Real estate managers are making a mad scramble to raise cash.
Real estate managers' two top priorities for 2009 are refinancing maturing debt and raising capital, according to a new survey of real estate money managers by Ernst & Young LLP, New York. Both goals will be extremely challenging to achieve, noted Gary Koster, the firm's Americas leader, real estate fund services.
“We'll be talking about 2008 and 2009 for decades,” Mr. Koster said.
Cash and financing are hard to come by. Of the managers responding to the survey, a vast majority, 92%, generally or strongly agreed that as with other debt, lines of credit for a fund will be very difficult to obtain. Fifty-four percent of survey respondents stated the denominator effect — meaning the drop in stocks pushing up investors' exposure to real estate and alternative investments — will result in investors reducing their investments in new real estate opportunities. Forty percent strongly agree with the statement that new fund sizes this year will be smaller. While most of the managers surveyed, 63%, are not concerned about the potential for limited partner defaults on capital calls for existing funds — although they are monitoring the situation closely — 27% stated that limited partner defaults are “a pervasive concern requiring management's close attention.”
Companies are struggling to survive and this is only the beginning, Mr. Koster said. “Consolidation is inevitable.”
Ted Leary, president of Crosswater Realty Advisors, a Los Angeles-based real estate consulting firm that was not involved with the Ernst & Young survey, agreed. “The general consensus in the business is that there will be 20% to 30% fallout,” Mr. Leary said. “It will impact the full spectrum of managers, big to small. When values are down 30% to 50%, it cuts the heart out of the financial model, especially when there are no incentive fees on the horizon.”
The difference between the managers that remain and those that “fade into the annals of history” are those that realized that real estate inevitably has a down cycle, Mr. Koster said.
“Real estate is a 10-year cycle with a five-year memory,” Mr. Koster quipped, quoting an old real estate joke. When times were good, real estate managers loaded up on higher and higher amounts of debt. For funds closed in 2006 and 2007, 20% of survey respondents indicated that the approximate amount of debt to equity on deals was up to two to one, 31% stated they employed two to three dollars of debt to every dollar of equity and 26% used three to four times the amount of debt as equity.
A modest decline in a highly leveraged property's value causes huge drops in the value of the investment, he said. With real estate values dropping from their 2007 peak, “the music stopped and there are no chairs left,” Mr. Koster said.
Some once-highly prized properties in plum locations are now selling for a fraction of the price they fetched just two or three years ago.
John Hancock Tower, Boston's tallest building, fell about 50% in value from 2006 when it was purchased for $1.3 billion by investment firm Broadway Partners LLC. In March, the building was sold to a joint venture of Normandy Real Estate Partners and Five Mile Capital Partners, he noted.
As of April, there was more than $86 billion in distressed U.S. real estate, according to Real Capital Analytics Inc., New York.