RCA Technology & Intelligence Briefings Issue 4

Interview with Bowen H. “Buzz” Mc Coy, CRE — Third Quarter 2006

If there were a “National Real Estate Finance Historian Emeritus,” Bowen H. “Buzz” McCoy would be it! He serves as a trustee for the Urban Land Institute and is a past president of the Urban Land Foundation. He is a past president of the Counselors of Real Estate and a fellow in the Royal Institute of Chartered Surveyors. His civic and philanthropic activities are extensive and include service as past Chairman of the Los Angeles Chapter of the American Red Cross, Chairman of the Hollywood Bowl and Chairman of the Medical Ethics Committee at UCLA Medical Center. Contact him: buzzmccoy@aol.com

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1. For nearly 40 years, McCoy has been writing articles on commercial real estate capital markets; his pieces covering the 1970s forward, present a unique history of that field.
2. The Evolution of Real Estate Capital Markets: A Practitioner’s Perspective, to be published by the Urban Land Institute, compiles that history.
   

1. Interest rates were very stable for a long period from the 1930s into the 1960s; during WWII, rates were fixed as low as 2%; in the 1960s, the major institutions that invested in real estate established administered rates that were not market linked.
2. At the beginning of each year, these institutions decided how much money that they wanted to put into cash, corporate bonds and equities vs. real estate mortgages and owned real estate.
3. Institutions priced themselves in or out of the market for the remainder of the year based on whether or not they made their allocations; their people got bonuses at the end of the year based on making the allocations, not on beating the market.
4. Brokers would go to local savings banks to finance sales; a major developer would go to a life insurance company; pension funds were not active in this arena in this time frame.
5. Beginning in the mid-1960s, market volatility increased—AAA corporates went as high as 6% by the late ‘60s; a down cycle in real estate began in the early 1970s—money became harder to get.
6. Investment bankers began to be involved in real estate; they took advantage of real estate debt markets not being linked to the capital markets for arbitrage.
7. Valuation techniques changed because of market volatility, rising interest rates and improved technology; computer financial models helped to link real estate to the asset allocation process being used by pension funds.

1. Financial deregulation came into effect in the mid-1970s; banks and savings-and-loans could bid for money instead of relying on fixed rates; the resulting “spread banking” emphasized getting an improved rate on money rather than on lending to quality borrowers.
2. People with no real estate background began making real estate loans without regard for loan-to-value calculations and covenants; it took five to ten years to work off the over-building that took place, especially in downtown commercial office space.
3. New finance vehicles were created such as opportunity funds, commercial mortgage-backed securities and a new generation of REITs with tax benefits.
4. Lending institutions created discipline in the early 1990s to prevent over-building from occurring again.

1. The late 1990s through the early present decade was one of the most benevolent periods for real estate, especially commercial real estate; the low cost of money, stable interest rates, controlled inflation and disciplined building created an ideal environment.
2. The end of the idyllic period is a matter of debate—interest rates are still low by historical standards; many people in the real estate industry for 15 years have not seen a down-market.
3. However, real estate is about cycles—about being ready for a downturn when it comes; recent increases in interest rates are bound to do damage to people who over-borrowed; some over-building is likely; cap rates have gone from 8%–9% to 5.5%.
4. There is more risk in the real estate market now than in the last four to five years.
5. The rough periods of the Great Depression and the early 1990s wiped out some good people; ironically, some who hid assets overseas and some who owed a lot of money to banks came through relatively well—banks did not foreclose in order to avert their own bankruptcy; delay and deferral were survival strategies.

1. Cycles are inevitable—don’t assume that things will remain the same; there is a lot of money to be made in cycles by playing pricing spreads between public and private markets.
2. For example, the stock of a bankrupt company in the early 1970s traded around $8; McCoy sold its 16 high-rise office buildings on an asset basis and distributed $27 to shareholders; assets of a holder of shopping centers yielded $72 for shareholders of stock valued at $8.
3. Similar anomalies are being seen today; opportunities in real estate turn up as markets get out of synch and companies take themselves public or private accordingly; e.g., some public REITs are likely to go private.
4. The opportunity funds have too much money, which is driving cap rates down too low; some of these funds will not be able to meet the risk-adjusted returns they have promised.
5. Commercial mortgage-backed securities are vulnerable to a market downturn; they have no one administering properties who could work them through rough times until the market recovers.

1. Run a little scared about increasing interest rates and do not over borrow.
2. Calculate your own loan-to-value ratio on the assumption that interest rates are going up another 100-150 basis points so that you borrow a little less on a project.

1. Recognize the importance of cycles and the differentials between public market and private market pricing.
2. Be aware that public market pricing, private market pricing, interest rates, local supply and demand, all have their own cycles; overlaying those are larger economic cycles.
3. The interplay of these cycles is what creates pricing anomalies, which equate to opportunities to play the spreads.
4. Real estate is not a passive investment that can be locked up for prolonged periods—even lenders and funds cannot afford to have a passive attitude; real estate is an active business.
5. The most frightening period in McCoy’s experience was the early ‘90s, which ruined some good developers and stressed even major banks as their real estate portfolios lost value; a lot of new regulations resulted.