By Jonathan Hajar '15 and Dennis Giuliano '15
Moderator: Lynne B. Sagalyn, Earle W. Kazis and Benjamin Schore Professor of Real Estate, Director, MBA Real Estate Program, Columbia Business School, Founding Director, Paul Milstein Center for Real Estate
Panelists:
Erik Horvat '04, Managing Director, Fosun Property Holdings
Daniel Neidich, CEO, Partner and Member of the IC, Dune Real Estate Partners
Glenn Rufrano, Chairman of the Board and CEO, O’Connor Capital Partners
Philippe Visser '04, Senior VP of Development, Hudson Yards, Related Companies
This intergenerational panel, the closing session of the day, brought together prominent industry figures to discuss trends, expectations, and concerns related to real estate development. Professor Lynne Sagalyn set the stage by pointing out the current surge of development activity in "gateway" cities like New York, Chicago, Miami, San Francisco, Seattle Los Angeles and Boston. She asked the panelists to opine on the drivers of this increase, risks relative to construction timing and leverage, and the red flags investors should watch for to avoid the mistakes of the pre-crisis era. Glenn Rufrano responded with an admittedly bearish view of development, pointing out that national GDP growth and the underlying demand remain low. He also referenced secular industry changes – like the shifts toward e-commerce and fewer square feet per office worker – that will cause retail and office tenants to lease smaller spaces. Expressing his concerns about a potential multifamily bubble, Rufrano worried that demand in that sector is driven by buyer demand (i.e., core investors) rather than true consumer demand. Nevertheless, he did cite the urbanization of the millennial generation and the strength of the energy sector as positive factors for development.
Philippe Visser presented a more optimistic take on development. He argued that supply of modern office space is limited, with few options available for users seeking large blocks of space. Visser cited a "war on talent" as a demand driver causing employers to compete for young, tech-savvy employees. To remain attractive, tenants inspired by Google and Facebook have turned to building customized amenities like in-house dining facilities and collaborative work areas in pursuit of a live-work-play environment. Although build-out of these spaces is usually the tenant’s responsibility, developers nevertheless must supply larger floor plates (60,000 to 70,000 square feet) to accommodate new needs in Class A office space.
Daniel Neidich stated that "multi-family and condo boom" may be a more accurate description than "development boom," but also stated that investors face less competition in development than in acquisition of existing assets. He explained that development is the method of choice for creating opportunities, pointing out that capital is more easily attracted to new assets.
Erik Horvat brought an international perspective to the group given his position with Fosun Property Holdings. He mentioned that the risk-control measures enacted by the Chinese government (such as a recent "one-condo policy") have stoked investor demand for the safety of American assets. The US is attractive because it offers transparency and an ability to move quickly on as-of-right developments. He also discussed the ongoing boom of TAMI tenants (technology, advertising, media, information) as a major source of current and future economic growth in New York City.
The discussion next turned to foreign capital sources, with the panel largely agreeing that sovereign wealth funds seek "safe haven" investments in US metro areas that offer less volatility than foreign markets. However, the panelists expressed concerns that this foreign investment could create artificial demand for real estate that is unsupported by market fundamentals. In any case, the overall sentiment of the panel was that such foreign investment is unlikely to slow in the near future.
Following up on this point, Sagalyn asked Neidich about his takeaways from 56 Leonard Street, a luxury condo project currently under construction in Tribeca. Neidich explained that despite high foreign demand, five sixths of the customers are local buyers. He discussed a contrasting environment in Miami, where 65% of buyers are of Latin American origin. Conversation then shifted to trends in retail. Rufrano explained that national retailers focus heavily on distribution of goods, especially in light of the slim margins on e-commerce (due to perks like free shipping and unlimited returns). In any case, the popularity of Internet shopping now required tenants to take smaller spaces from landlords. Class B and Class C retail assets have been particularly hard-hit by these trends as REITs and other institutional buyers remain wary of suburban retail assets. Rufrano pointed to development figures – 0.5% per year of new retail stock compared to 3% in previous cycles – as healthy for avoiding overbuilding.
Sagalyn asked Visser about the unique development challenges at Hudson Yards. Visser stated that a key issue was maintaining strong relationships with public agencies, especially considering that a substantial portion of his project will be constructed above active rail lines. He also explained the difficulty of quantifying logistical risks when many factors are at the discretion of public entities, such as the MTA. Visser discussed precedents for Hudson Yards by reminding the audience that Park Avenue was originally constructed above an active rail yard. In terms of cost allocation, Visser explained that Related began with 10 Hudson Yards because the building is located on terra firma rather than on a platform above the rail yard, which reduced infrastructure obligations and expenses. With regard to financing, Visser shared that the use of EB-5 equity significantly reduced the project’s cost of capital. EB-5 is a visa program instituted by the US government that allows foreign investors to contribute at least $250,000 or $500,000 (depending on location) toward projects that create employment opportunities. Investors achieve US residency in exchange for their contributions, and therefore generally require modest returns on equity. Visser explained that EB-5 investors contributed about $600 million to Hudson Yards, and that 85% of this capital came from Chinese individuals.
The panel next addressed redevelopment and the array of opportunities that are embedded in older building stock. Horvat discussed Fosun’s recent acquisition of One Chase Manhattan Plaza, and described the redevelopment plans which should substantially upgrade the Class A building to be competitive with the World Trade Center. He emphasized the rationale behind investing in the Financial District by citing the rebirth of Lower Manhattan, including an increase in residents from 24,000 in 2000 to over 60,000 today– a major shift in demographics. He also described the challenges which can be encountered when converting older office buildings to residential assets. Particular difficulties include inefficient floor plates with high loss factors, and the tremendous upfront expense sometimes required to "re-skin" a building’s façade.
Rufrano described O’Connor Capital Partners recent redevelopment of 200 East 62nd Street as a case study. The firm acquired the asset at about $1000/SF from CalPERS, and aim to reposition the property as a condo building before selling units at approximately $2000/SF. Rufrano compared these figures to the cost of new construction, which would require approximately $3000/SF for a comparable project. He shared his view that repositioning is at times preferable to ground-up development given the advantages of a condensed construction timeline and the occasional ability to acquire assets at or near replacement cost.
Sagalyn moved the discussion to risk assessment by asking the panelists to identify potential red flags in the extremely active condo market. Rufrano pointed to high condo construction costs, over $3,000/SF, that require developers to sell units at tremendous prices to earn their returns. Similarly, Horvat cited statistics that show for-sale units are remaining on the market for longer than before. Visser opined that New York is beginning to resemble London as a destination for luxury residential buyers and shared his beliefs that capital is eager to "park" itself in the city. He stated that sovereign wealth funds actively seek US trophy assets like those they see around the world, which makes for many attractive sites in New York.