Leadership Roundtable: the real estate industry & the CRE organization.

As the saying goes: "You make money in your own backyard and you lose it in other people's." For instance, in San Jose, we opened an office, hired full-time people, and we've bought a second lot to build a second building. We didn't just go to San Jose to build one building. We went to start a business. It links back to the earlier comment about lenders wanting people with a track record and people with a relationship.

So, internationally, if I were to go storming into, name a country, they would say, who the heck is he? What do we know about him? But there is another aspect to your question and that is buying our buildings' parts and materials overseas. Our second biggest cost, after the concrete frame, for the Legacy at Millennium Park is our curtain wall--the whole cladding on the building, plus all the glass and windows and frame. We're buying it all from China, and that's created a whole set of interesting questions about currency fluctuations, insurance, warranties and payment procedures in the United States.

COCHRAN: Is that what's happening across the board if you went to almost any developer these days? They would be getting most of their curtain wall materials from China?

HANSON: I think it's a new trend. We're buying our curtain wall from a company called Yuanda, and when we did that a year ago, we were the company's second North American buyer. Now they have more than 20. And the glass is coming from a company called China Glass. They're using brand new facilities, state-of-the-art machinery and equipment, and our architects and contractors, who have visited two, three, four times, are very pleased so far. Of course, there are added delivery challenges. We have to ship 700 crates from China and store them, but so far so good.

COCHRAN: How do you compare the most recent years in the real estate industry with the real estate cycle from 20 years ago?

PASQUARELLA: They're not even close, for some fundamental reasons. This market aberration and the adjustments are capital driven, not supply driven. Back in the mid- and late '80s, we had a period of about four to five years of explosive development--you name the property type, as an industry, we were building it. And underwriting was being done on ridiculous premises. In hindsight, it was like you were drinking too much and you woke up and said, "What did we do?" People were underwriting and capitalizing office building rents pretending that they were $20 per square foot, when in reality tenants were getting two years free rent on a five-year lease, so the real net rent, the effective rent, was overstated by 40 percent. The whole thing was a house of cards.

Now, the industry is much more transparent. The presence of public REITs (Real Estate Investment Trust) in the market has added to that. True, REITs are getting hammered right now, but the advent of securitized mortgage products has helped create additional transparencies in the market. I think funds like ours provide a lot of transparency to our investors as to the real conditions of their investments; what the real prospects of new investments look like. The industry is much more mature now in how it operates. Even though many companies are still private, including mine, we all operate more publicly than ever.

COCHRAN: Do you foresee potential trouble, as in the late '80s, when Japan was moving in on the U.S. real estate market so much that people were starting to get concerned about the Japanese having too much control over the U.S. market?

HANSON: No, it's different, though not an entirely right-field concern. Where we might have to worry is China's level of purchases of U.S. Treasuries. China is responsible for our interest rates being so low because it takes all its surplus and buys our Treasuries. So we depend on them in a totally different way, but still in a significant way. However, the Chinese aren't here buying our office buildings, hotels and golf courses. No one is saying about China what we said in the late '80s, when we were saying that Japan would own all of New York and San Francisco ... which, in any case, didn't happen.

PASQUARELLA: Recently, Bloomberg.com published a prediction that commercial real estate prices will drop something like 15 percent over the next 18 months. I don't see that at all. That's headline grabbing. What people fail to understand is that the real driver of value in any asset is its earnings potential. And in that regard the underlying fundamentals of real estate remain sound.

Most property types and most regions are seeing increasing rents, which means there are increasing earnings. And when you have increasing earnings in any investment, whether they are stocks or real estate, you're seeing valuation grow in the long term. There will always be some aberrations bouncing around because of capital market swings, but long term, it's growing in value. So I think such predictions are a bunch of nonsense.

Everybody is talking about dislocations in the financial markets, but no one is talking about the fact that Treasury rates have fallen probably 75 to 100 basis points over the last few months, and that has a huge impact on the borrowing cost of real estate because all of our debt instruments are ultimately tied to spreads over Treasury bills. So when you look at the 10-year Treasury rate and see that it's down to 4.5 percent from 5.2 or 5.3 percent just 60 days earlier, the cost of money has come way down, and it has a significant impact on how you value your assets.

COCHRAN: A major point of conversation recently has been about green concerns. How are you responding to green development issues?

HANSON: We made the decision that all our buildings will be LEED-certified. I think green is terrific. Having said that, it can also go too far or get ahead of itself. Cities such as San Francisco, Seattle and Boston are now mandating that all new buildings be green. That's okay in today's environment of what it takes to be green, but if these cities continue to mandate this and if the green standards continue to go up in a crazy way, it will get very difficult and very expensive.

PASQUARELLA: I think that's why there's a continued allure to mixed-use development. I keep remembering back when I first came out of school in the early '80s, the talk was all about urban living, 24/7 environments, being able to work and play within a few blocks of where you live. Maybe that vision was ahead of its time then. But I see that vision now getting legs. Some of it is just the convenience, of course, but the concept of the 24/7 environment also ties very nicely into the green movement. There's a lot to be said for keeping people out of their cars, where they consume fuel and contribute to today's worsening congestion.

COCHRAN: What are the most challenging issues facing your business?

HANSON: We have a housing market that's very soft, which affects people's ability to buy on the revenue side of our equation. Then on the expense side, we have ever-increasing costs, at a rate of 1 percent per month--in some places a bit slower at 10 percent per year and in many places you'll hear 15 and 20 percent. It's amazing how fast costs are increasing and that's frankly why we are turning to China and other places; even with the cost of transportation and added storage costs, it's still net less expensive.

Then we have a demographic factor driving the multi-family market on the positive side. The empty-nest baby boomers--an enormously wealthy generation of people who are now in or approaching their 50s who I've heard have $2 trillion of cash lying around and who want to live in cities. They're astute and much more urban than their parents. They want to be near the orchestra and the museums and restaurants and work. We aren't selling them shelter; we are selling them choice. We don't sell to somebody who just needs a roof over his or her head; we sell to somebody who already has a roof overhead but who wants a different roof ... or a second one. How much are those people who have that choice going to be affected by the current economy? Right now, not much. Our Legacy building is 83 percent sold with two years to go, and our San Jose building is 50 percent sold, four months after opening the sales office.

SCHWETHELM: When I became active as an appraiser for eminent domain some 45 years ago, I assumed that, since eminent domain had been going on for so many years, the legal procedures were well established and static. How naive that was. I soon learned that the eminent domain process is ever changing. Increasingly, appraisers are being asked to critique appraisals made for the opposing side. During my early years in the business, the appraisal organizations very strongly opposed this. The appraiser was to appear in court, testify to his or her opinion--without concern for what the other side testified to--and leave the courtroom. If there were disparities between opinions, the appraisal organization would address that issue through its ethics procedures. As time went on, however, this position was relaxed. As long as the appraiser acted as an independent expert without bias for the client, or against the opposition, it was considered all right to consult with the attorney about the opposing appraisals, the theory being that you were an advocate of your position, not of the client.