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Real estate won't fail but beware of over-leveraging

Real estate won't fail but beware of over-leveraging


Glenn Rufrano, the president and CEO of Cushman & Wakefield, talks during an interview with Business Focus. / Korea Times photo by Shim Hyun-chul

Veteran investor sees market recovery in 2012 and tells how REITs should be done

By Kim Da-ye

Real estate has long been considered an invincible asset class in Korea. 

Owning a piece of real estate has been nearly every Korean’s dream as the prices of apartments jumped 1,037 percent on average in 24 years between 1987 and 2010, compared to 652 percent growth in stock prices, according to a research by KB Financial Group.

Koreans’ unwavering faith in investment into properties is now being challenged. One aging apartment complex in the wealthy neighborhood of Gaepo-dong in southern Seoul saw its value skyrocketing 1,074 percent in 20 years but drop 11.5 percent in the past five years, the research showed.

While bubbles in the housing market are apparently deflating amid the government’s efforts to slow down the process, people started to question if the “invincibility of real estate” has come to an end.

One of the world’s leading real estate investors’ answer to the inconvenient question, however, is rather simple.

“Real estate in general as an asset class has gone up, and it’s not hard to understand. Real estate ultimately changes in value depending on growth of the GDP and inflation,” says Glenn Rufrano, president and chief executive officer (CEO) of Cushman & Wakefield (C&W), a global commercial real estate services firm.

A real estate veteran for more than three decades, Rufrano says that real estate is bound to grow in value in the long term as long as the gross domestic product (GDP) and price levels rise. 

And the world’s economy continues to grow — the International Monetary Fund (IMF) said the world output grew 5.1 percent in 2010 and would expand by 4 percent in both 2011 and 2012.

He elaborates his point by saying that the value of properties will go up as long as businesses grow to afford paying more for them.
While real estate as an asset class can’t fail, Rufrano stresses that the issue is if investment into a property performs at or above average.

The CEO says that it became clear to him in the past decade why some investors gain less than the average return. 

He lists poor location; physically obsolete buildings that fail to attract investors, poor functionality of the properties, portfolios that didn’t diversify enough; and over-leveraging by investors.

When asked what the single biggest factor spoiling a real estate investment would be, Rufrano replies, “Among all of those, where people lost most of their money was over-leveraging.”

Over-leveraging means excessive borrowing of funds to make investments — often associated with risks — that are expected to generate higher return than funding costs.

He brings up an example of the savings and loan crisis in the 1980s and 1990s in the U.S. during which excessive real estate lending brought the demise of small-scale financial institutions and a recession as well as the case of the not-so-distant financial crisis in 2008 and 2009. 

“We run through cycles. If you have a very good piece of real estate but over-leverage and get caught in a down cycle, you are going to lose money. The next person who owns it may do well,” Rufrano said.


Safe investment

Dressed in a dark grey suit with a navy-and-white checkered tie, the 61-year-old Rufrano comes across scholarly as much business-like. 

In an unexpectedly clear voice like that of a 30-something negotiator, he always begins his answer with thorough explanation of the background. It’s no surprise he is an adjunct professor at the Real Estate Institute of New York University. 

His expertise lies with real estate investment trusts (REITs) which invest directly in real estate and are traded like stocks on exchanges. Often called “mutual funds of real estate,” REITs allow investors with a small capital to invest in prime buildings while providing liquidity to property owners or managers. 

Prior to joining Cushman, Rufrano had been the CEO of the Australian-based Centro Properties Group which acquired New Plan Excel Realty Trust, a REIT headed by Rufrano between 2000 and 2007. The latter grew to own or manage 460 shopping centers under Rufrano, according to his profile.

He also served as a director of Trizec Properties, a national office REIT; Crimmi Mae, a mortgage REIT; and General Growth Properties, another REIT specialized in shopping malls.

When asked to offer some advice for Korea’s fledgling REIT industry, Rufrano acknowledges he is not familiar with the local market but makes a crucial point that REITs should invest in safe, established real estate regularly generating income, not in development projects.

Rufrano lists safety, not much leverage and income producing properties for dividend payments to investors as characteristics normally associated with REITs.

“I think there is a lot of development going on here, which is not a good vehicle for REITs. You don’t find many developers involved in REITs because they do not have the cash flow,” he says.

Rufrano mentions one shopping center his former company owned — its average occupancy rate was 95 percent and it generated stable income that was paid as dividends to the investors.

He says that REITs form a $400-billion market in the U.S. “Not one developer I could think of in that market,” Rufrano says. 

Countries with strong REITs segments tend to be mature economies including the U.S., Japan, Australia, France and Great Britain, he adds.

As of October 2011, in Korea, there were 64 REITs and 15 of them were specialized in development. 

In fact, Korea’s REITs industry went through several humiliating moments last year, prompting the Ministry of Land, Transport and Maritime Affairs to toughen regulations against them. 

Between 2007 and 2009, the government lowered the bar for entry into the market by changing the minimum capital required for setting up a REIT from 25 billion won to half a billion won. 

