{"id":1004146674,"date":"2016-06-24T04:22:41","date_gmt":"2016-06-24T12:22:41","guid":{"rendered":"https:\/\/www.commercialsearch.com\/news\/?p=1004146674"},"modified":"2016-06-24T06:19:21","modified_gmt":"2016-06-24T14:19:21","slug":"qa-with-tom-flexner-citigroup-global-head-of-real-estate","status":"publish","type":"post","link":"https:\/\/www.commercialsearch.com\/news\/qa-with-tom-flexner-citigroup-global-head-of-real-estate\/","title":{"rendered":"Q&A with Tom Flexner, Citigroup Global Head of Real Estate"},"content":{"rendered":"
\"Tom<\/a>

Tom Flexner, vice chairman & global head of real estate, Citigroup<\/p><\/div>\n

Paul Fiorilla: Welcome Tom. We at CRE Finance World are\u00a0thrilled to hear your thoughts about the global economy and\u00a0commercial real estate. You travel internationally and experience\u00a0the economies and central banking policies in countries around\u00a0the world\u2014what is your view of major global economies and\u00a0the generally accommodative monetary policies central bankers\u00a0are employing?<\/strong><\/p>\n

Tom Flexner:<\/strong> We\u2019re in a world of 2 to 3 percent GDP growth\u00a0globally\u2014with many factors ranging from demographics to\u00a0commodity prices to excessive leverage levels to regulatory drags to\u00a0geopolitics to a pervading sense of uncertainty and ambiguity\u2014all\u00a0conspiring to tamp down economic activity. The demand side of\u00a0the world is just not responding, at necessary levels, to the\u00a0concerted efforts of many Central Banks to stimulate job growth\u00a0and capital investment.<\/p>\n

Policy tools like quantitative easing (QE) and low interest rates\u00a0are just not translating into stimulating the real economy. Even the\u00a0China engine of the past 20 years is trending at its lowest GDP\u00a0growth rate since its economy modernized.<\/p>\n

These accommodative monetary policies have served to elevate\u00a0financial asset values\u2014balance sheet inflation, if you will, but have\u00a0largely failed to create fundamental demand in the world\u2019s real\u00a0economies where new jobs are produced and wages are determined.<\/p>\n

And I\u2019m not sure the central banks have much left in their tool kits\u00a0at this point. Who knows the effect of sustained negative interest\u00a0rates? Fortunately the U.S. was the first to address these issues\u00a0during the financial crisis and is, on a relative basis, ahead of its\u00a0counterparts in Europe and elsewhere. But even here we continue\u00a0to experience subpar growth. 2 percent annual long term is not enough\u00a0to lift all boats.<\/p>\n

\"Paul<\/a>

Paul Fiorilla, Yardi Matrix Associate Director & CRE Financial World Editor-in-Chief<\/p><\/div>\n

Paul Fiorilla: So what is the way out of this weak economic\u00a0growth cycle that we\u2019ve been in for some time?<\/strong><\/p>\n

Tom Flexner:<\/strong> Paul, that is the big question confronting most world\u00a0leaders. And there are no obvious answers which are pain-free or\u00a0even politically feasible. It just feels to me that we\u2019re in the midst of\u00a0adjusting to some sort of overarching longer-term secular change\u00a0marked by continued tepid growth, low interest rates, low oil prices,\u00a0forced deleveraging by foreign sovereigns and so on. If so the\u00a0adjustment may be to bring down return expectations to reflect the\u00a0lower productivity of capital in this new world. Right?<\/p>\n

So we have a whole bunch of things working against us, and\u00a0frankly it\u2019s hard to identify a single reason to be terribly optimistic\u00a0about the world\u2019s growth trajectory. Other than somehow it always\u00a0seems to work out at the end. But, you know, up until the financial\u00a0crisis we had a global economy supported by huge credit\u00a0expansion\u2014consumers, governments, companies. It lifted growth\u00a0beyond what would have happened had credit not expanded at\u00a0such a vigorous pace. Today, we still have a significant amount of\u00a0leverage, particularly at the sovereign level, but also in the banking\u00a0systems in China, Japan and Europe; plus regulatory initiatives\u00a0which will serve to constrain credit creation going forward. And this\u00a0kind of countervailing pressure\u2014deleveraging\u2014will possibly hinder\u00a0growth, as credit creation will not be the tailwind it once was.<\/p>\n

And demographically, here and through most of the developed\u00a0world, we have headwinds in terms of aging populations, the\u00a0percentage of people that are going to be productively engaged\u00a0in the workplace versus the growing number that have to be\u00a0supported by those in the workplace.<\/p>\n

