Such a stir created by a departing Goldman Sach’s executive writing in The New York Times about how the firm is more interested in creating profits for partners than gains for clients. Is this really “breaking news” about Goldman or most other investment banks and management firms?
Sure the talk coming from investment advisors is all about performance for clients and aligning interests. “If we deliver for clients, they’ll stick with us and give us more to invest. If we do well for them, we’ll do well for ourselves.” But the pre-2008-collapse, institutional investment model for real estate was all about maximizing profits for managers or general partners and not necessarily investing in properties for their clients’ best long-term advantage. And if managers have their way, they’d like to resurrect the same game although the real estate and debt markets have not exactly been cooperating lately.
Let’s call it the “Wall Street Model” (WSM) adopted in the real estate world beginning in the mid-1990s and derived directly from stock market trading floors. WSM works off generating lots of fee making transactions, trading properties after relatively short holding periods, and using leverage to help escalate prices and values, which can generate big promotes. Short-term holds mean many managers don’t need to build expensive employee-intensive infrastructures to manage properties. Even though real estate is better suited to buying, holding, leasing, and improving over time, WSM is more oriented to market timing and spending as little as possible on the property. Better to push future expenses to the next owner. And even though real estate should be properly positioned as an income-producing investment based on securing rents and keeping occupancies high for long-term holds, WSM works off pushing up appreciation as quickly as possible and ultimately creates volatility. You cannot make your promotes to secure more immediate profits if all you are interested in is buying and managing a property for income and long-term appreciation. That’s no way to get your big year-end bonus even though real estate arguably just isn’t suited to the opportunistic WSM approach except for very short market windows.
And of course, the beauty of WSM is you use as little firm money as possible—the clients provide the equity, lenders provide the leverage, and the manager puts in a relatively token amount to create the notion of alignment. When markets inevitably turn down, firm exposure is relatively limited, clients take the big hits, and the partners cut staff, but nobody turns back their enhanced compensation from previous years.
Now the Goldman story makes that firm look particularly craven and extreme since it comes directly from an insider, but who is kidding whom about typical investment manager priorities.
Interesting that the story appears on the same day CALPERS lowered its actuarial assumption for future returns, probably a bellwether for other pension funds. Plan sponsors have been crowding into WSM private equity investments of all strips including real estate for more than a decade to try to boost returns to pay off their increasing liabilities. Alas, it hasn’t worked out. This move will put even more pressure on states and cities to cut back on public employee pensions.
Should we be surprised?
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Jonathan D. Miller
A marketing communication strategist who turned to real estate analysis, Jonathan D. Miller is a foremost interpreter of 21st citistate futures – cities and suburbs alike – seen through the lens of lifestyles and market realities. For more than 20 years (1992-2013), Miller authored Emerging Trends in Real Estate, the leading commercial real estate industry outlook report, published annually by PricewaterhouseCoopers and the Urban Land Institute (ULI). He has lectures frequently on trends in real estate, including the future of America's major 24-hour urban centers and sprawling suburbs. He also has been author of ULI’s annual forecasts on infrastructure and its What’s Next? series of forecasts. On a weekly basis, he writes the Trendczar blog for GlobeStreet.com, the real estate news website. Outside his published forecasting work, Miller is a prominent communications/institutional investor-marketing strategist and partner in Miller Ryan LLC, helping corporate clients develop and execute branding and communications programs. He led the re-branding of GMAC Commercial Mortgage to Capmark Financial Group Inc. and he was part of the management team that helped build Equitable Real Estate Investment Management, Inc. (subsequently Lend Lease Real Estate Investments, Inc.) into the leading real estate advisor to pension funds and other real institutional investors. He joined the Equitable Life Assurance Society of the U.S. in 1981, moving to Equitable Real Estate in 1984 as head of Corporate/Marketing Communications. In the 1980's he managed relations for several of the country's most prominent real estate developments including New York's Trump Tower and the Equitable Center. Earlier in his career, Miller was a reporter for Gannett Newspapers. He is a member of the Citistates Group and a board member of NYC Outward Bound Schools and the Center for Employment Opportunities.
