I love Wall Street. The 1987 Oliver Stone movie is a cult classic where Bud Fox (played by Charlie Sheen) is lured into the illegal, lucrative world of corporate espionage and insider trading when he is seduced by the power, status and financial wizardry of Wall Street legend Gordon Gekko (played by Michael Douglas). Michael Douglas won an Oscar for his performance. It is, indeed, one of my favorite movies, but the movie is not the Wall Street I am referring to. I am referring to the capital market activities of the bankers who continue to do things, both positive and negative, that make investment in real estate so attractive. In the movie, one of Gekko’s famous lines is “Greed, for lack of a better word, is good”. I think the line should be changed to “Greed on Wall Street is good…for the real estate market”.
What I am referring to are the various things that have happened on The Street in the past 25 years that have changed the perception of real estate as an asset class to Americans. The insider trading scandals of the early 1980s are well documented and created a ground swell of skepticism in the stock market and those responsible for trading its securities. Until that time, investment in real estate had been primarily viewed as an activity for risk taking entrepreneurs and a few large institutions. So many people were burned in these insider trading scandals that purchasing stocks, which was previously seen as relatively conservative, was falling out of favor and increasing numbers of people became interested in purchasing investment properties. During the 1980s allocations of institutional investors toward real estate continued to grow and the pool of private investors seeking commercial real estate opportunities followed suit.
The popularity of the real estate investment trust (REIT) brought the ability to purchase commercial real estate to even the smallest of investors. Real estate was becoming a Main Street investment vehicle and private capital had a significant impact on the market recovery experienced during 1993, 1994 and 1995 as the RTC implemented its disposition strategy. Professional management and institutional style ownership became more popular, even in segments of the market where it hadn’t previously existed such as the small property market.
Throughout the late 90s and in 2000, internet companies were growing wildly, some trading at infinite price earnings ratios because they had no earnings and were selling at prices which would indicate that they did. I remember clients telling me, “Bob, why should I buy that building at an 8% cap rate when I am making 25% per year with my internet stocks?” Then along came March of 2001 and the tech stock bubble burst. Many of these investors, who lost millions, were investing in little more than smoke and mirrors. Yes, some people made money, a lot of money, but most lost significant equity. Consequently, the attraction of tangible asset, like real estate, got another shot in the arm. So much so, that in the New York City real estate market we were not even aware that the country was experiencing a recession.
Stock market investors rationalized that internet firms produced no tangible products and had no tangible track records so their investment criterion had to be altered. Of course these investments were ill conceived as the investors ignored the basic fundamentals investing in operating companies. They felt a return to looking at the fundamentals of the companies they would invest in would be prudent so back to blue chip stocks it was. Blue chip companies at the time included Enron, WorldCom and a host of others that were soon out of business due to poor management, cooked books, bad decision making, fraud or a combination of all of these. These scandals were so well publicized that in the following years more capital was deployed into commercial real estate investment than at any time before.
In the summer of 2007, the subprime crisis began to unfold publicly. The result of excess and greed, this crisis still has a long way to go before it is behind us. The investors in these bad loans had very little knowledge of the quality of the underlying assets these loans were collateralized by. The stamp of approval by a rating agency or the issuer was all the investor relied on. Investors, now more than ever, want to understand what they are investing in. Real estate is so transparent. It is so easy to understand. The income is what the income is, as are the condition of the property and the operating expenses. I’m not saying that being a successful real estate investor is easy. It is not. It takes creativity, instinct, guts and capital. It is, however, transparent so if you want to know what you are investing in, invest in real estate.
In the most recent chapter, auction-rate securities fraud has dominated the headlines. Offering investors slightly higher yields than money market funds or other fixed-income investments, auction-rate securities are a type of short-term debt that gained popularity. They also allowed issuers, including municipalities, student-loan organizations, corporations and charities to borrow for the long term, but at lower, short term interest rates. These rates reset in weekly or monthly auctions conducted by Wall Street firms. In November of last year, I was marketing a $45 million, elevatored apartment building on the upper west side which would have required about 20 million in equity at the selling price. An investor who said he really wanted to buy the building said, “Bob, why should I invest 20 million of equity into this property with no return at all on this equity. I could buy Treasuries or auction-rate securities and make 3 or 4% on my money.” Well Mr. C, I’ll tell you why: In February, this $330 billion market stopped functioning when Wall Street firms stopped supporting it with their own bids. These securities were marketed to investors as cash or cash equivalents. In recent weeks, an avalanche of litigation has brought to light many inappropriate actions by participants in this market such as brokers selling personal auction-rate holdings just prior to general public awareness of the impending collapse of the market. To date, investment banks have committed to reimbursing some of their clients approximately $40 billion due to the illiquidity of auction-rate securities. Former SEC chairman Arthur Levitt recently said, “The image of firms being dragged to the table is destabilizing. Very few issues have shaken public confidence in the integrity of our markets as much as this.”
So, will this encourage even more capital to be earmarked for investment in commercial real estate? I realize that investors who were buying auction-rate securities are very risk averse and certainly will not equate buying auction-rate securities or T-bills with buying commercial real estate. And don’t get my thesis wrong, I realize that Wall Street is a critical component of the New York City economy and real estate markets in many ways. A large percentage of the billions of dollars of bonuses made on the street each year support the strength of our residential market. The financial services sector represents a significant percentage of the tenant base in our office buildings. We should credit Wall Street with creating and popularizing REIT investing. The mortgage backed securities business had added significant liquidity to the commercial market and while CMBS activity is down 95% from 2007 levels, I am sure this market will make a comeback in one form or another. Whether its resurgence is in a modified form or in the form of covered bonds, which are so popular in the commercial real estate market in Europe, we will be dependent on Wall Street for its implementation.
Participants in the New York building sales market should be thankful to those guys on Wall Street, both for what they do right and for what they do wrong. They both help our real estate market albeit in different ways. I am a fan of anything that helps our industry so I am a fan of Wall Street.