Real Assets Adviser February 2015

F E B R U A R Y 2 0 1 5 | A p u b l i c at i o n o f I n s t i t u t i o n a l R e a l E s tat e , I n c .

Loving

Life Adviser Harvey Spira eschewed the wirehouse route to form Hyperion Wealth Advisors as an IAR.

Year in Review

2014 proved to be a breakout year for real assets

Grand Gestures

Splashy corporate HQs are making a major comeback

Final Bid: Sold!

Auctions are a viable method of direct real estate investing

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THIS IS NOT AN OFFER TO SELL NOR THE SOLICITATION OF AN OFFER TO PURCHASE A SECURITY OR AN INTEREST IN REAL ESTATE.

Contents 30

FEBRUARY

2015

VOLUME 2 | NUMBER 2

features

30 | Loving Life

dviser Harvey Spira eschewed A the wirehouse route to form Hyperion Wealth Advisors.

By Ben Johnson

36 | Year in Review

014 proved to be a breakout 2 year for real assets.

By Joel Kranc

42| Grand Gestures

Splashy corporate HQs are making a major comeback.

By Mike Consol

50 | Final Bid: Sold!

uctions are a viable method A of direct real estate investing.

36

42

By Jennifer Popovec

54 | Shock Absorbers

Midstream energy infrastructure investors are positioned better than most to withstand oil’s price volatility.

By Drew Campbell

50

54

F E B R U A R Y 2 0 1 5 | # 2 7 $ . + % #6 + 1 0 1 ( + 0 5 6 + 6 7 6 + 1 0 # . 4 ' # . ' 5 6#6 ' + 0 %

On The Cover Harvey Spira of Hyperion Wealth Advisors hopes to grow his AUM to $500 million in the next two years as an IAR. Photo Credit: William Neumann

realAssets Adviser | FEBRUARY 2015

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Contents

FEBRUARY

2015

reala s s e t s a d vi s er . com

News & views

22

24

26

28

Real Estate

Infrastructure

Energy

Commodities

22 | Offices Sell for $3B NYC office building sales heat up at year end

24 | Investors Stymied Study finds pent-up demand for new infra deals

26 | Aloha Merger NextEra snaps up Hawaiian Energy for $4.3B

28 | Timber Tumbles Lumber prices dropped 10% in late 2014

23 | PREIT Deals REIT sells off 13 centers for $420M

25 | Debt Funds Collect After raising billions, where to invest?

27 | Thanks, Not Tax break extension carries a glitch

29 | Palladium Shines Metal rises 10% while platinum falls

23 | L.A. Commits SoCal pension fund pays $536M for properties

25 | Norway Considers Unlisted infra is now on the sovereign’s menu

27 | Guaranteed Money DOE makes $12.5B in loan guarantees

29 | Not So Sweet Sugar market facing strong headwinds

22 | Seeking REIT Status Investment firm hoping for IPO soon

24 | North Dakota Commits U.S. pension invests $105M in Grosvenor fund

26 | MLPs Turn Sour Lower oil pricing hit MLP index hard in 2014

Coming Next Month

departments

4 | Notes & Trends

14 | The Big Picture

59 | Ad Index

8 | Contributors

18 | Up Front

61 | Editorial Board

20 | people

64 | Last Word

12 | 5 Questions

28 | Gold Declines Prices end 2014 down 4.4%

eal Asset ETFs get R spotlight treatment.

The publisher of Real Assets Adviser, Institutional Real Estate, Inc., is not engaged in rendering tax, accounting or other professional advice through this publication. The opinions expressed in articles or columns appearing in Real Assets Adviser are those of the author(s) or person(s) quoted and are not necessarily those of Real Assets Adviser or Institutional Real Estate, Inc. Advertisements appearing in the magazine do not constitute or imply endorsement by Institutional Real Estate, Inc. Although the information and data contained in this publication are from sources the publisher considers reliable, its accuracy cannot be guaranteed, and Institutional Real Estate, Inc. accepts no responsibility for any errors or omissions. No statement in this magazine is to be construed as a recommendation to buy or sell any security or other investment.

The contents of this publication are protected by copyright law and may not be reproduced in whole or in part or in any form without written permission. Š 2015. All rights reserved. Printed in the USA.

2

realAssets Adviser | FEBRUARY 2015

There’s more than one road to prosperity.

Broadstone Real Estate offers real estate investment options for yield-driven advisers and accredited investors seeking an alternative to the public markets.

Visit Broadstone.com/RAA to download an investor kit.

[

notes & trends

]

By Ben Johnson Managing Director, Editor-in-Chief Real Assets Adviser

2014: A Rare Vintage Indeed for Real Assets

Time flies, but looking back, the mile markers all indicate that real assets are becoming more mainstream.

W

here in the world did the year go?

Of course, I’m speaking of 2014.

As I write this, it is the middle of January 2015, and the calendar absolutely does not lie. Neither does the fact that this represents our fifth monthly issue of Real Assets Adviser, the first and only information brand to bring investment advisers the actionable news they need to make informed decisions when it comes to diversifying investors’ portfolios.

If you’re like me, the recent holidays were a blur and are fast becoming a distant memory. Now it’s time for a quick return to reality, complete with corporate year-end 2014 earnings season and thinking about the Tax Man in less than three months.

For me, 2014 will always be remembered as a watershed year, characterized by more robust economic growth, a record-breaking stock market and, oh yes, the launch of the aforementioned magazine you are reading.

Any discourse regarding the role of transparency and legitimacy is a healthy one.

This particular issue of Real Assets Adviser is devoted to both looking back in a major league way,

4

as well as continuing to elevate the dialogue around real assets as a viable investable asset class.

Our lead feature is a formal year in review, where we have identified eight major trends or “game changers” that shaped (and continue to shape) the real assets space. And oh my, what a difference a year makes. Our lead trend addresses the “couldn’t miss it even if you were under a rock” news in the nontraded real estate investment trust space regarding accounting irregularities at American Realty Capital Properties and the ongoing impact on the nontraded REIT sector, primarily from a reputation management perspective.

Rather than writing another sensational headline about former ARCP chairman Nicholas Schorsch to grab your attention, I will reserve final judgment (which is not mine, yours or anyone else’s but a court’s to render anyway) over the next few months as the story continues to play itself out. Again, this is a major event of 2014 that could have a long-term impact on nontraded REIT fundraising. But my guess is that, given that the sector still raised some $15 billion in 2014 and had a near record-breaking raise in December alone, nontraded REITland will continue to do just fine. Memories have a peculiar yet predictable habit of fading away, and we will all move on to another “story of the moment.” Ultimately, any discourse regarding the role of transparency and legitimacy is a healthy one, and can only serve to make the real assets sector more relevant and credible to investors and their advisers. realAssets Adviser | FEBRUARY 2015

February 12 - 13, 2015 The Ritz-Carlton, Grand Cayman www.caymansummit.com

FEBRUARY 12-13 2015

For more information please contact: info@caymansummit.com

Industry Guest Speakers:

Special Guest Speakers:

Sir Richard Branson

John Mauldin

Founder, Virgin Group

Chairman, Mauldin Economics

Emmanuel Jal

Gregory Coleman

Renowned recording artist, award winning activist

Special Agent, FBI Case Agent, Wolf of Wall Street Investigation

Nouriel Roubini

Jacqueline Novogratz

Chairman, Roubini Global Economics

Founder and CEO, Acumen

Paul Lindley

Louis Hernandez, Jr.

Founder and CEO, Ella’s Kitchen

President and CEO, Avid

Keith Benedict - COO, A.G. Hill Partners, LLC Anric Blatt - Chairman, Global Fund Exchange Robert ‘Bob’ Borden - Managing Partner and CIO, Delegate Advisors David Bonderman - Co-Founder,TPG Capital Matt Botein - CIO and Co-Head of Alternative Investors, BlackRock, Inc. David Brief - CIO,The Jewish Federation of Metropolitan Chicago Tom Brown - Global Head of Investment Management, KPMG Gary M. Brown - CEO, CMG Life Services Inc. Anthony Cowell - Partner, Head of Alternative Investments, KPMG in the Cayman Islands Max Darnell - Managing Partner and CIO, First Quadrant Adi Divgi - President and CIO, EA Global LLC Chris Duggan - Vice President, DART Enterprises Ltd. David Einhorn - President and Co-Founder, Greenlight Capital Christophe Evain - Managing Director and CEO, Intermediate Capital Group Plc Johnston L. Evans - Managing Director and General Partner, INVESCO Private Capital Tim Fitzgerald - Head of Alternative Fund Services, Deutsche Bank James G. Glasgow, Jr. - Managing Member and Portfolio Manager, Five Mile Capital Jane Amanda Halsey - Founder and President, Roundtable Forum, LLC Lord Michael Hastings - Vice President, UNICEF UK Kenneth J. Heinz - President, Hedge Fund Research, Inc. Andrew Hoine - Director of Research, Paulson & Co. Inc. Constance Hunter - Chief Economist, Alternative Investments, KPMG Laird R. Landmann - Group Managing Director and Co-Director Fixed Income,TCW Eric Lloyd - CEO, Babson Capital Finance Robert ‘Bob’ Maynard - CIO, Public Employee Retirement System of Idaho (PERSI) James P. McCaughan - CEO, Principal Global Investors Andrew Mehalko - Founder and CIO, AM Global Family Investment Office Angela Moss - Director of Investments, UNC Management Company Mark Okada - Co-Founder and CIO, Highland Capital Management, LP Larry Powell - Former Deputy CIO, Utah State Retirement Fund James P. Rankin - Director of Investment Operations, PAAMCO, LLC Anne Richards - CIO, Aberdeen Asset Management PLC Mark E. Roberts - Managing Director, Ironside Asset Advisors/Biltmore Family Office Bill Rogers - Founder,TexWest, LLC Erin Ross - General Counsel and Chief Compliance Officer, Hitchwood Capital Management LP Parag Saxena - Co-Founder, Vedanta Capital LP Darsh Singh - Portfolio Manager, Satori Alpha Brian Sponheimer - Portfolio Manager, Gabelli and Partners Sally J. Staley - CIO, Case Western Reserve University Lisa Stanton - Legal Counsel, Man Investments Inc. Dr. Daniel Summerfield - Co-Head of Responsible Investment USS Ltd. Michael Underhill - Co-Founder and CIO, Capital Innovations, LLC Mark W. Yusko - CEO and CIO, Morgan Creek Capital Management Bruce Zimmerman - CEO and CIO, University ofTexas Investment Management Co.

The Cayman Alternative Investment Summit is produced by CAIS Ltd., a sister company of Dart Realty (Cayman) Ltd. Renowned for its longstanding commitment to thoughtful, sustainable development in the Cayman Islands, Dart Realty is the visionary behind a repertoire of high-end developments including the master planned community Camana Bay, the residential neighborhood Salt Creek and a Kimpton branded hotel and residences opening on Seven Mile Beach in 2016.

[

notes & trends

]

Other and equally important trends made headlines — and waves — in 2014. The rise of exchange-traded funds (ETFs) was absolutely undeniable. The market for master limited partnerships (MLPs) also grew by leaps and bounds, despite the dramatic drop in energy prices toward the end of the year. Consider that 11 MLPs held initial public offerings that raised more than $5 billion last year and you have a more publicly available means of investing in infrastructure.

Commodities including gold and oil both saw dramatic price declines, but the big question remains: How long term is the trend? I, for one, do not mind paying less than $2.00 per gallon for gas at the pump, but can it really last forever?

We all know that in the economy, as in life, the one constant is change, so maybe we shouldn’t get too comfortable just yet. One of the things I keep asking is this: Who knew with any certainty (guesses don’t count) that oil would drop so precipitously based on a variety of seen and unseen circumstances? Exactly, that’s what I thought.

Our year-end feature also draws attention to the increasing elevation of real assets as a viable asset class in 2014, thanks to the S&P Dow Jones and MSCI recognition of real estate as a separate asset class as defined within the Global Industry Classification Standard. That’s actually a pretty big deal, so I urge you to read more about it on page 39.

Three other trends that had a dramatic impact on real assets in 2014 included the growing influence of institutional investors on the real estate sector, the rapid escalation in commercial real estate pricing (which is reaching pre-recession levels in many markets and becoming a potential cause for worry in the investing community), and also the growth of business development companies. BDCs, as they are known, have become a much more legitimate means of investing in small- to medium-size firms, which seems to be an investment strategy that is resonating with more and more advisers.

At this point, we are all left with a certain high school lesson I learned long ago. Though I was a decent student, there was a time when history was not a subject I much cared for nor embraced in any positive fashion.

In fact, I asked to speak with my school counselor to find out why it was even relevant (looking back, I often ask, geez, what was I thinking?).

My counselor had a wise and stately demeanor, and was actually quite believable to a youngster such as myself. He leaned forward, looked me straight in the eye and said, “By understanding the past and learning from it, we can better shape the future. Don’t you want to shape the future?”

Truer words could not be spoken.

I, for one, do not mind paying less than $2.00 per gallon for gas at the pump, but can it really last forever?

On Twitter: @RealAssetsAdv and @Bjohn9

6

A publication of Institutional Real Estate, Inc.

president & CEO Geoffrey Dohrmann CHIEF Operating OFFICER Erika Cohen Managing Director, PUBLISHER & editor-in-chief Ben Johnson SENIOR VICE PRESIDENT, MANAGING DIRECTOR of business development Jonathan Schein EDITORIAL DIRECTOR Larry Gray ART DIRECTORS Maria Kozlova Susan Sharpe COPYEDITOR Jennifer Babcock Contributing Editors Drew Campbell Loretta Clodfelter Reg Clodfelter Mike Consol Denise DeChaine Jennifer Molloy Andrea Waitrovich vice president, marketing Sandy Terranova marketing & client services Michelle Raab Brigite Thompson Michelle Tiziani Caterina Torres BUSINESS DEVELOPMENT Elaine Daniels Salika Khizer Karen McLean SPONSOR SERVICES Wendy Chen DATA SERVICES MANAGER Ashlee Lambrix DATA SERVICES Justin Galicia Derek Hellender Karen Palma Administration Andrew Dohrmann Jennifer Guerrero

realAssets Adviser | FEBRUARY 2015

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[

contributors

] Drew Campbell Shock Absorbers (page 54) Drew is senior editor of sister publication Institutional Investing in Infrastructure (I3). He joined IREI in 2004 as the editor of IREN, a weekly commercial real estate news digest, and in 2006 became editor of High Return Quarterly, Global Quarterly and European Real Estate Quarterly. Previously, Campbell was a contributing reporter for the San Jose Mercury News and the Palo Alto Daily News.

Mike Consol Grand Gestures (page 42) Mike is editor of The Institutional Real Estate Letter – Americas, a publication of Institutional Real Estate, Inc. Prior to joining IREI, Consol spent 17 years with American City Business Journals, the nation’s largest publisher of metropolitan business journals. Consol was also managing editor of the Los Angeles Business Journal and news editor of the Pasadena Star-News.

Kevin M. Hogan Business Development Corporations (page 16) Kevin is president and CEO of the Investment Program Association. Previously, he was senior vice president of product development and marketing for LPL Financial, where he was responsible for brokerage product sales and marketing, including annuities, mutual funds, alternative investments, retirement plans and cash products.

8

ISSN 2328-8833 Institutional Real Estate, Inc. Vol. 2 No. 2 FEBRUARY 2015 PURPOSE Real Assets Adviser is dedicated to providing actionable information on the real assets class and facilitating important business connections for investment advisers, wealth managers and family offices. Through print, online, conference and data p ro g r a m s , R e a l A s s e t s A d v i s e r provides thoughtful, cutting-edge analysis, helping advisers make informed decisions to diversify clients’ portfolios, provide long-term income and hedge against inflation.

Real Assets Adviser (ISSN 2328-8833) is published 12 times a year for $195 per year, by Institutional Real Estate, Inc., 2274 Camino Ramon, San Ramon, CA 94583; www.irei.com; Tel +1 925-244-0500; Fax +1 925-244-0520.

CHANGE OF ADDRESS: Send address changes to Real Assets Adviser, 2274 Camino Ramon, San Ramon, CA 94583 USA. Copyright © 2015 by Institutional Real Estate, Inc. Material may not be reproduced in whole or in part without the express written p e r m i s s i o n o f t h e p u b l i s h e r.

Copyright Permission: Larry Gray, Tel +1 925-244-0500, x119; l.gray@irei.com

Joel Kranc 2014 Game Changers (page 36) Joel is an experienced and award-winning editor, writer and communications pro. As director of KRANC COMMUNICATIONS, he has performed writing and communications work for large financial institutions such as Manulife Financial, Morneau Shepell, Sun Life, Standard Life, the Human Resources Professional Association and the Canada Pension Plan Investment Board (CPPIB).

Circulation or Subscription Inquiries: Direct all subscription inquiries, payments and changes of address to Client Services, Tel +1 925-244-0500 or Fax +1 925-244-0520; circulation@ irei.com. Subscribers have 30 days to claim issues lost in the mail.

