Real estate leaders explain how they manage during the upswings—so they can better withstand the inevitable downturns.
Nearly everyone seems to be able to name a move they wish they had not made during the years leading up to the Great Recession. Maybe it was buying a building or a parcel of land. Maybe it was taking on debt, acquiring a company, or expanding a practice. During the hottest years of the early 2000s, nearly everyone agreed to a deal that shortly thereafter—once stock markets and real estate values began to collapse in 2007—appeared decidedly ill-advised.
Practically everyone downsized; some development firms went into long-term planning mode. Those that were able to do so took a sabbatical while watching the market for signs of life. Many leasing and management companies downsized their leasing departments while focusing intensely on management as a cost-cutting tool and tenant-maintenance program. Individual projects failed, certainly, and those projects often were bought out by those better positioned to ride out the downturn.
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With the economy finally on the upswing, smart companies are heeding the hard lessons of the recession—and preparing themselves for the next one. They are hiring new underwriting and risk management professionals and putting them in senior positions. They are instituting new controls on borrowing, hiring, and expansion. And they are monitoring global political and economic events with far more precision, hoping to get a hint of when trouble might start brewing—and what form it might take once it arrives.
“Businesses tend to be slow to cut—slow to cut staff, cut overhead expenses, or just to say, ‘okay, this is on hold,’” says Bill Conerly, an economist and business consultant in Portland, Oregon. “By thinking about it ahead of time, companies can get prepared for it. And it doesn’t need to be a thick binder of detailed plans.”
With new business to chase and opportunity expanding, what could go wrong is not necessarily the first thing people are thinking about. But real estate is nothing if not cyclical: the next downturn is already on its way. And just as was the case in every previous recession, some companies will be prepared and some will not.
“If you think about it, late in the cycle you should be going up the quality spectrum, and the problem is that the market pushes you in the other way because that’s the only place where the pricing is right.”
Heeding the Signs
For a look at what companies are doing differently to prepare for the next recession, meet Tom Owens.
Owens joined Hines Interests, the Houston-based office owner and developer, in 1973, playing a prominent role in expanding the privately held company into one of the country’s prominent real estate firms, holding assets of $24.3 billion in more than 100 cities worldwide. With experience in construction, project management, asset management, and acquisitions, Owens in 2010 oversaw four venture funds and managed the development of more than 7 million square feet (650,000 sq m) of office and retail space with a value of $1.5 billion.
But in 2010, even with U.S. commercial property values finally on the mend, Hines leadership asked Owens to do something altogether different—become the company’s first chief risk officer.
Hines had weathered the 2008 recession better than most, but it did not come out unscathed. In the San Francisco Bay area, for instance, where Hines has developed some of the region’s prestigious office towers, the company and its partners ran into trouble when values dropped, putting some properties underwater. Banks took back a number of recent Hines purchases, including 333 Bush Street, a 43-story mixed-use tower in San Francisco; an 814,000-square-foot (76,000 sq m) office complex in nearby Emeryville; and a 455,000-square-foot (42,000 sq m) office complex in San Rafael.
“If you think about it, late in the cycle you should be going up the quality spectrum, and the problem is that the market pushes you in the other way because that’s the only place where the pricing is right,” says Hasty Johnson, vice chairman and chief investment officer for Hines.
Jeffrey C. Hines, the company’s president and chief executive officer, says that even though he thought the company had remained a strong operator and an excellent manager of buildings throughout the downturn, it simply should have seen warning signs about the market getting too hot. But the company kept buying. “We should have stopped earlier,” Hines says.
Before all the damage from the financial collapse had been cleaned up, the company in spring 2010 brought Owen into his new role. With the help of a new research group and risk management team, he now regularly, and formally, monitors risk in a way that the company once did less consistently. The team attempts to determine where real estate and the capital markets stand in their cycles, making sure that the company is not compromising on the quality of tenants, location of properties, or building product. The team also works to identify as specifically as possible where the company is creating value, which helps it determine which deals and lines of business make sense—and which ones do not.
The aim is to think through every scenario, all the way up to the decisive conversation Hines would have to have with its financial partners. “Can you weather the storm?” Owens asks. “It’s very hard to look an investor in the eye and say, ‘I can’t give you back your capital.’ It’s much easier to say, ‘I can’t get you the return I promised.’”
“In the ’80s, it was easy to finance 105 percent of a project,” he notes. “And it was very profitable—in the short term.”
Hines says having Owens considering risk at all times has freed the company to do what it does best—finding and creating value for its investors. “It’s one of those things that, now that we’ve done it, it’s like, ‘Why didn’t we do this 20 years ago?’” Hines says. “It’s brain-dead obvious.”
Setting the Trigger
Whether his clients have $10 million in revenue or $1 billion, they all should be following a few simple rules, Conerly says. It starts with planning. “This can easily be done by rolling into your favorite Starbucks or bar and saying, ‘okay, if things turn down, what am I going to do?’” he says.
For real estate companies, it is particularly important to have a trigger point, Conerly says. Determine ahead of time—when all is rosy and the sun is shining—which bad occurrences or factors in the market would force a change in course on a project or business unit. Sometimes making those changes can be exceedingly difficult; having a predetermined trigger point can make it easier. “It’s a lot easier to pull the trigger if you said—at a time when you were emotionally calm—that you were going to pull the trigger at a certain point,” he says.
