Sam Zell: Optimistic on Commercial Property Values

Includes: IYR, VNQ
by: Brad Case

Reuters on Wednesday published an article by Ilaina Jonas quoting billionaire real estate investor Sam Zell on the future of commercial property values, and also on global real estate investment. I largely agree with his views.

Real estate mogul Sam Zell said he expects little U.S. commercial real estate construction over the next one to three years except for apartment buildings, a hiatus that would restrict supply and boost the value of existing properties. "We're now approaching 3 1/2 years of no development, and I see little prospect for new supply over the next 12 to 36 months except multifamily." With little new supply, the value of existing (properties) should increase and vacancies should fall, Zell said. "I think real estate is going to do well over the next 24 months."

What was particularly interesting to me was that he thinks that the decline in vacancy rates is what will kick banks out of the current "pretend and extend" practice, which has suppressed transaction volume, inhibited price discovery, and enabled a continued cover-up by real estate investment managers who have lost everything (or nearly everything) on behalf of their investor clients but who have not yet been forced to admit it.

I've been saying that the key to ending "pretend and extend" would be the health of the banking system: that is, federal bank regulatory agencies (such as the Federal Reserve) would start forcing banks to recognize true property values in the processing of underwriting commercial mortgage extensions and originations, but only after those banks were healthy enough to withstand the resulting defaults. Banks seem to have regained some health, but "pretend and extend" is still happening. Zell, though, is saying that the key to ending "pretend and extend" is a recovery in real estate operating fundamentals.

Anyway, the key is that when "pretend and extend" ends, that would trigger a wave of new commercial property transactions, many of them distressed. That will show up as bad news in the newspapers and magazines, but it will be terrific news for real estate investors who have access to capital, especially publicly traded equity REITs.

Zell also talked about investing in foreign real estate markets including Mexico, Brazil, China, Vietnam, and Indonesia. One comment particularly resonated with me: "he said there is a trade-off in emerging markets: giving up the rule of law for growth." In my opinion, many investment managers forget the importance of rule of law, and end up with lousy returns as a result.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Author is long Vanguard REIT Index Fund and ING Real Estate Fund.

Disclaimer: The opinions expressed in this post are my own and do not necessarily reflect those of the National Association of Real Estate Investment Trusts ((NAREIT)). Neither I nor NAREIT are acting as an investment advisor, investment fiduciary, broker, dealer or other market participant, nor is any offer or solicitation to buy or sell any security investment being made. This information is solely educational in nature and not intended to serve as the primary basis for any investment decision.