And so I think the twin impacts of globalization and technology are\u00a0showing they also have downsides. Technological advances used\u00a0to amplify human muscle or human capital if you will. That was a\u00a0fundamental precept during the first two industrial revolutions\u2014you created machines that increased human productivity in a way\u00a0that allowed everyone to participate in the benefits of enormously\u00a0increased output. People were able to become much more productive\u00a0and people harvested a portion of those gains for themselves.<\/p>\n

But today, it seems that technology is as often substituting for or\u00a0replacing human capital as it is amplifying human capital. Think\u00a0robotics and automation. And that puts a lot of downward pressure\u00a0on job growth and wage growth in the traditional sectors. And with\u00a0globalization we have an entire world competing against each other\u00a0for a finite number of jobs. That\u2019s why there\u2019s so much noise about\u00a0unfair trade, currency manipulation and so on. The leaders of every\u00a0country, if they want to stay in power, have to win on the jobs front,\u00a0and globalization puts everyone in competition with everyone else.<\/p>\n

What else? We have a lot of uncertainty and ambiguity, whether\u00a0it\u2019s the fractious noise around the presidential election, whether\u00a0its migrant pressure in Europe, a nuclearized North Korea, terrorist\u00a0attacks, climate change, a non-isolated Iran, or low commodity\u00a0prices which create difficulties for the emerging market countries\u00a0having to deal with dollar-denominated external debt.<\/p>\n

I\u2019m beginning to get depressed listening to myself. So all of these\u00a0things combine, you know, to suggest it will be a long hard climb\u00a0out of the low-growth world we\u2019re in right now. And, of course,\u00a0on top of all that and near and dear to CREFC and others is the\u00a0impact of regulatory changes affecting bank capital, bank liquidity,\u00a0trading rules, risk appetite, all of which are interrelated and which\u00a0potentially serve to restrain credit and liquidity and which, in my\u00a0opinion, could make it harder for the financial system to help avert\u00a0or soften the impact of a future recession or liquidity disruption.<\/p>\n

And of course all this affects decision-making in the C-Suite. How\u00a0do you know where you want to invest and build and develop and\u00a0produce when you don\u2019t know what the tax code is going to look\u00a0like, you don\u2019t fully understand the evolving regulatory environment,\u00a0you don\u2019t know whether free trade agreements are going to be\u00a0torn up, you don\u2019t know which currencies will be manipulated\u2014all\u00a0of this works, again, to create more caution and hesitation on the\u00a0part of business.<\/p>\n

Paul Fiorilla: We\u2019ll get into some of those things a little bit later.\u00a0However I wanted to follow up because you seem to feel that\u00a0the global economy is exhausted and things are going to get\u00a0worse. Do you think that the Fed has been pursuing the wrong strategy\u2014what should they have been doing? And what could\u00a0they do?<\/strong><\/p>\n

Tom Flexner:<\/strong> I don\u2019t think the Fed has been pursuing the wrong\u00a0strategy, I think what I\u2019m saying is the Fed pursued the only\u00a0strategy it could. And it\u2019s easy for people to second guess the\u00a0Fed on the heels of their multiple rounds of QE and so forth, but\u00a0the fact of the matter is the Fed was staring at a true black swan\u00a0financial crisis almost eight years ago. Think back to the fall of \u201908\u00a0and what was happening. So today, I think even though we\u2019re not\u00a0feeling all that great about our economy and our country\u2014and\u00a0the election primaries are raising all the fundamental issues we\u00a0should be concerned about\u2014we\u2019re in better shape than most.\u00a0My personal opinion is the Fed did what it should have done and\u00a0could have done, but by itself it was not enough.<\/p>\n

I think gridlock in Washington, in terms of budget reforms and\u00a0stimulus spending etc., meant there was no real fiscal policy\u00a0corollary that would have reinforced the Fed\u2019s actions. Instead,\u00a0there was just partisan divisiveness over spending bills, tax reform,\u00a0entitlement reform and so forth over the past six years. So you can\u2019t\u00a0put the entire weight of an economic recovery on a Central Bank\u00a0because they only have one tool and that\u2019s monetary policy. And it\u00a0takes more than one tool.<\/p>\n

Paul Fiorilla: Do you get the sense that they\u2019re going to continue\u00a0to be dovish about raising rates going forward, which seems to\u00a0be the consensus right now?<\/strong><\/p>\n

