Location: You’re optimistic. Why?
Mr. Arena: First, I think I have to draw a distinction between being a pie-eyed optimist and being a responsible optimist. I choose to be an optimist. Like Lincoln said, you can be as happy as you choose to be. So, an optimist, from my perspective, is how do you interpret the present situation and how you can define the future?
So being optimistic about the economy is different than why I’m optimistic about my own performance or the performance of the team that I’m part of or the firm that I’m with; those areas of my life I’m optimistic about because my experience says if you work hard, magic happens.
Well, is there enough work going around at this point in the industry?
There’s enough work to survive, there’s no question. For smart, creative people—brokerage professionals, property management professionals, real estate professionals in general—it’s probably the most important time for them in the last 20 years.
Why is that?
No. 1, the market is kind of uncertain. When it’s uncertain, it needs people who, one, know how to create pricing; more people who can put a floor under pricing; more people who can advise others on what to do, whether it’s to dispose of assets that no longer are as valuable as they were a year or two or three ago, or whether it’s to acquire new space in an environment where there’s a great market. …
You have to be sober and practical about what’s occurring. There’s no question that there’s an awful lot of value deterioration, all really from the consequence of de-levering. So, values of properties are probably off 25, 35, 45 percent. … This is not unlike other cycles I’ve lived through in the early 1990s. So you have to be sober about that.
It’s not ‘unlike’?
It’s not unlike; it’s similar to.
Sure. There’s no question it’s similar. In the early 1990s and the late 1980s, maybe the events that surround the downturn were different, but the outcomes were similar. The outcomes are that values of properties are dropping precipitously and those buildings that are now owned by certain individuals are going to end up being transferred to other individuals. … You could say that this will be the largest transfer of ownership in the real estate business in 20 years; and it seems inevitable.
Where do those investors come from?
I think they come from all different facets of the investing world, and I’ll start with people who are real estate investors to begin with; there are real estate people who are flush with cash and who understand the product. There are people who were not overleveraged in this environment, so those are people who are already in the real estate capital markets.
In addition, I think, you’re seeing hedge funds or funds formerly focused on multi-strategy, formerly focused on equity plays, that now have an intuitive sense that the real estate business is a place where they could make opportunistic returns.
You could say that this will be the largest transfer of ownership in the real estate business in 20 years; and it seems inevitable.
But do funds like that invest for the long-term?
They are typically not long-term investors. And these may or may not be long-term investments at the end of the day. If you use history as a guide and you go back to the early 1990s—I was at Morgan Stanley in the early 1990s, there were 10 people in the real estate group. I don’t know how many there are now, but I’d bet you there’s a thousand, something like that. And I think that was the same at Goldman and Credit Suisse, etc.
Prior to 1990, the real estate business was a life company business and a private entrepreneurial business that yielded current returns and was considered an investment that required a risk premium above a Treasury; it was understood it was an operating business, but the advent of the RTC made it look like an opportunistic business to people with large pools of capital. … So they all entered the market with a lot of money to make opportunistic returns, which was to buy low and to sell at a premium. Could that happen again? I think it’s inevitable it will happen again. So, how long term is the hold? My sense … is that the real estate market is going to take a while to stabilize and to deliver high returns.
Financial services is the big leaser for the top-shelf space—some of them simply don’t need that much space anymore. Who comes in and pays those rents?
New York has been a market where it’s hard to predict who back-fills when industry moves out, but someone always does. … The financial services business is not going away; it feels like it’s changing in character, so that larger institutions will become smaller and newer institutions, small institutions, will grow larger and kind of take the place in the picture. … Someone will fill the void of the traditional investment banks.
In addition, what’s occurring is people working for financial services companies today, for one reason or another—either are fed up with the corporate environment or too much regulation, or want to try something that’s more fulfilling—are starting these small entrepreneurial start-ups.
Is that enough to fill these towers?
I don’t think it fills the entire void. And it also changes the nature of buildings in the end—because large floor plates, while they might have been a boon in a particular period to an owner, right now I think they’re probably a bane. So I think you’ll see buildings change in nature. People will take less space; they will use the space differently; they will be more efficient about how they use the space.
From my perspective, I think the smaller financial services users will grow, and they will help pick up some of the slack—but they won’t pick up all of the slack. What’s going to pick up the slack, I think, in the short term, when bankruptcies pick up, law firm bankruptcy practices will grow; law firms will grow slightly; right now, I think they’re feeling a little nervous because their business has slowed down.
A lot of the activity that I think both we and the legal profession thought was going to occur rapidly—which was bankruptcies and big distress—has taken a lot longer to manifest itself.
But that should come next year, correct?
You would think it’s inevitable. You can see by recent trends that it’s accelerating at a rapid pace. We see properties coming back to us in receivership; we have created an asset stabilization and restructuring group, and we couldn’t be busier.
So, to go back to your first question, which is why am I optimistic about real estate: This is a great time for investors.
How did the market get to this point? Some of the same people who are now saying, ‘This is what happened,’ were around then. You know what I’m saying?
Greed. Mania. Sometimes, when you’re in a paradigm, you can’t see what the downside is. Remember the technology bubble? When people said, ‘Price-per-earnings, they really don’t matter—it’s a new paradigm.’ Well, in the real estate business, you had people buying buildings and literally borrowing the money to pay the debt service; so, they bought a building that didn’t return any money, and, in fact, lost money for the first three years. But the bank was willing to lend them the money to pay the debt service for the first three years? In hindsight, that kind of looks insane, right?