Jennifer Duell Popovec Sold! (page 50) Jennifer is an award-winning journalist and for the past 15 years has focused on business journalism with a specialty in commercial real estate, finance/investing, retail, hospitality and healthcare. She has more than 1,000 bylines to her credit and lives in Fort Worth.

Sponsorship Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com

Editorial Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com Advertising Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com

Requests for Reprints: Susan Sharpe, Tel +1 925-244-0500, x110; s.sharpe@irei.com Visit us online: RealAssetsAdviser.com

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Opening

VIEW

Keeping It Weird

It might be a surprise to many, but Austin, Texas, (along with its colorful slogan) ranks as the secondmost popular city for real estate investment in 2015, according to the Urban Land Institute.

[5] Questions

Building the Future of Life Science

How did Alexandria Real Estate Equities come to dominate life science real estate in top U.S. cities?

J

oel Marcus is passionate about his work. As CEO and founder of Alexandria Real Estate Equities (ARE), he runs the only publicly traded REIT focused exclusively on the biotech and life science sector. We asked Marcus for a quick take on what sets his firm apart.

Why do you focus only on this specific sector?

When we founded Alexandria Real Estate Equities, there was no other real estate company out there in the early ‘90s able to buy, own, manage and redevelop properties for the world’s leading life science and biotech firms. The reason was there was a tremendous lack of knowledge in this niche for constructing highly complicated buildings that these firms needed for R&D. Also, developers were hesitant to take on risky client tenants. We founded ARE on the belief that life science and tech companies are most successful when located in the epicenter of the world’s best innovation hubs, like Cambridge, New York City and San Francisco, immediately adjacent to world-renowned academic and medical institutions, cutting-edge scientific and managerial talent, and sophisticated capital. Today, Alexandria is the dominant provider of life science real estate in the top cities in the United States.

Why is this industry such a hot investment prospect?

2014 was a remarkable year for the life science industry, and one of the best

12

years for Alexandria in company history. We are seeing occupancy, demand and new development reach record-high levels. Factors behind the current boom include the advent of a new generation of precision medicines, such as cancer immunotherapy drugs. At the same time, the Food and Drug Administration has been approving safe and effective drugs at an all-time record high. Both developments have increased the need for scientific research space. This trend will not slow down anytime soon. Large-cap biotech firms are generating organic revenue growth, there is a robust IPO market for emerging biotech companies and private and venture capital investment continues to be strong. We can’t service all the demand we have.

Why are city centers so popular with the pharmas today?

It has become clear that fast-growing companies, especially in the tech sector, are avoiding isolated suburban campuses for urban innovation clusters.

One of the main reasons is because they are following the younger workers, the millennial generation, who want to live and work in city centers. Urban hubs offer a 24/7 work-play environment, and these dense locations foster greater innovation and collaboration. Last year, two of our client tenants – Biogen Idec and Roche – moved from their suburban locations to our urban innovation

Joel S. Marcus

clusters in Cambridge and New York for these exact reasons. It’s a trend that is not going away anytime soon.

How is the industry positioned to solve the global healthcare crisis?

We are still in the early innings of solving the global healthcare crisis, but the industry has come a long way over the last 20 years. The level and quality of new science is just phenomenal. However, there is a clear unmet need for new drugs and diagnostics, which are a key solution for reducing chronic disease burden and lowering healthcare costs.

For instance, there are 30,000 diseases out there of which 5,000 have a known cause and only 250 have cures.

How specifically do investors gain access to this industry through ARE? Investors gain access to this industry through Alexandria because we are the largest and leading REIT serving the life science and technology sectors, and the landlord of choice with strong relationships across our markets. We also host creative programming events that provide our tenants with access to ARE’s unparalleled thought leadership network.

Alexandria Real Estate Equities is traded on the New York Stock Exchange under the ticker symbol “ARE.”

realAssets Adviser | FEBRUARY 2015

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Market Update

INSTITUTIONAL INVESTING IN INFRASTRUCTURE

Institutional Real Estate

FundTracker October 2014

A tall order Finding investments in Australia’s office market may mean moving up the risk curve Inside 2

Back in the saddle Toll road investors have traveled a rocky road of late, but experts believe the future holds promise

InstItutIonal Real estate letteR TH E

InstItutIonal Real estate letteR A M ER I C A S

The new fund challenge Brand-name firms are building mega-funds, but for the rest of the field it is a mighty climb

November 2014 Institutional Real Estate, Inc. www.irei.com

Fundraising Trends It’s getting hot, hot, hot ...

Fundraising market sizzles as year-end activity heats up

InstItutIonal Real estate letteR THE

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markeT Focus Up, up and away

Fund news

A closer look at year-to-date 2014 and the past 12 months in the North American funds market

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News of recent fund launches and capitalraising activity

A sampling of investors’ recent commitments to real estate funds O c t O b e r 2 0 1 4 | A p u b l i c At i o n o f i n s t i t u t i o n A l R e A l e s tAt e , i n c .

A S I A PA C I F I C

A foreign affair Various factors are pulling — and pushing — Asian investors into overseas real estate markets

The end of deleveraging in Europe is in sight for some, but major work lies ahead for others November 2014

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Game

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the Reit choice Weighing your options across the traded vs. nontraded spectrum

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A case for MLPs as a core allocation in investors’ portfolios

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Why the precious metal presents compelling benefits over the long term

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[

The Big Picture

By Hugh F. Kelly, PhD, CRE

]

The Art of Discipline in Today’s Cycle

While a true “bubble” may not be imminent, real estate investors should exercise extreme caution in 2015.

O

ne of the highest compliments we can pay a person is to call him “a renaissance man.” The prototype, of course, is Leonardo da Vinci. Not only could da Vinci produce art of the quality of Mona Lisa and The Last Supper, but he was a scientist and engineer who invented an early adding machine, made contributions to anatomy and even had a basic theory of plate tectonics.

We consider this remarkable (and it is) for many reasons. Most people consider art and science to be radically different areas of human endeavor, such that those who master both must be “geniuses” — that is, people whose talents are based on gifts far beyond normal abilities to integrate domains of skill. In fact, both art and science draw upon one of the most basic of human capacities: discipline.

Disruptive bubbles are not the same as predictable real estate cycles.

In thoughtful moments, investors sometimes try to decide whether their success is a matter of art or science (or, if feeling unusually humble, a matter of good fortune). Right now, though, it is best to ask ourselves how disciplined we are. Real estate, and the economy as a whole, is profoundly cyclical. Recent signals from the equities markets,

14

beginning in July 2014, have been indicating the kind of volatility in profit outlook that suggest 2015 will be a period where real estate (a) has significant opportunities to outperform other assets classes and (b) will be subject to shifts in demand that require careful attention and disciplined execution.

Fundamental economic indicators, such as GDP growth, employment trends and consumer confidence, are as strong as they have been in the past decade. While that is all to the good, real estate prices have anticipated the economy by implicitly incorporating “future good times” into the very low capitalization rates that have marked the 2012–2014 period. If you are among those who were early investors in this real estate cycle and have unrealized capital gains in commercial property assets, congratulations! 2015 might be a good year to consider taking profits in an era of higher values and more widespread economic optimism. While this might leave a few dollars on the table, the exact timing of a cyclical peak is a very risky guess, and no one ever went broke locking in profits.

Return on investment in real estate, over the long run, has been more heavily weighted to income returns than on asset appreciation. So even if we are nearing a cyclical pricing peak for some real property types (apartments especially, but CBD office properties in gateway cities as well), that doesn’t mean new acquisitions will not realAssets Adviser | FEBRUARY 2015

make sense. Those new investments, however, need to be examined for the quality of the net operating income stream.

For multifamily properties, for instance, the risk is in the short-term lease profile. Buyers need to look beyond this year’s pro forma to the volume of new competition likely to lure tenants in 2016 and 2017. For offices, the longer duration of leases mitigates that particular risk, but pay close attention to lease expiration schedules and the renewal options embedded in existing leases. These factors reveal a lot about income quality and durability.

There is always a temptation to increase cash-oncash returns by moving to higher levels of leverage.

This is a particularly bad idea if you believe we are nearing a cyclical peak in the economy. Any deterioration in supply/demand fundamentals is amplified by leverage. Keeping your equity cushion generous is the best way to ride out the cycle. “Buying low” is a great opportunity to generate alpha for your investment portfolio, but cheap properties are just not available in most commercial property markets at this point. A focus on conservation of capital — “return of investment” — is as important a consideration as the overall “return on capital,” especially if the increased volatility in the stock market in the second half of 2014 expresses nervousness about the economic outlook for 2016 and beyond.

I do not mean to suggest that another “bubble” is on the horizon. Disruptive bubbles are realAssets Adviser | FEBRUARY 2015

not the same as predictable real estate cycles.

Prudent investors, though, always need to keep both of those potential changes in their planning and in their risk-management thinking.

Event risk is always with us. When real estate assets are as richly priced as they are today, the discipline to shift focus away from appreciation to income, and then to strategize toward maintaining the quantity of income by focusing on its quality (or reliability) is key.

Whether you think investment is an art or a science, be a renaissance man and call on a sense of discipline in your real estate moves. And if you are among those who believe that an element of luck is also involved, remember the

The exact timing of a cyclical peak is a very risky guess, and no one ever went broke locking in profits. observation of baseball executive Branch Rickey, who said, “Luck is the residue of design.”

Hugh Kelly is a clinical professor of real estate

at NYU’s Schack Institute’s master’s degree programs, and the 2014 chair of the Counselors of Real Estate.

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The Big Picture

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Demand Driving Growth in Nontraded BDCs Investors seeking noncorrelated strategies might consider this emerging asset class.

T

he growing demand for alternative investment strategies among financial advisers and their clients continues at a rapid pace. Many investors are realizing that their retirement income might not be as strong as originally anticipated. And many advisers are realizing that the traditional portfolio allocation of stocks and bonds will not deliver the retirement security that their clients deserve.

Nontraded business development companies (BDCs) are an emerging asset class that could be part of the solution.

Several diverging trends are driving the demand for income-oriented alternative investment products.

Approximately 77 million Americans born between 1946 and 1964 are entering retirement at a historic pace, and many are worried about

of low interest rates and stock market volatility, has many investors seeking more stable, noncorrelated investment strategies for a portion of their portfolio.

It is probably no coincidence, then, that nontraded BDCs are experiencing a surge in demand. In 2014, approximately $5.5 billion was invested in these vehicles, an increase of more than 13 percent from 2013. BDCs provide access to the types of alternative strategies that can help investors increase diversification and lower portfolio volatility. They seek to generate a high level of current income in today’s low interest rate environment, while helping to reduce correlation to the broader markets.

Private companies represent approximately 99 percent of all U.S. companies and contribute nearly

In 2014, approximately $5.5 billion was invested in these vehicles, an increase of more than 13 percent from 2013. outliving their savings. Additionally, the decline in pension plans means that most of these retirees will be depending on defined contribution plans to provide for their retirement.

The combination of these factors, along with the recent period

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$4 trillion toward U.S. private sector GDP. Because these businesses play such an important role in our economy, financing their operations is of utmost importance. That is why Congress created the BDC in 1980 through an amendment to the

By Kevin M. Hogan

Investment Company Act of 1940 (40 Act) to help facilitate the flow of capital to private U.S. companies.

A BDC provides financing, whether through loans or ownership, to small- and medium-sized businesses. BDCs pool capital from individuals in exchange for shares in the BDC. The growing role that BDCs serve as financing solutions for private companies comes at an opportune time. Since the financial crisis, traditional bank lenders have significantly reduced their lending activity due to increased regulations and higher compliance costs. Before BDCs, there was very limited opportunity for small companies to raise capital from individuals.

In addition, investing in private companies has been limited historically to large, institutional investors such as endowments or pension funds. BDCs allow individuals to invest in many private U.S. companies at low investment minimums within a 40 Act fund that provides a high degree of regulatory protections.

Considering today’s demographic trends and investor demand for alternative investment strategies, it appears the stage is set for continued growth of nontraded BDCs. Kevin M. Hogan is president and CEO of the Investment Program Association. realAssets Adviser | FEBRUARY 2015

Covering the institutional real estate industry for more than 25 years.

The Institutional Real Estate Letter — Americas

InstItutIonal Real estate letteR THE

AMERICAS

Climate change at land’s end Real estate investors like targeting coastal cities, but so does a seething Mother Nature

October 2014 Institutional Real Estate, Inc. www.irei.com

The Institutional Real Estate Letter – Americas is IREI’s flagship publication and has been around for more than 25 years. It has stood the test of time and continues to be the must-read publication for gaining insights, news and data on the institutional real estate marketplace.

Although written for institutional investors, by reading it investment advisers get a true, deeper understanding of how investors are thinking, strategizing and planning.

Try it out for FREE at www.irei.com/tirelam_trial.

Your trial includes: • The next 2 issues of The Institutional Real Estate Letter – Americas • 24/7 access to all of our back issues on our website • Access to our publication app, which is available in the Apple iTunes App Store and Google Play, so you can read issues on your tablet or smartphone.

INSTITUTIONAL REAL ESTATE, INC.

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people data insights

up front

LONDON REMAINS WORLD’S MOST EXPENSIVE OFFICE MARKET

IFM TAKES STAKE IN VIENNA AIRPORT

CBRE study finds London outpacing Hong Kong, Shanghai in annual office space ranking.

The Australian investment manager has purchased a 30 percent interest in Austria’s largest airport.

Fidelity: RIAs Need Help with Marketing, BizDev

A new study by Fidelity Institutional Wealth Services found that only 5 percent of U.S. RIAs feel their firms are advanced in the areas of marketing and business development, and seven in 10 do not have a plan in place to guide them toward better business results, a number that has gone unchanged since 2011.

“Three-fourths of firms see improving their marketing and business development as a top strategic initiative, but they are struggling to make progress,” says David Canter, executive vice president and head of practice management and consulting, Fidelity Institutional Wealth Services.

Here are a few key survey findings: • High-performing firms are focused on telling a consistent firm story, while half of RIA firms are still struggling to establish one. Only 56 percent of all firms studied agree that they have a clearly defined and differentiated firm story, and only 43 percent agree their stories are tailored to the specific needs of target clients.

• While firms are making progress when it comes to targeting the right clients, high-performing firms are almost twice as likely to effectively communicate their target client profiles to help generate the right referrals. Firms with a target client profile reported that 90 percent of new clients added in 2013 fit this description, compared to only 75 percent of clients on board prior to 2013. High-performing firms are almost twice as likely to agree that

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they effectively describe their target client profiles to both clients and centers of influence.

• Few firms have an “advanced” referral process; high-performing firms are four times as likely to leverage COI referrals to the fullest. Referrals from existing clients and centers of influence are important channels of growth for RIAs, accounting for 75 percent of all new clients. However, less than one-third of the firms rate their referral processes as advanced, or even fairly strong. Only 14 percent agree that they have analyzed their client base to focus on the clients most likely to make referrals.

• High-performing firms have the talent and resources in place, while one-third of RIA firms are pursuing business development officers.

High-performing firms are about twice as likely to be pursuing strategic initiatives to develop talent-management plans or change firm compensation plans — signs that they may be managing talent more proactively. They are also less likely to see lack of internal sales and marketing capabilities as an issue and, possibly as a result, are less likely to be hiring business development officers.

Real Assets Gain With Institutions

Institutional investors are increasingly turning to real assets to increase investment returns and manage macro-environment risks, but they would rethink allocations if interest rates rose significantly, according to a new survey from BlackRock.

The survey polled 201 executives on their attitudes and allocations to real assets. It found 46 percent of respondents had increased allocations to real estate, infrastructure, commodities, timber and farmland in the past three years, while 60 percent expect to do so in the next 18 months.

InfraREIT Files for IPO

InfraREIT Inc., an externally managed REIT that owns rate-regulated electric transmission and distribution assets, has filed for an IPO. It expects its shares to trade on the NYSE under the ticker symbol HIFR. In its SEC filing, InfraREIT did not specify a share count or price range for the offering, but set a proposed maximum aggregate offering price, for the purpose of calculating the registration fee, of $400 million.

Immediately following the consummation of the offering, InfraREIT Inc. will merge with InfraREIT LLC, which owns electric transmission and distribution assets in Texas and leases them to Sharyland Utilities LP, a regulated utility. The REIT will be externally managed by Hunt Utility Services LLC, which is owned by an affiliate of Hunt Consolidated Inc., a privately held company engaged in energy, real estate, investment and ranching businesses. realAssets Adviser | FEBRUARY 2015

WILSHIRE ROLLS OUT NEW BDC INDEX

RECORD YEAR FOR U.S. IPO MARKET

Move is set to create a new class of investable products in the business development arena.

The number of U.S. IPOs set a 14-year record in 2014 with 273 filings versus the all-time record of 406 in 2000.

