Real estate firms that have downsized during the economic crisis will be slow to rehire, except to the extent they need to support greater internal due diligence.

Two weeks after the last U.S. presidential election, Obama’s chief of staff, Rahm Emanuel, told a group of business executives, “You never want a serious crisis to go to waste.” He later clarified this comment with the following: “It’s an opportunity to do things you could not do before.” Thus far, in a perusal of the real estate industry after the current economic crisis, it appears that we are letting a good crisis go to waste. So far, except for the enormous downsizing that has taken place, it seems all too much like “business as usual.”

A developer friend of mine asks, “Where do you go if you have no money and no credit?” He responds with the surprising answer that a lot of folks—the fund guys—have lots of money if you have deals in Boston, California, or Washington, D.C. He initially thought this would be like 1991, but the big difference is this: there are no good deals. “There are no bargains out there, at least in those areas favored by the funds,” says Ted Raymond, president of Raymond Property Company in Boston. But there is plenty of money for experienced developers, even those with lots of scars—as long as one can deliver a 20 percent internal rate of return (IRR).

To achieve those returns in the absence of buying bargains, one has to take entitlement and approval risk. However, there are few new development opportunities that are moving forward. Funding for new development will be scarce as long as the market for completed office and commercial space is replete with high vacancies and broken deals. It will take three years or more before the market reaches equilibrium—with rents high enough to support new development.

Randy Hawthorne, principal at RGH Ventures in Boston, observes a similar phenomenon. Firms that have extensive legacy issues are “resetting, reloading, and starting again.” He notes that he was surprised that the California State Teachers Retirement System recently announced major commitments to California homebuilders who had many deals they had to give back. Hawthorne points out that fund managers can only earn their “promotes” (i.e., their share in the upside [profits] of a fund after they deliver certain rates of return to their investors) if they draw a line in the sand and raise money for a new fund. The theme he hears is this: “Don’t run away from old obligations, but reset new ones and move forward.” Hawthorne responds: “Are we so short of talented people that one has to do it again with the same guys? You can guess where their time will be focused—not on workouts.”

Many real estate firms have assembled funds to chase distressed debt. Everyone seems to express concern that the banks are not selling yet and that bargains are hard to find. There are too many distressed deals held by the banks and commercial mortgage–backed securities (CMBS) holders for this market not to come alive at some point; but, so far, the United States seems to be following in Japan’s footsteps, whereby banks held on to their nonperforming loans (NPLs)—leading to their lost decade. As long as the overhang of distressed deals remains, there will be reluctance on the part of investors and lenders to underwrite new projects. This could act as a drag on the real estate market and the larger economy for years to come.

The one area where the market is changing dramatically is in sustainability. Many corporations and fund managers, as well as government bodies, are requiring that the buildings they occupy or invest in meet new standards of sustainability. This change in demand is creating a new specialty within real estate for companies that retrofit older structures and supply technology, consulting services, and money to promote sustainable buildings and communities.

On the regulatory side, anticipate some easing in approvals in communities that are eager to see more development and that need cash to make up for severe budget cuts. However, there will be little change in wealthier communities that have traditionally opposed new development—and do not expect the long-term trend toward ever increasing development regulation to reverse course.

What does this mean for organizations? Ken Hughes, president of Hughes Development in Dallas, says that his firm’s business model never went back to having in-house construction and management companies after the 1990–1991 recession. According to him, his firm just hires outside consultants. In-house, Hughes Development has three critical people engaged in development and a bookkeeper. “This is the right model unless you have a lot of asset managers,” he maintains.

Buzz McCoy, president of Buzz McCoy Associates in Los Angeles, opines that there will be a lot more due diligence—more in-house analysis rather than relying just on rating agencies. “There will be more compliance,” he notes. “But we are still cycling through the downside. Services are the hardest hit—consultants, architects, planners, and other service providers.” McCoy suggests that opportunity fund managers will do fine if their timing is right—whereas entrepreneurs and developers will face a slow recovery. He predicts that it will take at least two to three years to resolve the CMBS situation.

Chris Lee, CEO of CEL & Associates, Inc., in Los Angeles, predicts a lot more consolidation as firms continue to downsize and look for partners to strengthen their positions. He points out that many of the entrepreneurs who led the market after the savings-and-loan crisis are now 20 years older and will be more conservative in their underwriting, and more cautious in moving forward.

How people are compensated is changing, too. Employee compensation will be much more geared to the firm’s overall profitability, not just the employee’s individual performance. But, Lee points out, because firms are slow to rehire, people get more responsibility, authority, and autonomy.

In summary, two different states seem to be manifest in the economic recovery. Development is still almost nonexistent and is expected to be slow for the next two years or more. Firms that have downsized will be slow to rehire, except to the extent they need to support greater internal due diligence. On the other hand, real estate funds have reloaded and many—even firms that have significant legacy issues—have raised new money that they need to invest. Everyone is still waiting for distressed debt and broken deals to start trading. Until the banks and other holders of distressed debt are forced to take their losses and move on, the real estate market will be slow and real estate organizations will remain lean and cautious about internal growth.