Those countries that had easy access to debt — such as the U.S. and Japan — are taking the biggest hit from the current financial crisis, while those countries without access to debt capital — such as Brazil — have been somewhat spared, according to Gary Garrabrant, CEO of Equity International. During the Knowledge at Wharton Real Estate in Emerging Markets Forum, Garrabrant spoke about his company’s strategy for weathering the down market, how investment decisions are made, and what he sees happening in the next 18 to 24 months.
An edited transcript of the conversation follows.
Knowledge at Wharton: Our guest today is Gary Garrabrant, CEO and co-founder of Equity International, an investor and builder of real estate-related companies operating outside of the United States. Gary, thank you so much for joining us today.
Gary Garrabrant: Thank you very much for the opportunity.
Knowledge at Wharton: The question on everyone’s mind is how the international financial climate has affected real estate investment. Could you give me a sense about what the impact has been on your operations?
Garrabrant: Well, several reactions. One, we are living in historic and, at the same time, unprecedented times and so everyone is attempting to formulate a response. The problem is that the response changes every week because the volatility has been so dramatic. Fortunately, when we created the business 10 years ago, we were not provided debt capital we asked for. I am now thanking the banks for not providing that debt capital. So at the Equity International level, we run an unleveraged business. That would be important point one.
Secondly, we have capital through our fourth fund, so that dry powder enables us to capitalize on the prevailing opportunities.
Knowledge at Wharton: Could you give us a sense of the global scale of your operations and which markets are most affected by the slowdown? Also, which are the strongest markets?
Garrabrant: We have, from the inception, focused on emerging markets, believing that the capital inefficiency, the growth of the middle class, weak or non-existent competition and the presence of great partners were among the factors that were attractive. We have avoided Western Europe [along with] Canada, and until recently Australia, New Zealand and the UK, although we have recently entered our first developed markets, namely those three, through a senior housing business. We have invested in 18 portfolio companies. We are recognized now for our style, which is an active co-investment style.
In terms of what areas are most affected, I would suggest that the United States and countries that had easy access to debt, Western Europe, Japan, among them, are being affected the most. Those countries without access to debt capital, Brazil, for example, are being affected less.
No one is safe today, but on a relative basis the emerging markets are better positioned.
Knowledge at Wharton: When you look at emerging markets, what are the kind of pros and cons that you weigh in deciding where to invest and where not to go?
Garrabrant: It is an interesting question. People use that expression to capture a number of countries. And I would suggest that there are two categories. There are the traditional BRICs [including] those that are either institutional or can be institutionalized with relative ease, and then there is the frontier. We have spent considerable time in all of the traditional BRICs. We favor Brazil for various reasons.
We have tried in each of the BRICs to establish operations; we have three companies in China, four in Brazil. We had an investment in the Ukraine, nothing in Russia per se, but we have spent considerable time there and spent considerable time in India as well.
Egypt should also be included in that list in our view. Mexico should also be included in that list. More frontier markets like Sub-Saharan Africa or Vietnam are also intriguing to us and we are in the exploratory phase with respect to those countries.
Knowledge at Wharton: What are the principal risks that you have encountered when you enter these emerging markets compared to more developed markets like the U.S., for example?
Garrabrant: The risks can be enormous. Starting with political risk we were an investor in Venezuela and we got educated. We did not know we were enrolling when we began our adventure in Venezuela but we learned several things. One was having a world-class partner who was by our side through our experience and, at our initiative, assisted us in monetizing our investment, which we are very proud of. We remain close friends with that partner.
As well, we learned that political risk cannot be quantified really. There are a lot of intelligent people who disagree with that statement, but simply for us liquidity equals value. For years, we had no liquidity and, by extension, no value with respect to our investment in Venezuela.
So I would say that political risk ranks very high and we avoid situations — Russia would be a current example where we just cannot quite get our arms around it. Also, [as a] global enterprise, we have opportunities available to us in any number of countries so that we do not have to push so hard. We do not allocate capital. We are opportunistic. Rule of law, property rights, the way mortgages operate, foreclosure laws — all of those things come into play and we are quite careful with respect to documentation. But ultimately, the investments that we make are along side of partners that are distinguished in their own right and that relationship is graduated from the documents.
Knowledge at Wharton: You referred to India, and of course this is as current a time as any to be thinking about political risk in India, considering the unprecedented terrorist attacks that have taken place there in recent times. There has also been a significant political backlash following those attacks. Is that likely to affect the way you think about your activities in India?
Garrabrant: It is a factor. We stay at the Taj Hotel and I recognize those images. It is really haunting and a terrible tragedy. And there may be a local linkage — to what extent, we do not know. What it says to me is that anything can happen anywhere. We consider India to be a country that is characterized by non-violence and democracy and process, and so this is really unprecedented for India.
For us, the bigger issue as an investor in India is finding the right partner. We continue to look for that partner.
Knowledge at Wharton: You also referred to liquidity as being a very key part of your thinking. Considering the state of the markets today and the kind of virtual freeze in credit markets, where are the emerging sources of liquidity?
Garrabrant: Fascinating question. We have not been dependent on debt and that independence serves us well today. We have also considered mostly private companies, but today we see extraordinary value in public companies and the listed securities of those public companies — namely, the common shares. And through our various funds, funds II, III, and IV, which are operative today, we have a series of public companies. We love those companies and at these price levels we have started to invest more and increase our position. It goes without saying that in each of those cases we are intimately involved with the businesses beyond board level activity. That gives us, I would say, an edge. It makes us unique. It is really what we do; we create and grow leading businesses outside the United States.
Knowledge at Wharton: One final question: What is your prognosis for the next 18 to 24 months?
Garrabrant: I think it is going to be a difficult period. I am very bearish on the U.S. I think the consumer is exhausted and overlevered and it is going to take some time to reverse that. We remain quite bullish about emerging markets and those areas which are seeing growth even on a diminished level. [I’m talking] about India, China and Brazil specifically.
The growth of the middle class is a powerful trend. We are still selling homes in Mexico and Brazil as opposed to the developed economies. I think when we finally see a turn, likely sometime in 2010, it will begin in those markets.
Knowledge at Wharton: Gary, thank you so much for speaking with us today.
Garrabrant: Thank you very much for the opportunity.