CityView's Henry Cisneros Details U.S. Real Estate Market Opportunities With Chinese Investors

As we all know, real estate is of great importance to both of our economies. Even though the United States has suffered through a serious recession across its real estate sector, we know that real estate is essential to the smooth functioning of our economy. For example, every recovery in the last half century has been fueled in major part by the housing and real estate industries, which are important because they stimulate not just construction, but building materials, land finance, consumer appliances, transportation of supplies, and many other supportive activities. Americans also know that real estate is an important engine for wealth for businesses, individuals, and families. In the United States, it is well established that home ownership is on the principal paths to the middle class. For most Americans, the principal source of their net worth is the equity that they have in their homes. In many respects, housing and real estate constitute the basic infrastructure for the functioning of American society. It is therefore a sector that needs to be supported through governmental policy, as the Obama Administration has correctly understood.

A word about the scale of the real estate sector in the United States economy going forward is appropriate. A Brookings Institute report tells us that today the country has about 266 billion square feet of built environment. By 2030 it is expected the United States will require about 426 billion square feet. That is an increase of 171 billion square feet of space that will have to be built in order to accommodate the demands of commercial, industrial, and residential growth. In fact, the number will be substantially more than that because aging industrial plants and older homes will have to be replaced. As a result, economists estimate that about 213 billion square feet of additional space will have to be built over the next 30 years in the United States. That numbers serves to underscore the very great investment that will be required and the importance of the real estate sector in the American economy. I know those numbers will be even greater in China with its population growth and the rapid creation of a middle class with the spending power to afford new homes and to support new commercial activity in China.

It would be negligent on my part to talk about the future of real estate in the United States and not acknowledge the difficulties of the recent past. The American economy has endured the most severe economic recession of the post-war years. A few statistics from recent history drive home that point. Just 18 months ago, in the three-month period that ended in the first quarter of 2009, the American economy lost 2.1 million jobs, which was the largest three-month decline in our economy since 1945. GDP in the forth quarter of 2008 and the first quarter of 2009 fell 5.9 percent, the fastest six-month decline since 1958.

To respond to that economic reality, the Obama Administration undertook the following five-part response:

• The first step was the largest fiscal stimulus in the nation's history, equivalent to 5 percent of GDP. The intent was to stimulate aggregate demand through tax-cuts, assistance to state and local governments, and infrastructure investment.

• The second step was to create a support system for the banking structure. Capital assistance programs and stringent tests of the strength of individual banks resulted in a re-stimulation of credit flows and strengthening of the banking system.

• The third element was reform of the regulatory structure to include definition of bank capital requirements, restriction on bank activities, assurance of credible financial ratings, and the creation of a consumer protective regime.

• The fourth step was to stop the deterioration of the housing markets by attempting to reduce the number of foreclosures and to provide tax credits for new home buyers. Both of these have proven essential to the stabilization of the housing sector.

• The fifth step was to work with other nations to address the global dimensions of the economic downturn, including increasing capital flows to emerging markets. China's role in this economic strategy was critically important and may well have prevented a global crisis of tragic dimensions.

As we gather here in the summer of 2010, all across this nation businesses are now reporting that they expect improved market conditions, job growth is beginning to stabilize, credit is flowing, and the pace of economic growth is positive. It is not the rate of economic growth that we would prefer, but growth in the 2.5 percent range is projected for the year ahead.

The implications for investments in U.S. real estate are important. Whereas the previous consensus of advisors in real estate investment had been "keep your powder dry", it is now clear that those who have the liquidity to invest can beneficially act on plentiful investment opportunities. There are many real estate properties that have dropped below replacement value and, as a result, the investment consensus today is as follows: "Buy it, manage it, wait for the full recovery, expect to hold for up to five years, and strong returns are attainable." The investment points to watch include the rate of job and employment increases in local markets, the pricing of specific assets, and management considerations related to each individual asset, such as occupancy rates on rental properties. It is generally advisable to use leverage prudently and rely principally on cash-driven transactions not leverage-driven structures. Increasingly investors are finding well-operated and fundamentally sound real estate assets owned by capital-constrained owners who must dispose of properties. The circumstances create substantial opportunities for ready investors.

Let me just say a few brief words about the major sectors of real estate in the United States today beginning with those that hold the greatest promise.

• Hotels: Many people believe that hospitality investing will lead the commercial real estate sector to recovery because so little new supply has been built over the last several years. There are great investment opportunities in prime downtown hotels, particularly in the large gateway cities. And though the hospitality industry depends on the travel budgets of companies and consumer travel spending, there are indications that the tourism is coming back that provides a strong basis of support for hotel investment.

• Infrastructure: Basic infrastructure is a new category of real assets investing in the United States, but it includes the transportation network of roads, rail, ports, and airports, as well as telecommunications facilities and basic municipal water and power systems. While investment in public-private partnerships has not gained steam in the United States the way it has in Australia and parts of Europe, there are attractive investing opportunities as public agencies find they cannot finance infrastructure using traditional public debt, though they must upgrade deteriorating infrastructure as well as build new infrastructure entirely. Public-private partnerships constitute investment opportunities as does deployment of capital in creative debt frameworks.

