Corrections or additions?
This story was excerpted in U.S. 1 Newspaper on March 31, 1999. All rights reserved for the author.
In Real Estate, Vision Counts, Too
by Peter D. Linneman
A frequent topic of casual conversation at gatherings
of real estate owners is the lack of visionary managers in other industries.
The common view — which is probably correct — is that there
are only a handful of visionary leaders in industries such as auto,
steel, banking, or rails. Yet almost every operator of real estate
who participates in these conversations believes that they are a visionary
leader. One can only wonder at the fortunate happenstance that when
the Almighty was passing out visionary leadership skills, every other
major industry was only granted three to six great leaders, but the
real estate industry was blessed with 4,192 (or at least every ULI
The truth is that the real estate industry has — at most —
a handful of visionary leaders who also possess the ability to sell
their vision to their employees and the capital markets. It is essential
that the industry’s assets become concentrated in the hands of this
select group if it is to become a strong industry.
As was the case in other industries in the early years of their transformations,
the real estate industry has far too many mediocre operators, controlling
too many assets. The consolidation of capital-intensive industries
has historically been particularly rapid during periods of industry
distress. This is because in periods of distress only the strongest
can effectively access the capital needed to survive and grow. In
normal times the consolidation process continues, though at a slower
rate, as some weak operators see the handwriting on the wall and sell
their assets while they still have real value. As a result, they receive
prices greater than their assets are worth to them, but less than
they are worth under the control of the strongest industry operators.
These consolidation dynamics are at work in the real estate industry
today. As the industry recovers, the "forced" consolidation
process will slow — until the next period of industry distress.
In fact, one of the reasons industry evolutions take so long is that
it takes several periods of industry distress to fully shake out the
In capital-intensive industries the relative importance
of "great ideas" to the "capital required to execute these
ideas" is low. Thus, in order to generate the greatest value from
the limited capital allocated to the industry, it is essential to
generate the biggest bang per "great idea." When capital was
irrationally allocated to the real estate industry was possible for
even the most mediocre operators to survive and prosper. However,
real estate has now joined the ranks of all other industries where
capital is more or less efficiently rationed — perhaps for the
first time in its history. Once capital demands a return, only those
most skilled at predictably generating returns ultimately survive!
It is particularly important in capital-intensive industries like
real estate to concentrate asset control under a few visionary operators.
Real estate owners should realize that collections of assets, without
the ability to obtain visionary-driven growth, always trade at steep
discounts. The in obvious examples of this phenomenon are closed-end
mutual funds, which generally trade at 20 to 30 percent discounts
to their liquidation values. This is because value derives from the
visionary enhancement of assets, rather than the mere holding of assets.
Those operators with the ability to add the greatest value to their
assets — as Warren Buffett has done at Berkshire Hathaway —
will ultimately outbid mere asset collectors for managerial talent,
tenants, and additional properties.
The value of managerial vision (and the ability to sell this vision)
in the real estate industry will increase as consolidation occurs,
cash flow payout ratios to owners decrease, more equity is used in
the capital structure, and binding debt operating and financing covenants
Why? If a property company borrows heavily and pays out its entire
cash flow, it has little borrowing capacity, and therefore is restricted
in its operations by debt covenants. This, in turn, means that when
management identifies value-enhancing opportunities (which generally
require the deployment of significant amounts of capital), they cannot
be executed without time-consuming and expensive capital market activities.
Since capital market "windows of opportunity" do not generally
coincide with operating and investment "windows of opportunity,"
many value-enhancing opportunities slip away for the lack of timely
capital. As a result, firms constrained in their ability to exploit
opportunities without going back to the capital markets will be valued
at discounts, while those with ready access to capital will be priced
in the Real Estate Industry Forever," published by the Wharton
Real Estate Review. The remarks above have been excerpted from that
article. Linneman spoke last week in East Brunswick at the New Jersey
chapter of the National Association of Industrial and Office Properties.
Corrections or additions?
This page is published by PrincetonInfo.com
— the web site for U.S. 1 Newspaper in Princeton, New Jersey.