While it helped the industry take off, side effects were observed. Dasan REIT was forced to delist from the Seoul bourse when an auditor refused to give an opinion on its financial status. The company had initially rejected the Korea Exchange’s (KRX) decision for delisting, but later confirmed that a former executive was responsible for issuing bills worth 20.82 billion won to pay back his own debts, embezzling 23 billion won. 

Golden Narae Real Estate Investment Trust was another firm caught up in a controversy because its owner allegedly bribed an official of the land ministry.

The government continues trying to vitalize the local REITs market. On Jan.2, the land ministry announced the introduction of “mother and son REITs” to attract investment from the National Pension Service (NPS).

Under the new regulation, when the NPS acquires more than half of the shares of a “mother REIT” which then owns more than half of “son REITs,” the son REITs do not need to offer shares for public subscription.

Rufrano could also provide a fundamental answer to the question of why project financing by savings banks often failed.

He brought up the case of the savings and loan crisis in the 1980s and 1990s in the U.S. He said small institutions’ costs of funding are higher than those of large counterparts, so tend to seek high returns associated with high risks. 

“In order to compete, they started to finance high risk real estate investments — even poor real estate that couldn’t get financing from anywhere else. When the markets went down, the federal government took them all,” Rufrano says.

When asked for recommendation on the best destinations for Korean investors, Rufrano first points out that Koreans who buy overseas properties tend to be involved in pension funds. He picks New York, Washington D.C., London, Paris and Tokyo for investors with a similar goal for stable income in the long term.

Under the circumstances, the CEO spoke favorably of the recent real estate investments made by the NPS. He commented on the NPS’ purchase of HSBC headquarters in London that the world’s fourth largest pension fund bought the property before the market went up. 

Rufrano says that the Association of Foreign Investors in Real Estates primarily consisting of pension funds and insurance firms meet four times a year, and they have identified those five cities as the best places to invest.

“Every one of those is a mature market, not an emerging market. Core locations make good investments in the long term,” Rufrano says.

2012 outlook

Across the globe, 2008 and 2009 were terrible years for the real estate markets. Not only did housing prices plummet with many home owners going bankrupt, investors and occupiers of commercial properties postponed their plans to invest or move. 

Rufrano says that the markets began to revive in the middle of 2010 and remained active through the first three quarters of 2011. But the downgrade of the U.S. credit-rating by Standard & Poor’s and the escalation of the sovereign debt crisis in Europe dampened investors’ confidence, causing another downturn of the markets.

Because the period between the middle of 2010 and the third quarter of 2011 was too brief for investors and occupiers to make decisions that were postponed from 2008 and 2009, Rufrano sees the momentum building for 2012. 

“All the pent up demand from 2008 and 2009, I can’t believe they are satisfied in one year. There is still plenty of capital to invest and occupiers who consider growing and moving,” the CEO says.

He says that investors and occupiers will continue to take some time to understand the economy more firmly through the first quarter, maybe even through the second.

The markets may pick up by the second half along with some certainty over the European crisis and the U.S. economic recovery, he says while stressing on the positive impacts of the U.S. presidential election on the markets. 

“I think the election would keep us at least active because everybody will try to look good before the election,” Rufrano says. “In an election year, everything goes up normally in the U.S. I’m not sure if it will go up this year, but it won’t go down,” Rufrano says.”

Year 2009 was difficult for the privately-held Cushman as well. The firm posted a net loss of $127 million on an IFRS basis. Under Rufrano’s leadership, the figure improved by $140.1 million to a net profit of $13.1 million in 2010 because of cost cuts and recovery of the markets.

“It was a combination of good management of the company before I got here and after I got here, and the good markets,” Rufrano reminisces. He replaced Bruce Mosler, the current co-chairman of Cushman’s board.

The company drew up a five-year business plan when Rufrano joined the firm in March 2010. The CEO says that the plan is to stay with five business segments — leasing, capital market, corporate occupier and investor services, valuation and consulting — while boosting the firm’s capability in certain regions. 

Asia is clearly Cushman’s focus — Rufrano says the company hired 1,500 people across the globe through the first nine months in 2011, 500 of whom were from Asia. This region generates some 10 percent of the firm’s total revenue.

“The disproportionate growth in hiring relative to the revenue generated here shows we want to grow our Asian unit for the next five years,” he says.

Among Asian markets, Rufrano identifies Korea as a “major country” for Cushman. 

“Three to four percent GDP growth... The 3.5 percent unemployment rate which I still wonder... Unbelievably terrific,” he says.

The CEO adds that Korea’s retail market is particularly important for Cushman’s global client network. European and North American retailers, many of which are already Cushman’s clients, want to enter the market, and by arranging retail spaces for them, the firm catches two rabbits — expanding in the Korean market and building a stronger relationship with existing clients. 

The third beneficiaries would be Korea’s shoppers who can now purchase global brand goods locally at reasonable prices. Cushman has so far worked with Zara, H&M, Uniqlo and Forever 21 in launching their stores here. 

When this reporter suggested Rufrano to help Topshop, a U.K. clothing brand, open stores in Seoul, he bursts into laughter. 

“And all the SPAs (specialty retailer of private label apparel) you were talking about? We would like to bring everyone here. That’s our goal. Give me a list,” Rufrano says.