Tom Flexner:<\/strong> You know Paul, I hope they continue to be dovish\u00a0because I don\u2019t think we\u2019ve seen enough domestic progress on\u00a0growth, wages or inflation, and the world economy is pretty fragile\u00a0and we are not decoupled from that. What is the primary fear of\u00a0ballooning up the money supply? The primary fear is that inflation\u00a0expectations and then inflation itself will get out of control, right?\u00a0And the dollar will crash, correct? Well we haven\u2019t seen either\u00a0meaningful inflation or a weakened dollar. We\u2019re finally seeing a\u00a0little wage growth which is very good, but the fearfulness, you\u00a0know, around a Fed balance sheet which has grown by $3 trillion\u00a0over the past several years is completely misplaced. In fact, the flip\u00a0side of the Fed\u2019s balance sheet expansion has been a dramatic\u00a0increase in excess reserves deposited at the Fed by member banks.\u00a0And you better get used to it. A $4 trillion Fed balance sheet is the\u00a0new normal in my opinion. Why? Because the new bank regulatory\u00a0liquidity requirements are most efficiently met through holding\u00a0excess reserves, which I believe will stay at quasi-permanently\u00a0elevated levels which by definition requires a much larger Fed\u00a0balance sheet. And by the way, will also mean that the targeting\u00a0of the Fed funds rate will be much less relevant in the future.<\/p>\n

Now you can argue that what it has done has created balance sheet\u00a0inflation in the sense that financial asset classes of all types\u2014both\u00a0risk off and risk on\u2014have risen in value and probably become a bit\u00a0disconnected with underlying fundamentals. So maybe you have a\u00a0correction. But I think that a small price to pay for pursuing a policy\u00a0that is trying to avoid the U.S. slipping back into a recession and\/or\u00a0seeing a possible re-spiking of unemployment.<\/p>\n

So, in my mind it\u2019s almost an asymmetric options value approach\u00a0the Fed is taking. They\u2019re basically saying, \u201cWe\u2019re willing to run\u00a0the risk of overshooting our inflation target and then correcting, in\u00a0order to avoid the risk of suddenly pushing our country back into\u00a0recession, and then having to correct for that.\u201d<\/p>\n

And it\u2019s complicated because everything is interconnected across\u00a0the globe. The Fed, you know, is not just dealing with a closed\u00a0economy. It is dealing with trade partners, cross-border financial\u00a0flows and relative currency movements. And if the Fed starts\u00a0tightening while everyone else is in easing mode, as we\u2019ve seen\u00a0already, even the expectation of tightening caused the dollar to\u00a0materially strengthen over the past 18 months. Now, it has given\u00a0some of it back as the Fed is viewed as being more dovish again.\u00a0But all of these things are interconnected and have to be considered.<\/p>\n

Paul Fiorilla: I agree. One of the interesting things about real\u00a0estate is that the technical or capital market side led it out of the\u00a0recession ahead of the fundamentals, but now we seem to be\u00a0seeing that the capital markets are slowing down while fundamentals\u00a0are still not bad.<\/strong><\/p>\n

Tom Flexner:<\/strong> Yes, I personally think, looking at the fundamentals,\u00a0we\u2019ve got more runway in front of us. Sixth inning maybe? Extra\u00a0innings? It doesn\u2019t feel so bad looking at the space markets, rents,\u00a0vacancies etc. That\u2019s been because with few exceptions\u2014like New\u00a0York hotels and ultra-luxury condos\u2014we haven\u2019t had significant\u00a0new development. And over the course of my career, the majority\u00a0of real estate cycles ended when there was a supply shock, not a\u00a0demand shock.<\/p>\n

2008, on the other hand, was\u00a0a demand shock that affected\u00a0everything everywhere, not just\u00a0real estate. Although real estate\u2019s\u00a0beta was front and center for a\u00a0while then. But historically, most\u00a0of the imbalances in real estate\u00a0were driven by supply shocks\u2014ample easy capital, or tax shelter\u00a0demand, or improvident demand\u00a0forecasting\u2014leading to excess\u00a0development.<\/p>\n

I think today, due in large part to regulatory constraints and an\u00a0embedded lower risk tolerance, we are not going to see the\u00a0profligate sort of lending we saw leading up to the crisis. And\u00a0while underwriting standards did loosen a bit over the past several\u00a0years, lenders are pretty disciplined compared to pre-\u201907. And the\u00a0B-piece buyers are lot smarter these days, so the market will to\u00a0some degree regulate itself. And that will help put a cap on the\u00a0supply side.<\/p>\n

Paul Fiorilla: There\u2019s a lot of discussion at real estate events\u00a0about whether we\u2019ve gotten overheated. Property sales have\u00a0gotten almost back to 2007 levels, cap rates are at the all-time\u00a0lows and prices are at all-time highs. Total debt outstanding is\u00a0once again setting records every quarter, and a lot of people say,\u00a0well, \u2018it\u2019s been seven years since the last recession, so we\u2019re\u00a0about due for another one.\u2019 But on the other hand, cap rate\u00a0premiums are still above historical averages and well below\u00a0where they were in 2007 and leverage as you just said is not\u00a0nearly as aggressive across the board. Plus, the economy is\u00a0continuing to chug along and create jobs, workforce participation\u00a0and wages are going up, stuff like that. So where do you think\u00a0that will lead?<\/strong><\/p>\n