N.Y. Deposes London as Top Choice by Foreign Investors

Washington, D.C., continues to fall from favor among foreign real estate investors according to the 23rd Annual Survey taken among the members of the Association of Foreign Investors in Real Estate (AFIRE). Washington was at the bottom of the five-city U.S. ranking; it ranked 15th among global cities, down from last year when it was ranked 10th.

Conversely, New York has returned to its long-held slots as both the #1 global and #1 U.S. city. With the exception of last year, when London nudged it into second place, New York has held the top rank, both globally and among U.S. cities, since 2010.

Here are a few highlights from the survey: • More than 90 percent of survey respondents say they plan to maintain or increase the size of their U.S. portfolio in 2015.

• By a wide margin, the United States was voted the most stable and secure country for investment, outstripping both second-place Germany by 55 percentage points, and

realAssets Adviser | FEBRUARY 2015

AFIRE Survey Snapshot Top Five Global Cities 1. New York (#2 last year) 2. London (#1 last year) 3. San Francisco (#3 last year) 4. Tokyo (#6 last year, tied with Madrid) 5. M adrid (#6 last year, tied with Tokyo)

third-place United Kingdom by 60 percentage points.

• The United States also offers the best opportunity for capital appreciation, outperforming second-place Spain by 34 percentage points and third-place United Kingdom by 40 percentage points.

• Two-thirds of survey respondents expect China to become the largest source of capital into the United States in 2016 and beyond; 10 percent expect that could happen as early as 2015. Seventy-two percent of survey respondents said they expected this investment to be a long-term, permanent inflow.

REITs Perform in 2014

U.S. equity REITs ended 2014 with a total return for the year of 27.5 percent, double the 13.7 percent return posted by the S&P 500 for the year.

The SNL U.S. Manufactured Home REIT index led all REIT indexes in 2014, with a total return for the year of 46.0 percent. The SNL U.S. Multifamily REIT index finished a strong second, with a 2014 total return of 40.5 percent.

The healthcare, regional mall, hotel, self-storage and shopping center sectors also outperformed the SNL U.S. REIT Equity index in 2014. Diversified REITs were at the bottom of the list with a total return of 17.1 percent, which was still more than 3 percentage points higher than the S&P 500’s total return for the year.

Total returns for the top 25 individual REITs show a healthy dose of multifamily and hotel REITs, with five of the top 25 coming from each sector. Winthrop Realty Trust, a diversified REIT, led equity REIT returns in 2014 with a total return of 65.5 percent. Shopping center–focused AmREIT, which agreed to sell to Edens Investment Trust in November, was next on the list, with a total return for 2014 of 64.3 percent.

U.S. equity REITs are expected to grow FFO in 2015 by a median of 7.4 percent. The hotel sector tops the list, with median projected FFO growth of 16.6 percent for 2015.

In other news, six U.S. REITs completed IPOs in 2014, raising an aggregate amount just under $4.1 billion. This was less than half the number of IPOs completed in 2013, when 13 U.S. REITs completed IPOs for an aggregate of $4.9 billion.

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people

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Cushman & Wakefield Taps Santora as New North America CEO John C. Santora has been named CEO for North America at Cushman & Wakefield. The region is the firm’s largest John C. Santora global operating region. A 37-year veteran of the firm, Santora will drive forward the execution of C&W’s strategic plan in the United States, Canada and Mexico, which consists of 146 owned and alliance offices and nearly 8,000 employees. Santora also will provide continuity in his new role with key multinational client relationships and further integrate service lines in the region across leasing, capital

markets, valuation and advisory, and property management. He will continue to serve on the firm’s senior governing body, the board of directors.

Santora takes over North America as Jim Underhill has left the firm to pursue other career opportunities.

“Throughout his career, John’s success in a variety of managerial and operational positions with increasing authority and responsibility is due to placing the utmost importance on organizing services and driving solutions for the benefit of Cushman & Wakefield’s clients,” said Edward C. Forst, Cushman & Wakefield’s president and CEO. Santora is one of the industry’s most experienced commercial real estate executives, most recently serving as president and CEO of Cushman & Wakefield’s corporate occu-

pier & investor services (CIS) group. Since becoming a strategic initiative under Santora in 2010, CIS has more than doubled its revenue and earnings before interest, taxes, depreciation and amortization (EBITDA).

Santora previously served as the firm’s global chief operating officer, where he helped plan and drive the firm’s global expansion into Europe and Asia and the integration of new service areas. He is chairman of the board of the business integration group (BIG), a real estate technology company based in Tempe, Ariz.

He is a fellow of The University of Pennsylvania Wharton School, chairman of the Realty Advisory Board, and an active member of the Building Owners and Managers Association and the Board of Governors of the Real Estate Board of New York.

L. Clay Adams Jr. has joined Pacolet Milliken as president of real estate. Adams brings more than 22 years of experience in the real estate industry to the firm. In addition to being responsible for new real estate investments, he also shares significant responsibility in the management of Pacolet’s existing portfolio. Prior to joining Pacolet Milliken, Adams served as a managing director and partner of Childress Klein Properties and led the investment management division. Prior to Childress Klein, he was a cofounder and principal of MXA Capital. At both companies, Adams was responsible for leading deal sourcing, capital structuring, business plan formation and asset management with regard to new investments in office, industrial and retail asset classes.

to facilitate strategic, long-term growth of the company’s commercial brokerage business. In his 30-year career, Bowles has held senior management positions at leading national commercial brokerages, including Colliers International, Cushman & Wakefield and CBRE. During his leadership from 2001 to 2014, CBRE’s Seattle operation grew its annual revenue from $12 million to nearly $200 million.

ing three professionals to its Los Angeles office. The new team includes former Blackstone managing director Michael Dal Bello, who is investment partner for the healthcare investment team. Dal Bello is joined by Ceron Rhee, vice president-healthcare, who was previously a vice president at TPG Capital in San Francisco. The team also added Evan Earley, associate, who joined from UBS Investment Bank, where he was an analyst.

Commercial real estate veteran Jim Bowles was named president of Kidder Mathews’ West Coast brokerage division in Seattle. The new position was created

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Doug Crocker has joined the board of directors of Associated Estates Realty Corp. as an independent director. Crocker is chairman of Pearlmark Multifamily Partners and the former vice chairman and CEO of Equity Residential. Mark L. Milstein retired from the board. Crocker serves as chairman of the finance and planning committee of the Associated Estates board, which, in consultation with the firm’s financial adviser, is conducting a thorough review of the company’s assets, operations and business strategy.

Pritzker Group Private Capital is expanding its West Coast investment team, add-

Mark Evans has joined Ascent Private Capital Management, U.S. Bank’s ultrahigh-net-worth wealth management unit, as managing director of investments in Minneapolis. He will provide investment advice to Ascent clients and will be responsible for understanding the factors that drive economic and capital-market trends and performance to help clients take advantage of appropriate investment opportunities and mitigate risk.

Wilmington Trust has hired Patricia Farrell as managing director for the firm’s wealth advisory office in Buffalo, N.Y. In this role, realAssets Adviser | FEBRUARY 2015

she leads a team of professionals who provide wealth and investment management, trust, estate planning, family office, and philanthropy services for clients throughout western New York. Farrell joins Wilmington Trust, part of M&T Bank Corp., with more than 20 years’ experience in financial services. Most recently, she was a senior vice president and private client adviser at U.S. Trust in Manhattan, where she was private banking team leader.

An adviser team known as Quattuor Capital Partners has joined Raymond James & Associates, managing $900 million in assets. The group left J.P. Morgan Securities and is led by managing director Howard Franzblau, and it includes managing directors Richard Devine, Wayne Froud and David B. Brennan. The team opened Raymond James’ first office in New York.

Cushman & Wakefield announced that Owen Hane, a 29-year veteran of the commercial real estate industry, has been promoted to executive director. Hane’s career at Cushman & Wakefield spans more than 20 years, successfully handling assignments for major corporations and managing building agency assignments totaling approximately 3 million square feet. In addition to his extensive work in the New York Metropolitan market, Hane has cooperatively handled significant assignments in Boston, Chicago, Cleveland, Dallas, Miami, New Jersey, San Francisco, Seattle, Washington, D.C., London and Mexico City.

Jeffrey Heimstaedt has joined Wells Fargo Advisers. Heimstaedt was most recently with Oppenheimer & Co., but he started his career in 1981 with Merrill Lynch. He reports to Phil Winterson, regional brokerage manager for Los Angeles and north Orange County.

Metropolitan Area, as executive vice president/chief investment officer and principal. Ikeler’s responsibilities will include identifying and executing new strategic initiatives to expand the company’s investment and development platforms, including overall responsibility for capital markets and project finance. Previously, Ikeler was managing director at Penzance responsible for arranging transactions totaling $1.6 billion. Ikeler also built a national investment banking practice for Jones Lang LaSalle, co-managed a $600 million initial public offering for Security Capital Group, and shaped Oliver Carr Company’s suburban infill investment/ development division into a dominant competitor.

Clyde W. Robinson Jr. has joined ASB Real Estate Investments as managing director and head of client services. Robinson comes to ASB from Dallas-based Hunt Realty Investments where he was responsible for capital partner development and strategic capital raising. Previously, he managed global client relations and capital raising for the private equity arm of J.E. Robert Companies.

James D. Robinson IV has joined the board of directors of Empire State Realty Trust. He replaces Lawrence E. Golub, who resigned at the end of 2014. Robinson is a founder and managing partner at RRE Ventures and has been active within the technology community as a venture capitalist, entrepreneur and banker. He has led investments in, and served on the boards of, more than 40 companies, with a focus on networked technologies, data analysis and financial services.

A former Morgan Stanley trio with more than $300 million in assets joined Raymond James Financial Services, the firm’s independent broker-dealer. Advisers Craig Houck and Richard Schooley formed Dogwood Wealth Advisors with offices in Atlanta and Savannah, Ga. Director of client services, Alyssa Donaldson, also moved with the team.

Will Rowson has become a partner of Hodes Weill & Associates, a global real estate advisory boutique that focuses on the investment and funds management industry. He will be based in London and will lead Hodes Weill’s advisory and capital raising activities across Europe and the United Kingdom. Previously, Rowson was the chief investment officer for CBRE Global Investors across Europe, the Middle East and Africa (EMEA), a member of its European executive committee, and chairman of the EMEA investment committee.

Thomas Ikeler has joined PN Hoffman, a developer of urban mixed-use properties and communities across the Washington

Laura Seidel has joined law firm Ballard Spahr’s real estate department as a partner in the Atlanta office. She advises

realAssets Adviser | FEBRUARY 2015

major players in the real estate economy nationwide on matters involving secured lending and commercial real estate. Previously, she was a partner in the Atlanta office of Womble Carlyle, where she practiced for more than 17 years.

Former Dallas Cowboy footballer Emmitt Smith’s firm, E Smith Realty Partners, has hired Greg Seitz and Marc Rankin, CCIM, to launch E Smith Capital Partners, a new capital markets division. Seitz, senior managing director, and Rankin, managing director, will headquarter the division in Austin and will have offices in additional markets throughout the country. Seitz brings more than 33 years of commercial real estate experience to the firm, with a focus on the capitalization of all income-producing property. Previously, he served as office head at HFF and principal at Bridgepoint Advisors in Atlanta. Prior to joining E Smith Capital Partners, Rankin launched and served as managing principal at Market Maker Realty and Investments, where he arranged financing for more than $600 million in real estate assets.

Jack Taylor, the head of Prudential Real Estate Investors’ global debt unit, has joined Pine River Capital Management to oversee a commercial real estate investment program that will be seeded with $500 million of equity. Pine River is a Minnetonka, Minn., investment manager. Taylor has been joined by Pru team members Stephen Alpart and Steven Plust, who were named managing directors. Their responsibilities will include oversight of the commercial real estate investment program being planned by Pine River’s affiliate, Two Harbors Investment Corp., a mortgage REIT. Matthew Tilghman-Havens has joined U.S. Bank’s Private Client Reserve highnet-worth unit as a senior wealth planner in Seattle. He was previously an attorney with Graham & Dunn in Seattle, where he was part of the estate planning team.

John Van Donge joined Stifel Nicolaus & Co., the broker-dealer subsidiary of Stifel Financial Corp., to run a new branch office in Santa Barbara, Calif. He was a 17-year Merrill Lynch veteran and was managing director and resident director of the brokerage company’s branch in Century City, Calif., where he managed $600 million in assets.

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R ea l E stat e news

Investment Firm Seeks REIT Status

E

asterly Government Properties, a Washington, D.C.–based investment firm, intends to qualify as a real estate investment trust and has filed a registration statement with the SEC for its proposed IPO. The number of shares of common stock to be sold and the price range for the proposed offering have not been determined, but the new REIT would trade on the NYSE under the symbol “DEA.” The

IPO is expected to commence after the SEC completes its review process, subject to market and other conditions.

Easterly Government Properties specializes in the acquisition, development and management of class A commercial properties leased to U.S. government agencies through the U.S. General Services Administration.

Upon completion of this offering and the formation transactions, Easterly Gov-

ernment Properties will own 29 properties in the United States, including 26 properties that are leased primarily to U.S. government agencies and three properties that are entirely leased to private tenants, encompassing approximately 2.1 million square feet. The initial portfolio consists of 15 properties contributed by the Easterly Funds and 14 properties contributed

by Western Devcon.

Four NYC Offices Sell for $3B

Apartment Rents Set to Soar in 2015

In four separate deals, four New York City office buildings have sold for $2.79 billion, with each selling for more than $200 million.

The 400,000-square-foot Crown Building located at 730 Fifth Ave. is under contract for a rumored price of $1.75 billion, or $4,375 per square foot, to joint venture partners Jeff Sutton and GGP. The sellers are Spitzer Enterprises and Sicc-Combined. Major tenants include Bergdorf Goodman, LVMH, Tiffany & Co., KKR and Apollo Management.

Just two blocks west, The Blackstone Group purchased 1740 Broadway from Vornado Realty Trust for $605 million. The asset is the largest of the four properties, totaling 601,000 square feet. Major tenants include Limited Brands, Citibank, Cognac and Davis & Gilbert.

In midtown, the National Association Building at 28 W. 44th St. sold for approximately $235 million to APF Properties. The seller of the 359,000-square-foot office was Prudential Real Estate Investors.

Lastly, 386 Park Ave. South sold for approximately $200 million to Heng Seng Realty. The sellers were Principal Real Estate Investors and William Macklowe Co.

Reis has reported that U.S. apartment vacancies have risen for the first time in five years, but rent growth has not subsided, nor will it subside during 2015, according to a 2015 multifamily forecast from Pierce-Eislen. It has prophesized that effective rent growth during 2015 will be 4.5 percent in class A and B+ apartment communities, while rising an even more vigorous 5.1 percent in class B and C apartment complexes.

The news is even better in markets such as Atlanta, Denver, Miami, Portland, San Francisco and Seattle, where rental rates are expected to swell by 7.5 percent to 9 percent. This comes on the heels of rental rate growth that is estimated to finish 2014 at 5.9 percent. Rental rates keep rising despite a national apartment vacancy rate that inched up to 4.2 percent during the third quarter in 79 large U.S. markets tracked by Reis.

Despite the modest increase — the first in “a virtually unprecedented run” of five years — the apartment market remains “incredibly tight.” Pent-up demand is expected to keep them that way, even as new construction of multifamily properties is still increasing and

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will likely reach a post-recession high this year, according to Reis.

Pierce-Eislen forecasts that the strongest rental growth markets will be Denver and San Francisco with 9 percent rental rate growth, the Portland, Ore., and San Francisco East Bay markets with 8.5 percent growth, and suburban Atlanta and the Silicon Valley areas with 8.0 percent growth. realAssets Adviser | FEBRUARY 2015

PREIT Selling 13 Properties for $420M

Pennsylvania REIT has sold eight properties for $191.7 million and plans to sell another five retail properties for approximately $228.3 million.

These transactions were planned as part of the company’s strategic disposition program, under which PREIT has been selling noncore properties to improve overall portfolio quality and focus resources on assets that represent the greatest value-creation opportunities. PREIT began its disposition program in 2012 and has sold its interests in 16 assets to date.

Properties sold in 2014 include South Mall in Allentown, Pa.; Nittany Mall in State College, Pa.; North Hanover Mall in Hanover, Pa.; Whitehall Mall in Whitehall Township, Pa.; and The Gallery in Philadelphia.

The five properties to be sold during 2015 include Palmer Park Mall in Easton, Pa.; Uniontown Mall in Uniontown, Pa.; Lycoming Mall in Williamsport, Pa.; Washington Crown Center in Washington, Pa.; and Springfield Park in Springfield, Pa. realAssets Adviser | FEBRUARY 2015

Los Angeles County Pays $536M for Eight Buildings Through Separate Accounts The $45.9 billion Los Angeles County Employees Retirement Association has completed eight investments, six core investments and two noncore, totaling $535.8 million through three of its separate account managers, according to board documents.

