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Sam Zell Blames Account Rules for Real Estate Crisis

CHICAGO — At the gloomy DLA Piper conference of real estate executives, Chicago billionaire Sam Zell blamed much of the turmoil on Wall Street on tough new real estate accounting rules that drained capital away from banks’ balance sheets.

“This entire crisis could be placed on the accounting system,” Zell told an audience of more than 1,000 assembled on Tuesday at the Four Seasons Hotel. He revealed that he called Treasury Secretary Henry Paulson early this year to ask him to suspend rules forcing banks and other institutions to write down the value of their real-estate mortgage assets — both residential and commercial — to reflect the latest valuations.

So-called mark-to-market accounting, required as part of the post-Enron reforms enacted by Congress, led “to a whirlpool of lower and lower marks,” Zell said. “Without mark-to-market fair value accounting, this crisis would never have reached this level. You took a big problem and made it into a gargantuan problem.”

Zell predicts that the U.S. will sink further into recession by early next year, but he suggests it will be a shallow downturn. “It’s not likely to be as catastrophic as people think,” he said. He expects residential construction to pick up again as the apartment sector is strained by demand. Equity Residential, the Chicago-based apartment REIT he controls, is experiencing 95% occupancy rates currently. “We could probably run at 97%,” he said. “But there are 1 million new households being created each year in this country. I don’t know where these people will live.”

Similarly, Zell believes that the commercial real estate sector faces a cyclical upturn before long as demand begins to outrace supply. “Almost nothing [in new construction] has been committed since April [2007]. A lot has been deferred,” he said. He forecasts that the best-located Class-A buildings in major 24/7 central business districts will recover first. Office buildings erected in outer suburbs “on the assumption gas would be cheap” are likely to encounter trouble in finding tenants, he suggested.

No surprise, Zell also is predicting that the days of easy credit are likely to be over. When he sold his Equity Office Properties Trust to Blackstone Group two years ago for $39 billion, Zell recalled, Blackstone put up just $3 billion — or less than 10% — of its own money. “That’s absurd,” Zell said. Still, he observed, “There is no shortage of equity today” available to acquire commercial real estate assets. But he says that most of the investment in coming months is likely to be in AAA properties. “Second-tier assets for sale won’t have much prospect,” he asserted.

He concluded by saying that “we will have a slow recovery.” Meantime, he expects institutions to keep their current fund allocations in real estate relatively unchanged.

In a newly-released survey of 424 commercial real estate industry leaders, law firm DLA Piper found that nine out of 10 respondents described themselves as “bearish,” up from 68% a year ago and the most negative outlook since the survey started 14 years ago. Most executives don’t foresee recovery coming in 2009, but in 2010 or later. Some 62% said markets would not “stabilize” until 2010, while 22% don’t expect stabilization until 2011.The majority also don’t expect securitized lending to return to prior levels until 2010 or later.

“It’s easy to say you’re bearish,” said Jay Epstien, chairman of Piper’s U.S. real estate practice from his base in Washington, D.C. “But in fact a number of people in this industry have never seen a real down cycle in real estate. Many of them weren’t around for the S&L crisis in the early 1990s.”

When asked which industry sector is likely to be most attractive to investors in the next 12 months, some 50% of the survey respondents chose multifamily housing. Nearly 19% voted for downtown offices, followed by 12.5% picking industrial. Just 6% identified retail as an attractive opportunity.

Also, when asked which investors are most likely to be active in commercial real estate in the coming year, 51% predicted it would be foreign investors, followed by 26% choosing private equity and 11% choosing pension funds. Some two-thirds of respondents said John McCain would have a favorable impact on commercial real estate if elected. Just 30% thought the same of Barack Obama.

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