Risk Management

Storms, Debt Roil Real Estate CFOs

Finance chiefs ponder what to do when the levees break or interest rates rise.
Kathy HoffelderJanuary 14, 2013

CFOs of real estate development companies have always worn several hats and wished they had more hands. But after tackling superstorm Sandy and reinventing their finance functions after a big real estate downturn, a panel of them at a New York State Society of CPAs conference last week said that it’s time to get conservative across all their operations.  

Michael Brenner, CFO and executive vice president of Related Companies, a privately-held real estate developer, said hurricane Sandy taught his firm to be more cautious when it comes to its IT infrastructure and to prepare for another possible storm that could come again. At the time Sandy struck, Brenner’s firm had its IT back-up facility in Carlstadt, New Jersey, a suburb near New York City, where its main IT facility is located. Ordinarily, that wouldn’t be a problem. But Sandy was no ordinary storm.

After a levee broke in northern New Jersey, Related Companies’ back-up facility was just as incapacitated as its New York facility, which shut down amid many other storm closings in Manhattan. “The more you think about it, it really doesn’t make sense to have your two IT facilities within 15 miles of each when both can be affected by the same disaster,” said Brenner. The firm has since relocated its back-up facility to Nashville, Tennessee, and he is in the process of rethinking the firm’s entire disaster-recovery strategy.

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Whether planning for another super storm or a new investment project, CFOs like Brenner are looking at more conservative ways to operate. Glenn Cohen, CFO of Kimco Realty Corporation, for instance, said his company now more than ever is keeping its cash close to home. In these volatile times, he recommends having “lots of liquidity.”

Just how does he do that? In any given year, Kimco has only a small amount of debt maturing on its balance sheet. What’s more, the debt it does have has very long maturities, avoiding the trap of expiring short-dated debt and a the necessary rush to refinance. “We’ve really weathered the storms. Just keeping a very, very long debt-maturity profile has worked out well for us,” he added. “We just keep a tremendous amount of capital available to us.”

Similarly, Michael Giglio, CFO and director of acquisitions at the New York-based Kaufman Organization, said he doesn’t expect to “get choked by its debt or its expenses,”— two areas that hurt other real estate-focused firms during the recent recession. “In the event that we do make a mistake, we are not very highly leveraged. We have room to flex with the market,” he says. In such volatile times, Giglio says it’s important to have as little debt as possible.

That conservative attitude permeates all of Kaufman’s relationships, especially with those it has with its bankers, according to Giglio. Lenders “are looking for the best markets with the best buildings, with the best sponsors. Those are the companies that are getting the capital,” he notes.

At the height of the recession, too much debt on companies’ books hurt financial institutions as well real estate developers. And with much of that debt getting securitized as commercial mortgage backed securities (CMBS), investors and bankers alike lost much of their holdings, as the price of CMBS dropped dramatically.

Now, bank underwriting standards for CMBS are more strict, panelists said. That’s because banks previously loaned money based on the false belief that rents on properties would continue to go up by as much 10% to 20% with each new lease. But today “that’s just not happening,” and rents are rising at a much slower pace.

Still, rental properties are considered a more prudent investment for real estate companies than condominiums which, panelists said, could lose value quickly. As Related Companies’ Brenner noted, if the economy picks up and interest rates go up, having rental property is a built-in hedge for many CFOs who own or manage properties, since rents can rise along with an increase in interest rates. “As a company, we always rather build rentals than build condos. A rental you can keep improving, and it grows over time. But with condos, you make a lot of money but [then] you’re done.”

Too often, though, real estate firms use complicated hedges to protect against volatile markets. That, according to Scott Shay, founder and chairman of the Board of Signature Bank, a commercial bank based in New York, can stop some of the best business plans CFOs have in their tracks. “I can’t tell you how many CFOs have complained to me about hedges that they’ve done, about [interest rate] swaps they’ve done, that somehow don’t work out,” he said on the panel, noting that the conditions under certain hedges have actually caused CFOs to stop the selling of properties when their firms wanted to.

What’s a better way to hedge interest rates? By thinking conservatively, Shay added. The most successful CFOs in real estate, he noted, are the ones that are not swayed by the current low-interest- rate environment and realize it will come to an end. “When it does, I will tell you the Fed is going to have to move rates by a whole hundred basis points, not by quarters like what [former Fed chairman] Alan Greenspan did,” he said.  

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