The largest investment, the Palazzo-Westwood, a 350-unit luxury apartment mixed-use project in Los Angeles, was one of two core investments completed by Clarion Partners for $300 million. Clarion also purchased Las Cimas, an office building in Austin, for $43.3 million.

The other core investments were a high-rise apartment project located at 3555 N. Clark in Chicago and the Ingram Micro Distribution Center in Carol Stream, Ill., completed by Deutsche Asset & Wealth Management.

Stockbridge Capital Group was responsible for the final two core investments.

The larger of the two is the Pinole Vista Shopping Center in Pinole, Calif. Stockbridge has also completed two noncore

investments as part of separate accounts with LACERA. The larger of the two is the $16.4 million acquisition of the Scripps Tech Plaza in San Diego.

The final investment, which LACERA considers high-yield, is the acquisition of the Warm Springs Business Center in Fremont, Calif.

Approximately 98 percent of LACERA’s core real estate investments, by market value, are in separate accounts.

Core real estate makes up 69 percent of LACERA’s real estate portfolio, and those investments achieved a much higher five-year return, at 9.1 percent, than LACERA’s value-added and high-return investments, which portfolios make up 15 percent and 13 percent, respectively, of the real estate portfolio.

North Carolina Commits $550M to Real Estate The North Carolina Retirement System has committed $550 million to real estate, with $250 million divided among three noncore investments and the remaining $300 million going to one core-plus fund, according to a transaction summary from a recent Investment Advisory Council meeting.

The Blackstone Group received two of the commitments. The larger of the two was a $300 million commitment to Blackstone Property Partners, Blackstone’s newly launched open-end core-plus fund, which invests in substantially stabilized assets across the main property types in major U.S. markets.

NCRS also committed $100 million to Blackstone Real Estate Partners Europe IV, an $8.2 billion opportunistic fund that invests in a wide variety of property types in Europe.

The fund targets high-quality distressed assets

that can be turned over as a core property once stabilized.

Harrison Street Real Estate Partners received the other two commitments. NCRS committed $100 million to Harrison Street Real Estate Partners V and another $50 million to a sidecar co-investment with the fund.

The opportunistic fund, which opened earlier this year, is seeking $850 million to invest in niche property types such as medical office, student housing, self-storage and senior housing/assisted living.

NCRS is looking to invest $300 million to $750 million annually in noncore real estate through 2016 and $700 million to $1 billion annually in core real estate over the same period. The pension fund is transitioning toward its long-term goal of investing 5 percent of its $102.3 billion in assets in core real estate and 3 percent in noncore real estate.

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Infrastructure news

North Dakota Pension Makes Big Commitment

T

he $9.7 billion North Dakota State Investment Board has committed up to $105 million to an infrastructure fund managed by Grosvenor Investment Management. The name of the fund could not be disclosed at this time.

“We have an existing infrastructure investment with Grosvenor, and this is a follow-on to it,” explains Dave Hunter,

executive director and chief investment officer with the North Dakota Retirement and Investment Office, which serves the NDSIB. “It has performed well since inception, and we look forward to hopefully realizing those historical benefits and returns going forward.”

The state investment board originally committed $75 million in late 2011.

Survey: Infrastructure Investors Stymied

U.S. P3 Market Set for Expansion

The Organization for Economic Co-Operation and Development’s Annual Survey of Large Pension Funds and Public Pension Reserve Funds finds that infrastructure investors remain active and their rate of commitments remain stable. However, there is pent-up demand for greater allocations to the asset class that is being held back by uncertain government regulatory frameworks as well as a relative scarcity of available assets.

Despite the difficulty some investors perceive and experience with investing in infrastructure, interest remains high.

“Some [pension] funds are increasing their allocation to infrastructure or opening new allocations to the asset class,” the OECD report explains. All but three funds that reported a separate target allocation to infrastructure were below targets at the end of 2013 — suggesting investors continue to need to make commitments to reach their target allocations. Looking forward, six pension funds also indicated they plan to increase their target allocations to infrastructure during the next 24 months.

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Chadbourne & Parke has published a new report — The Expanding U.S. P3 Market — that reviews the current U.S. public–private partnership market and provides information about projects in procurement pipeline, deal structures, market participants and public sector programs. It also analyzes the trends and developments that are shaping the U.S. P3 market, how the market has matured in recent years and what the future might hold for the market. The report concludes, “the U.S. P3 market has been expanding over the last several years, although not as fast as

NDSIB has a target allocation to infrastructure of 5 percent within the pension trust, and was approximately 4 percent allocated to the sector at the end of 2014. The state investment board anticipates making further infrastructure investments during fiscal year 2015 based on asset growth, Hunter adds.

many would like, and will likely continue to expand in the future.”

The Chadbourne & Parke report notes an increasing number of state governments have recently turned to P3s for the first time; in some cases, however, while the states are rolling out their first P3s, cities or local agencies within these states have previously closed a number of P3s.

Illinois, for example, has had P3s previously procured by Chicago. Colorado is another U.S. state where local agencies have previously procured P3s. realAssets Adviser | FEBRUARY 2015

Infrastructure Debt Investing à la Carte

G20 Launches Infrastructure Investment Project In November, the G20 hosted the 2014 Brisbane Summit where its members announced the formation of a new Sydney-based infrastructure program — the Global Infrastructure Initiative, a platform to encourage public and private infrastructure investment, including social infrastructure such as the opera house.

The Global Infrastructure Hub has a four-year mandate to help both G20 and non-G20 countries with their infrastructure investment. The Global Infrastructure Initiative will provide resources to help implement the G20’s multiyear global infrastructure agenda, including: • Develop a knowledge-sharing network to aggregate and share information on infrastructure projects and financing among governments, international organizations, development banks, national infrastructure institutions and the private sector.

• Address key data gaps of significance to investors.

• Develop effective approaches to implement the voluntary G20 Leading Practices on Promoting and Prioritizing Quality Investment, including model documentation covering project identification, preparation and procurement.

• Build the capacity of officials to improve institutional arrangements for infrastructure by sharing best practice approaches.

• Enhance investment opportunities by developing a consolidated database of infrastructure projects, connected to national and relevant multilateral development bank databases, to help match potential investors with projects. realAssets Adviser | FEBRUARY 2015

Infrastructure debt funds have made a successful entrance into global institutional investment fundraising during the past 18 months, with several vehicles closing after collecting billions of dollars of commitments.

Now comes the challenge of deploying that capital.

According to a report by Bloomberg News, these funds may find Chinese municipal debt offerings a tempting item on the global menu of fixed-income investments. Ratings agencies are predicting many Chinese municipalities will be in dire need of financing due to changes in policies governing their options to raise funds, which could lead them to follow the example of Beijing Infrastructure Investment Co. The city’s metro transportation operator raised $1.3 billion in 2014 via global bond offerings — the first Chinese metro operator to do so — including a $1 billion offering in November.

Analysts predict more local government financing vehicles will come to market as “dollar bonds” similar to Beijing Infrastructure’s recent offerings because a longstanding policy that supported these financing vehicles’ local fundraising was called into question by the State Council in October. Municipal

governments are increasingly coming under scrutiny regarding the amount of debt they are able to take on and comfortably service.

A recent spread between onshore and offshore bond offerings was 5.06 and 3.75, respectively, or 1.31 percent, making the offshore route more affordable for these municipalities, Bloomberg notes. Investors have to consider that these municipal debt offerings often do not have a guarantee of repayment, but they are backed by the Chinese government.

With their ability to raise capital locally clipped, these municipalities are expected increasingly to look for overseas investors as cheaper sources of financing that can replace the local bond buyers. China’s local government financing vehicles are estimated to be responsible for some 40 percent of local government debt, implying there should be a lot of offerings in the market.

Bloomberg notes there are 40 cities in China with approval to construct a metro system by 2020: “By that time, the central government targets 6,000 kilometers (3,728 miles) of metro lines will be built, which S&P estimates will require as much as 2.5 trillion yuan ($401.4 billion).”

Norway’s SWF Considering Unlisted Infrastructure Move Norway’s Ministry of Finance is currently considering whether to allow Norges Bank Investment Management, manager of Norway’s $865 billion Government Pension Fund Global, to finally dip into unlisted infrastructure, including the renewable energy sector and emerging markets. A final decision will not be presented to Norway’s parliament until the spring of 2016, according to a statement released by the Ministry of Finance.

“Developing the fund’s investment strategy through better diversification will help to ensure continued robust, long-term management of the fund,” explains Minister of Finance Siv Jensen.

NBIM first became open to the idea of investing in infrastructure earlier this year when it released its 2014–2016 strategic investment plan, despite outlining reasons to avoid the class as recently as 2013. Still, only listed infrastructure options were being con-

sidered at that time, and no specific timeframe or capital allocation for future infrastructure investment was outlined.

Norway’s Ministry of Finance will also be assessing the sovereign wealth fund’s 5 percent real estate allocation cap set back in 2010, though it is unclear whether they are considering an increase or a decrease to the cap. Currently, only 1.3 percent of the sovereign wealth fund is invested in real estate, though NBIM’s 2014–2016 strategic investment plan called for 1 percent of the pension fund to be invested in real estate annually through 2016, a move that has seen NBIM engage in multiple billion-dollar property deals in 2014, including a $1 billion joint venture with Prologis to acquire U.S. industrial properties in January and the purchase of a 45 percent interest in three U.S. office properties from Boston Properties for $1.5 billion in September.

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ene r g y n e ws

MLPs End 2014 on Sour Note, Losing to S&P for Third Straight Year

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mid freefalling oil prices, the Alerian MLP Index (AMZ) ended 2014 with four straight negative months and the worst quarter (–12.3 percent) in six years. The rough run was capped off by a December (–5.6 percent) that saw the index’s worst monthly performance since May 2012 (–7.5 percent).

The year’s underwhelming finale brought the index’s 2014 returns to 4.8

percent — well below the performance of the FTSE NAREIT all Equity REIT Index (28.0 percent) and the S&P 500 (13.7 percent) — marking the third year in a row that MLPs lost to the S&P 500, following more than a decade of MLPs outperforming the stock market. Prior to this streak, the AMZ had never lost to the S&P 500 for consecutive years.

CONSOL Plans Coal MLPs

NextEra Energy Acquires Hawaiian Electric in $4.3B Merger

Investors looking for dividend cash flow from the coal sector will be pleased to know that CONSOL Energy plans to launch an MLP for its thermal coal business, with an IPO planned for mid-2015. The MLP will give investors access to ownership interests in CONSOL’s thermal coal properties and related mining operations in Pennsylvania, including Bailey Mine, Enlow Fork Mine, Harvey Mine and the related preparation plant.

CONSOL has plans for a separate subsidiary entity, as well, centered on the company’s metallurgical coal properties and mining operations. The company plans an IPO of up to 20 percent of the subsidiary’s equity in the second half of 2015. The subsidiary’s assets would include the Buchanan Mine and related preparation plant and CONSOL’s interest in its Western Allegheny joint venture.

In the midst of freefalling oil prices, 2014 became a banner year for some coal MLPs, such as Rhino Resources, which returned 77.8 percent for the year and led all MLPs in the Alerian MLP Index.

The giants are only growing in the renewable energy market, as Florida’s NextEra Energy, the nation’s leading clean energy company, has acquired Hawaiian Electric Industries for $4.3 billion. The transaction excludes HEI’s banking subsidiary, ASB Hawaii, and includes the assumption of $1.7 billion in HEI debt.

“While our goals are among the most ambitious in the nation, including increasing renewables to 65 percent, tripling solar and lowering customer bills 20 percent by 2030, we are confident that by leveraging both NextEra Energy and Hawaiian Electric’s expertise and the additional financial resources that

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Despite the down year, the year-end positive return for the index made 2014 the sixth straight in the green, beginning with 2009’s massive 76.4 percent return.

2014 was not all bad for MLPs though, especially outside of the oil market, where MLPs such as Rhino Resources (coal) and Niska Gas Storage Partners (natural gas storage) saw year-end returns of 77.8 percent and 77.1 percent, respectively.

NextEra Energy brings, we can meet these targets even sooner,” said Connie Lau, HEI’s president and CEO and chairman of the boards of American Savings and Hawaiian Electric, in a statement.

“What’s more, HEI’s shareholders will realize significant value for their shares by participating in the upside potential of the combined company and the future growth of American Savings Bank, one of Hawaii’s leading banks,” Lau added.

Hawaiian Electric Industries’ shareholders will receive 0.2413 NextEra Energy shares per Hawaiian Electric Industries share and a one-time special cash dividend payment of $0.50 per share. realAssets Adviser | FEBRUARY 2015

Thanks But No Thanks: Congress Passes Feeble Wind Credit Extension In what would appear to be good news for the wind energy industry, the U.S. Senate voted 76–16 for an extension of the renewable energy Production Tax Credit and Investment Tax Credit through the end of 2015. But there is just one problem: To qualify for the tax credit, a wind project had to begin construction by the end of 2014, two weeks after the extension was passed.

“Unfortunately, the extension to the end of 2014 will only allow minimal new wind development, and it will have expired again by the time the new Congress convenes,” said Tom Kiernan, CEO of the American Wind Energy Association, in a statement.

Though it will retroactively apply to all projects that began construction in 2014, the PTC will almost certainly encourage no new construction. This is because the only projects that could possibly qualify and haven’t already broken ground by the time the bill was passed were already approved, funded and in the pipeline to commence construction before the new year either way.

“These short-term extensions are terrible for investors,” says Nancy Rader, executive director of the California Wind Energy Association. “You can’t plan, you can’t sign contracts, you have no certainty and it puts wind energy at a competitive disadvantage against energy sources that have more stable tax benefits.”

The PTC, which provides turbine owners 2.3 cents in tax credits per kilowatt-hour of energy produced over the first 10 years of a project’s lifespan, has been around since 1992 but has lapsed on many occasions, making it very hard for investors and developers looking to wind energy to plan long-term. When the PTC expired in 2013, there was a 92 percent drop in new wind project installations compared to 2012, according to the AWEA, and the latest feeble extension could produce similar results. realAssets Adviser | FEBRUARY 2015

DOE Makes $12.5B in Loan Guarantees for Nuclear Energy

Continuing its effort to encourage an “all of the above” energy policy, the U.S. Department of Energy is now making $12.5 billion in loan guarantees available for advanced nuclear energy projects, specifically nuclear energy projects with evolutionary, state-ofthe-art design improvements in the areas of fuel technology, thermal efficiency, modularized construction, safety systems and standardized design.

Though “any technology that meets the eligibility requirements is welcome to apply,” according to Peter W. Davidson, executive director with the Loan Programs Office, the four areas of particular interest for the loan guarantees are advanced nuclear reactors, small modular reactors, uprates and upgrades at existing facilities, and front-end nuclear. Of the $12.5 billion, $2 billion is available exclusively for front-end projects, which include ura-

nium conversion or enrichment, as well as nuclear fuel fabrication.

The Loan Programs Office’s latest solicitation follows an $8 billion Advanced Fossil Energy Projects solicitation, a $4 billion Renewable Energy and Efficient Energy Projects solicitation, a $16 billion Advanced Technology Vehicle Manufacturing loan program, and $8.3 billion in loan guarantees for Georgia’s Plant Vogtle, the first new nuclear reactor in the United States in more than 30 years.

“LPO has $40 billion available to advance America’s all-of-the-above energy strategy,” added Davidson, in a statement. “In leveraging LPO’s remaining authority, we hope to replicate the success of our current portfolio of loans, loan guarantees and commitments to some of the most innovative clean energy and vehicle manufacturing projects operating in the world today.”

Energy Boom Powers Utility ETFs A rising tide certainly can lift all boats, and the U.S. energy boom has done just that for many utilities exchange traded funds (ETFs), as lower electricity prices and higher demand fueled by the economic recovery helped many such ETFs to a fantastic 2014.

One standout is the Utilities Select Sector SPDR, which increased by 24.89 percent in 2014, though it was closely followed by the iShares Dow Jones US Utilities and Vanguard Utilities ETF, which

went up 23.95 percent and 23.37 percent in 2014, respectively. In the broader utilities market, the PHLX Utility Sector Index went up 24.75 percent in 2014.

Industrial electricity sales from shale-gas producing counties increased 28 percent in the third quarter of 2014, and total industrial electricity sales increased 1.2 percent in the three months ended September 2014, Nick Akin, chief executive of American Electric Power, told ETF Trends in December.

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Commodities news

Gold Price Drops 4.4% in 2014

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he price of gold ended 2014 at $1,184 per ounce — a 4.4 percent decline during 2014 and a 2.27 percent drop for the fourth quarter. All told, in 2014, prices ranged from a high of $1,390 to a low of $1,130.

Some of the decline was due to falling demand for the precious metal, while a stronger dollar, weakness in other com-

modities and lowered interest in gold ETFs also took their toll on the price.

