Business Week - Two Views of the Real Estate Boom
Source: Business Week
Publication date: 2006-04-30
Any time you get two market heavyweights to predict the future of the real estate boom, you're going to attract a lot of investor interest. And when they hold views as divergent as those of Sam Zell, the Chicago investor who early in his career earned the nickname "The Grave Dancer" for his skill in picking up distressed properties, and former Starwood Hotels & Resorts Worldwide (HOT) chief Barry Sternlicht, sparks are bound to fly.
The venue for the Apr. 26 faceoff was the annual Milken Institute Global Conference in Los Angeles. Zell immediately dismissed inflation figures showing relatively benign 2% to 3% growth. "If you're trying to build, you're looking at 30% increases in construction costs in the past 24 months," he said. The financier believes inflation will continue to hold real estate prices up. "I don't think there's bubble or any area with oversupply," he said, before hedging by naming a few markets -- Las Vegas, San Diego, and Phoenix -- where he thought high-end condos were overbuilt.
Zell quickly shot down the notion that Americans have overextended themselves by paying too large a share of their income for mortgage payments. "In Europe, it's more like 50%. Here, people think they're pressed if its 20%," Zell said. And if buyers get strapped, they'll cut down on discretionary spending before they stop paying their mortgage. "We're still the cheapest housing in the world," he said.
ON THE CHASE. Zell, who controls two large real estate investment trusts -- Equity Office Properties (EOP) and Equity Residential Properties Trust (EQR), an apartment owner -- said that while there are still some markets with relatively unfettered opportunity to build new homes, many cities and states are increasing zoning restrictions and other artificial barriers to construction. "The whole country is going the route of California," he said.
Sternlicht took the opposite view. "This is too bullish," he said. "One thing I learned on Wall Street is that the flow of funds overwhelms fundamentals. There are so many funds chasing the real estate game -- oil sheiks, Hong Kong billionaires, hedge funds. This is a totally different market than even a year before."
Sternlicht stepped down from the chief executive's job at the hotel company he founded -- the parent of the Westin, Sheraton, and W brands -- two years ago. He now manages $10 billion of property for outside investors at his Greenwich [Conn.]-based Starwood Capital Group. Sterlicht said real estate prices have risen so high that returns have fallen to unacceptable levels. "HOT POTATO MARKET." One hotel he looked at recently in Aruba produced $14.7 million in cash flow but the owner needed $265 million to pay off his debt on the property. At that price, the investment would produce a return of just 5.5%. "I would pay $100 million less for it," Sternlicht said.
The situation has all the hallmarks of the Internet bubble, Sternlicht said. "It feels like a hot potato market," he said. "I have to think, 'Who's the bigger fool I'm going to sell it to?'"
Zell disagreed with the Internet-bubble analogy. A startup like Internet grocer Webvan, he said, could easily go out of business and leave nothing behind. Real estate, on the other hand, has land, bricks, and mortar backing it. Zell also noted that there were demographic trends supporting real estate prices, such as young people getting married later in life and being able to afford their own condos in their twenties. That has boosted urban real estate prices. LOOKING ABROAD. Zell agreed there was a lot of money coming into real estate, but said it was there because of a dearth of better places to invest. The Arab sheik who's investing will accept a lower return, he said, because "the supply of capital is way in excess of the opportunities."
Asked for one place they would each put their money today, Sternlicht said India. He was recently outbid on raw land near Mumbai. Zell said Brazil, a market with growth but not as much access to capital. Sternlicht and Zell may have differing views of where real estate prices are headed, but their answers to the last question revealed their common ground. The best opportunities right now lie outside of the U.S.
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