• Apartments: The greatest positive consensus about a sector in which to invest is apartments, where there is tremendous pent-up demand because so little supply has been built in recent years. Trammel Crow Residential, which has built hundreds of thousands of apartments units over the last decades, for the first time in its history built not one single apartment unit in 2009. The age cohort of recent college graduates need places to live as the economy recovers. Immigrants in the gateway cities are living in overcrowded conditions that require a supply of affordable apartments. Every one point decline in the homeownership rate generates a need for about 1.1 million rental units. Between now and the later years of this decade, about four million additional multi-family units must be developed. A recent report from Trammel Crow Residential stated the following: " As occupancy rates begin to rise in 2010, rent levels should stabilize. Thereafter record setting rental demand at a time of zero net completions should drive effective rents sharply higher up about six percent in 2011 and nine percent in 2012."

The next discussion covers sectors that are in difficulty and in which investing presently may be more in distressed properties at discounted prices.

• Retail: There is a crisis among B and C level properties with many store failures. All of they key metrics have been consistently lower in recent years including property values, occupancy rates, and rents. One has to be very sober about the role of internet shopping going forward and the degree to which retail investments are dependent on job growth, wage increases, and demographic patterns. There are promising returns to be generated, however, from purchasing distressed retail space and re-purposing it, for example, in suburban sites.

• Office Space: Demand for office space has declined dramatically throughout this recession. Many properties today are headed to foreclosure. There is little internal growth form existing tenants, as many are downsizing and requiring less space. There is no doubt that office space will bounce back, but it will be several years before demand for space begins to grow beyond the existing inventory. One are of promising office space is medically-related offices. Those U.S. investments funds which have focused on medical real estate have been the office-centered investments funds that have shown the strongest returns in recent years.

• Industrial Space: industrial space was hit hard by the recession, but the hope is that the worst is over. Many areas of the United States particularly in the traditional manufacturing regions such as the Midwest suffered greatly. As industries recover and job growth begins to increase, demands for industrial space will increase. But it is clear that some will be in new forms. There will be new opportunities at the gateway ports, such as Los Angeles, Seattle, and New York, to handle new levels of imports. Also the greening of industrial space with sustainable technologies, such as solar power, and with the application of new logistical technologies will be important. Older warehouses must be replaced by new distribution centers with computer-driven logistics. There will also be new opportunities for real estate for research and development needs.

The final area clearly experienced great difficulty but should steadily improve over the next two years.

• For-Sale Residential Sector: While the sector has been held back by the flatness of employment growth and mortgage financing restrictions, over the next several years, the pent-up demand for housing will lead to full recovery. A critical problem has been the level of foreclosures, and that is why the government has paid so much attention to the mitigation of foreclosures. There are tremendous investment opportunities in distressed land for residential construction. There is also the potential for strong returns from well chosen "smart growth" projects near metropolitan centers, near public-transit, and designed to avoid the cost of gas prices and congestion.

This provides a brief overview of the major sectors of real estate investment in the United States. It should be clear that, like China, the United States is a metropolitan nation. The Brookings Institution reports that just the 100 largest metropolitan areas of the United States contain 65 percent of the U.S. population and produce 75 percent of the gross domestic product. In terms of the innovation required to support new economic growth and productivity, 76 percent of knowledge jobs and 81 percent of research and development activity are in those 100 metropolitan areas. The global gateways cities of New York, Los Angeles, Chicago, Washington, D.C., San Francisco, Boston, and Seattle will clearly be places in which continued growth and, therefore, productive investments will occur. The creative centers with large universities and research and development complexes, such as Austin, Texas; Raleigh, North Carolina; San Jose, California; San Diego, California; and the Washington-Baltimore corridor, are all places where investment will be successful. The emergent cities with strong economic trajectories, such as Denver, Colorado; the Texas triangle cities of Dallas-Houston-San Antonio; Portland, Oregon; Charlotte, North Carolina; Salt Lake City, Utah; Nashville, Tennessee; Columbus, Ohio; Indianapolis, Indiana; and Minneapolis, Minnesota, all represent solid opportunities for investing.

In the final analysis, I want to reaffirm my solid conviction that the United States will return to strong economic growth. As it does, real estate investment will play a critical and important part.

We look forward to hearing over the course of this conference more about the investment potential in China. It is clear to me that mutual and bilateral investment strategies are in the interest of our two nations and it is also clear that preeminent among the sectors in which such investments should be encouraged is real estate and housing. Such investment will place our two nations on a trajectory of interlaced destinies. It will also contribute greatly to business-to-business exchanges and cultural understandings that must support the responsibilities of global leadership which our two great nations must offer in a troubled world. That makes this conference very important. It is much more than a gathering of self-interested business executives. Here, we-who are accustomed to building foundations for buildings and homes-are building new kinds of foundations, ones that will support relationships of respect and collaborations to a world of peace and progress.