Christopher Cole: Emerging trends in real estate investment

"In real estate, if you keep yourself in front of long-term demographic trends, you will prosper," observes Christopher Cole, founder and chief executive of the Cole Companies, who received the Distinguished Achievement Award at the W. P. Carey undergraduate convocation recently. A survivor of Phoenix's boom-and-bust real estate markets for more than 28 years, Cole maintains real estate as an investment class is in its baby years. The biggest inflows of capital, he says, have yet to happen.

"In real estate, if you keep yourself in front of long-term demographic trends, you will prosper," observes Christopher Cole, founder and chief executive of the Cole Companies, who received the Distinguished Achievement Award at the W. P. Carey undergraduate convocation recently.

A survivor of Phoenix's boom-and-bust real estate markets for more than 28 years, Cole has proved that his strategy leads to success. His Phoenix-based Cole Companies, a holding company of real estate finance and management firms, oversees almost $2 billion in property investments. Still a futurist, Cole maintains real estate as an investment class is in its baby years. The biggest inflows of capital, he says, have yet to happen.

Getting started: Limited partnerships and land

A state champion in the 400 meters, Cole came to Arizona State University from Mercer Island High School in the Seattle area on an athletic scholarship. In addition to athletic talent, Cole brought with him a taste for business. When he arrived in Tempe, Arizona, he already had his securities and real estate licenses.

Financial success came early &mdash while he was still a first-year student and sophomore. By his junior year he had left college to pursue his business deals full-time. In the early 1970s, when he was slipping into the real estate brokerage business, the country was witnessing the early phases of real estate securitization. In 1979, he created the first of many Cole company iterations. It was also the year he put together his first limited partnership — a Phoenix neighborhood shopping center.

Soon after, his nascent concept of keeping ahead of demographic trends began to develop. Subsequent limited partnerships focused on the raw land that was just ahead of the Phoenix metro growth path. By the end of the 1980s, the country was sliding into a real estate recession and the thrift industry collapsed. The Phoenix market was one of the worst hit. Cole had been managing about a dozen different limited partnerships at the time, and as he notes, it was five years of slogging through tough times.

But when the market turned up, he was one of the few left standing. Those who survived the recession found that land was cheap, and Cole started over, mostly buying up retail properties for 50 cents on the dollar. Since January 1, 1997, Cole has sponsored 71 private real estate programs with an aggregate of over 6,500 investors. He remained on that path until the turn of millennium when he began to formulate a new vision of real estate.

Real estate: the emerging asset class

"If you take the net worth of the country's investments at about $60 trillion, it wouldn't surprise most people to learn that about 40 percent of that is made up of stock," he explains. "Real estate as an asset class represents about 40 percent of the net worth of the country, but only a tiny one to two percent is securitized and owned by the public. So, my feeling is, real estate is in its infancy as an asset class as far as the individual investor is concerned."

Think of any other financial services sector, Cole suggests: insurance, commercial banking, investment banking or mutual funds. For each there is a brand name that most people can identify with, he says: MetLife, Bank of America, Goldman Sachs or Fidelity. But, there is no identifiable brand name for real estate. "Often people mention a residential real estate brokerage firm," Cole laughs, which is not at all in the realm of real estate investing.

The second part of Cole's equation concerns investment inflow. Baby boomers are approaching their peak earnings years at the same time they are hitting their prime inheritance years. Some $10 to $40 trillion will change hands over the next 20 to 25 years, Cole notes. The investment characteristic of the baby boomers as they move from preparing to retire to actual retirement is a shift from growth orientation to income and capital preservation. Think of it as a switch from stocks to bonds and real estate.

Cole predicts that 20 to 30 years from now, the real estate asset will rival stocks and bonds for primacy in the financial services sector. He believes that real estate will jump from just one to two percent of securitization and public ownership to as much as 50 percent. If so, trillions of dollars will be moving into the real estate market.

When Cole refers to real estate as an investment class, he doesn't mean buying an old house, refurbishing it and flipping the property. And he doesn't even mean getting together with a few buddies to purchase a strip shopping center. What Cole is referring to is investments in real estate through pooled property, publicly-registered instruments such as real estate investment trusts (REITs), or real estate financing vehicles such as mortgage-backed securities.

Purchasing a strip center or an old house to refurbish are speculative plays, while investing in publicly-registered pooled real estate vehicles is more like taking a flyer on a bond, where a steady return is promised based on the performance of the underlying real estate. If the manager of the real estate fund selected well and there is a finite life to the instrument, investors get a bonus on their investment based on the appreciated value of the individual properties.

Starting in 2002, Cole determined that for his company the best vehicle for tapping into the real estate investment market was the non-traded public REIT, a Securities and Exchange registered vehicle that is not listed. Unlike publicly-traded REITs, the non-traded REIT generally has a finite life, usually about 10 years, after which the vehicle has to eventually list or undergo some sort of liquidity event.

Today, the structure of the Cole Companies consists of three parts: a 1031 exchange program, the non-traded REIT program and Cole Realty Advisors. The basic product that the Cole Companies invest in, especially through the REITs, is the free-standing, single-tenant commercial property which is net leased to investment grade tenants. Among the many tenants in Cole investments are Home Depot, Lowe's, Walgreens, CVS, and Wal-Mart.

In the first quarter 2007, Cole Companies entities acquired 34 properties or 3.1 million square feet of space, for $356 million. These deals included a HOM furniture store in Fargo, North Dakota; a La-Z-Boy unit in Newington, Connecticut; an ABX Air building in Coventry, Rhode Island; an Academy Sports in Katy, Texas; an Advance Auto in Maryland Heights, Missouri; a Tractor Supply in Rutland, Vermont; and an Office Depot in Enterprise, Alabama.

Cole's portfolio is largely composed of properties with the following characteristics: long-term leases (10 years or more); expenses that are the responsibility of the tenant; free-standing, single-tenant buildings; power or lifestyle shopping centers; $3 million minimum deal size; properties largely free and clear of existing debt; and location anywhere in the United States.

Getting ahead of the boomers

The next trend to anticipate, Cole says, involves those baby boomers. "With the aging of the baby boomer, a massive population migration is moving to the South and to the West. It is literally going to require the rebuilding of the United States," he comments.

"If you want to position yourself in front of that trend, then you are not going to be buying existing shopping centers, but strategically-located land where the next 50 to 100 million dwelling units or the next hundred billion square feet of additional space will be built."

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