David B. Reiner is the Managing Director of Grosvenor Investment Management US, Inc. (GIM), is responsible for the development and implementation of GIM’s business strategy, capital markets activities, fund and investment development, fund raising, fund operations, and investor relations. He also is Co-Manager of Grosvenor Residential Investment Partners I, L.P. (GRIP), a fund that invests in the U.S. homebuilding industry.
What is your outlook for the real estate investment market in the coming year?
We generally believe that the real estate market across most sectors will continue to improve along with the economy. Traditional debt is becoming more available as more participants have entered the market. We are even starting to see a renewed CMBS market beginning to gain traction. There are still risks, however, in this business. There is a huge amount of CMBS-related mortgage coming due in the next few years, and there are real questions as to how that will be dealt with. In addition, the number of CMBS mortgages being referred to special servicing has increased.
What types of investments is Grosvenor Investment Management targeting?
We are focusing on the residential market, both rental apartments and “for sale.” On the apartment side, a shortage of new apartment construction combined with demographic trends have driven down vacancies and driven up rents in many key markets. Adding to this is the growing number of foreclosures nationwide and the difficulty in qualifying for mortgages, which in turn is driving down the national homeownership rate and creating many new renters. We like apartment development in particular; we want to create Class A product that will attract the best renters and core asset buyers, thus creating our exit strategy.
Why are you bullish on “for sale” residential?
We are finding that many of the same forces propelling the demand for rental apartments also are increasing demand for for-sale residential product. These trends include a stable growing economy, new household creation, and absorption of existing product. In addition, there has been a nationwide re-pricing of virtually all for-sale housing assets, including existing homes, finished lots, and residential land. At the same time, there is a huge shortage of organized capital focused on the industry. These trends are creating some very attractive opportunities.
Many leading analysts believe that the for-sale market will bottom out nationally in 2011. Several early-to-recover markets already have bottomed out and are now stabilized; some are even seeing price increases. These markets include greater Washington, D.C., several Texas metros, Seattle, and parts of southern California. On the other hand, other markets will continue to face major challenges, such as many parts of Florida, Arizona, and Nevada.
Over the past 13 months, GIM has made 11 separate investments across the country in the for-sale residential market. We believe that this sector is starting to find its legs, but continues to be capital-starved. This situation provides our fund with very attractive returns, while enabling our local partners to pursue their projects profitably.
What did you see in 2009 that convinced you to launch a for-sale housing fund when the market was crashing?
Actually, we began planning the fund, Grosvenor Residential Investment Partners I, LP (GRIP), as far back as 2005, with the original investment strategy focused on creating new inventory of entitled land, finished lots, and new homes inventory to satisfy the nation’s apparently insatiable demand for new homes. GRIP planned to target the fastest-growing metro areas that were setting records for home deliveries driven by growing populations and investor demand.
In 2007, we closed on the fund, which is co-sponsored by GIM and Key Fund Management Group. But then the market began to deteriorate rapidly, and the GRIP acquisitions team was unable to find suitable investments. Underwriting quickly recognized that home prices were rapidly falling, while land owners were still holding to their asking prices. This caused margins to be compressed, which produced low returns on investments.
So then what happened?
It was not a pleasant time to be an investment manager entrusted with $100 million that was not being deployed. During 2008, the GRIP team conducted a thorough review of the housing market and GRIP’s strategy in order to determine whether the strategy should be changed or even if the fund should be discontinued. We decided to adapt the fund’s strategy to the new market realities. We narrowed the fund’s geographic strategy to about a dozen “first to recover” markets including Washington, DC, Seattle, Philadelphia, Dallas, Houston, Portland, Los Angeles and San Diego. Within these markets, we targeted infill locations, which are better protected from new home competition and have less exposure to foreclosures and distressed sales. We shifted from being a creator of new inventory to acquiring existing inventory at big discounts to original cost, primarily by acquiring distressed partially completed projects—mostly from financial institutions —and repositioning them to fit current market conditions, working with surviving builders and developers that offer strong market expertise. In addition, the fund shifted from being a mezzanine lender to a senior lender to fill the void of senior debt in the market, while preserving projected returns.
Are you seeing more foreign investment? Which foreign investors are the “next big thing” likely to make substantial investments in US real estate?
Many foreign investors, including European pension funds and funds backed by retail investors, have targeted the U.S. for investment in 2011-2012. We also expect many of the world’s sovereign funds, including those from the Middle East and Asia, to redirect capital to the U.S. I think that foreign investors tend to believe the U.S. is beginning to recover economically, and given the turmoil all over the world, the U.S. remains a safe haven with a large and deep real estate market.
What is your perspective on the CMBS market, what will change?
The CMBS market is clearly gaining some momentum. Estimates for 2011 issuance range from $25 billion to $40 billion, up significantly from $3.5 billion in 2009 but still a far cry from the 2007 peak of $240 billion. The recent wave of activity is being hailed by many as “CMBS 2.0” due to new structural features and more stringent underwriting standards. Lenders are aiming for lower LTV’s and higher DSCR’s in pools with mortgages on fewer properties. But, as on the core side, there is a lot of capital chasing a relatively small number of top-tier assets and, as market fundamentals improve, there will be increased competition to loan, notably from insurance companies and the GSE’s. The question going forward is, in a competitive yield-chasing environment, how long will the modified underwriting standards of CMBS 2.0 last?
What do you see as the changing needs and desires of institutional investors? For example, managed accounts, niche investments?
Many institutional investors have expressed a desire to invest through separate accounts and club-type funds, as opposed to commingled, closed-end vehicles with 10-20 other Limited Partner funds. They want more discretion and control over investment decisions and strategy and are also demanding more attention and direct communication from their General Partners. As a result, they are putting downward pressure on certain types of fees and requesting more favorable governance features in their funds and accounts. Another trend we’re seeing is investors wanting to invest with fewer GPs—essentially preferring larger relationships with a smaller number of managers. That said, there does not seem to be as much interest in the “mega-fund” asset-allocation vehicles which have been prominent in recent years. Many investors are targeting more focused strategies with “best-in-class” managers in specific sectors. There are over 400 funds in the market at the moment so investors and their consultants certainly have a lot to choose from.