Tom Flexner:<\/strong> It\u2019s a worthy debate, Paul. The backdrop on fundamentals\u00a0is OK, but nothing to write home about. Values have not\u00a0been supported by rosy forecasts this time around, but rather by\u00a0historically low interest rates and reasonably tight risk premia. But\u00a0I think, you know, there is a general sense that for the first time in\u00a0seven years we\u2019re beginning to see a plateauing of commercial real\u00a0estate prices.<\/p>\n

We\u2019ve seen certain credible major investors say that they think the\u00a0market has leveled off, and we\u2019ve seen some Wall Street research\u00a0saying that we\u2019ve actually suffered a slight decline since the\u00a0beginning of 2016.<\/p>\n

And it does feel that way. If you\u2019re\u00a0an intermediary brokering real\u00a0estate deals, a year ago you\u00a0might have gotten 20 bids, five\u00a0final round bidders and a fierce\u00a0bidding war by the final two.\u00a0Today you might get six bids, two\u00a0make it to the final round, and\u00a0the winner then tries to re-trade.\u00a0Different dynamic and one that\u00a0points to a less exuberant market.<\/p>\n

And I would add that all of the\u00a0regulations that you\u2019re familiar with\u2014Dodd Frank in terms of risk\u00a0retention and market-making liquidity; Basel III rules around total\u00a0loss absorbing capital; Tier 1 common equity, risk weightings,\u00a0liquidity requirements; the Formal Review of the Trading Book risk\u00a0capital treatments which are punitive for securitization\u2014these will\u00a0serve to further constrain the extension of capital to not just real\u00a0estate but other asset classes. They\u2019re certainly not going to act to\u00a0increase credit overall.<\/p>\n

My view is the regulatory envelope will impose a level of discipline\u00a0on the market that many players will not like. And many of the fine\u00a0details of the regulations I don\u2019t necessarily agree with, and they\u00a0may in fact increase certain types of risk in an unintended way. But\u00a0overall, the financial system is far stronger with greater regulatory\u00a0oversight than it\u2019s ever been historically, and I think this is a good\u00a0thing long term.<\/p>\n

But, having said all that, on a global basis including the U.S., I\u00a0think real estate will outperform other asset classes over time.\u00a0In this world we\u2019ve been talking about\u2014low rates, low growth,\u00a0high volatility\u2014real estate offers yield, stability and predictability,\u00a0all characteristics which are attractive in such an environment.\u00a0The world is starving for yield. So call real estate the least worst\u00a0investment alternative, if you will.<\/p>\n

Paul Fiorilla: What\u2019s your outlook on CMBS volume? A lot of the\u00a0analysts have downgraded the volume expectations since the\u00a0beginning of the year from $100 billion or more to $60 billion to\u00a0$70 billion.<\/strong><\/p>\n

Tom Flexner:<\/strong> I guess we don\u2019t have a good view on that. Volume\u00a0forecasts have certainly degraded as you point out, although the\u00a0pace of issuance has begun to pick up. And we have a wall of\u00a0maturities this year and next, approaching $200 billion, of which\u00a0maybe only 15 percent have been addressed so far. So you have at least\u00a0a picture of the demand side. But forecasting is tough because\u00a0world volatility levels remain very elevated\u2014back and forth risk\u00a0on, lurching from new datapoint to new datapoint\u2014which is why\u00a0I think it\u2019s hard to have a prediction forecast, especially in an\u00a0election year like this one.<\/p>\n

Also, remember CMBS issuance faded toward the end of 2015, we\u00a0thought the year would end at $110-115 billion but it ended just shy\u00a0of $100 billion. And then we had material spread widening through\u00a0January and February, hedging strategies failed, and it was clear\u00a0that CMBS was not insulated from the broader credit markets.\u00a0You had record corporate bond issuance and near record high\u00a0yield issuance in 2015. And then we saw, starting in mid-summer last\u00a0year the massive knock-on effects of China\u2019s currency devaluation\u00a0and stock market collapse, and continued pressure on oil prices\u2014we saw credit spreads gap out across both the high yield and\u00a0investment corporate bond markets. And it wasn\u2019t just limited to\u00a0energy companies, whose P&L\u2019s were getting crushed because\u00a0of oil prices.<\/p>\n