This may be particularly true for companies with a wide international presence. Chicago-based Jones Lang LaSalle (JLL) has 48,000 employees in more than 70 countries, which means a big part of managing risk is monitoring political and economic situations that could cause a rapid downturn in any of the company’s markets. For example, when a popular uprising took place this summer in Egypt against Islamic political leadership, Janice Ochenkowski, managing director of risk management for the firm, was getting details over the weekend.
The first concern, she says, is making sure the company’s employees and their families were safe; clients come in a close second. JLL has a global operating committee that runs a risk management program that incorporates information from all the company’s markets into its assessments. Ochenkowski, who has spent all 33 of her years at JLL in risk management, says she relies heavily on staff in the field to provide real-time information about changing conditions and what their effect might be on the local economy, whether they involve political change, a hurricane, or a terrorist event.
“When you’re dealing with an international or global matter, it’s really important that the people who are on the ground lead those initiatives because they understand the cultural aspects much better than someone sitting in a tower in Chicago,” she says.
For smaller firms with an international footprint, getting a global picture may not be as easy, so relationships become even more important. Ayers Saint Gross, a 100-year-old architecture and design firm based in Baltimore, typically does as much as 40 percent of its annual business internationally—in China, Brazil, the Middle East, and elsewhere—even though most of its employees are in the United States. Although the U.S. recession officially ended in mid-2009, global financial crises last years longer. William C. Skelsey, who manages the Ayers office in Washington, D.C., and much of its international work, says it feels like “we are all are still living in that mode. We’re very careful; we’re very deliberate about what we do.”
Ayers, which specializes in developing campus plans for educational and cultural institutions, as well as consulting, turns work around more quickly today than it did before the collapse, even with less staff, and sees far more competition for work today, Skelsey says.
“Our typical project would go from, say, a two-year exercise to maybe a three-month exercise, but [our clients] would need the same information and advice and guidance. And that’s what we figured out—that they still have the same plans to build things, but they had to make decisions more quickly,” he says.
But whereas Ayers is leaner and working faster, it is more careful about the clients it will work with and about clarifying in contracts who is responsible for what, whether the client is in Raleigh, North Carolina, or Riyadh, Saudi Arabia, Skelsey says. “If it’s someone you haven’t worked with before, there’s a lot of due diligence before determining whether it’s worth the risk,” he says.
Planning for Opportunism
Part of preparing for the next downturn involves not just making sure a company will not suffer great losses, but ensuring that it will be able to take advantage of opportunities that arise when the economy turns sour.
Hines Interests does this in part by sometimes limiting its profitability in the good times in order to build up cash reserves. This allows the company to recalibrate and get back into the market more quickly when values fall and opportunities arise to make acquisitions. “One thing we’ve always done is that we’ve focused less on profitability and more on cash,” Jeff Hines says. “Liquidity is king in this business, and that is one thing that we look at on a monthly basis.”
During the financial collapse, JLL actually launched new business lines to help clients manage distressed properties. In the United States, it launched a receivership business to aid in management of financially distressed office and retail properties. It also created a “value recovery services” unit to help property owners and financial institutions make complex decisions required by a dramatic change in real estate values. “We’ve learned that our corporate clients have great needs during the downturns because they need to find cost savings,” says Ochenkowski.
For many companies, the long-term changes put in place as a result of the financial collapse are not as specific as adding a new business unit, creating a new risk model, or hiring a person specifically to plan for the next downturn. Instead, they are operating in a new state of caution, whether that means hiring more deliberately or ensuring that the firm’s business is more diversified even when times are good.
The real estate market was already getting overheated when Peter Heald joined San Diego–based real estate services firm Cumming in 2007, but the firm made two acquisitions in 2008—Construction Controls Group (CCG) and Southern Management Group. Though in some ways those deals helped the company persevere, Heald says, overall Cumming’s annual revenues dropped from $60 million to the mid-$40s. Had Cumming maintained its business focus on casinos—which had been highly profitable in the middle of the decade—it might not have survived the downturn. The firm’s casino business, much of it development, “went from 100 miles an hour practically to zero miles an hour, and projects that we thought were long-term contracts were just canceled,” says Heald, U.S. president for Cumming.
As Cumming slowly began to grow again, it nearly returned to the same size it was before the collapse, but the firm had reconfigured itself. Rather than try to regrow gaming to the size it was before the recession, Cumming kept it as a focus but built its expertise to serve clients in the fields of education, health, government, and cultural institutions, plus added a semiconductor industry expert to its West Coast staff.
Cumming is keeping a closer eye on data, measuring profitability, staff use, and revenue growth. “If you can’t measure it, you can’t manage it,” Heald says.
The firm is expanding geographically as well, adding offices in London, Abu Dhabi, and Washington, D.C.; expanding its New York City office; and looking at other locations to add offices or serve from existing offices on the U.S. East Coast. But rather than create myriad new offices, Cumming is doing much of the work from regional offices, and not signing any leases of more than five years, down from some that were ten years or more. There are synergies in a larger office,” Heald says. “So to the extent that we can serve a larger market from core regional offices, that’s our intent.”
Some might argue that such an intense focus on risk during a period of economic expansion could cause a firm to miss out on an important deal or contract. Though Conerly acknowledges that rejiggering a business to prevent catastrophe can lead to missed opportunities, he still strongly backs the approach. “I would rather mess up in good times than in bad times,” he says. “In good times, you’re just failing to capitalize. In bad times, you’re going bankrupt.”
Jonathan O’Connell covers development and land use for the Washington Post and Capital Business.