Editor's Note: At the 2001 NAREIT Annual Convention held last October in Chicago, a panel of experts discussed the major issues facing the commercial real estate industry—particularly the impact the terrorist attacks will have on the industry over the next year.

The panel was moderated by Samuel Zell, chairman Equity Group Investments, Inc. Panelists included: Martin Cohen, president of Cohen & Steers Capital Management, Inc.; Patrice A. Derrington, managing director, Victory SBSF Capital Management; Nancy Holland, senior vice president, ABN-AMRO Asset Management; Jonathan Litt, senior real estate analyst, Salomon Smith Barney; Lawrence D. Raiman, managing director, Credit Suisse First Boston Corporation; Gregory J. Whyte, managing director, Morgan Stanley Dean Witter & Co., Inc. This column features some of the highlights of that discussion. To order an unabridged tape of the panel discussion (or any other session from the conference), call AVEN at 1-800-810-8273.

Zell: I'd love to get a sense from all of you on what you think the next 12-month impact of the September 11 attacks is going to be on our industry, and specifically on the way the public markets trade.

Cohen: Up until recently, we've not been at this point in an economic cycle without a lot of capacity in the real estate industry. There's always been overbuilding that's led to high vacancy rates.

What's disappointing to me is that we've not had overbuilding but we're still winding up in the same place that we have in every other cycle with a lot of overcapacity. And I think the [September] events have truly illuminated that phenomenon. For example, we lost 25 million square feet in New York City, either permanently or temporarily, and everybody has a desk today, no one's working from home, and a lot of the excess space was absorbed.

But other markets, fortunately, have not lost capacity through catastrophic events. However, the excess capacity [in those markets] is coming to light due to an almost collapse in demand for space, and that's pretty much every other major office market. My fear is that we'll wind up where we were in other cycles, and I think [this is also true for] other property types.

The bright side of this is that it creates new opportunities for this industry. The industry is so well capitalized today that this downturn essentially restarts the clock and allows all of the major companies to pursue new opportunities, and those opportunities are in their own portfolios as well as in new portfolios.

I think we're in for rough sledding, that's probably conventional wisdom, and it could be as long as 12 months. However, those [companies] that maintain some growth and liquidity are going to do extremely well, particularly relative to every other industry in America.

Derrington: [Looking at] the broader economic context, you see the anticipation of the Federal Reserve further easing interest rates as well as a changing attitude in Washington, D.C. with respect to tolerating deficits in the federal budget. Those factors combine to indicate that we are probably going to enter into a more stimulative [economic] environment.

We are seeing a sinking yield curve. This has three implications for real estate. First, future interest rates will probably be higher. Second, if such a two-pronged stimulus package were to work rather quickly it would likely be followed by rising inflation—which is good for real estate. And third, while we enter into this recession with fairly reasonable supply and demand equilibrium, I expect that the next downturn, the one subsequent to such a stimulative boom, will be more severe. We will have high interest rates and high inflation and stimulated over-supply. I'm concerned about those possibilities given the broader economic environment exacerbated by the September 11 events.

Holland: I think the real estate market is going to be looking at the stock market. I really think that real estate is going to continue to outperform but that prices are going to trade sideways for the next six to 12 months, that what we're going to see coming out of this basically is the dividend return.

Zell: Is that bad?

Holland: Actually, I think it's fabulous.

Zell: I mean, if you were guaranteed a 7 percent performance for the next 12 months would you take it today?

Holland: I think anybody in the U.S. would take that today versus the performance they've seen in the broader markets [in 2001]. Quite frankly, anything above zero most people would take.

Zell: We are looking at the catastrophic effects of September 11 over the next 12 months to the publicly traded [real estate] markets, but if you were up here on September 10 what would you have said differently than you would today?

Litt: The biggest change has not been the direction of the economy and the impact on real estate, but the pace at which it has happened. I think there's clearly an acceleration in the slowdown in the U.S. economy and an acceleration of the impact the slowdown is going to have on U.S. real estate. And we're starting to see that unravel now.

