Capital Markets Gain Strength as Some Investors Remain Cautious
BoyarMiller Forum Panelists Express Optimism, Urge Patience
‘Houston has Favored Nation Status’
HOUSTON, Texas (September 21, 2012) — The U.S. economy is growing stronger as it emerges from the economic downturn, and Houston and Texas are leading the way to a national recovery according to panelists who spoke recently at BoyarMiller’s annual “Current State of the Capital Markets” forum. While there is capital to invest, panelists emphasized the need for patience as the national real estate market in particular continues to improve.
Panelists discussed the state of the U.S. economy, the European debt crisis, and optimism for economic conditions in Houston and Texas. The program featured Michael Ellington, senior managing director at Bernstein; Cliff Atherton, managing director with GulfStar Group; John Fenoglio, executive vice president with CBRE; and Hank Holmes, president, Houston region, Cadence Bank.
According to the panel, investors face a variety of challenges, including longer capital-raising cycles – especially in real estate; national debt; investors alternating between “risk-on/risk-off” behaviors; complex government regulation for banks; tighter credit; and the upcoming presidential election and looming fiscal cliff.
Public markets have been extremely volatile in the last five years, Ellington said. Although stocks are up around the world – returns increased by more than 50 percent between January 2009 and August 2012, investors prefer safety. “Investors remain uncertain about the future and seem to be investing more out of fear than opportunity,” he said, urging a long-term view. “Be patient and move your investment time horizon out.”
Measures to shore up the European banking sector and sovereign debt markets have helped stave off disaster, Ellington said. “Actions in the last six to nine months have reduced the odds of a spectacular meltdown.” However, the problems in Europe won’t be solved quickly as countries there address structural, economic and political issues.
The United States is faring much better than Europe as consumers have reduced their debt and increased their spending, and job growth is slowly returning and housing has turned the corner.
And companies are reporting continued earnings growth. “Corporations are sitting on more cash than ever and earnings per share are higher than ever,” Ellington said. “Historically, stocks make a huge comeback each decade after they lag.”
Private investment is driven by activity in the credit markets, Atherton said. “If you’re selling a business, you’re going to ask, ‘How much can I get for my business?’ Purchases prices are related to credit market conditions. Currently, total debt multiples and purchase price multiples are right back to where they were before the crash.”
“Leverage must be available for the private equity market to be active,” he said. “As we have moved back into an active phase of the deal cycle, debt multiples have returned to pre-crash levels – currently 3.3x – and the average multiple paid for Total Enterprise Value (“TEV”) in lower middle market transactions has increased….6.2x is the average.”
The market has become more segmented, and is willing to pay more for middle market deals of $50 million and above. “Smaller deals are just not going to sell at the same multiples that larger deals do,” Atherton said. “You can see a very clear break point between deals above $50 million and deals below that value.”
A strong energy market is vital to Houston’s recovery, and investors are always interested in energy deals, Atherton said.
While there is some uncertainty about rig counts, Atherton said a greater concern is the cost of a BTU. “What industrial consumers care about is the cost of a BTU. Today, they pay six times more for oil BTU than for a natural gas BTU and that gap has to close. This is not something markets will let persist, but the adjustment will take time.
Finally, bank underwriting requirements have an impact on deal flow. “It’s all about quality today, even though the credit markets are back and you can get leverage,” Atherton said. “Underwriting standards are so much tighter and some deals just aren’t getting done because buyers can’t raise the debt necessary to pay the transaction price.”
In the commercial real estate capital market, U.S. REITs in particular continue to be active, Fenoglio said. REIT’s raised $33.21 billion in the first half of 2012, including $22.36 billion in equity offerings and $10.85 billion in unsecured debt offerings, putting them on track to match or surpass last year’s record for the annual amount of capital raised. By comparison, the industry raised $51.28 billion in all of 2011.
Direct investment fundraising reached its highest first-quarter point since the 1980s, Fenoglio said. Real estate returns have become more attractive than other investments, especially U.S. stocks and bonds. Accordingly, pensions, institutional investors and others have shifted more assets into real estate.
As far as distressed assets go, Houston is well down the list, he said. “We did not take the hits we have in the past.” However, it is taking longer to raise funds for deals – up to 19 months, compared with 8.8 months in 2007.
Houston is becoming a hotbed for real estate investment, Fenoglio said. Investors typically flock to the coastal markets such as New York, Washington, D.C., San Francisco, Los Angeles, Seattle and Boston but “Houston is on everybody’s radar screen right now,” he said. “We are considered one of the top investment markets for both domestic and foreign investors.”
“Houston has favored-nation status,” he said. “Everybody wants to be here. In my 40 years of doing this, I’ve never seen a greater harmonic convergence of low interest rates, great supply and demand for amenities, and great job growth.”
Increased regulation means more expenses for banks, which will drive consolidation in the industry, said Holmes of Cadence Bank. “It is very expensive for banks and will push M&A activity. It will become more expensive to borrow and will narrow industries banks can lend to. Accessing capital will be more stringent in this credit environment.”
Banks must take some risk and invest in their communities to help them thrive, Holmes said. Smaller banks, those under $500 million (82 percent), are targets. “If you are a $480 million bank, you are for sale, in my opinion,” Holmes said.
Texas banks have performed well compared to their peers in other parts of the country, Holmes said. “I feel good about how we’re doing in Texas,” Holmes said. “We are creating jobs in Houston. We are creating jobs in Texas. We are an energy economy – we have to embrace it.”