Billionaire real estate investor Sam Zell discusses the state of the commercial real estate market and financing during the Milken Conference in 2009.
During the boom between 2003 – 2007 he believes that 50% of institutional commercial real estate traded. That’s a very high number. And those new owners are under water so they will likely be wiped out and the lenders converted to owners via bankruptcy and foreclosure.
Best Quotes by Sam Zell at Milken Conference 2009
If you start by looking at commercial real estate and you attempt to justify why you would want to make a loan and you decide that the basic economics aren’t too terrific, then you decide not to make the loan. Whether that’s a credit crunch or prudent decision making is certainly a question.
What is the property worth? The most important elements of valuation and the only metric that’s been consistent in my extensive career in real estate has been replacement cost.
The problem in the boom was that replacement cost included the cost of land and land is the accordion because land is of no value except what you put on it.
If you look at the numbers, from ’03 to ’07, 50% of the institutional real estate in the United States traded. That 50% ended up being over leveraged. Even historic all-cash buyers played the leverage game. The result was that you have a scenario today where there are very few 2003 – 2007 financings that are above water.
You have more debt than you have value. That takes the equity players out of the picture until the lenders foreclose.
Is there any question that there is a direct correlation between leverage available and value?!
One of the myths is that real estate will start to the trade. The answer is that the owner has no equity so the real estate won’t trade. There is no incentive to sell anything. As long as the owner is under water, he’s going to anything and everything he can to stay in position in the hopes of being there when it recovers.
It will be a couple years before the ownership structure changes as a result of foreclosure.
If you are a big lender, you’ve got maturities coming up on loans you made, you are not sure you are going to get paid back on loans you’ve made. Therefore you look at your own capital balance and say, how can we lend new money out when we don’t know if we are going to get paid back, even though the properties are performing.
Bankruptcy courts, after watching them for the last 40 years, don’t respect maturities.
All kinds of big institutions are in liquidity problems. Why are they in liquidity problems? Because they made investments in private equity [around 2000] and those investments returned money faster than everyone expected so the solution was double the commitment so you don’t get too much back too fast. So they doubled the commitment and all of a sudden they are all illiquid.
A lot of this (deleveraging) will be someone converting a debt claim into an equity claim.
Transactions are off 85%, which means the market is not clearing.
Sales have historically occurred where there [are] prospects. The single biggest problems today is the lack of prospects (and no visibility).
What’s the future? That’s what determines the price, not the past.
Notes
Zell saw the pending real estate crises and sold out of most of his holdings before the crash. However, even after 40+ years of business experience he fell into a common trap and felt compelled to buy something with the proceeds. He bought major-market newspapers and sports teams, notoriously money-losing operations. It would have been better to hold the money and wait for the crash but at a certain stage in life, people make interesting decisions.
