It’s no surprise that a conversation with arguably the world’s most successful commercial real estate investor would garner intense interest at this year’s REITWeek conference in New York City, where attendence has set a record amid a vastly improved market environment for both public and private investors.
Jonathan D. Gray, the 44-year-old global head of real estate for Blackstone Real Estate Advisors who has become a billionaire by delivering outsized returns as the world’s largest private CRE acquirer and asset manager, did not disappoint the lunch session audience at the NAREIT conference on Tuesday. While there are fewer distressed opportunities and deep discounts, property fundamentals and market conditions are strong and getting better.
"In the U.S., it feels like the economy is getting something closer to escape velocity," Gray said during the conversation Tuesday with Ronald Havnor, NAREIT’s 2014 chair and CEO of Public Storage. "We’ve been stuck at 1.5% to 2% growth, but housing is picking up, the energy and tech sectors are strong, there’s emerging confidence... the capital markets are working."
"The first quarter didn’t indicate this, but what we see across our business, both in private equity and real estate, is very good," Gray told the crowd at the Waldorf Astoria, a property owned by Blackstone controlled Hilton Worldwide. "We can see it in our lodging companies in same-store sales. We’re seeing it in office, with broader based demand and smaller tenants showing up, and we’re seeing it in our industrial and retail [businesses]."
On the flip side, with fewer distressed opportunities available, investors will find it difficult to duplicate the outsized returns logged earlier in the recovery. However, supply remains limited and pricing isn't appreciating to bubble-era 2005-07 levels, Gray noted.
"Fundamentals are still very good. Rising interest rates will obviously dampen things, but if you look at the fullness of time, I think real estate values correlate more to supply and demand, and therefore, we remain constructive on U.S real estate," he said. "We’re in the middle of the recovery, just no longer at the deep discount phase. We don’t think we’re in a bubbly stage where there’s an abundance of construction and banks are lending excessively."
Many CRE sectors are seeing the added pop of rising market rents as larger numbers of below-market rate leases signed at the bottom of the market expire. "Offices and shopping center leases tend to have longer terms, so the cash flows today don’t reflect the current market, which is growing," he said.
While REITs own almost 20% of commercial property in the U.S. and have almost $2 trillion of property under management, ranking as the 9th largest asset group in the S&P 500, "real estate is still predominantly a private business," Havnor noted.
But even the largest REITs are dwarfed by Blackstone, the global leader in private-equity real estate with over $80 billion of equity under management. Gray and his 200-member team spread across five continents have delivered average 17% net annual returns over the last 20-plus years, compared to 9% for the S&P 500 and 10.5% for the FTSE NAREIT Index, by identifying undervalued asset classes or sectors through rigorous analysis and "going all in" to capture upside, Gray said.
For example, Blackstone owned no industrial assets In the U.S. four years ago. Coming out of the crisis, the fund saw opportunity: falling rents and occupancies, little available debt, and many distressed assets being unloaded by public companies needing to deleverage.
"We thought it was a very interesting asset class because we knew at some point the economy would recover and there was very limited new supply. We knew that when debt and equity returned, values would recover also."
Blackstone assembled IndCor Properties, a top industrial team headed by Tim Beaudin, and bought 120 million square feet of warehouse and light industrial property across the U.S., and began a substantial investment in Europe that has reached almost 50 million square feet.
Likewise, in 2007 Blackstone made a contrarian play in acquiring Hilton Worldwide, seeing revenue and asset values plunge during the financial crisis the following two years. Blackstone was forced to mark down Hilton’s value significantly, and Gray "got to read in the paper, it felt like on a daily basis, that I wasn’t very smart."
But lodging emerged from the cyclical downturn, and Blackstone and Hilton President Christopher Nassetta recognized that brands such as Hampton Inn, Hilton Garden and Doubletree would begin to grow again, even in the middle of the downturn.
"In both cases, the idea was believing in, and investing significantly into your strategy when you believe the analytics, the fundamentals are holding on. And that’s a tough thing to do, particularly when everyone is saying you’re wrong."
Blackstone’s mantra of "buy, fix and sell" assets acquired at a discount to replacement cost prompted its entry into the single-family housing business. The company has acquired 45,000 homes over the last 2 ½ years through foreclosure and bank sales.
Once the single-family rental businesses stabilize and refine their business model, net cash flows will improve and public investors will look at them as attractive investments relative to apartments, where large amounts of new supply are entering the market, Gray said.