We are now going to have more fiscal and monetary stimulus so maybe we're going to come out of this [downturn] a little bit faster. But one of the things that can get lost is that for a lot of the major companies in our industry, the numbers are still positive.

So to me we're quibbling over nickels and dimes, and I think the real estate industry is going into [this downturn] with a very healthy balance sheet and supply declining. I am concerned about demand falling off, but I suspect that as the economy gets back on its feet demand will pick up. I think we're positioned for a terrific 2003, and we just have to wait it out. And I think REITs are going to be a lot less volatile than the broader market.

Raiman: In regards to the next 12 months, any comment requires a certain element of precision and a steep yield curve. The fixed-income markets are implying that the economy will soon re-emerge in a positive fashion and the stimulus package that Patrice [Derrington] mentioned will soon have their impact in a positive light.

Well, that might not bode well for real estate shares in the next 12 to 18 months. Why? When S&P companies [excluding Equity Office Properties and other recently included real estate stocks] start showing resilient operating trends, that will bode well for some of the shares in broader equities markets. However, REITs are driven by real estate trends that are somewhat lagging and may still experience some of the downward earnings trends. As a result, there may be a negative perception for real estate stocks as positive impressions emerge in a broader equities market again.

Longer term, the real estate business is better managed, financed and operated so REIT shares could do quite well. But we're a little bit nervous over the next 12 to 18 months in regard to real estate stocks in comparison to other equity securities in the marketplace.

Whyte: With the exception of hotel assets, REITs in my opinion are late cycle stocks. So, if you look at the performance of the REIT group this year, it's obviously been a fabulous absolute and an outperforming sector.

But I think some of the considerations that drove the stocks this year were almost by default. They weren't deteriorating, or their fundamentals weren't deteriorating as fast as other sectors of the economy. The lease mechanism put a floor in place, and I think a number of investors concerned about other sectors in the market looked to REITs. The dividend [from real estate stocks] is a particularly strong driver in a declining short-term rate environment.

The Morgan Stanley REIT Index went up almost daily through August 22. After that it didn't just stop going up, it actually started going down. Some of the factors that were at play were concerns about how much more Fed action we could anticipate and whether we were going to start seeing some equity issuance.

I think the events of September 11 reignited a lot of the characteristics that drove [real estate] stocks in the early part of 2001. Unless we see some sort of economic stimulus that starts a course for investors to go back toward very early cycle starts, I think REITs will actually, on a relative basis, outperform.

Raiman: I'd agree with the underlying thesis that the real estate product type across many different sectors should be less “bad” during this economic downturn, be it 12 months, 15 months or 18 months. However, let's make sure we distance analysis of fundamentals from stocks.

Fundamentals may prove less bad and actually quite resilient in this economic downturn, but the question is how do the stocks perform? And to the extent that the broader equities market sees growth resuming by late 2002 or early 2003, maybe that generalist portfolio manager says, “you know, I think I'll start getting into stocks again in advance of that GDP growth.”

Holland: I agree with where Larry [Raiman] is going. Real estate has been shown to be a late cycle stock. So as long as we're in this recession, we will probably continue to see some support from real estate stocks. As soon as we see an indication that the economy is improving, there will be a rotation to early cycle stocks.

Zell: I think it's relatively clear that the panel envisions the next 12 months to be difficult, perhaps more difficult in the stock market than for [the real estate] businesses themselves. There's almost a unanimous consensus that fourth quarter of next year, or the first quarter of 2003, represents the period of recovery.

I think there is a general consensus that the real estate industry as a whole, in the public markets, continues to improve its image by presenting a clearer and more defined picture. Certainly the inclusion of REITs in the S&P suggests a broader acceptance of real estate stocks as part of everybody's portfolio. Obviously, all of that is relatively optimistic in the long run, if not so terrific in the short run.