No. It was a broad sell-off. Liquidity was drying up. The High-Yield\u00a0index gapped out 200 to 300 basis points. And CMBS was not\u00a0immune because your typical portfolio manager is going to say:\u00a0\u201cWhere am I going to get value on a risk-adjusted basis?\u201d And\u00a0he\u2019s looking at CMBS, he\u2019s looking at high yield, and he\u2019s looking\u00a0at investment grade corporate. And the latter two just got a lot\u00a0cheaper, making CMBS less interesting unless the price drops.\u00a0That\u2019s why I think it\u2019s hard to predict. And it\u2019s the supply side that\u2019s\u00a0less predictable.<\/p>\n

I\u2019d love to see a $100 billion CMBS market this year, to address the\u00a0upcoming maturities and new financings. At this point I don\u2019t think\u00a0we\u2019ll get much help from the life companies because they started\u00a0the year with $60 billion allocated and I think they\u2019ve been using it\u00a0up pretty fast.<\/p>\n

And banks aren\u2019t certainly being prodded by the Fed and their\u00a0other regulators to go all in on commercial real estate. And we\u00a0have risk retention to look forward to also.<\/p>\n

Paul Fiorilla:\u00a0Right, I think\u00a0that probably\u00a0the big effect\u00a0in terms of\u00a0the lending\u00a0markets right\u00a0now is the cost\u00a0is going to go\u00a0up a little bit\u00a0for borrowers.\u00a0I guess you could debate whether that\u2019s such a terrible thing,\u00a0given how low rates have been, but it seems to me that\u2019s probably\u00a0going to be the biggest impact in the second half.<\/strong><\/p>\n

Tom Flexner:<\/strong> I agree with that.<\/p>\n

Paul Fiorilla: Let\u2019s talk about liquidity. One of the causes of the\u00a0recent spread widening is a reduction in liquidity as market makers\u00a0leave the secondary markets due to regulatory restrictions and\u00a0Volcker rules. Is there any way you think liquidity can be brought\u00a0back into the market?<\/strong><\/p>\n

Tom Flexner:<\/strong> You know, \u201cliquidity\u201d is an interesting word because\u00a0on the one hand you can count up all the hedge funds and credit\u00a0funds that have dry powder, all the private equity firms that have dry\u00a0powder, all the pension funds and endowments that have increased\u00a0their real estate allocations but not yet fulfilled them, the sovereign\u00a0wealth funds. There is, I think, on one level, a lot of liquidity, right?<\/p>\n

And real estate to some degree is competing for that liquidity\u00a0along with other asset classes. That is one form of liquidity. Let\u2019s\u00a0call it investor liquidity. Then there is, say, the dealer or intermediary\u00a0liquidity which embraces the market making activities you just\u00a0referred to\u2014the lubricant which historically functioned to narrow\u00a0bid\/ask spreads, to allow buyers and sellers to execute trades\u00a0quickly and efficiently, and to reduce overall market volatility.<\/p>\n

This market-making liquidity has in many cases been materially\u00a0reduced because of the Volcker Rules, because the definition of\u00a0what is treated as a customer-driven trade versus a proprietary\u00a0trade is not clearly and crisply distinguished. And Basel III makes\u00a0it more expensive to maintain market-making functions because\u00a0you\u2019ve got to allocate more regulatory capital to supporting those\u00a0functions than you did before Basel III.<\/p>\n

And you have the FRTB right? The formal review of the trading\u00a0book which intends to impose extra capital costs on assets that\u00a0are in securitizable form or will be securitized.<\/p>\n

And then you have the liquidity requirements that compel banks\u00a0to hold a significantly higher percentage of their total footings in\u00a0the form of liquid instruments like Treasury bills and other cash\u00a0equivalents or readily marketable securities.<\/p>\n

Paul, these all serve to constrain not just overall bank lending but\u00a0also market-making liquidity. Now maybe, I think, we will see more\u00a0shadow banks step up, and maybe the whole way origination and\u00a0securitization occurs will change. Risk retention especially may\u00a0change the types of players and their roles in this business.<\/p>\n

Paul Fiorilla: If the industry is not successful in changing regulations\u00a0that you just described, does that mean that there will be sort\u00a0of a wholesale change going forward in terms of how banks\u00a0approach the market-making functions and everyone is just\u00a0going to have to adjust? Or do you think that eventually people\u00a0will get comfortable with the regulations and basically get back\u00a0to doing what they were doing before?<\/strong><\/p>\n

Tom Flexner:<\/strong> Well I don\u2019t think you can just go back to the good\u00a0old days because these rules will literally change the cost of\u00a0lending when fully implemented. It\u2019s both a pricing and availability\u00a0of credit issue. And while borrowers will inevitably bear most, if not\u00a0all, of the surcharges, that only works up to a point\u2014proceeds are\u00a0affected, positive leverage at some point possibly disappears. Lots\u00a0of unknown unknowns.<\/p>\n

