By Morgan Mann '17, Anand Bhatia '16 and Pablo Redondo Lopez '16
The 2015 Columbia Business School Real Estate Symposium drew alumni from every aspect of the real estate industry, covering topics from development to market disruptors. Tom Barrack, Founder and Executive Chairman of Colony Capital Inc., rounded out the program, delivering an exciting closing address in the form of a fireside chat, with Professor Lynne B. Sagalyn. The conversation started with Mr. Barrack offering a macro view of where the market stands today, moved into a discussion of the growing importance of permanent capital, Colony’s investment in single house rentals, public-private arbitrage and closed with questions regarding the role of the hotel operator and the perceived disruptors within the hospitality industry. In Mr. Barrack’s macro perspective, all bubbles are bursting with the exception of private market Real Estate (noting that oil, commodities, and leveraged loans have suffered from financial market volatility emanating from concerns about China’s rebalancing, geopolitical tensions and the rearranging of a world order following the collapse in oil and commodity prices).
Historically, real estate has served as a "safe haven" for capital by producing stabilized, rent-driven yields and abstaining from emotional mark to market valuation adjustments; however, this safety, is not everlasting. Going forward a wave of refinancing will continue amid a CRE debt market characterized by uncertainty surrounding the implementation of Basel III and Dodd-Frank regulations. These uncertainties, such as Risk Retention for CMBS and the capital charges associated with CRE loans, including HVCRE classification, pose questions surrounding the presence of banks and CMBS in CRE lending. Mr. Barrack further explained that a permanent capital balance sheet (such as the one Colony Capital now has as a result of going public in 2015) as opposed to the ephemeral and slow moving capital formation process for private funds with redemption options, enables a sponsor to invest indefinitely, reducing illiquidity pressures, enabling a long-term investment horizon and protecting investors from timing risk. Such a source of infinite life capital ensures the presence of capital in times of volatility – allowing the manager to more effectively capitalize on opportunity and benefit from the "forgiving nature" of real estate as an asset class. Additionally, the ability to leverage the balance sheet is reassuring to existing and future investors (both shareholders and LPs) as the GP has a symmetric risk profile and has the capacity to double down in the case that short-term vagaries cause irrationally driven dislocations.
Mr. Barrack noted that the current 2/20 compensation structures will not survive because of lack of alignment, an increased push from investors to see more capital or "skin in the game" and industry maturity driving more competition terms to the limited partners. It was recently announced that Colony American Homes merged with Starwood Waypoint Residential Trust, to combine their single-family residential rental portfolios; Mr. Barrack gave insight into that decision, citing the power of a large single-family residential presence, the increasing difficulty average American family’s face obtaining home loans and the future reliance on rental properties. Of note is that American rentership has increased from 55% to 68%, and by creating a portfolio of over 40,000 homes the merger created a company that would be intriguing to the public markets. This strategy allowed for the scale, governance, transparency and succession planning that both Colony and Starwood were looking for.
Following the discussion of macro-economic trends and Colony’s recent transactions, Mr. Barrack’s shared his predictions for public-private arbitrage in real estate. Private market valuations are significantly higher than their 2007 peaks, recently driven by an inflow of private equity and foreign capital. The latter stage of the cycle is nearing but has the potential to be perpetuated by these price insensitive and leveraged investors. When speaking on the recent volatility in the high yield market, he noted that mutual funds are currently driving a lot of capital and need to make investments beyond the public markets. This quest for returns may lead to disintermediation in the future as large pools of capital look to invest directly in the future. His question to the audience was "When spreads widen, underwriting is stricter and the market drops, assets will have to be sold at large haircuts, so who holds the illiquidity ball?" Mr. Barrack let the audience reflect, simply noting that the future will be in passive investing structures, ETF’s and the private market. So is this the end of an era in real estate investment? Mr. Barrack doesn’t think so. While Real Estate is not immune to changes in the macro economy, there are still pension funds and endowments that need places to harvest yield and the efficiency of all markets still leaves room for real estate to be an attractive investment. Sovereign funds may come from new origins as there is instability in the Middle East and South America, but investment will continue to flow to the United States because we have a legal system that works.
The conversation closed with some commentary on the hospitality industry, and Mr. Barrack’s thoughts on the recent Marriott acquisition of Starwood. He indicated that this was another example of the power of scale in the hospitality world, that given focus of hotels on the "business of business (travelers)" scale was everything, and that U.S. multiples only get better by going with scale. Mr. Barrack responded to an audience member who inquired about Airbnb’s threat to the hotel industry, and he agreed that there has been a disruption of sorts, by technology in the hotel industry, not necessarily in the booking space, since Airbnb will never be able to accommodate conference size crowds, but certainly in the unbundling of services. By allowing customers to use products like Seamless, apps for cleaning services, car services and entertainment services, there is a decreasing role for hotel management companies, and these companies are going to be the most disrupted by the disintermediation of the hotel industry.