“The dollar strength will continue to be a feature of the market in the first half of 2015 on the prospect of imminent interest rate hikes … and that will weigh on gold in the medium term,” Carlo Alberto de Casa, a senior analyst with ActivTrades, told Reuters.

Base Metals Saw Major Price Drop in 2014

Timber Prices Fall in U.S., Timber REITs Return 8.6%

Both iron ore and copper saw large price declines in 2014. Slowing demand in China was to blame for the drop in copper prices, while a surge in iron ore supply undercut prices even as demand in China grew.

The price of copper on the London Metal Exchange fell 15 percent in 2014 to close the year at $6,358 per ton. And the price of iron ore with 62 percent ferrous content delivered to China fell 47 percent in 2014 to $71 per dry metric ton, according to Bloomberg.

Regarding iron ore, Tom Price, a London-based analyst at Morgan Stanley, told Bloomberg: “In terms of price downside, the worst is probably over. The major factor that undercut [iron] ore prices in 2014 was the Australian-led supply surge.”

As a sign that iron ore may be on the upswing, the base metal closed 2014 with five days of advancing prices to end December with a decline of just 0.1 percent for the month.

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In the third quarter, softwood lumber prices declined in the United States, Russia and Japan, according to Wood Resources International, while rising in China and the Nordic countries. The firm notes that U.S. lumber prices in November were 10 percent lower than they were in August, with the largest drop in price for southern yellow pine.

The effects of falling prices were felt by U.S. timber REITs, which underperformed the broader REIT

Holdings of the largest gold ETF, SPDR Gold Trust (NYSEARCA: GLD), have dropped near a six-year low, and the ETF fell 3 percent in 2014.

Still, there is a bit of good news. When considered as a standalone currency, gold outpeformed every global currency except the U.S. dollar in 2014.

market in 2014. The subsector (which comprises five companies with a total equity market capitalization of $31.95 billion) had a total return in 2014 of 8.57 percent (including a dividend yield of 3.51 percent) — a respectable figure, and an increase from 2013’s 7.86 percent total return. But the broader equity REIT market returned 28.03 percent in 2014, according to the FTSE NAREIT All Equity REIT Index.

Timber REITs in the FTSE NAREIT All Equity REIT Index

REIT

Symbol 2014 Return

Equity Market Capitalization ($M)

Weyerhaeuser Co.

WY 14.66%

$18,787.0

Potlatch Corp.

PCH

0.43%

$1,699.6

Plum Creek Timber Co.

PCL

–7.78%

$7,570.0

CatchMark Timber Trust

CTT

–17.61%

$373.9

Rayonier

RYN –34.46%

Timber sector

— 8.57%

$3,523.8 $31,954.3

Sources: NAREIT, Google Finance

realAssets Adviser | FEBRUARY 2015

Lumber Industry Sees Consolidation at Year-End

Palladium Rises 10% in 2014, Platinum Falls 13% One of the shiniest spots in the precious metals sector in 2014 was palladium. The rare precious metal, used in automotive manufacturing, had a strong year, as the LBMA Palladium Price was up 10.4 percent over the year to close at $798 per troy ounce.

Palladium, part of the platinum group metals (PGM), benefited from both strong demand (the metal is used in catalytic

converters, as well as other electronic uses) and tightened supply. The majority of the world’s palladium is produced in South Africa, where a five-month mining strike sharply reduced output, and Russia.

By contrast, another member of the PGM, platinum, fell sharply in 2014. The LBMA Platinum Price dropped 12.8 percent in the year to close at $1,210 per troy ounce.

Sugar Market Facing Strong Headwinds in 2015

Several M&A transactions have taken place in the lumber and timber industries. Toronto-based Norbord and Vancouver-based Ainsworth Lumber Co. have agreed to merge. Norbord will acquire all of the outstanding shares of Ainsworth in an all-share transaction.

The combined global company will focus on oriented strand board (OSB) wood products. On a pro forma basis, the combined company had $1.63 billion in sales for the 12 months ended Sept. 27, 2014, and will have a combined capacity of 7.7 billion square feet, making it the largest in the OSB industry. Norbord has seven mills in North America (mainly in the U.S. Southeast and one in Quebec) and four in Europe. Ainsworth has four mills in Canada (three in Western Canada and one in Quebec).

In other news, Vancouver-based Canfor Corp. has agreed to acquire the operating assets of Moultrie, Ga.–based Beadles Lumber Co. and Thomasville, Ga.–based Balfour Lumber Co. The transaction comprises two sawmills in Georgia.

And Green Bay, Wis.–based US LBM Holdings LLC has acquired Dyersville, Iowa–based Lumber Specialties from its majority shareholders. realAssets Adviser | FEBRUARY 2015

Global sugar markets are facing some strong headwinds in 2015, according to a fourth quarter 2014 report from Rabobank’s Food & Agribusiness Research and Advisory Group. Prices are expected to be under pressure from abundant global stocks as production in 2014–2015 will be little changed from the previous year.

“Eighty percent of global sugar production today comes from cane. Cane is a semi-perennial crop, meaning that if farmers don’t like the current cane price, it nevertheless takes them time to switch land out of cane into other crops. That is one reason for the slow response to low prices,” said Andy Duff, a sugar analyst with Rabobank, in a statement.

“Another reason is the diminishing incentive

to switch to other crops, given that the prices of many other agricultural commodities are also falling along with sugar prices.”

Brazil, one of the key sugar exporting countries, is forecast to have 2015–2016 production of 550 million to 580 million tons.

Canadian Gold Mining Companies Merge New Gold has completed its acquisition of Bayfield Ventures Corp., exchanging 0.0477 shares of New Gold for each share of Bayfield. The offer valued Bayfield at C$16.6 million ($14 million).

New Gold acquired all of Bayfield’s assets, including a 100 percent interest in three mineral properties adjacent to New Gold’s Rainy River project in northwestern Ontario.

“The acquisition of Bayfield further consolidates our position in the Rainy River district,” says Hannes Portmann, vice president, corporate development, at New Gold. “By adding these three properties within and adjacent to our project area, it simplifies our development plans, increases our gold and silver mineral resources, and adds to our prospective land package.”

New Gold has four producing assets — New Afton Mine in Canada, Mesquite Mine in the United States, Cerro San Pedro Mine in Mexico and the Peak

Mines in Australia. In addition, it has three development projects: Rainy River and Blackwater in Canada, as well as a 30 percent stake in Chile’s El Morro project.

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By Ben Johnson

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realAssets Adviser | FEBRUARY 2015

Hyperion Wealth Advisors’ founders Harvey Spira and Stuart Conley eschewed wirehouses to take the IAR route.

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or advisers Harvey Spira and Stuart Conley, the decision was an easy one after affiliating with a major wirehouse for a number of years.

They chose to become investment advisory representatives, and thus their New York City–based Hyperion Wealth Advisors was born in June 2013.

Together, Spira and Conley affiliated as IARs with National Holdings Corporation, a holding company for several major financial services firms. With more than 1,100 independent advisers, brokers, traders and sales associates, National Holdings includes two operating subsidiaries, National Securities Corp., which holds Hyperion’s broker/dealer Series 7, and also National Asset Management, a registered investment adviser that holds Hyperion’s Series 65.

“We are dual licensed through them and 98 percent of our business is fee-based only,” says Spira. “We charge a monthly fee to our clients. We do very little commission business, and where we would charge a commission, they are one-off situations.”

Spira and Conley certainly are not alone in their thinking, since the hybrid market is

the fastest growing segment of the financial advisory marketplace.

Hyperion itself gets its name from the unlikeliest of sources: a 400-year-old, 380-foot-tall redwood tree located about 3,000 miles to the west in California. It is a symbol that has undoubtedly stood the test of time. Establishing that sense of durability and experience was key to Hyperion’s founders, who have long track records in client service.

Spira recently celebrated his 32nd year in the financial advisory profession. He started as a loan officer trainee with National Westminster Bank analyzing balance sheets and income and cash flow statements in the early 1980s. He then moved to well-known Wall Street powerhouse Donaldson Lufkin & Jenrette, joining its first financial adviser training program.

Eventually, Spira moved on to Bear Stearns, where he spent 20 years in the private client services department. After Bear Stearns’s hedge fund business famously collapsed in 2007, he was intrigued by UBS’s wealth management model and made the move.

“I saw their available products, and they truly had a wealth management practice

Life realAssets Adviser | FEBRUARY 2015

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that I could roll my clients into and be happy there,” says Spira. He also met his future business partner, Stuart Conley, who is founding principal and chief investment officer at Hyperion.

Conley’s background included stints as a managing director at Further Lane Wealth Management, a senior vice president of investments and senior portfolio manager at UBS, a director of investments and senior portfolio manager at Oppenheimer & Co., and a financial consultant and portfolio manager at Smith Barney.

Conley’s father was an investment adviser, and the apple did not fall far from the tree.

“I read a book in my early twenties that illustrated very clearly the power of compounded return over time,” he says. “I also saw that in practice, as some small investments I made as a teenager, with the guidance of my father, grew into a substantial sum that I was able to use to buy and renovate my first home. I thought that if I could learn to do the same thing for others, I would make a substantial difference in their lives for the better.”

Conley easily cites the advantages of being an IAR. “The freedom of choosing and managing strategies that are truly custom-tailored to the client means the relationship is truly one-on-one,” he says. “We can set our fees to be fairer to us and to the client without having to feed the appetite of a large institution that may not always act in the best interest of the client.”

We are not only a wealth manager and a risk manager, but we are also a life adviser.

His UBS experience also convinced Spira that going the IAR route was most appropriate. “Stuart and I had a similar mindset about the way we wanted to manage money, fundamentally and technically, and we didn’t

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use packaged and house-manufactured products. When we felt that the firm wasn’t providing us with the necessary resources and capabilities that we were looking for, we would need to find a better solution.”

The move fed an entrepreneurial bent in the duo. “We really didn’t want to manage somebody else’s franchise — we wanted to manage our own. There was no benefit to be with any of the major firms, one, because it wasn’t helping us, and clients are realizing that the big firms are not helping them since they don’t provide the transparency and have limitations on the type[s] of products that are available.”

BREATH OF FRESH AIR A year and a half after making the IAR move, Spira is ebullient. “We love it. It is very entrepreneurial. We have access to 20,000+ different investment opportunities. We couldn’t be happier. We have the oversight that we need to have, but we don’t have an army of lawyers telling us that we can’t do something because it doesn’t match up with anybody else in the system. It is just such a breath of fresh air.”

Spira and Conley have a decent book of business, and their major goal is to reach $500 million in assets under management in the next two years.

The target audience is entrepreneurs, “both pre- and post-liquidity events,” as Spira describes it. “On the post side, it is primarily a person who sold their company.

On the pre-liquidity side, every entrepreneur has to be thinking about their eventual exit, but most do not. We like to get in earlier in the process so we can help them see that it is not the gross dollars that they receive, but the net dollars that they end up with. We will bring in the right lawyers, accountants and insurance professionals wrapped into one solution that can help them manage that process better.”

The ultimate goal with clients is to maintain their lifestyle and for them not to worry about the daily fluctuations in their personal net worth.

“We are a goals-based financial planning organization, and it is important to meet the essential cash flow needs with a very high probability,” says Spira. “The question

for clients shouldn’t be how do they beat the market, but rather how do they achieve their goals objectively in a way that makes them comfortable?”

Hyperion manages a U.S. portfolio of mid- and large-cap stocks using both fundamental and technical screens.

As Spira notes, “The fundamentals tell you what to buy, and the technicals will tell you when to buy and when to sell. We have a very disciplined sell approach, so if you look back, we weren’t in the WorldComs and the ENRONs of the world. We were long out of those positions before they imploded. Technicals, which is a graphical representation of the underlying buyers and sellers of a particular stock, will present problems anywhere between six and nine months in advance of their fundamentals. So when the stock is breaking certain moving averages, we will be out of that position and not look back.”

Hyperion has invested in real assets through commodity funds, LPs and mutual funds in the past, but it is most sold on the performance of publicly traded REITs. “We have done quite well with them,” says Spira.

“We have been a big fan of REITs because they have provided an attractive alternative for us over the last couple of years. We have invested in REITs both through mutual funds and separate managed accounts.”

Spira has also uncovered a few new investment strategies that are appealing, given the current market environment.

“Most investors are seeking noncorrelated alternatives,” he says. “The alternatives hedge fund space has been rewarding, but usually comes with seven- to 10-year investment horizons. I have found a noncorrelated shorter duration hedge fund vertical that works well in this environment and falls into the absolute return category.”

GETTING PREPPED As a relatively new entrant to the IAR platform, Spira says that Hyperion is cautious about the future. “We are welldiversified and we see cash as an asset class, and we are not making any major market call. I think the market is doing ok. Are we in a better position today in terms of finding cheap opportunities versus 2008?

Of course not.” realAssets Adviser | FEBRUARY 2015

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He does sound a note of caution: “The market has done very well for a very long period of time now, so everyone is waiting for that correction. The correction is going to happen when it happens, and since we are technically oriented, we will raise cash when we feel that we need to.”

Despite the plethora of technical and analytical capabilities in today’s market, Spira notes that investors will always be human.

“What is never going to change is human nature,” he says. “People operate based on fear and greed, and that is what makes the market. The key is being able to separate

We really didn’t want to manage somebody else’s franchise — we wanted to manage our own.

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realAssets Adviser | FEBRUARY 2015

your emotions and seek value when it presents itself. An example today might be some areas of the oil industry.”

Looking farther into the future, Spira thinks that clients will become increasingly sophisticated, but not to the point that eliminates the need for one-on-one professional advice. “You still need to build a relationship, that high touch, and technology is not going to provide that for you.”

Spira remembers a discussion that took place in the 1990s, when the rise of day trading spawned a similar concern of do-it-yourself disintermediation. The realities facing the wealth advisory client market, however, point to a continued embrace of outside counsel. “If you have a certain net worth, you are too busy to do it yourself. You are going to look to the outside to get professional guidance.”

Advisers will need to continue to up their game to maintain their value in clients’ minds.

The advisory business is more competitive today, however, than at any other time.

“Winning business really comes down to chemistry,” says Spira. “People form an opinion within less than a second. Hyperion represents the Hyperion tree, building a foundation for the long term and providing a legacy for the next generation or generations.”

While many advisers could cite a similar mantra, there are other facets of Hyperion that are differentiators. “We are trying to find the best risk-adjusted returns with people who have long-term track records,” says Spira. “We tend to like smaller managers, because the more money you have under management, the harder it is to provide excess alpha. The other differentiator for us is that we are independent, transparent and not conflicted. In addition, we have to act as a fiduciary, putting clients’ needs first and foremost and not only focus on suitability since something could be suitable for a client and not necessarily be in their best interests.”

Over the next several years, Spira and Conley will concentrate on growing their business by providing more family office– type services. “We are not only a wealth manager and a risk manager, but we are also a life adviser,” says Spira. “We are not only managing their money, but helping them manage their lives.” realAssets Adviser | FEBRUARY 2015

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By Joel Kranc

In 2014, real assets continued their healthy rise due to eight specific trends at the individual and institutional levels.

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realAssets Adviser | FEBRUARY 2015

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or all the talk last year about interest rate normalization, little changed with respect to the Fed’s stance on monetary policy. That may change in the coming year as the United States and economies in Europe show signs of further growth and recovery, but in 2014, volatile growth and a low interest rate environment gave investors pause as to where they should look for solid returns.

More than the traditional fixed-income and equity markets, investors looked at alternative assets and specifically real assets to augment their portfolios. At the institutional level, nearly half of the institutions surveyed in a BlackRock report, The Ascent of Real Assets, said they have increased their allocations in at least one category of real assets in the last three years. Over the next year and a half or so, about 60 percent will increase in at least one category (breaking that out, 49 percent of infrastructure investors, 48 percent of real estate investors and 46 percent of commodities investors expect to increase their allocations).

This asset class is trickling down to individual and high-net-worth investors as advisers look for tangible assets for their clients. Certain trends were identified in 2014 that impacted the way real assets were perceived and, in many ways, increased their influence within the investment community.

Those trends are:

• Nontraded REITs in the news • Rise of Exchange-Traded Funds (ETFs) • Impact of the Master Limited Partnership (MLP) • Oil and Gold Prices

•R eal Estate Recognized as an Asset Class by S&P/MSCI •G rowth in Institutional Commitments to Real Assets • Commercial Real Estate Prices • Business Development Companies

Nontraded REITs Investors had an interesting relationship with nontraded REITs in 2014.

Following the financial crisis in 2009, the popularity of nontraded REITs grew significantly, given their generally high dividend payout — often 6 percent or higher by some estimates. However, according to a 2014 Wall Street Journal article entitled “Nontraded REITs Attract Less Cash,” the investment vehicle helped drive commercial prices up, creating a situation where selling properties at a profit became more difficult.