Paul Fiorilla: Is that going to change the way CMBS is originated\u00a0or securitized?<\/strong><\/p>\n

Tom Flexner:<\/strong> Well, when you look at the FRTB rules, they apply\u00a0to all securitizations, not just CMBS, but RMBS, student loans, car\u00a0loans etc. And I think that the regulators, in their sincere efforts to\u00a0de-risk the system\u2014and they\u2019ve done a lot to accomplish that goal\u00a0already\u2014could find that in some unintentional ways the result is to\u00a0elevate certain systemic risks. Not at the individual bank level but\u00a0at the broad market-functioning level.<\/p>\n

I think historically, when there was an event that caused people to\u00a0run for the exit, the intermediaries have always been the ones to\u00a0step in and try to restore some order out of the chaos. Primarily\u00a0through their market making. But these regulations make that less\u00a0likely to happen in the future. So in some ways I think the de-risking\u00a0of the financial markets could actually increase the risk to the\u00a0underlying economy, by causing deeper adjustments that would\u00a0have historically been somewhat muted by the market-making.<\/p>\n

Paul Fiorilla: I guess it\u2019s a tradeoff\u2014I know there are a lot of negative\u00a0impacts in our industry, but regulation has reduced leverage in\u00a0the banking system, which is one of the things that was intended.<\/strong><\/p>\n

Tom Flexner:<\/strong> Yes. And I think the number one benefit of this\u00a0regulatory scrutiny and regulatory change over the last seven years\u00a0is to de-lever the banks and encourage them to have more liquidity.\u00a0And it\u2019s not just a function of deleveraging but it\u2019s also changing\u00a0the composition of their leverage, terming it out, less reliance on\u00a0repo, better match funding, so that we don\u2019t have the same short-fund\u00a0contagion risk that dramatically broadened and magnified the\u00a0impact of the financial crisis.<\/p>\n

Now do I think in some cases they may have gone too far?\u00a0Personally, yes. But I think on balance what they\u2019ve done\u00a0directionally has strengthened the financial system and I applaud\u00a0them for that. Again, the devil is in the details, and we may even\u00a0find over time that as certain unintended consequences become\u00a0apparent, the regulators will proactively respond to fix them.<\/p>\n

These regulations are not cast in stone for the rest of eternity. I\u00a0think if it is determined that they are doing more harm than good\u00a0at the margin, they\u2019ll be tweaked. But we may have to go through\u00a0some pain to get to the tweak.<\/p>\n

Paul Fiorilla: Right now I think the biggest regulatory initiative in\u00a0the CMBS industry is risk retention and there\u2019s a lot to talk about\u00a0how the required capital will be raised from whom at what price.\u00a0How do you think the industry is going to handle risk retention?\u00a0Has your firm developed a strategy?<\/strong><\/p>\n

Tom Flexner:<\/strong> Clearly everyone is looking at a number of strategies.\u00a0And I do think we\u2019ll see a number of the sub-scale originators exit\u00a0the business for multiple reasons. But the committed players are\u00a0thinking about how best to execute in this new environment. For\u00a0instance maybe someone who originates today will rent somebody\u00a0else\u2019s balance sheet, use someone else\u2019s shelf, act solely as a\u00a0distribution agent for the securities, or create a minority-controlled\u00a0subsidiary to meet the risk retention requirement. Who knows?<\/p>\n

But at some point, at the margin, the pricing will adjust. If the\u00a0B-piece buyer retains the risk, the pricing will adjust to reflect\u00a0the fact that the 5 percent market value requirement will include BBB\u2019s\u00a0which don\u2019t currently meet the return requirements of the B-piece\u00a0buyer. If the bank retains the risk, as a vertical strip for example,\u00a0the price will adjust to reflect the bank\u2019s cost of regulatory capital\u00a0supporting that risk retention. And by price, I mean interest coupon\u00a0to the end borrower.<\/p>\n

And of course there are other CMBS issues to be considered.\u00a0B-piece transferability, AB II, qualified mortgage definitions etc.<\/p>\n

Paul Fiorilla: So do you think this will impact issuance volume\u00a0going forward or the willingness to lend?<\/strong><\/p>\n

Tom Flexner:<\/strong> I think at some point it has to. I mean, these\u00a0regulations are not neutral. And they\u2019re not supportive of\u00a0increased issuance.<\/p>\n

Paul Fiorilla: Do you think there is going to be a problem finding\u00a0B-piece buyers? That\u2019s one of the major concerns, to have a\u00a0normal B-piece market the way it functioned in the past.<\/strong><\/p>\n

