Related's Bill Witte Opines on California's Housing Market

When TPR interviewed you last year, the effects of the recession were just being felt. Assess the past year. What surprised you? What did you expect and not expect regarding the vitality of the real estate industry in metropolitan Los Angeles?

At this time a year ago, everybody knew that things were slowing and financing was tightening. If you could pick one point in time where things fell off the cliff in the financing world, it would be when Lehman Brothers failed, which was last September. It was the tip of the iceberg, but it gave credence to the notion that the financial system was falling apart. Since that point in time, the ability to access the credit markets-particularly in real estate for construction financing, debt in general (it could be refinancing as well), the sale of condominiums, and other forms of real estate-pretty much stopped.

In the last interview, you commented about the need to focus on submarkets rather than the entire market. The impact of the Lehman fall and the financial crisis has hit across markets. Have the metro markets fared better than the suburban markets?

In general they have, as there is a greater supply-demand imbalance in many suburban areas than in the infill-oriented cities. It's unlike the real estate recession of the ‘90s, which was a supply-demand imbalance fueled by the easy credit of the ‘80s, construction of all forms of real estate in excess and, in Southern California, job losses in the defense industry. In many markets, including the metro L.A. area, there isn't a significant supply-demand imbalance. Rather, there has been a complete collapse of financing markets and an over-valuation of many forms of real estate prompted by the aggressive financing of the last five or six years. If you look at the greatest losses in real estate value nationally, in South Florida, Arizona, Las Vegas, and parts of California, easy money and the relative ease of entitlements and development have been the culprits. In metro L.A., it's still not easy to obtain development approvals and it takes a lot of time. As a result, we're not sitting here with a huge over-supply of product in most of the asset classes of real estate.

In the Antelope Valley, Inland Empire, and other suburban markets it is going to take a long time to burn through the supply of entitled land and product.

What are the attractive sub-markets? Given that Related is a national company with a bi-coastal view of these markets, where are the opportunities and what are the markets to stay away from?

Related is national in scope but only has development entities in New York, Chicago, Miami, and California. We've never attempted to set up shop in every major metropolitan area. The philosophy then, now, and for the future for Related is to focus on urban-oriented markets with high barriers to entry. We're building properties that are more than just commodities, whereas in the Southeast, Southwest, in Texas, etc...a lot of real estate tends to be more of a commodity because it is relatively easy to build. Our philosophy isn't going to change materially. We still think that L.A., San Francisco, New York, and Chicago, once the economy recovers, will be strong markets, just as they were before.

Last month, TPR coupled an article by Rick Cole with an interview of Christopher Leinberger, talking about urban infill and opportunities for livable urban environments. Given the demographic numbers you just shared. Are Cole and Leinberger in line with Related's strategy, as opposed to the opinion of Joel Kotkin, who believes that suburban markets will drive the housing markets of the future?

My good friend Joel Kotkin seems to suggest that real estate is a zero-sum game. That is, if there is growth in the suburbs, it necessarily must come at the expense of urban areas. The last time I looked, a lot of this country-certainly California-is growing in population. The question is not whether one will grow at the expense of the other, but rather how growth will be managed in both places. There will continue to be growth in the suburbs. Provided (and here I may not differ that much with Joel) our cities continue to make efforts to be smart about their growth and also to improve non-real estate amenities like schools, public facilities, and transportation, cities will prosper as well.

I also believe that, in both places, there will be an increasing focus on smart and sustainable growth. Joel has a more almost libertarian attitude about government involvement in regulating growth; if people want to live in large, less expensive homes far from jobs and transit-well then the market has spoken and they should be allowed to do so. It is certainly clear, and Joel missed this completely in his recent Newsweek article, that the greater pain is being felt in the suburbs. There is no question about that, especially in the outlying suburbs that he predicted will be the signposts for growth. That is true everywhere in the country.

Jim Thomas and Korean Air announced plans this past week for a billion dollar project at the current site of the Wilshire Grand. How does that play out in the dynamics of "location, location, location" in Downtown Los Angeles, vis-à-vis Related's project?

I was very pleased to see that because I'm, not surprisingly, a believer in Downtown's coming of age. It will happen in fits and starts, as any development does, but there is ample evidence that the growth Downtown is going to continue. When a significant player makes a statement or commitment to that end, it helps everybody. It is clear, for example, that the hotel merely being under construction at L.A. Live has raised everybody's game. Hotels around the area are going through major renovation programs. That said, the market will determine when that project goes, when our project goes, and when other projects go-the announcements won't and the understandable desire from public officials won't.

There is plenty of room for projects like this. I feel very strongly that the Grand Avenue location will be the pinnacle, literally and figuratively, in value. I say that for several reasons. One, L.A.'s cultural center already exists there, starting with Disney Hall and the Music Center. Second, our anchor is the Mandarin Oriental Hotel, which is really the ultimate five-star address in L.A. Third, vertically integrated mixed-use environments have commanded the highest values in other cities in which we have developed. Fourth, we have continued to move forward to design and develop the new Civic Park, which will start construction next year. That will be completed before we open the project, another huge amenity.

