John Schoenfeld of Houlihan Lokey

Talk about your mixed messages. The current economy is teetering on the brink of recession, and the overall real estate market may not be far behind. John Schoenfeld, however, sees the glass as half full. Schoenfeld is co-national director (with John Bralower) of Los Angeles-based investment banking firm Houlihan Lokey’s real estate group. He says that while public and private markets are heading into the doldrums–more so since September 11–there are certainly opportunities for capital on the buy side and lending opportunities for those who can move quickly. In all, he offers, the long-term promise is one of recovery. Of course, like most market watchers, Schoenfeld divides the world into pre- and post-September 11 terms. And while his optimism is admirable, Schoenfeld makes no bones that there is a new market characteristic, one that casts a long shadow of uncertainty. (Please note: statistics refer to the week of October 8 unless otherwise noted.)

GlobeSt.com: Are the public markets performing much differently than the private markets right now, John?

Schoenfeld: You can look at REITs because the public sector is easiest to follow, but what makes sense in the public market is happening in the private sector as well, and the property type taking the biggest hit–both from a capital standpoint and perceived value– is hotels because the sector deals essentially in short-term leases; their revenue stream changes nightly. In a macro sense, real estate will be hit across all sectors but long-term, the values will ultimately be there, so unless you believe that the economy will not survive, this market will return.

GlobeSt.com: Obviously you count yourself in that number.

Schoenfeld: Even now there’s good news to be had. Companies aren’t as highly leveraged as they were in the early ’90s; capital was put out there in a much more reasonable fashion since the last recession. The sectors that will be hardest hit will be so because their profits will fall and they can’t service their debt.

In the short term there are significant opportunities for people with capital on the buy side. The ironic thing is that, on the sell side, given the perceived uncertainty concerning current values (and that’s the problem, that no one can really say what current values are), if owners don’t have to sell they may want to hold on until there is more certainty.

And there’s good news on the debt side as well. There are opportunities to build market share for those lenders who are willing to take a bit more risk and take advantage of the fact that a good number of lenders are sidelined.

GlobeSt.com: What’s the upshot for the public markets?

Schoenfeld: The two extremes are self-storage and hotels. Self-storage has performed well on a relative basis, possibly because apartment dwellers tend to take advantage of self-storage. Hospitality, on the other hand, will largely have to wait for performance to improve until business gets back on the road. Let’s compare self-storage to hotels. The dividend yield in self-storage was 11% before September 11, and now it’s at 6.7. By contrast, the hotel REIT dividend yield was 11 and now its 14.3%. So you can see both ends of the spectrum. The yield corresponds to perceived risk. Where there’s a lower yield, there’s lower risk.

GlobeSt.com: What about the performance of the mainline market sectors?

Schoenfeld: In the office sector, FFO multiples for the latest 12 months dropped from 8.7 to 8.6 while the dividend yield rose from 7.8 to 7.9. In industrial, the dividend yield went from 8 to 8.3, with no change in their multiples. So while there have been changes, they are relatively minimal compared to the numbers we saw for hospitality. In multifamily, LTMs went from 6.9 to 7.2, while multiples went from 10.7 to 10.2.

GlobeSt.com: So what’s the outlook for REITS for the foreseeable future–especially as it concerns mergers and acquisitions?

Schoenfeld: Comparing year-to-date results from last year and ’01, the absolute number of M&A deals went up–from 97 to 135–but the size went down. Clearly, for the balance of ’01, we’re not going to see significant deals as people take a pause to see what’s going to happen next. As we get into ’02 and some certainty returns, you’ll see transactions start up again, barring another catastrophe. One thing is certain–if values have fallen, equity cushions have eroded. But again, we get back to the good news. There’s a lot of capital currently on the sideline, and people perceive that there will be some significant opportunities.

GlobeSt.com: How much of that pause that you mentioned is attributable to September 11?

Schoenfeld: Prior to the attacks, private equity saw few domestic real estate investment opportunities, primarily because real estate was trading at prices that didn’t enable these groups to achieve their targeted returns. The dearth of attractive traditional investments led many funds to migrate to overseas opportunities or non-traditional, higher-yielding asset classes–such as land development. In short, deal flow was in limited supply unless investors chose to take significant risk. As a result, private equity funds have built up large war chests of capital for deployment. Post-September 11, while the economy has delved deeper into recession, there’s a clear sense that were will be more domestic investment opportunities, particularly in hospitality.

GlobeSt.com: And if there is another catastrophe?

Schoenfeld: There are those who say the market has actually priced in another attack. People are, in a sense, resigned to the possibility. If you believe in the efficient-markets theory, then another attack should be priced in. But look at the current wait-and-see that I mentioned. This is a situation we have never experienced before, and it truly does remain to be seen if the markets have priced in another attack. One thing’s for sure. The public markets don’t mind volatility. They hate uncertainty.