At the same time, nontraded REITs often carry high fees and can promote aggressive sales tactics, the article notes. One notable nontraded REIT scandal last year surrounded American Realty Capital Properties Inc. (ARCP) involving accounting errors that were intentionally hidden and erased about $4 billion in market value. An FBI and Securities and Exchange Commission review led some brokers to stop sales tied to AR Capital LLC (ARC), one of the biggest sponsors of nontraded REITs. Kevin Hogan, president and CEO of the Investment Program Association (IPA), an association formed in the mid-1980s to provide leadership for the direct investment industry, says, “They (ARC) have taken very clear measures to address the issues at hand. They are well documented, and I think we’ve seen a number of steps people have taken, people have been moved in different spots to facilitate those changes. … With all the situations they’ve encountered, I think they’ve taken the right measures, the right steps to move themselves, and the industry will move forward as it has.” realAssets Adviser | FEBRUARY 2015

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With that in mind, Hogan says nontraded REITs remain relatively strong with about 2 million individual investors investing into the products. “I wouldn’t categorize it as any fall from popularity,” he explains. Hogan stresses that comparisons are being made to 2013 — a record high year for nontraded REIT sales, according to Robert A. Stanger & Co., when sales reached an all-time high of about $19 billion. This past year came in at the $15 billion to $16 billion mark, which Hogan notes, compared to the all-time record for this industry, “is a very strong, substantive year.”

He says one of the major factors that accounted for the drop from 2013 to 2014 was liquidity, which generally helps nontraded REIT investors to reinvest into new products. This past year proved to have fewer such liquidations, notes Hogan. He concedes the ARCP event also may have had a slight impact on the market.

The price of oil as well as other commodities such as gold came down significantly off their highs in 2014.

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The Rise of ETFs A second trend in 2014 affecting real assets was the continued popularity of ETFs or exchange-traded funds. Financial data firm Markit says the asset class grew significantly by as much as 16 percent to $2.7 trillion in 2014.

Simon Calvin, a research analyst with Markit, was quoted in the Financial Times as saying: “The dollar is rallying, the U.S. economy is doing quite well, and the US S&P 500 is also doing quite well. Investors are clamoring to get exposure.”

So with that kind of growth, how are real assets affected?

Michael Rawson, an ETF analyst with Morningstar, says the discussion around ETFs and real assets should be limited to areas such as commodities, energy infrastructure and MLPs, as opposed to a broader concept of real assets. “In 2014, I was surprised at how well the assets in MLPs and energy infrastructure in ETFs held despite the fact that MLP and energy stock prices fell,” Rawson explains. He adds that the markets did not see strong outflows from those types of ETFs because as energy prices fell and stocks underperformed, speculative money came in and supported prices.

“I think we could point to some examples in 2014 where you had prices falling and there were investors coming into ETFs to potentially affect prices in a positive way when the market was collapsing,” says Rawson.

Impact of MLP Market In 2014, MLPs accounted for nearly half of the overall IPOs during the year, according to the EY Global IPO Trends: 2014 Q4 report. Eleven MLP IPOs raised a collective $5.145 billion. The Shell Midstream Partners LP IPO last year was one of the largest MLP IPOs in more than 10 years.

“What MLPs have done,” says Michael Underhill, chief investment officer with Capital Innovations, “is provide a liquid, publicly traded investment vehicle in which investors — individual, retail and institutional — can access infrastructure. And when you think about it, MLPs were created so the individual investor who doesn’t have $25 million or $50 million that’s required by some of these private equity infrastructure funds can, for as little as $500, get into an MLP.” Underhill adds that 2014 was such a good year for high-quality MLPs because institutional investors, along with individual investors, were looking for stability and yields and chose MLPs as an alternative to more scarce private equity funds in the same space. Underhill says there were a few notable trends in 2014. Essentially, investors understood the rewards of performance in the high-quality midstream space — income and stability realAssets Adviser | FEBRUARY 2015

— and upside potential was still maintained in a low interest rate and high volatility environment.

Gold and Black Gold Whereas oil and gas prices do not necessarily affect those companies that form MLPs (they are not the oil producers), the price of oil as well as other commodities such as gold came down significantly off their highs in 2014.

William Storum, author of Going for the Gold: Preserving Wealth, Lowering Taxes, says he does not think the drops in oil and gold in 2014 will change significantly in the foreseeable future. “I see gold meandering in 2015, and people are repositioning into the U.S. stock market because it’s a safe haven and that will continue because of the world economy,” he explains. And even though markets will increase, according to Storum, he still feels that gold will hold its own.

He also notes that oil will move up again this year because of its importance. “It’s a capital outlay and you have to stay on the treadmill just to keep the production at 92 million barrels, which is close to our consumption.”

Once you reduce supply, Storum believes prices will stabilize and eventually move higher. He says that as investors reposition they necessarily will look for real assets combined with further investment in oil infrastructure–type companies as prices come back. “It’s the timing aspect that’s the fly in the ointment,” he adds. “The need for hard assets has not gone away; it’s just a down cycle because economies around the world are soft and the demand isn’t there.”

Recognized Class One of the more interesting developments in 2014 related to real assets, in this case real estate, was the announcement late in the year that the S&P Dow Jones and MSCI would allow real estate to be its own sector as defined within the Global Industry Classification Standard (GICS) — moving it from the “Financial Sector” category and giving it a stand-alone category. That pushes the number of sectors in the list from 10 to 11.

“It’s a very important change from our point of view,” says Michael Grupe, executive vice president of investment outreach for the National Association of Real Estate Investment Trusts (NAREIT). “It matters because it’s [now] visible. Because you see it, you think about it. If you don’t see it, you don’t think about it.” Most organizations, he adds, fall back on institutional structures to help guide their thinking and product development, for example, and seeing real estate will give investors reason to pause and invest in it more than they might have before.

Grupe stresses the immediacy of the effect should not be overstated. “I think it’s a positive change … but investment behavior and investment capital flows — those markets are very large and they basically change their habits slowly, and so I would not try to lead [anyone] to think that because of this change there is going to be some sudden increase in the amount of funds invested in REITs or real estate.”

Institutional Growth As previously discussed in this story, real assets, including real estate especially at large institutional levels, remain an attractive asset class for investors.

Greg MacKinnon, director of research with the Pension Real Estate Association (PREA), like Underhill, says these types of assets provide strong yield, good diversification and a fairly steady income. “Certainly in 2014 the returns realAssets Adviser | FEBRUARY 2015

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were good, and investors are satisfied with how real estate has turned out,” he says. According to PREA, on an unleveraged basis, at a national level through the third quarter, returns on real estate ran about 8.2 percent (commercial and multifamily). Last year, notes MacKinnon, saw a rising economy “which lifts all boats,” as well as a relatively quiet building period that is keeping supply lower and prices higher.

As for continued interest, the BlackRock report (mentioned earlier) notes that nearly one-third (32 percent) of institutional respondents to their survey have a real-assets team. About 30 percent plan to increase the number of employees dedicated to real assets in the next 18 months. Of those without a dedicated real-assets team, 14 percent say they will put one in place in the next 18 months. Nearly all respondents (96 percent) have staff dedicated to specific real-asset strategies.

The big takeaway is the drop in interest rates, which we think helped raise values and prices for commercial real estate.

Commercial REal estate Pricing By many accounts, real estate pricing is approaching — and in some cases has attained — 2007 levels.

“When I look back at 2014, the big takeaway is the drop in interest rates which we think helped raise values and prices for commercial real estate,” says Todd Lukasik, senior analyst with Morningstar. “I think the other factor becoming more prevalent over the last few years is the cross-border flow of investing capital in real estate, particularly from sovereign wealth funds.” They are more inclined to look around the world for investments, and as capital competes for acquisitions, prices are driven up, he explains.

Lukasik also points out the need to find yield in low interest rate environments, and real estate has been an important investment for that reason. And as large investors move capital across borders, Lukasik feels many of the large commercial real estate service firms, such as CBRE or Jones Lang LaSalle, for example, have local market expertise and the ability to find properties on behalf of investors.

One point to note, adds Lukasik, has been the move by REITs from acquiring properties to developing them, as prices rise. “When they do developments they are taking on a bit more risk, but if they are successful they think they can get yields higher than just acquiring an operating asset outright.”

Business Development Companies The IPA’s Hogan says Business Development Companies (BDCs) continue to provide strong performance and investor value. BDCs generally invest in smaller and mid-size companies. “It’s a strong value proposition for a portfolio that seems to be resonating with investors and advisers alike.”

Hogan notes that BDCs have come off a strong year at the $5.5 billion mark up from about $4.5 billion the year before. He says there is new potential as well, as existing product developers consider whether they should be making investments. “It’s pretty exciting when you see asset managers and investment banks taking a look at this space.”

Overall, the growing appetite by investment advisers and wealth managers for alternative investments and real assets is explained, in many ways, by these major trends. Changes are afoot, however, as interest rates are considered, portfolios are rebalanced and cross-border capital continues to flow into these investments. In the meantime, many of the strong fundamentals remain intact and, for the foreseeable future, real assets remain at the forefront for many investors.

Joel Kranc is director of KRANC COMMUNICATIONS in Toronto.

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people data insights

Grand

By Mike Consol

gestures Technology fortunes have triggered a resurgence in architectural grandiosity for corporate HQs.

Y

ears ago, skyscrapers such as Rockefeller Center, Sears Tower and the Chrysler Building were testaments to the financial might of the iconic companies that helped build America. They reached high above their respective city centers, as if to embody both their financial superiority and limitless aspirations. It was not unusual for major corporate headquarters to also acquire exquisite collections of art to embellish the interior of those landmark buildings.

Then a long period of architectural and financial modesty ensued as ostentatious displays of wealth sent the wrong message to restive shareholders and customers. The era of empire building had ended, and architectural design was relegated to vapid rectangular boxes. Instead, we saw architectural splendor move abroad and express itself in Berlin, Dubai and Shanghai.

But times have finally changed in the United States with the meteoric rise of Information Age industries, and that appears to be reigniting a golden age of corporate headquarters. Companies such as Amazon, Apple, Facebook and Google are building sprawling corporate compounds with a motivation different from their Industrial Age predecessors. Now those vast expenditures are being made on behalf of company employees, and the campuses are calculated to embrace their people’s values and work requirements. The above names say it clearly: This new movement is almost entirely the province of

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realAssets Adviser | FEBRUARY 2015

|

oogle will construct G 1.1 million square feet contained in nine boomerang-shaped buildings, each three to five stories tall on its 42-acre site.

(all photos courtesy of NBBJ)

realAssets Adviser | FEBRUARY 2015

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|

amsung, not to be outdone by archrival Apple, S broke ground on a $300 million, 10-story U.S. headquarters complex in San Jose.

The scale of the developments varies widely, though they are all immense and ambitious.

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realAssets Adviser | FEBRUARY 2015

technology-related companies, a grouping of enterprises flush with cash and locked in ferocious battle to attract and retain the brightest talent money and a work/live/play corporate campus can buy.

Indeed, Google had to adopt a rule that employees were not allowed to live at the company, that they must have a separate address. With free meals available at more than 30 cafeterias, as well as free laundry facilities, fitness centers, bicycles, sleep pods and 24-hour “micro-kitchens” (stocked with a daily supply of fresh fruit, cereal, coffee, tea, espresso, bottled drinks, string cheese, carrots and yogurt), it was plausible to turn the so-called Googleplex into a full-time residence. The company even offers free access to cars for those who choose not to own an automobile.

That is a major differentiator between the vertical, urban HQs of yore and the sprawling suburban corporate compounds of today. The former were little more than vessels inside which mostly repetitive and hierarchically determined work was completed during an eight-hour workday before departing for home and the family dinner.

The latter is a work environment focused on innovation, teamwork and distributed decision making spread over an extraordinary number of hours by people characterized as passionate about the technologies they are determined to bring to market. What’s more, the visually magnificent and physically imposing skyscrapers of yesteryear were more a statement about the values and self-image of the companies’ corporate brass.

The new breed of corporate headquarters is a campus environment designed to accord with the values and lifestyles embraced by the companies’ employees rather than their leadership.

Among the biggest of those values is helping to solve the planet’s most pressing issues, including protecting the environment, reducing the production of carbon emissions and promoting the development of renewable energy and other green technologies. To that end, Google plans to have solar-panel arrays, as well as a low-energy heating and cooling system that will allow the company to economically supply a continuous intake of fresh air. Its ambitious Healthy Materials Program realAssets Adviser | FEBRUARY 2015

has a goal of procuring building materials free of potentially harmful chemicals.

Apple CEO Tim Cook has gone so far as to proclaim the company’s massive spaceship-like headquarters will be “the greenest building on the planet.” Apple says the new building will use 30 percent less energy than similar offices (in part because it will be outfitted with low-energy LED lighting) and 100 percent of the power the building does require will come from renewable sources, including what it claims will be the largest onsite corporate solar installations in the world. Onsite fuel cell plants will store and distribute the energy as needed. Meanwhile, natural ventilation will provide enough cooling that air conditioning will not be needed 70 percent of the year. Then there are the 7,000 trees encircling the site and helping ensure privacy and a forested environment.

There will also be cherry, plum, apricot and olive trees in an enclosed arboretum, as well as apple trees inside Apple’s new building.

The health and wellbeing of those trees will fall into the lap of the company’s “senior arborist” David Muffly. Consider that 80 percent of the campus will be landscaped.

Apple’s archrival Samsung, not to be outdone, has broken ground on its new $300 million North American 10-story headquarters building in San Jose. It is targeting LEED certification.

None of this is to indicate that the corporate leadership at technology’s most vaunted companies is not bringing a healthy sense of ego to the process. Consider that Rockefeller Center and its original 14 buildings were erected between 1931 and 1940 at a cost of $1.7 billion in today’s dollars. Apple is reportedly spending roughly $5 billion for its new corporate mothership and hired renowned architect Norman Foster, whose firm’s signature works include the bullet-shaped Gherkin in London and the restored Reichstag in Berlin. Stefan Behling, one of the Foster and Partners architects working on the project, says in the presentation video: “This project is pushing the boundaries of technology in almost every aspect.”

Facebook hired heralded architect Frank Gehry to design a 22-acre compound in Menlo Park, Calif., that CEO Mark Zuckerberg wants to replicate the look and feel of

a college campus. The company spent $250 million on the design alone, never mind construction and landscaping costs. According to Dezeen magazine, Gehry had to “tone down” his plans for the campus because they were “too flashy” for Facebook’s company culture.

(As originally envisioned, its central building was to have a bold, curving facade reminiscent of well-known Gehry buildings, such as the Guggenheim Museum in Bilbao, Spain.)

Dezeen quoted Craig Webb, a partner at Gehry’s practice, saying: “They asked us to make it more anonymous.”

The scale of the developments varies widely, though they are all immense and ambitious.

AMAZON’s BIOSPHERES Amazon is building the only urban headquarters of the four companies, covering three city blocks in downtown Seattle. Three glass biospheres and three office towers will comprise the project’s 3.3 million square feet of office space. The eye-catching biospheres will be made of faceted glass and filled with plants.

The largest of the futuristic-looking spheres will be 95 feet tall and 130 feet in diameter.

NBBJ architect John Savo said in a National Public Radio report that the biospheres were conceived as a place where Amazon employees could think and work more productively and creatively.

“There are ample studies that indicate that people walking in an urban street are thinking and feeling very differently than people walking in a park,” Savo says. “In the parkland, they’re both more relaxed and can concentrate better.”

John Schoettler, who manages Amazon’s global real estate facilities, told National Public Radio that the project gives Amazon the flexibility to add 12,000 new employees in Seattle. He emphasized the company’s decision to build in the heart of the city rather than in the suburbs. “I think it differentiates us from other companies and allows us to attract the type of employee that wants to be urban and live in an urban environment,” he says.

In that same report, architecture critic Allison Arieff, who writes for the New York Times and other publications, said technology companies thrive on impromptu meetings and conversations instigating

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new ideas — but she is not convinced the deliberately self-contained suburban buildings foster that.

“The only people that you’re really running into are your co-workers, and at a certain point that leads to a certain level of navel-gazing because you’re only talking to people who agree with what you’re saying,” she says.

APPLE’s MOTHERSHIP Apple’s new headquarters will be 2.8 million square feet all contained within its circular four-story building whose circumference stretches for nearly a mile — large enough to bring 13,000 Apple employees under a single roof. An aerial vantage of the building is reminiscent of the circulator control ring on the company’s enormously popular iPod, which revolutionized the sale and consumption of music.

When completed in 2016, the 176-acre headquarters campus in Cupertino, Calif., can be considered one of the final acts of Steve Jobs’ storied career. The futuristic-style development is his brainchild, and in typical Jobs fashion it has been designed and is being constructed with exacting detail.

