Real estate investments might be all about location, location, location, but Cohen & Steers Inc.'s growth mantra appears to be diversify, diversify, diversify. The firm's expansion to full-fledged real estate manager from a real estate investment trust and mutual fund sponsor is starting to take off as Steven Coyle — who joined two years ago with his team from Citigroup Property Investors — builds up Cohen & Steers' new real estate fund-of-funds business.
Mr. Coyle and Martin Cohen, co-chairman and co-CEO of Cohen & Steers, have more than real estate in common. Mr. Cohen also worked at Citibank, where in 1980 he organized and managed the Citibank Real Estate Stock fund for the bank's pension fund clients. Five years, later Mr. Cohen and Robert Steers created the first real estate securities mutual fund while both worked at National Securities and Research Corp. A year later, the pair formed the publicly listed real estate investment firm that bears their names.
Not only is Cohen & Steers diversifying into funds of funds, but it also has been going global, with offices in Brussels, London and Hong Kong in addition to its New York headquarters and Seattle office. The firm's funds have moved from 60% U.S. real estate with no emerging market investments in its 2005 fund to 20% emerging markets and 30% U.S. real estate in its latest fund. The fund also has a long-short effort.
Messrs. Cohen and Coyle recently shared their thoughts on the firm's future, the state of the private real estate investment management business and the madcap world of real estate investment trusts.
Are institutions gravitating to core real estate investments today? Mr. Coyle: On the private side, we are definitely seeing more movement toward core. Investors are looking for anything with yield. ... There are strong inflows back into the REIT market and investors are looking for yield. I'm surprised that there are not more flows into opportunistic, by which I mean distressed, real estate. Investors are tripping over themselves to get into core, whether they are sovereign wealth funds, other foreign buyers, or REITs. On the other hand, we've seen, net, the money slightly increasing into debt.
There's a bifurcation between the haves and have-nots. Even the value-added buyers are sitting on problems that were originally two times to four times levered, where there's no equity value left in the building and the debt is underwater. Then the question is: What are the banks going to do? There's a lot of talk of extend and pretend (extend the loans and hope the properties will recover enough to sell when the loans come due later). We don't love that term, as it doesn't explain the whole story.
Do you think there will be a time for distressed investment anytime soon? Mr. Coyle: In a lot of cases, the day of reckoning will come for many overleveraged owners and their banks. In an office property, for example, when the leases expire, the owners will have to either put more money into the properties to lease it back up or will have to then give the property back and the lender will have to deal with it. 2010 is a big year for lease expirations. Most leases are five to 10 years, and a tremendous amount of leases will start rolling this year and next. We're starting to see the number of loans where rising vacancies are pushing the loan into default start to increase.
Where else will there be distressed opportunities? Mr. Coyle: Hotels are struggling. We're starting to see more hotel assets hit the market. In June 2009, we saw a wave of sales but it slowed down. We will probably see it run back up in the next 12 to 24 months. Hotels have been in trouble for quite some time. (Commercial mortgage-backed securities) take longer to get through the pipeline. It takes more of the assets to get in trouble before the bondholder starts to get hit.
The same is true in terms of industrial but to a lesser degree. In office, rental levels are lower and owner concessions are higher. Today, most properties have to offer free rent if they want to renew existing tenants or to sign new leases.
Mr. Cohen: It's not fair to generalize about property transfers. The fundamentals for hotels are improving, but not the suburban hotels in secondary cities. Plus, there's a difference between a distressed property and a distressed owner. A distressed owner paid too much and can't repay debt. There are plenty of those; look up and down Park Avenue and at the Four Seasons Hotel. In the suburbs, there are a plethora of distressed properties. That's why REITs have rallied and a lot of money is coming into the marketplace. We're starting to see higher rents in apartments, moving well beyond what anyone thought six to 12 months ago.
Where will the buyers of these properties in distress get the leverage to buy? Mr. Cohen: The loan situation may not be as bad as people thought. I don't know how many millions of loans have to be rewritten or recast, but it's not turning out as bad as we thought. There was a lot of overbuying, not overbuilding, as I'm fond of saying. Overbuying is paying too much with too high expectation on future rents.
Mr. Coyle: People thought as soon as the loans came due, they would go into default. They did not. It's understandable because the banks said if I do that (foreclose) there is nobody there to take me out (buy the property). We saw a lot of theoretical exercises that said values had dropped 40%, but very few transactions. We think actual distress will increase. It's more interesting to see what happens if people can't pay their debt coverage, rather than just having the debt come due. To date, people have been bailed out by low interest rates. However, as tenants suffer and leases roll, owners now will have to put money into the properties. Those properties that require less capital to re-lease, re-tenant and reposition, will generally be better off. So, industrial will likely be better off than other property types. The other problem is that while we see growth, other fundamentals, such as job growth remain elusive.
How many investors will make riskier investments right now? Mr. Coyle: Usually when it's the toughest time to raise capital, it is the best time to deploy capital. We have not deployed a single dollar into the opportunistic distressed space since 2007. We've been waiting for this market to come to us. Is there a struggle to get capital? Yes. The enlightened investors will take the opportunity. Those who do not will be chasing markets that are fairly bullish or overinflated. Unfortunately, that will be the bulk of investors.
Mr. Cohen: This is my third cycle and it's just the same as other cycles. I'm highly encouraged by the lack of investor interest in distressed real estate situations.
Mr. Coyle: There were fewer than 400 private real estate funds four years ago. Today, 785 funds are in the market. The amount of capital is the same, but the size of the average fund has gone down dramatically. This makes it more difficult to pick managers and to invest.
Among opportunistic funds, very few have gotten it: meaning that they really need to buy distressed and not buy yield today. Smart investors will be those who can buy properties that need an injection of capital, reposition the asset, reset the capital position and then lease up the properties. Most opportunity funds are still chasing yield. They can't compete given their cost of capital with the public markets. This will lead to a shakeout within the real estate investment industry. There is potentially a tremendous amount of money to be made by those private players who understand what distressed ownership truly is and can then execute to take advantage of those situations.
As a fund-of-funds manager, is it more difficult to select real estate funds? Mr. Coyle: Definitely. For the first time, we have to underwrite whether a manager will survive or not. A number of managers are facing a capital crisis. Of about 785 we track globally, our view is that it will be lucky if 200 will raise capital.
Mr. Cohen: Of the 200 that will raise capital, 30 in the U.S. will raise significant capital. There will be some new managers that will come through this. Our view is there are some good managers.