A Look Ahead: Opportunities in a Changing World

Success in real estate requires optimism and the ability to identify opportunity under any circumstances. This year's Urban Land Institute Fall Meeting opened with plenty of advice for tackling both short-term challenges and long-term market shifts.

Los Angeles—Success in real estate requires optimism and the ability to identify opportunity under any circumstances. This year’s Urban Land Institute Fall Meeting opened with plenty of advice for tackling both short-term challenges and long-term market shifts.

Stan Ross, chairman & senior fellow for the Lusk Center for Real Estate at the University of Southern California, opened the day and the ULI/Stan Ross Real Estate Trends Conference with an eye to benefits in the current troubled economy. Among his recommendations, he noted the growing number of bankruptcies among U.S. cities, which began with the city of Vallejo, Calif., and was recently followed by Harrisburg, Pa. With 92 percent of cities finding it difficult to pay for basic services, according to National League of Cities data, he noted a growing tendency to outsource such services (everything from parking meters to water to airports and zoos) and a resultant opening for real estate companies to become involved. “Everything is up for grabs,” he said, including state-level services.

At the federal level, Ross advised a look toward a wide range of agencies: Agriculture, Farmers, the General Services Administration, the government-sponsored enterprises. In a recent move, the Securities & Exchange Commission renegotiated a 900,000-square-foot lease and sized it down to 300,000. When asked what the developer should do with the rest, the agency responded, “That’s your problem.” Government entities are increasingly downsizing, Ross cautioned, and Washington, D.C., itself, as a result, is no longer the solid real estate market it once was. Nonetheless, he believes there is opportunity there, too.

Legislation currently under discussion may require some immediate action in order to benefit, Ross said. There will be changes to capital gains and dividend taxation, he noted, as well as home mortgage interest deductions (although he does not expect that to be entirely eliminated—just limited or perhaps treated as a refundable tax credit). Congress has floated the idea of capping deductibility for debt and proposed limiting the tax exemption on low municipal interest and eliminating tax credits. It is looking at a change in carried interest—“a very significant and major change”—as well as in some way addressing partnerships, REITs and 1031 exchanges. And next year may be the last year to take advantage of the gift and estate tax as it now stands.

Looking further into the future, a panel of top real estate executives offered big-picture predictions for larger changes that will impact the way people live and work—and therefore use real estate—during a media roundtable. Joseph Azrack, managing partner for Apollo Global Real Estate, noted technological advancement and innovation as benefits that will create a “different and I think on balance a better world,” particularly improving both developing countries and political systems as a whole.

Thomas Toomey, president & CEO of UDR Inc., tackled the popular subject of Generation Y characteristics versus the baby boomers and noted he looks in particular at college students, the next big group to enter the workforce and the residential market. In their lifestyles, he said, he sees a greater focus on community and desire for interaction—but largely through handheld technological devices. For rental apartments, that means increased focus on quality of Internet connections and centralized business centers that are open 24/7. In addition, they require flexible housing that meets their price and other terms.

Gen Y also prefers different neighborhoods than older generations, put in Victor MacFarlane, CEO of MacFarlane Partners. He pointed to his own daughter’s preference for Brooklyn over Midtown Manhattan as evidence of a desire for walkable places where this group can easily get together with their friends. Such preferences combined with those of the also-huge Baby Boomer generation—a generation that will continue to work long past the traditional retirement age—means a need for multifaceted urban areas, Azrack added.

And urban areas will continue to be the place to focus, with suburbs likely to see significant change as people shift closer to the best places to work, the group observed. Peter Rummell, principal of the Rummell Co. and ULI’ s chairman (and formerly  CEO of the St. Joe Co.), sees the location of suburbs changing and a resultant long-term need to develop or redevelop those areas close to downtowns. Such areas are not cheap, but Azrack anticipates a repricing to an affordable level. “The sooner we can get through that … the better off we will all be,” he declared.

Finally, on the debt front, while still-murky Dodd-Frank and Basel 3 elements make it tough to know exactly what needs to change, certainly CMBS will need to evolve further, he said, as will the banking system overall. Nor will debt alone suffice. The panel agreed there will need to be a higher equity component in all deals, which will produce particular challenges for developers. MacFarlane expects them to either integrate into institutions or at least joint venture with such entities in order to obtain the levels of capital they will need.

Corporations will also need to reinvent themselves to accommodate more liquid investment by 401(k)s and other defined contribution plans, which are increasingly replacing the defined benefit plans—or pension plans—that have traditionally been such large investors in real estate.