Think in terms of 40-foot-tall floor-to-ceiling panes of concave glass. Jobs claimed there will not be a straight piece of glass in the entire building. Businessweek reported that Jobs decided the industry-standard 1/8inch breaks between surfaces was not precise enough and instead insisted those breaks be a maximum 1/32-of-an-inch wide. Stefan Behling, one of the Foster and Partners architects working on the project, says in a video presentation that the building is “pushing the boundaries of technology in almost every aspect.”

Contractors will also tunnel underneath the building to create a subterranean two-level, 2,000-space parking garage.

Above ground, employees will dine in a 90,000-square-foot cafeteria that connects to an outside picnic area. The cafeteria will be a short walk from the company fitness center.

Given the mammoth size of the campus and cylindrical structure, employees will sometimes find themselves a long distance from one another. For that reason, more than

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1,000 bikes will be kept on site to help staff members move quickly across big expanses.

GOOGLEPLEX 2.0 Google’s current Mountain View, Calif., headquarters campus, already referred to as the Googleplex, will yield to a new 42-acre site with 1.1 million square feet of new office space contained in nine boomerang-shaped buildings, each three to five stories tall and only 78 feet wide, a floor plan whose narrowness allows a maximum of the buildings’ usable space to receive energy-saving daylight. The structures are arranged in a manner that creates a network of courtyards, placing all Googlers, as they are called, in close proximity to one another, in part because walking bridges will connect the buildings.

“You’re never more than one floor away from being able to connect horizontally throughout the entire campus, says Ryan Mullenix of NBBJ, the architecture firm designing new headquarters for Amazon, Google and Samsung.

An estimated 3,500 to 5,000 people will work at the new Google compound.

The landscaping surrounding the buildings will have elements of native habitat that will be reintroduced by local landscape architect Cheryl Barton.

Her assignment on this project includes restoring 8 acres of bayside salt marshes that Google will open to the public.

But Googleplex 2.0 was designed from the inside out, according to David Radcliffe, a civil engineer who oversees operation of the company’s 60-plus buildings in various locations. Radcliffe told a Vanity Fair magazine reporter that Google gathered and studied data and tried to quantify everything about how its employees work, about what kind of spaces they wanted, and how much it mattered for particular groups to be near other specific groups. The buildings’ bent rectangular shape were a result of the company’s insistence that the floor plan maximize “casual collisions of the workforce.”

“You can’t schedule innovation,” Radcliffe says. “We want to create oppor-

tunities for people to have ideas and be able to turn to others right there and say, ‘What do you think of this?’”

FACEBOOK’S HACKER CAVE Architect Frank Gehry and his team were given the assignment of creating 435,000 square feet of optimal workspace with a collegiate atmosphere on 22 acres of Menlo Park turf. The resulting architectural design calls for a giant new building that dips and rises from 45 feet to 73 feet in height, is built above a concealed ground-level parking lot and features a massive rooftop green space with full-size trees that most observers will mistake for a park. That foliated roof will serve as an entertainment deck with three separate themed areas that include several outdoor cafes, barbecues and workbenches.

But the project’s most notable feature is the so-called hacker cave — a single room housing 2,800 engineers. Company founder and CEO Mark Zuckerberg said this about the hacker cave on his Facebook timeline: “The idea is to make the perfect

realAssets Adviser | FEBRUARY 2015

engineering space: one giant room that fits thousands of people, all close enough to collaborate together. It will be the largest open floor plan in the world, but it will also have plenty of private, quiet spaces.”

Everett Katigbak, the company’s environmental design manager, wrote in a blog post: “Just like we do now, everyone will sit out in the open with desks that can be quickly shuffled around as teams form and break apart around projects.”

Facebook’s 2,800 employees housed at its new West Campus will be connected via tunnel to the company’s existing 1 million-square-foot East Campus in Menlo Park, which accommodates about half of Facebook’s 8,400 employees.

The social networking company is also developing a $120 million, 394-unit housing community near its headquarters, another perk designed to assist those struggling to afford housing or plagued by long commutes. The 630,000-square-foot housing complex, currently under construction, has been named Anton Menlo Apartments and will offer rental units walking distance from

realAssets Adviser | FEBRUARY 2015

When completed in 2016, the HQ campus

in Cupertino can be considered one of the final acts by Steve Jobs. |

mazon’s urban headquarters will cover three city blocks in downtown A Seattle, sport eye-catching glass biospheres and encompass a whopping 3.3 million square feet of office space.

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the Facebook campuses. The development is slated to include a clubroom, sports lounge, concierge service, convenience market, self-service bike repair shop, fitness center and yoga room, resort-style pool and spa, and an entertainment lounge.

Facebook’s “amenities team” is working with developer St. Anton Partners, a San Francisco multifamily real estate developer, and KTGY, an architecture and planning firm, to create an environment that mimics the ambience at its corporate campus.

Like its Silicon Valley peers and rivals, Facebook’s goal is to provide services for as many aspects of its employees’ lives as possible — from food, transportation and laundry to child care, fitness and personal grooming. That eliminates a good deal of stress and allows them to focus on the professional tasks at hand.

URBAN VS. SUBURBAN The billions of dollars being spent to design and build these suburban campuses comes at a time when young professionals are showing a growing appetite for urban living. Many companies — including Silicon Valley technology enterprises such as Salesforce and Dropbox — are moving their digs to urban venues in pursuit of the employment talent that wants to live and work there.

Even companies headquartered in Silicon Valley, Google and LinkedIn among them, have been expanding their satellite offices in San Francisco.

“The decision to seek an urban location rather than a suburban location is largely about the desired culture the company wants to create and what talent it wants to attract,” says Kelly Givens, an executive in the corporate services group at Savills Studley. “One of the true benefits of the urban presence is the abundance of amenities for the employees that do not necessarily need to be created within the tenant’s envelope.”

Givens says the decision to build new headquarters office complexes or campuses is driven in part by the inadequacy of older office buildings with small footprints and low ceilings, formats that are

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not conducive to the way companies work today — particularly those with Generation Y workforces looking to build highly collaborative environments.

There are architecture critics who say the construction of suburban campuses sometimes represent missed urban opportunities.

One critic says that, as impressive as Apple’s plans are, Steve Jobs could have made a transformative impact by building the company’s headquarters in downtown San Jose and emboldening Silicon Valley’s urban core. That is exactly what companies such as Quicken Loans and Twitter are doing in downtown Detroit and the mid–Market Street district of San Francisco, respectively.

Quicken Loans founder Dan Gilbert has invested $1 billion to buy 2.6 million square feet of commercial space in Detroit’s otherwise decimated city center and relocated 7,000 employees there a few years ago in a bid to resuscitate the Motor City from its decline.

During 2014 the company was in talks with dozens of restaurateurs and retailers about opening outlets in a downtown many had left for dead. He also invested in an incubator for technology startups. Adding more tonic to the formula, Gilbert and other business leaders fronted most of the $140 million needed for a light rail line into the heart of the city.

Twitter did something far less ambitious but no less instructive when it moved into a part of San Francisco that city leaders had repeatedly tried and failed to gentrify. The middle stretch of Market Street was famous for its seven blocks of strip clubs, check-cashing outposts, vacant office space and homeless vagabonds. Twitter, which was rumored to be contemplating a move out of the city, instead leased space from Shorenstein Properties in an 11-story building the real estate company had bought in 2011, even though it had been vacant for five years. According to reporting on that deal, Shorenstein considered the 1937 Art Deco building undervalued. Twitter signed a lease until 2021 for 295,000 square feet in the building and has room to expand as its staff grows.

Charles Malet, CIO at Shorenstein Properties, told the New York Times: “In our gut, we believed if we changed it, they would come. We thought it would be a real catalyst for the neighborhood.”

So did Twitter, and the micro-blogging company was soon followed by the likes of Spotify, Square, Yammer and at least a score of other young, tech-oriented companies that signed leases to occupy more than 1 million square feet in the area. The city has since renamed the district Central Market. Thousands of apartment units have been either constructed or are planned, and the well-paid throngs of professionals now living and working in Central Market have been followed by retailers and restaurateurs bent on serving them.

Such is the power of a well-placed corporate presence.

PAST AS PROLOGUE It would be naive, of course, to ascribe all this flamboyance to a desire to attract and retain star talent by making life easier for employees and reflecting their values. That could be accomplished by Apple without building a headquarters redolent of an extraterrestrial spacecraft, or without Amazon erecting glass biospheres.

Steve Jobs was all about design, user experience and grand presentations. Amazon founder and CEO Jeff Bezos has repeatedly shown a flair for the ostentatious, as have Sergey Brin and Larry Page at Google with their driverless cars and their project to create a flotilla of high-altitude balloons providing global Internet access. Zuckerberg at Facebook did not become overlord of the social media space by being a wallflower. Dan Gilbert at Quicken Loans has no doubt considered the heroic status that awaits if his initiatives can restart Motor City’s engine.

We can also be assured that shareholders and other important constituencies will only cheer vast expenditures on these crowning achievements as long as the companies involved are dominating their lines of business and minting sales and profits.

So the motivations and conditions have not entirely changed. Human nature is what it is. Whatever the financial and emotional dynamics at play, the return of an architectural golden age to corporate America is a beautiful thing.

Mike Consol is editor of sister publication The Institutional Real Estate Letter – Americas. realAssets Adviser | FEBRUARY 2015

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Online auctions have become a more popular form of investing in commercial real estate.

By Jennifer Duell Popovec

o s 50

l realAssets Adviser | FEBRUARY 2015

! d Investors like the efficiency,

transparency and access that online auctions offer.

realAssets Adviser | FEBRUARY 2015

An experimental U.S. penny struck in 1792 to test a new design.

A landscape painting by French Postimpressionist artist Paul Cézanne.

A rare 1966 Shelby Cobra Mustang.

A bankrupt hospital in southern Ohio.

A three-bedroom single-family home in suburban Phoenix.

What do these things have in common? They were all sold via auction.

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uctions are one of the oldest and most popular methods of buying and selling. They have been around for thousands of years, providing a trading platform for everything under the sun.

Technology has modernized the process, allowing buyers and sellers to complete transactions online, and every day more people use online auctions to find residential and commercial property investments. Online auctions allow buyers to purchase properties from anywhere in the world, as long as they have access to the Internet.

Across the globe, hundreds of companies host online auctions, but only a handful have sold a significant volume of properties. Irvine, Calif.-based Auction.com is the largest online property auction platform. Launched in 2007, the company auctions off an average of $5 billion of real estate annually. Last year alone, its auction volume totaled more than $7 billion, and it has sold nearly $20 billion in residential and commercial property since 2010.

In March 2014, Auction.com announced a $50 million investment from Google Capital. The investment is part of a strategic partnership focused on expanding Auction. com’s share of the global real estate marketplace.

“The online auction industry has experienced tremendous growth over the past several years,” says Rick Sharga, executive vice president of Auction.com. “Investors like the efficiency, transparency and access that online auctions offer.”

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MORE THAN DISTRESS Years ago, most auctioned properties were distressed. Banks and other lenders used auctions to off-load problematic assets, particularly foreclosed and real estate–owned (REO) homes and undeveloped land.

Bidders bought real estate for pennies on the dollar, often on the courthouse steps.

But auctions have evolved. Though auctions still remain popular with banks and lenders, they now include assets of all types, sizes and quality, says Fontana Fitzwilson, senior vice president of Williams & Williams, which conducts both live, at-the-property auctions and real-time, interactive online bidding. The firm auctions roughly $2 billion of residential, commercial, farms and ranches, and land annually.

“We routinely sell multimillion-dollar properties, some of them sight unseen,” Fitzwilson says.

It is worth mentioning that most properties listed via online auctions are not purchased sight unseen. Investors have the ability to “kick the tires” — view and inspect the property — just as they would in a traditional marketing process.

Fans of online auctions contend that these technology-driven transactions allow investors to be exposed to potential acquisitions they would not see otherwise. This is particularly true for commercial real estate. Unlike residential real estate, which has an industry-wide listing service known as MLS, commercial real estate has no such clearinghouse.

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Even investors who work with seasoned, in-the-know brokers face geographic limitations since most brokers only cover one specific market or region. Moreover, most brokers specialize in a single property type, e.g., multifamily or retail.

“Online auctions allow you to broaden your horizons and extend beyond local markets,” Sharga says. “At any given time, Auction.com has 15,000 to 20,000 properties scheduled for auction.”

And for investors who buy more frequently, Auction.com works with them and their advisers to target certain types of assets. The firm lets the auction platform do the work, identifying assets and alerting investors in advance so they can get a head start on the due diligence process.

FAIR PRICE, FAIR SHOT Though real estate is a popular investment, many investors shy away from this asset class because they are worried about valuations. They do not want to fall into the trap of overpaying.

But what is a fair price, after all? Whether it is residential or commercial real estate, prices are usually determined by brokers and what they think is a “fair” list price.

They base the price off recent transactions or list the property without a list price.

Unfortunately, neither of these options ensures that a property will sell at a “fair price” or its true market value. Many investors believe an auction is the only way to determine true market value.

Consider this: When a property’s value is based on so-called market comps, do you factor in how long ago those deals closed? Property valuations change rapidly, and market data often lags by several months.

“When we buy a property via auction, we feel good about the price because we know we’re paying a fair price,” says Zareh Najarian, an Atlanta-based investor who is a repeat client with Auction. com. He has purchased more than 100 residential properties via both live and online auctions.

Buyers like Najarian find comfort in the bidding process, which allows buyers to determine the value of the property. They have studied the market and the investment, and they have a better sense of what is a “fair price.”

Beyond pricing, online auctions provide a level of equality that live auctions and traditional marketing cannot, Sharga contends. Because of the way they are set up, they are agnostic when it comes to the buyer. They do not favor one investor over another, which means that all qualified buyers have an equal shot at winning the auction.

“Our goal is to make the whole process transparent, and that means there’s no question about who wins — it’s the qualified buyer with the top bid,” Sharga says.

“There’s no favoritism.”

Favoritism is actually quite pervasive, particularly in the commercial real estate realAssets Adviser | FEBRUARY 2015

brokerage world. All too often, brokers will limit their marketing process to a select group of buyers — their favorites for a variety of reasons.

MAXIMIZING TECHNOLOGY Technology has changed nearly every type of business, and the auction business is no different, Fitzwilson says. In fact, it is fair to say that technology has completely transformed the auction industry by allowing investors to buy and sell properties regardless of their location.

Williams & Williams launched its online auction platform in 2007 to deal with the volume of residential foreclosures in the Midwest. “There were so many foreclosures in that region, Michigan in particular, and we realized that the local investment community was tapped out,” Fitzwilson recalls. “By auctioning these properties online, we opened up the buyer pool to anyone with access to the Internet. During the first months, 50 percent of the properties were bought by investors outside the market.”

Sharga says investors do not have to be tech savvy to buy real estate via online auctions.

All they need is an Internet connection.

Recently, Auction.com unveiled a new iPad application that allows buyers to locate and bid on both commercial and residential real estate from virtually anywhere. The app fully integrates Auction.com’s platform and iPad’s technical infrastructure to produce an entirely new user experience. The application can be downloaded for free from Apple’s App Store or on Auction.com’s website.

In mid-January, Kalthia Group Hotels became the first bidder to win a commercial real estate auction using the Auction. com iPad app. The hospitality management company acquired Quail Hollow Inn, a Best Western property in Benson, Ariz., for $2.2 million.

DUE DILIGENCE Obtaining information about residential property is fairly easy. But investors who want to put their money into commercial bricks and mortar face a larger challenge when it comes to reliable due diligence. realAssets Adviser | FEBRUARY 2015

In fact, commercial property investors say due diligence is one of the most challenging aspects of buying real estate, even for sophisticated buyers. If an investor does not approach the due diligence process with a keen eye and conduct a thorough review, he could lose millions.

When it comes to commercial real estate, there are three forms of due diligence: financial, legal and physical.

Financial due diligence consists of financial documentation such as current and historical financial statements, property tax bills, federal tax returns, utility bills and other proof of expenses.

Legal due diligence consists of all legal documentation related to the property including title, survey and tenant leases.

Physical due diligence refers to documentation that shows the physical condition of the property, including professional site inspection and property condition assessment.

Compiling this information, keeping track of it, and making it available and accessible to all interested parties can be time consuming and messy. Most auction companies archive at least some of this information online. Auction.com,

they are bidding against other bidders or if they are bidding against the auctioneer.

Sharga attributes this distrust to a lack of understanding about the auction process.

In particular, investors can become confused regarding the reserve price and how auction companies bid against the reserve.

A reserve is the minimum price the seller will accept, and the reserve price is set when the auction listing is created.

If the reserve price is not met during the bidding process, the asset cannot sell. It is common practice for auction companies to get involved in the bidding if the highest bid has yet to reach the reserve. Although many people question this practice, it is important to point out that an auction cannot end successfully unless the reserve is met.

In addition to confusion about the reserve price, many buyers have questions about fees and deposits for online auctions.

In general, there is a misperception that online auctions have nonrefundable deposits and hidden fees.