Tom Flexner:<\/strong> No I don\u2019t. We have I think eight active B-piece buyers\u00a0out there today\u2014with most of the volume being done by the\u00a0top three or four. But the reality is I do think pricing will ultimately\u00a0self-adjust as I mentioned before.<\/p>\n

Paul Fiorilla: OK, to switch topics again, foreign investment in\u00a0the U.S. grew from $47 billion in 2014 to $90 billion in 2015.\u00a0Much of the increase is attributable to the commodities-based\u00a0economies in the Middle East and Asia. Can we expect this trend\u00a0to continue with commodity prices weakening? Will FIRPTA\u00a0reform be a difference maker?<\/strong><\/p>\n

Tom Flexner:<\/strong> That is a question on everyone\u2019s minds. A healthy\u00a0portion of the $90 billion was sovereign, but certainly not the\u00a0majority. And while the oil-dependent sovereigns are under pressure\u00a0right now, we haven\u2019t seen any pullback, at least not yet. In fact,\u00a0Norges, the largest one\u2014although not technically a sovereign wealth\u00a0fund\u2014just increased its allocation to real estate. The question is\u00a0if we continue to have sustainable lower oil and commodity prices,\u00a0consistent with the longer-term lower\u00a0GDP growth possibly we discussed\u00a0earlier, will that ultimately put pressure\u00a0on the sovereigns to reduce their real\u00a0estate appetite? And my definitive\u00a0and highly confident answer is: maybe.<\/p>\n

And that\u2019s the best answer I can\u00a0give you because, you have to ask\u00a0yourself, what would the sovereigns\u00a0actually sell first if their sponsoring countries needed to monetize\u00a0assets to fund deficits in their own national budgets?<\/p>\n

And if it gets to that, everything is up for grabs\u2014stocks, bonds,\u00a0real estate, private equity etc. My suspicion is the first things to go\u00a0are liquid securities and hedge fund redemptions for example. But\u00a0honestly, I just don\u2019t think it will get down to that in a meaningful way.<\/p>\n

With respect to your FIRPTA question, the recent changes were\u00a0helpful but I don\u2019t think they are a huge needle mover. First, on the\u00a0private investment side they only benefit foreign pension funds, not\u00a0necessarily your average SWF. And the definition of who is and who\u00a0isn\u2019t a foreign pension plan is still up for debate. On the public side\u00a0FIRPTA increases foreign limits on REIT ownership from 5 to\u00a010 percent. Again, helpful at the margin\u2014maybe $20 billion in potential\u00a0flows over time\u2014but I don\u2019t think a true needle mover will happen\u00a0until there\u2019s comprehensive tax reform which would include a much\u00a0broader revamping of FIRPTA or even its complete elimination. But\u00a0I\u2019m not holding my breath.<\/p>\n

Paul Fiorilla: Alternative investors expect to raise $67 billion\u00a0this year compared to $52 billion last year. The regulation of\u00a0the banks we talked about is providing debt funds with the opportunity\u00a0and means to come into the market. Do you see a big\u00a0increase in specialty lenders and debt funds increasing their\u00a0market share?<\/strong><\/p>\n

Tom Flexner:<\/strong> I\u2019d like to see more alternative non-bank debt funds\u00a0raise capital and make it available to our industry. As long as\u00a0they\u2019re prudently structured and competently managed.<\/p>\n

I think there are components of the credit markets today where\u00a0banks don\u2019t really want to play or have an inefficient cost of capital.\u00a0Mezz debt for example. We can\u2019t, it\u2019s too expensive to hold. Or\u00a0preferred equity, with a dollar for dollar risk capital allocation.<\/p>\n

So I think these alternative credit funds are actually going to\u00a0complement the large bank lending programs because the banks\u00a0would rather focus on the senior\u00a0tranches of debt, those that are\u00a0mortgage secured and investment\u00a0grade, whether for securitization or\u00a0balance sheet hold.<\/p>\n

But in many cases a typical borrower\u2019s\u00a0need for leverage goes through the\u00a0investment grade inflection point\u2014in either acquisition financing or\u00a0refinancing. So to the extent these credit funds are out there and\u00a0can take down the piece the banks can\u2019t afford to hold, it provides\u00a0the banks with greater assurance of circling the whole facility,\u00a0knowing that the bank\u2019s got a home upfront for the lower-rated\u00a0tranches that the bank doesn\u2019t want to keep. So yes, I like the idea\u00a0they\u2019re there.<\/p>\n

Paul Fiorilla: We are out of time, but on behalf of CREFC I\u2019d like\u00a0to thank you, Tom, for sitting down with us and sharing your\u00a0thoughts on the industry. I learned a lot, and I\u2019m sure our\u00a0readers will as well.<\/strong><\/p>\n

