Alternative Access July 2019

Alternative Access July 2019

LOOKING BACK AND LOOKING FORWARD, PART 1 Reflecting on the Real Estate Crisis of 2009 and What to Expect Next

Ten years ago, in the wake of the financial crisis, Investors’ Business Daily (IBD) sat down with me to discuss the long-term implications of the crisis together with observations from behavioral finance. In this two-part series, we revisit what I said at the time and update you on my views on current opportunities within institutional real estate and how the current cycle might unfold. When you look back at what you were thinking in early 2009, you were pretty bullish on real estate and emphasized that the recovery would be the kind only seen “once or twice” in a career. That was a good call, but what did you get wrong? At that time, mostly everything that we were looking at to isolate the bottom, sentiment especially, turned out to be accurate. At cycle extremes, sentiment works as a contrary indicator; negative is positive and vice versa. The herd is always bearish at the low and bullish at the high. In between the extremes, sentiment turns from contrarian to confirming, so,

once a new trend starts, sentiment isn’t that helpful because it tells you what you already know. The confusion for many in early 2009 was the disconnect between broadly positive fundamentals and extraordinary negative sentiment. So, what we really got right was being comfortable with all the negativity. Looking back, I was overly cautious on interest rates. What I missed was a profound secular shift in the cost of money, driven by durable and deflationary technological change that kept rates “lower for longer” than I or almost anyone else predicted. Back in 2009, my primary focus was multifamily simply due to the inevitable give-back in the homeownership rate after the financial crisis. Single-family lenders tapped a demographic that had always rented and could not afford ownership and gave them all mortgages. That was an easy call because they had to live somewhere. I did not see multifamily becoming the darling of the investment community. But sometimes you hop on the train and it takes you further than you ever thought possible. Ten years ago, I ranked retail last among all property types. In hindsight that was a good decision, but it is only now becoming broadly investable, as long as you have the right operating partner. Your thinking about behavioral finance is different than most. Where are we today from that perspective? Behavioral finance is best viewed through the lens of emotions and not rationality. All things being equal, I would rather be rational and make money, but let’s face it: Irrational ideas make money all the time. I’m interested in the

emotional extreme of fear. Today, for some real estate sectors and geographies, we are at the emotional extreme of complacency. For others, we may have much further to run than some expect. All the hand-wringing about being at the “top of the cycle” is possibly misplaced. Then is this the top of the cycle? What should investors do now? Stock and bond markets continue to post strong results. Should RE investors be worried? Every cycle is a bit different; that’s why history rhymes rather than repeats. U.S. real estate values cycle around a long-term upward sloping trendline that’s getting steeper because long-term replacement cost is increasing faster than inflation. There are four primary factors that anchor the long-term return of illiquid real estate and infrastructure, broadly what I call DISH assets: 1) dollar-denominated, 2) income generating, 3) supply-constrained, and 4) hard. The U.S. dollar is still king and provides stability. Income is in short supply, and the risk aversion and shorter duration demanded by most bond investors in their liquid fixed income portfolios limit real return. Supply constraints are key, especially since replacement cost inflation for construction is a high and rising hurdle for new supply. By hard, I mean anything that is not a paper asset; it must be difficult to replace and have intrinsic value. So, even if the business cycle is peaking, a much longer-term cycle for DISH assets is only beginning. Broadly speaking, illiquid DISH assets will outperform liquid paper assets for the next 10–20 years. Okay, but what individual property types and institutional execution strategies are best? Do you still like multifamily? I can’t tell you that stabilized core apartments in gateway markets bought at a four cap are a great investment. I can tell you that middle- market opportunistic and value-add apartments in secondary growth markets are a much better bet simply because you can get rents higher faster. Long-term structural, demographic, and social change — including younger people delaying marriage and starting smaller families; the lack of savings for down payments for houses; and a broader acceptance of rental housing by older

emotional continuum that defines market extremes. The bookends are fear and complacency. Greed is ever present. Ten years ago, we were at the

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adults — is driving a new kind of demand. And not just multifamily; I still like a number of sectors. Decades of >Page 1 Page 2 Page 3 Page 4

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