Most auctions for large-ticket items, commercial real estate among them, require good faith deposits. Experts contend that deposits actually protect bidders and sellers

Many investors avoid auctions because they simply do not trust the process. for example, uses an online “vault” where all due diligence documents are stored.

Sellers can update the information from anywhere, and buyers can easily access the same information.

Auction.com also has introduced due diligence standards to ensure that buyers and sellers are providing comprehensive documentation. The company has a minimum standard, and it is working on a “gold” standard, which will indicate sellers have provided a higher level of documentation.

TRUSTING THE PROCESS Many investors avoid auctions because they simply do not trust the process. Buyers worry that auctions are rigged by the auction company, and they wonder whether

because they “legitimize” the bidder pool.

Deposits provide a level of security for sellers because they do not have to worry about whether the bidders are serious.

As for hidden fees, Sharga says it is almost unheard of for a reputable company to charge someone for simply participating in an online auction as a bidder. At Auction.com, for example, the winning bidder is the only one who pays a fee.

“For those who’ve never invested in real estate, I think online auctions make the whole process easier,” Najarian says. “And for those like me, who regularly invest, online auctions are a key avenue for us to identify investment opportunities.”

Jennifer Duell Popovec is an award-winning writer based in Fort Worth, Texas.

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By Drew Campbell

Midstream energy infrastructure investors are positioned better than most to withstand oil’s price decline.

Shock Absorbers 54

realAssets Adviser | FEBRUARY 2015

C

rude oil’s price drop has grabbed the attention of anyone with a stake in energy markets, or any market for that matter, as oil is a ubiquitous part of the entire global economy. Ever since oil and gas became the global energy standard, the market has been subject to price booms and busts, so today’s oil price drop is not surprising; however, this price decline has a different feel than others because it is being driven by an oversupply rather than the typical lack of demand brought on by a stalled economy.

“It’s certainly not in the norm to see oil prices collapse as much as they have over the past four to five months,” says Hinds Howard, senior master limited partnership (MLP) and infrastructure research analyst

with CBRE Clarion Securities. “Its impact is going to be varied across the sector — certain companies will do better in this environment and other companies will see their growth slow down, and certain companies will see their results next quarter impacted directly.”

Regardless of why prices are falling and when prices will rebound, certain energy stakeholders will feel the impact more than others.

In markets such as Texas or Russia, for example, where oil drilling is a central part of the economy, a price drop will cause

drilling activity to shrink — drillers are cutting capital expenditure budgets by up to 75 percent in some cases, and the impact could be harsh for some.

In Mexico, meanwhile — where last year the government opened oil and gas to foreign direct investment for the first time in 70 years — enthusiasm for a new black-gold rush has noticeably dampened. With prices at $50 a barrel, Mexico looks less promising at the moment than it did six months ago.

“We had a demand problem in 2008–2009, and we came back from that relatively quickly,” says Tyler Rosenlicht, research analyst with Cohen & Steers’ infrastructure team. “In the 1980s we were materially

Regardless of why

prices are falling and when prices will rebound, certain energy stakeholders will feel the impact more than others.

realAssets Adviser | FEBRUARY 2015

55

oversupplied, and it took a decade to recover. We are somewhere in the middle — we are oversupplied but not too much, and it can be rectified rather quickly with a little demand increase and a little supply reduction.”

For infrastructure investors focused on midstream energy infrastructure there is a silver lining in oil’s recent price plummet — the market is relatively insulated from the worst of the effects and the price decline should be more muted. This is part of the appeal of midstream energy infrastructure investments — their ability to buffer commodity price swings and deliver cash flows in most environments.

Take the energy MLP market, which not only is where a lot of midstream infrastructure is developed and managed, but which also has diversified its assets during the past five to six years.

“The biggest change in this sector over the past 10 years is just how much diversity there is and how many different kinds of assets are within the MLP structure,” says Howard.

“There are 120 MLPs, and 60 of those have gone public over the past five years. This sector has transformed quite a bit.”

This means midstream energy investors with MLPs in their portfolios are more diversified across the energy supply chain, and while that could open them up to more exposure to a receding oil exploration sector, they also are allocated to other parts of the market that are less sensitive to a decline in crude oil prices. MLPs also are heavily invested in natural gas, which is a different market altogether, and so their assets are increasingly spread across upstream production to midstream delivery and downstream marketing and distribution, as well as between oil and gas.

“You can’t use MLP and pipeline interchangeably any longer because the types of assets in those MLPs have changed,” says Sam Arnold, managing director and portfolio manager with Brookfield Investment Management. “You now have frac sand companies, variable refining companies, petrochemical facilities to go along with midstream energy.”

Today’s MLP market is buoyed by a diversified portfolio that is not dependent on any

56

one market and opens up more possibilities to create value in more parts of the market, many of which are unaffected by oil prices.

CONTRACT PROTECTION Another reason infrastructure investors who allocate to midstream energy should fare better is the sector can provide protection from commodity price shocks like the one happening now. Midstream energy pipelines typically are much less commodityprice sensitive than exploration and production businesses, and they typically do not have any direct commodity exposure.

“It really depends on how the owneroperator of the assets has structured its contracts,” Arnold says.

Midstream owner-operators basically have three options for structuring pipeline contracts with oil and gas producers to move their products from the oil fields to market.

“The safest is fee based with ‘take or pay,’” Arnold explains. “The pipeline is turned into a toll road, and it takes a nickel or quarter or dollar per barrel that goes through the system. If you couple that with a minimum volume contract then you are fixed volume and fixed fee, and you are not exposed to either the direct changes in the prices of commodities going through the pipelines or the volumes going through the pipelines.”

That kind of contract is made for markets like today’s — to prevent swings in commodity prices and volumes from impacting cash flows. The investor in midstream energy pipelines and MLPs with these types of contacts is guaranteed payment from oil producers whether those producers are sending product through the pipes or not — even while many are pulling back on production as is happening now.

“Some MLPs and pipeline businesses have a lot of those types of contracts,” says Arnold. “[They are] really pretty stable and don’t have much direct or even indirect commodity exposure.”

That being said, there are midstream energy companies and MLPs that do not have these types of commodity price and volume protections, and investors should know this could impact their investments — or they will learn this soon enough.

“When you move out the risk profile, there are pipeline companies that just have fee-based contracts but don’t have minimum volume protection,” says Arnold.

These companies do not have the direct commodity risks because they have contracted the fee regardless of prices — they are still getting their nickel or dime per barrealAssets Adviser | FEBRUARY 2015

Despite the relatively

sanguine outlook for the overall midstream sector, analysts caution investors not to get complacent.

rel as written in the contract — but they are not protected against declines in the volume of product running through their pipelines.

This is where investors should begin to see impacts on their cash flows and investments.

Declining economic activity and declining oil and gas prices will cause producers to pull back on drilling activity and that will realAssets Adviser | FEBRUARY 2015

translate to lower volumes running through pipelines because there simply is less need for pipeline systems.

YOUR TIME IS UP For all the protection a contract can provide for midstream energy companies and investors, they are not foolproof. The timing

of a contract is another area that can open investors to risk. If these contracts expire in a market like today’s, securing new contracts when oil producers are pulling back on production creates a challenge.

“You are certainly seeing that with natural gas and the wave of pipelines that were built in the 2006–2008 timeframe,” says

57

Rosenlicht. “The companies that signed 5to 10-year contracts are up for renewal at lower rates, and in some cases the rates are low enough that the pipelines will have to be repurposed.”

For example, midstream owner-operators including Broadway Pipeline Partners, Trans Canada and Rockies Express are repurposing and backhauling pipelines to move gas out of the Utica formation. The demand is no longer strong enough to warrant tariffs at the rates agreed to when the pipeline was originally built or when a contract was last signed and natural gas was priced higher.

“Most of the crude oil lines have been built fairly recently and so those contract renewals are a ways off,” says Rosenlicht.

“However, those companies that are gathering crude oil who are expecting that growth to continue might not see that happen. I don’t think that will lead to any potential dividend cuts, but the growth expectations are still embedded in the price, and it is difficult to see how they could maintain these types of growth rates over the next couple of years even in a $70 to $80 crude oil world.”

RISKY BUSINESS Companies that develop and operate the infrastructure used to gather and process oil and gas at wellheads are the furthest out on the risk curve in the midstream sector.

58

“The biggest impact is going to be in the gathering and processing MLPs,” says Howard. “If you have an oil pipeline you are going to be fine because those are largely backed by contracts that are fee based in nature and that also have volume protection. The real risk is in the gathering and processing sector — the companies in Oklahoma, the Eagle Ford shale and the Bakken that are gathering natural gas from wells and splitting off natural gas liquids.”

The historical relationship between oil and the natural gas market is not as strong as it once was, but there is still a relationship, and when oil prices and drilling activity are down, that relationship will impact of course the oil market, but also the natural gas gathering and processing market.

“They are the closest to the wellhead, and they are the most exposed to activity declines,” says Howard. “If you have a gathering system that has no volume protection at all and all of your contracts have some level of commodity pricing exposure, then you are in a lot of trouble right now. That’s not the case for most of these gathering and processing companies, but that is where the biggest direct risk in the midstream space is today.”

Howard notes there is a clear subset of gathering and processing MLPs that focus solely on this activity, and there also is a subset of MLPs that focus only on gathering, in

particular in the Marcellus shale where producers have been actively spinning off their midstream gathering assets.

“This is unique globally,” says Howard.

“There are not a lot of integrated companies in this market, and instead there are a lot of pockets of assets in the form of gathering and processing MLPs.” These companies build pipelines and processing infrastructure that connect wellheads into the larger and longer haul pipeline networks as well as separating (processing) the different oil- and gas-derived products. With exploration and production companies pulling back on drilling activity, there will be less of a need for this gathering and processing infrastructure.

Private equity firms, in particular, have been active in this part of the market, and investors have enjoyed returns of north of 20 percent during the past several years, but expectations will have to be lowered in the near term now that drillers are expected to cut back production, and the need for gathering and processing pipelines will decline.

WAYS AND MEANS Despite the relatively sanguine outlook for the overall midstream sector, analysts caution investors not to get complacent. The price shock set off a flight to safety within the energy sector; investors have rotated into blue-chip MLPs and midstream companies that have strong balance sheets and broadly diversified portfolios. These are the companies investors rightly perceive to be best positioned to ride out a decline in oil prices, but experts warn that a prolonged decline in oil prices could test those perceptions.

In the meantime, MLPs and midstream energy companies have a number of options to keep their revenues and distributions healthy.

“These companies can repurpose pipelines for different products and back flow their stream,” says Arnold. “They find ways to keep their pipelines working.”

In some cases, these companies can take pipelines that had gone dormant due to shifts in demand and repurpose them to ship natural gas instead of oil or flip the direction of commodity flows — for example, a pipeline that took imported oil from realAssets Adviser | FEBRUARY 2015

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the Gulf Coast to Northeast markets can be flipped to bring Marcellus shale gas from the Northeast to the Henry Hub in Louisiana. This type of repurposing is increasingly available as the boom in drilling activity in North America is creating new sources of oil and gas in new regions.

Midstream companies are compelled to manipulate their pipelines in this fashion because they often have a tariff set for a pipeline that was granted when prices were higher, but now the contract has expired and the company cannot get anywhere near the old rate.

“We have seen this happen now with natural gas,” says Rosenlicht. “If things stay the same in oil markets, several years from now we would see the same thing happen with oil pipelines.”

Rosenlicht says he does not believe today’s oil market is at risk of prolonged low prices, however, and so does not foresee companies needing to repurpose their oil pipelines in the way natural gas pipelines are today. “We are not that oversupplied like we were in the 1980s,” he says.

Many of these companies also have built in a large equity cushion, and the chances for distress seem remote for now.

A longer term decline in oil prices, however, very well could drain that equity and force companies to look at other options. While a wave of mergers and acquisitions in the midstream energy sector seems unlikely, the longer oil

60

prices remain low, the more challenged companies could become.

“In the 2008–2009 downturn, only a few MLPs had to cut their distributions to investors,” says CBRE Clarion Securities’ Howard. “They have many ways to keep revenue growth on target and distributions flowing to investors.”

MLPs are typically spun out of a larger diversified energy company, and assets are continually “dropped down” from the parent into the spun-off MLP — this is one way revenue growth can remain steady for MLPs and distributions to investors can remain healthy.

“The MLP balance sheets are relatively strong, and the ability to drop down assets creates a stream of revenue,” says Howard.

“I don’t see a wave of consolidation within the MLP space.”

A trend that is a little bit of a red flag, Hinds notes, is the pace at which general partners are realizing their distributions.

MLPs are composed of general partners and limited partners, each with different rights and claims on revenues and distributions. Recently, GPs have been accelerating the rate at which they receive their distributions.

“There hasn’t been much pushback from the LPs because they are getting these distributions at an accelerated rate as well,” says Howard. “The concern is that LPs who need continued revenue growth to earn their distributions over the longer term will be locked out if these MLPs can no

longer sustain revenue growth. Then come cuts to distribution rates.”

So far, however, there has not been much of an issue raised by the practice of accelerating the rate of distributions.

CONCLUSION Most investors focused on lower risk midstream pipeline infrastructure are insulated from the current oil price drop because these companies have contracts that buffer them from price swings. However, investors more frequently take on some volume risk, and if the price of oil remains low for extended periods, the likelihood that drillers continue to hold off on new drilling projects increases. That means the need to move product through pipelines declines as well.

The good news is that any dip in the short term is probably going to be offset by longer term trends that point to expanding oil and gas production and the need for pipelines to bring that product to market.

In the meantime, as oil prices dip, companies up and down the supply chain will feel the pinch, but at the moment experts do not see too much risk of this stress hurting midstream energy companies and investors, with the distress mostly contained to gathering and processing companies.

Drew Campbell is senior editor of sister publication Institutional Investing in Infrastructure. realAssets Adviser | FEBRUARY 2015

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Cyclical Rebound Tempered by Risks Growth drivers point to continued robust market for real estate investors in 2015.

P

rincipal Real Estate Investors’ base-case economic outlook is for the U.S. economy to finally achieve a cyclical period of moderate escape velocity with the forecast for real GDP to expand by around 3 percent in 2015. This progress will be a welcome relief after nearly five years of sluggish growth following the end of the global financial crisis. The hesitant and sluggish economic and labor recovery has prompted questions on whether the United States has entered a structural downshift in its growth potential; only time will tell.

Looking out over the next 12 to 18 months, our optimism about a cyclical rebound is anchored in several factors: a continued robust expansion of the labor market; vigor in the three major cyclical drivers of growth — technology, energy and housing; and a long-awaited acceleration in corporate spending.

growth have presented significant barriers to more robust spending. Households remain somewhat cautious even five years after the end of the recession and have been reticent to overextend.

As a result, consumption has remained within the bounds of income growth.

Subsequently, personal consumption growth is unlikely to reach the 4 percent to 5 percent levels of the last two business cycles and may deprive the U.S. economy of a powerful source of escape velocity.

Externally, a weak stop-start recovery in the euro zone — combined with mounting geopolitical risks (Ukraine, the rise of the Islamic State, the impact of prolonged low oil prices on producer countries) — may also keep escape velocity moderate and limited. Thus, while the base-case for the U.S. economy is cautiously optimistic and indeed represents a bright spot across an oth-

The constructive environment for commercial real estate investors should remain in place.

Our optimism is tempered, however, by both internal and external constraints that may act as a governor on this cyclical rebound. Internally, growth may taper off if consumer spending remains sluggish. Despite significant deleveraging since the end of the last recession, until recently, a sluggish job-market recovery and subdued income and wage

64

erwise underwhelming global economic growth story, it is tempered by constraints that may prevent the U.S. economy from attaining escape velocity for a sustained period.

The implications of such a scenario on monetary policy are complex. On one hand, the Federal Reserve will likely move forward on its rate normalization

By Indraneel Karlekar

process as it continues to see improvement in high-frequency economic indicators. On the other hand, the Fed has stated its desire to keep monetary policy accommodative, given the uncertainty around the economic outlook. The tension between short-term economic confidence and longer-term ambiguity may prevent the Treasury yield curve from rapidly steepening.

So what does this mean for commercial real estate investors? A modest flattening of the yield curve would not be altogether detrimental. If 10-year Treasury yields remain relatively well anchored, cap rates should generally remain near current levels as values remain stable. In some markets where there is a larger spread over the riskfree rate, there is potential for additional compression. Higher LIBOR rates would probably lead borrowers to migrate from floating- to fixed-rate strategies to take advantage of curve flattening.

Another way to look at it is if the interest-rate environment does not change materially, real estate investors will be provided an “extra inning” of asset reflation. With NOI expected to grow in a meaningful manner in 2015, the constructive environment for commercial real estate investors should remain in place.

Indraneel Karlekar is managing director, global research and strategy at Principal Real Estate Investors. realAssets Adviser | FEBRUARY 2015

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