Reproduced with permission from Commercial Real Estate Finance World, Winter 2016, Volume 18, No. 1.\u00a0 Copyright 2016 by Commercial Real Estate Finance Council. www.crefc.org<\/a><\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

Citigroup Global Head of Real Estate Tom Flexner and Yardi Matrix Associate Director Paul Fiorilla discuss all things CRE in this extensive interview. <\/p>\n","protected":false},"author":873,"featured_media":1004517735,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[16,23891,21742,21744],"tags":[],"class_list":["post-1004146674","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-international","category-national","category-latest","category-people"],"acf":[],"yoast_head":"\nQ&A with Tom Flexner, Citigroup Global Head of Real Estate - Commercial Property Executive<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.commercialsearch.com\/news\/qa-with-tom-flexner-citigroup-global-head-of-real-estate\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Q&A with Tom Flexner, Citigroup Global Head of Real Estate\" \/>\n<meta property=\"og:description\" content=\"Citigroup Global Head of Real Estate Tom Flexner and Yardi Matrix Associate Director Paul Fiorilla discuss all things CRE in this extensive interview.\" \/>\n<meta property=\"og:url\" content=\"https:\/\/www.commercialsearch.com\/news\/qa-with-tom-flexner-citigroup-global-head-of-real-estate\/\" \/>\n<meta property=\"og:site_name\" content=\"Commercial Property Executive\" \/>\n<meta property=\"article:publisher\" content=\"https:\/\/www.facebook.com\/CPExecutive\" \/>\n<meta property=\"article:published_time\" content=\"2016-06-24T12:22:41+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2016-06-24T14:19:21+00:00\" \/>\n<meta property=\"og:image\" content=\"https:\/\/www.commercialsearch.com\/news\/wp-content\/uploads\/sites\/46\/2021\/04\/Tom-Flexner-vice-chairman-global-head-of-real-estate-Citigroup.jpg\" \/>\n\t<meta property=\"og:image:width\" content=\"167\" \/>\n\t<meta property=\"og:image:height\" content=\"205\" \/>\n\t<meta property=\"og:image:type\" content=\"image\/jpeg\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:creator\" content=\"@cpexecutive\" \/>\n<meta name=\"twitter:site\" content=\"@cpexecutive\" \/>\n<script type=\"application\/ld+json\" class=\"yoast-schema-graph\">{\"@context\":\"https:\\\/\\\/schema.org\",\"@graph\":[{\"@type\":\"Article\",\"@id\":\"https:\\\/\\\/www.commercialsearch.com\\\/news\\\/qa-with-tom-flexner-citigroup-global-head-of-real-estate\\\/#article\",\"isPartOf\":{\"@id\":\"https:\\\/\\\/www.commercialsearch.com\\\/news\\\/qa-with-tom-flexner-citigroup-global-head-of-real-estate\\\/\"},\"author\":{\"name\":\"\",\"@id\":\"\"},\"headline\":\"Q&A with Tom Flexner, Citigroup Global Head of Real Estate\",\"datePublished\":\"2016-06-24T12:22:41+00:00\",\"dateModified\":\"2016-06-24T14:19:21+00:00\",\"mainEntityOfPage\":{\"@id\":\"https:\\\/\\\/www.commercialsearch.com\\\/news\\\/qa-with-tom-flexner-citigroup-global-head-of-real-estate\\\/\"},\"wordCount\":5230,\"commentCount\":0,\"image\":{\"@id\":\"https:\\\/\\\/www.commercialsearch.com\\\/news\\\/qa-with-tom-flexner-citigroup-global-head-of-real-estate\\\/#primaryimage\"},\"thumbnailUrl\":\"https:\\\/\\\/www.commercialsearch.com\\\/news\\\/wp-content\\\/uploads\\\/sites\\\/46\\\/2021\\\/04\\\/Tom-Flexner-vice-chairman-global-head-of-real-estate-Citigroup.jpg\",\"articleSection\":[\"International\",\"National\",\"News\",\"People\"],\"inLanguage\":\"en-US\",\"potentialAction\":[{\"@type\":\"CommentAction\",\"name\":\"Comment\",\"target\":[\"https:\\\/\\\/www.commercialsearch.com\\\/news\\\/qa-with-tom-flexner-citigroup-global-head-of-real-estate\\\/#respond\"]}]},{\"@type\":\"WebPage\",\"@id\":\"https:\\\/\\\/www.commercialsearch.com\\\/news\\\/qa-with-tom-flexner-citigroup-global-head-of-real-estate\\\/\",\"url\":\"https:\\\/\\\/www.commercialsearch.com\\\/news\\\/qa-with-tom-flexner-citigroup-global-head-of-real-estate\\\/\",\"name\":\"Q&A with Tom Flexner, Citigroup Global Head of Real Estate - 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