By Martin Sinderman
Name: Ron Sturzenegger
Title: Managing Director, Real Estate and Lodging Investment Banking
Company: Banc of America Securities LLC
Age: 42
Experience: Ron has spent all 16 years of his investment banking career focused on REITs |
Real Estate Portfolio recently asked Ron Sturzenegger, managing director, head of real estate and lodging investment banking for Banc of America Securities LLC, to share his thoughts on the capital markets for publicly traded real estate and the industry as a whole.
Portfolio: What impact, if any, has the Enron situation had on the real estate capital markets? Are there any particular ramifications for either the debt or the equity side?
Sturzenegger: Both debt and equity investors are reacting to the Enron scandal by raising their level of due diligence and their scrutiny of accounting and earnings issues. However, the overall impact for public real estate companies has been more positive than negative since our industry has pretty good transparency and our sources of income are pretty easy to understand.
On the bond side, fixed-income investors have been very skittish. Some investment-grade companies outside the REIT sector have seen their bond spreads widen dramatically, by as much as 20 percent or more, in response to rumors of asset write-offs and/or delayed or restated earnings releases. But spreads in the REIT sector have held firm, and demand for REIT paper has spiked as investors seek safe havens and reward stability.
On the equity side, investors are paying more attention to accounting-related issues than ever before. For example, investors are scrutinizing off-balance sheet joint ventures, as well as focusing more on quality of earnings issues such as contributions to earnings from one-time events like land sales, accounting gains on sale, or lease termination fees.
Portfolio: With all that being true, which property types do you feel offer the best buying opportunities these days? And which sectors do you feel investors should avoid?
Sturzenegger: It all depends upon your risk appetite and your outlook for the broader economy. The industrial, multifamily and grocery-anchored retail sectors have been the "flavors-of-the-day" among most institutional buyers. However, we have some savvy clients who are preparing to exploit buying opportunities in the lodging and office markets, where declining property performance is expected to put pressure on any thinly capitalized owners.
On the public side, our real estate research analyst, Lee Schalop, predicts that the apartment and regional mall sectors, which have "early cycle" attributes, will outperform earlier in the year as the economic recovery kicks in. Meanwhile, the office and industrial sectors, which tend to strengthen in the latter stages of an economic recovery, will outperform later in the year.
Portfolio: In the broader sense, what's your outlook for the real estate industry for the remainder of the year? How does the state of the U.S. and global economies fit into that outlook?
Sturzenegger: In general, property performance has weakened due to a softening in demand, which is tied closely to the performance of the economy. For example, companies won't commit to leasing additional office space until they have some visibility regarding their own growth. At the same time, recent college graduates can't move out of their parents' houses and rent apartments until they have a job that can support the monthly rent payment.
In certain markets and property types, the dip in property performance has led to a widening of bid-ask spreads. Therefore, there has been a slowing of investment activity, because sellers are focused on the trailing periods of strong performance while buyers are underwriting a more modest recovery.
One important factor mitigating some of the economic weakness is low interest rates, which allow leveraged buyers to earn high current returns. The low rates have supported an active investment market. As the economy recovers later this year, property performance should respond nicely, since new supply has been held in check. Of course, for the investment market, the higher interest rates that will accompany an economic recovery will offset some of the benefits of performance improvements.
Portfolio: Could you also touch on your thoughts for the capital markets going forward?
Sturzenegger: As for the real estate capital markets, we see continued strength and good availability of capital. Both the CMBS and REIT bond markets are maturing and gaining credibility with a broader set of investors, which is a positive sign for real estate companies. For example, last summer we led Equity Office Properties Trust's $1.4 billion global note offering, which was the first time REIT bonds had been marketed globally. This year we have led two of the four REIT bond offerings (for Archstone-Smith Trust and CarrAmerica Realty Corporation) which were both oversubscribed in a matter of hours. One caveat, however, is the bank market, where continued bank consolidation and balance-sheet constraints are causing lenders to allocate their capital carefully and hold smaller pieces of any given facility.
On the equity side, we see REITs holding steady. Companies with good track records and, most importantly, a good use of proceeds are able to raise equity capital on attractive terms. And we expect this to continue. A number of REITs have successfully accessed the equity markets in the past few months, including The Rouse Company, Vornado Realty Trust, United Dominion Realty Trust and Developers Diversified Realty Corporation. Even in the hotel sector—which has clearly faced some tough conditions—the markets remain open. This was evidenced by the recent overnight offering we led for RFS Hotel Investors, Inc.
Portfolio: What about the private equity arena? How are REITs accessing institutional capital?
Sturzenegger: Over the past six months there has been a gradual but growing trend among institutions toward increasing capital allocations for real estate, and the recent under-performance of other private equity vehicles such as venture capital and LBO funds will likely ac celerate this trend. With these increased allocations, institutions are seeking efficient means to acquire stable, geographically diverse (or, in some cases, regionally focused) properties with moderate growth potential. REITs that can offer this will continue to be the beneficiaries of this new capital, primarily within joint-venture formats.
From the REIT perspective, this dovetails nicely with the trend toward developing a diversified set of capital sources, which can include joint ventures, discretionary funds and separate-account programs.
Portfolio: How are real estate stocks stacking up against other asset classes this year? What do you see happening over the remainder of 2002?
Sturzenegger: So far in 2002, real estate stocks—both publicly and privately held—are outperforming all the market indices, mostly because real estate has held steady while the stock market has fallen. We expect real estate to be fairly stable for the balance of the year, with the majority of public company returns coming from the sector's attractive and well-insulated dividends, as opposed to multiple expansion or NOI growth.
Whether real estate over or under performs, therefore, will depend largely on what happens in the rest of the market. If the economy comes roaring back, we expect real estate will have a hard time keeping pace with the broader market. However, if the recovery is more protracted, real estate will likely beat the market for the third year in a row.
