True Believer
Grid, July + August 2001
Grid: What’s so bad about focusing on short-term returns?
CL: Real-estate development is still a 40-year asset class from the point of view of tax treatment, which is what it should be. This means the project should not need substantial rehabilitation till those 40 years are up. But we don’t build suburbs that way. The financials say build for a five- or seven-year life, because that’s what’s “justified.” And yet the big cost in the building is the hard cost. So the real-estate community has become very expert at formulaic development. It is cheap and it goes up quickly, but it has two problems: it increases sprawl, and it’s junk.
Grid: It’s junk?
CL: You can see it on any strip development. A perfect example is Memorial Drive, in DeKalb County, east of Atlanta. In the 1980s it was called the Miracle Mile and had the highest concentration of restaurants and car dealers in the metropolitan area. Now it’s a ten-mile-long commercial slum filled with more than 15 dead or dying strip malls.
Grid: Are the 19 “product types” you describe widely recognized in the industry?
CL: Everyone knows about them. I was just the first to codify them and count them up.
Grid: Isn’t the marketplace concerned about low quality?
CL: It’s not seen as a problem because of the five- or seven-year focus. The prudent owner is supposed to sell the property at the end of that period. So conventional development has lots of different owners over time. The buyer may be a 29-year-old within a company who doesn’t know that he’s picking up a building that will require considerable reinvestment to continue to deliver the returns that it offered the seller. So when that project fails to perform, the company buries it. The kid has no doubt moved on. Then it’s sold to someone else, who milks it.
Grid: Can you demonstrate that the cash flows down the road actually accrue to your developments without the substantial reinvestment you say conventional developments require?
CL: We showed the McCune Foundation, who are second-tranche investors in Albuquerque, how revenues from this project that come from investing 4% of their asset base will cover 20% of their cash-flow needs in the period that begins after the project’s first seven years. The corner of First and Central is not going to go down in value. The approach is still too new to definitively prove the cash-flow projections. But what we found is there’s no data on conventional development either.
Grid: You’ve also tweaked the tranching idea to support the construction of affordable housing and to underwrite the nonprofit arts scene. Why do this when housing costs and commercial rents seem quite reasonable in Albuquerque now?
CL: The downtown affordable housing is essential so that service workers and middle-class people can afford to live close to downtown jobs. And we’re trying to nail it down now, because once the downtown takes off, the land values will make it impossible. It’s not easy: Housing early in the revitalization can only pay $2 per square foot for land, but surface parking, even at the $50 or $60 per month that prevails here, still generates $15 per square foot.
As for the arts, we’re using it to jump-start redevelopment. We know that when artists, students, and gays go into a neighborhood, redevelopment will follow. But artists and students don’t have any money. So we need to keep the arts alive to keep the process going. Foundation grants are underwriting some nonprofit arts organizations here.
Grid: The go-go real-estate outlook of just a few months ago now seems overly bullish. How does that affect what you’re trying to accomplish?
CL: It reinforces the validity of longer time horizons. Five years ago, high-tech investing was seen as something you did to achieve long-term rewards. But then those stocks all went through the roof and brought about a short-term mentality. Look where that got us.
(Continued)