That was mogul Douglas Durst’s judgement last week when asked whether Big Real Estate had learned anything from the Great Recession. Given the commercial industry’s punch-drunk state, it might seem poor form to start beating up on it all over again. But in light of recent news—news eerily familiar to those who, in 2006 and 2007, joined the run-up to the recently and spectacularly popped bubble—the temptation to do so is mighty.
To wit! In December, SL Green, the city’s largest office landlord, reportedly dropped $170 million on the distressed $185 million loan backing an empty office tower: 510 Madison Avenue. In other words, SL Green paid nearly the full price for the note on a cavernous skyscraper in a city suffering from a paucity of tenants. The same month, the Brazilian Bank Itau agreed to pay a positively bubblicious $130-plus per square foot for offices atop the GM Building.
In January, a fund called CIM Group dropped $305 million on the Drake development site in midtown. Sure, it’s perhaps the finest development site in the area, sitting at the intersection of Park Avenue and 56th Street in one of the most desirable business districts in the world. But, it’s also a development site.
And now, according to two industry sources, the human emblem of New York’s commercial real estate bust (and former GM Building owner, Drake Hotel site owner and 510 Madison developer), Harry Macklowe, is, working with partners, looking for investment opportunities.
Has New York real estate learned anything over the past two years? Anything at all?
“Nope,” Mr. Durst said. “Nope. Nope.”
“This is my third cycle,” Mr. Durst, co-CEO with his cousin Jody of mega-landlord the Durst Organization, told The Observer, sounding world weary. “And each time we get back into it quicker and quicker. We seem to be getting there fairly fast already. Some of the things that have been done don’t make a lot of sense.”
Really? Well, maybe Mr. Durst is just being his ornery, iconoclastic self. He and other real estate dynasties did play it conservatively even in the boom.
Jimmy Kuhn—president of brokerage Newmark Knight Frank, landlord, keyboardist for a classic rock cover band, casino owner—what do you think? “I think we may already have a bunch of people who overpaid.”
That sounds ominous. Care to elaborate?
“There already seems to be a lot of capital out there that thinks that just because it cost $1,000 a foot a few years ago that $500 a foot is cheap,” said Mr. Kuhn, referring to office building prices, which, during the heady boom years, routinely exceeded $1,000 a square foot, even, and most egregiously, for a comparatively modest office building in Soho. “There are a lot of people starting again to underwrite office buildings with aggressive projections for growth in rents.”
Mr. Kuhn followed up a few hours later with a strongly worded email:
“The worst invention in real estate history was the project and Argus models that encourage investors to compound growth rates so that the ultimate projected sale makes up the majority of the value,” Mr. Kuhn typed. “This lesson will never be learned. The great investors like Buffet and others don’t need inflation to bail them out. It’s why large oil companies will buy smaller companies with assets in the ground rather than waiting for oil to reach 150 dollars a barrel. So as in real estate the big money will be in the acquisitions that take advantage of weak borrowers, over leverage, or structural problems rather than buying based on 100 rent expectations that may or may not reach most buildings.”
FOLLOWING THE ASCENSION of Charles X to the French throne in 1824, diplomat Charles Maurice de Talleyrand-Périgord said of the Bourbon dynasty that it had “learned nothing and forgotten nothing.” (The king would make many of the same policy mistakes that got his older brother Louis’ head chopped off 40 years before, and ended up dying in exile.)
At this point, it’s fairly clear that among the countless culprits behind the Great Recession, profligate Wall Street reigns supreme. But commercial real estate, New York’s included, played an outsize part in the gambling that led to the overleveraging that led, in part, to the cratering of the global economy. And Big Real Estate suffered tremendously as a result, hemorrhaging jobs and equity, sending buildings underwater and back to banks, sullying reputations and—one would have thought—chastening everyone involved.
At first, the industry reacted to the downturn with paralysis. Then, as the economic free fall became more of a controlled slide, it reacted with a surfeit of deserved caution. Retail tenants ignored all but the most prime of storefronts. Office tenants began more meticulously reviewing leases before signing them. Investors shied away from any but the most conservative deals. Banks lent barely if at all.
Now, some industry experts argue that that excess of caution is evaporating too fast.
“A lot of clients are getting over their skis on value now,” said one investment sales broker. “It feels like people think we’re raging back. I think it’s a little more perception than reality.”
Others resorted to somber disquisitions on the boundless idiocy of human nature, and the perennially brutal and soon-forgotten lessons of the business cycle. “It’s so easy for borrowers and lenders to lose their sense of business discipline, and that’s typically motivated by greed,” said Mark Weiss, vice chairman at Newmark Knight Frank. “And if you think people’s basic nature is going to change because of a harsh lesson, I would argue that you’re wrong.”
Or, as David Schechtman, a senior director and investment sales broker at Eastern Consolidated, put it, “A lot of individuals will learn from history. But most are doomed to repeat it.”
The pressures to repeat it are not in short supply. A lot of real estate funds are flush with money right now—the so-called “money on the sidelines”—and assets on which to spend said money are scarce. “The pressure to do deals and do dealmaking has not gone away,” said Ashwin Deshmukh, of hedge fund AD Capital Partners. “[Investors] have not learned that things go bad all the time historically, that prices do go down, that your cost basis really matters.”
Nor is the federal government likely to use the financial reform legislation to really rein in the rating agencies or regulate the securitization markets, according to Sam Chandan, global chief economist at Real Capital Analytics.
Of course, for every timid bear in the market, there is an unabashed bull. And in light of recent dealmaking, the divide between them is growing fast.
“For the two years preceding the last few weeks, I think everybody was on the same page in terms of saying that fundamentals were degrading, that vacancies were rising, that value was falling, that distress was in the marketplace,” said Bob Knakal, chairman of brokerage Massey Knakal. “About a month to a month and a half ago, you started to see two very distinct groups of people forming in the marketplace based on their perception of where we were headed. It broke down into the optimists and the pessimists.”
Which is he?
“I think it’s too soon to say.”