand driven rather than supply driven as in the 1992-1994 period, with the housing market being the tail that wags the dog of the economy. While we see stronger markets — those not driven by housing — maintaining relatively stable values and occupancy, there is a general slowdown evolving due to the lack of consumer spending and concerns by business owners about economic growth. Tenants are just not willing to take on new space or expand while the outlook remains murky.
On the positive side, most property types are experiencing zero net absorption, while during the last recession demand was highly negative, especially in office space. Similarly, from a supply perspective, we have less new construction than during the tech wreck, although the starting vacancy levels are higher this time around. From a rent perspective, since there has been less of a spike than in the last slowdown, we would expect rents to hold fairly constant compared to sharp declines last time.
However, a big difference this time around is that this is more of a capital market slowdown. In particular, the shutoff of the leverage tap for most investors has significantly changed the market dynamic and will continue to impact prices.
What was your business model when you formed American Realty Advisors? I concluded I did not want to be a momentum player. I wanted to sell a fixed-income alternative with a low risk profile. I believe you have to have strong personal relationships, be accountable to the clients and find solutions for their problems. I thought that would be a business model that would be successful.
Is fundraising tough right now? New money is not being allocated to core real estate currently, as more money is being allocated into value-added and opportunistic strategies and there is a significant amount of money going into distressed debt. It depends on where people want to play. Our view is if you allocate money to the right managers and invest carefully throughout the cycle and not try to time the markets, investors will do well without a lot of volatility.
How do you prepare for down cycles? Our approach over the last four years was very conservative. There were pricing disparities from long-term norms, and although we did buy in these markets, we underwrote both upside gain and downside risk much more carefully, focusing on solid well-located assets and avoiding secondary and tertiary markets. We are not market timers, and our clients expect that we will invest, wisely and carefully, throughout the market cycle. ...
We are stressing occupancy through early renewals and underwriting credit quality very carefully. Well-diversified economies and markets are the key drivers for our investment decisions. We are buying multi-tenanted properties with rental rates at or below market rates to maintain value during this stage.
How do you manage risk? One of the lessons that will come out of this real estate recession that came out of the last real estate recession is, in core, you need to buy in markets that are relatively stable and have a diversified employment base.
Those markets that are highly susceptible like Houston and Dallas because they rely on the energy markets; what happens if the energy markets fall like they did in mid-1980s? A diversified economy is more driven by a broad cross section of different economic drivers. If the local economy is more balanced, there is less volatility in the employment base and less impact if there is fallout in one sector.
Another factor is that we look at supply constraints on new products. There are political supply constraints; economic supply constraints in that you can't build because there is no capital; physical supply constraints like San Francisco because there is little land to build; transportation supply constraints; and now, energy supply constraints. People will be looking at where they will move and set up due to high energy prices.
This country was built on cheap energy. We will have to move away from city planning to regional planning. We will have to think about planning regionally. It will impact the way we utilize real estate.
A few real estate investment managers have told me that this is a good time to sit on the sidelines. Do you agree? You really shouldn't be timing the real estate market, and, as such, it is never a good time to “sit on the sidelines.” However, it is important to make sure that you understand where in the cycle you are. So being ready to get in the game quickly — when you see a good play to make — may be the more accurate description.
Investors should focus on achieving their minimum target rates of return and on raising those targets as needed. We have been very choosy of late and are content to be patient, as many recent transactions have not met our return targets. We have been looking at other areas of the market, such as core and mezzanine debt with conservative loan-to-value ratios that offer some protection from declining property prices.
Finally, in our studies of similar weak points in the market (1982, 1993, 2002), we found that, for NCREIF (National Council of Real Estate Investment Fiduciaries) as a whole, investments made during these periods tended to outperform other assets by a substantial margin over the next three years. So the wise investor is not out of the market, but rather actively looking for the current opportunities that others are shying away from.
There's no big announcement on a billboard that you are hitting bottom. By the time you realize it, it's already down. As Baron Rothschild said: Buy when war starts; sell when peace returns.
Contact Arleen Jacobius at [email protected]