Any project of this magnitude can be expected to go through at least one downturn, and the planning and care we have put in thus far will ensure that we are well positioned when the market returns with pent-up demand for first rate product. The extent to which other higher-end or mixed use developments move forward will reinforce people's confidence in Downtown. That is a good thing.

A number of real estate firms-both regional and national-are leaving the scene. How healthy is Related vis-à-vis the other national firms? Who is going to survive?

Every developer that has been active during this past cycle has some issues to deal with today. Related has a relatively small amount of exposure. For the most part we have stuck to the markets that we have been successful in and know the best. In California, major projects in Santa Monica and the Grand Avenue project are on hold awaiting construction financing. These are unique locations with some unique attributes, which, when the market recovers, should be in a strong position to move forward.

Related also has a strong and ongoing presence in developing affordable housing in California and New York, which is a little unusual for a company of Related's size. Apart from it being an interesting line of business for a major for-profit to be involved in, it is something in which we can stay very busy in the midst of even the deepest recession. Last year we acquired a 307-unit Section 8 project Downtown from Rob Maguire, which we will soon be refinancing and renovating. We're co-developing, with the nonprofit homeless services provider PATH, a new construction project for permanent supportive housing for the homeless in East Hollywood. We have projects all over the Bay Area, San Diego County, Orange County, and San Bernardino County. If you want to look at it from a business point of view, it's a counter-cyclical thing.

In the public company arena there is going to be-and we have already seen this in the homebuilding arena with Centex and Pulte Homes-consolidation in the industry. That doesn't necessarily mean failure. It means fewer players. In the apartment world, for example, JPI, a major national developer, went under. You will see some consolidation. It's always a tough time for small, locally based developers. The ones that know their markets the best, even the smaller ones, will survive. The ones that spread themselves too thin are the ones that will be at the greatest risk.

According to DataQuick, the median price for single-family homes dropped an average of 37.2 percent nationally between February 2008 and February 2009. The median price of condominiums fell 29.3 percent during the same period. Do we get a sense that the worst is behind us?

For the most part, we do get that sense. One of the reasons those numbers and decline are as significant as they are-and this is true nationally-is that an unusually high number of those purchases are purchases out of foreclosure at below market or "short sale" prices. If the numbers of transactions in the market are heavily weighted toward the bottom, it will obviously bring down the pricing. In the wealthier communities like West L.A., Orange County, and the coastal areas, there are fewer transactions because there are fewer sellers who have to sell. Homes don't go on the market as often as they did. This is usually the first step in signaling the bottom of the market. When that stuff starts to move, as it has, and it is doing so in the Inland Empire as well, it's usually a sign that things are picking up.

In your last interview with TPR, you also made the comment, "Media, as is so often the case, are guilty of both over-hyping the boom and being very negative about the decline." Where does one, then, find good information about the housing markets?

At a time like this, good information about the markets is difficult because it requires digging and some speculation. The difficulty in answering your question is the reason things are so slow right now. There has been an understandable crisis of confidence, and there is uncertainty. People want evidence that values have bottomed out, or that they soon will. People want a sense of where the overall economy is going. Neither has been easy to answer, although it seems like new information is surfacing to at least give us some hints.

There are a couple of things your readers should do. Let's use an example of residential apartments. Right now we are in a climate where capitalization rates are volatile and probably climbing. It makes it much harder to finance anything. It's another way of saying that investors thought they were too low, and values were inflated. If you're going to finance new apartments, you're going to have to show a higher return. One thing you can do is look back over, say, the last ten or 15 years and take an average of cap rates. You can then say, "Okay. Two or three years ago rates were at historic lows. But over a period of time there has been some downtime in the cycle and some boom in the cycle. What do they average out to be?" You can begin to make some business decisions like that.

Similarly-although we are not a single-family homebuilder-you can look at the ‘90s when there was huge over-supply. How long did it take for that to be absorbed and burn off? It's not exact, but it can give you an order of magnitude. You can look at how long recessions have typically lasted. For example, there have been seven or eight measurable recessions in the last 30 to 40 years. You can say, "From the time that the government officially certified that the country was in recession, the reality is that it had probably been in it for six months. It probably lasted, on average, 12 to 18 months after that." What you have to do is look at all of those things and then layer on things like demographics. For example, let's go back to the apartment market. Demographic data suggests that the year 2014 will be the largest cohort of 20-30 year-olds in decades. That is also the age of the population that typically has the highest degree of new renters. If you are an apartment developer you might think that you want to start construction in 2010, or 2011, so you'll be opening into what is likely to be a high-demand for rental apartments.