Martin Sumichrast

Today in Russia, there are no developers, no mortgage lenders, no real estate brokers or title companies. In Moscow you won’t find associa­tions of homebuilders, mortgage bankers, property appraisers or construction firms.

Yet, conversations with dozens of Russian design and construction professionals as well as government officials suggest that some Russians would welcome an American-style real estate industry.

WHERE DO THEIR REAL ESTATE INTERESTS LIE?

According to Martin A Sumichrast, Russians talk increasingly about rediscover­ing and resurrecting their architectural and cultural heritage. The desire to preserve, restore, and recycle antique buildings has become a mini-movement in Russia, part of resurgent nationalism and renewed religious activity sanctioned by the government’s pol­icy of tolerance. Even the Russian Orthodox Church is becoming a developer. Much of Russia’s great architectural legacy resides in churches and monasteries in vari­ous states of disrepair and disuse. Thus Russians are now proposing joint ventures, including both the church and foreign investors, to restore these structures.

Because Russian monasteries are a major tourist attraction, both for Soviet and foreign visitors, development-minded Russians envision a future in which restored monasteries become the magnetic focal points of vaca­tion resort sites, sanctified spas complete with restaurants and recreational amenities.

Likewise, hundreds of pre-revolutionary buildings, and even entire neighborhoods, await revitalization. For example, designers are now preparing ambitious plans for com­pletely rebuilding an older section of Moscow near the Kremlin. Maintaining the 19th cen­tury fabric of streets and blocks, the plans preserve many buildings, call for a diverse mix of residential and commercial uses, pro­scribe high-rise or superblock buildings, and emphasize pedestrian rather than automobile circulation. They also envision restoration of a run-down monastery to anchor and give identity to the neighborhood.

RUSSIAN DILEMMA

But implementing such projects poses a thorny dilemma for the former Soviet block and for foreign participants. How can capital-intensive efforts be pursued without a real estate industry and all the legal and financial mechanisms that go with it?

How can new enterprises undertake pro­jects when basic concepts such as owner­ship, property titles, profit and competition are so alien to Soviet society? Who will furnish equity and debt financing when Russians save rubles in mattresses and cookie jars, not in banks? Without a supply of capital and a viable banking system, it’s hard to introduce capitalism.

However, that is exactly what the reform-minded government and many Russian citi­zens are trying to do.

Accomplishing this will be very difficult. Not only are they starting from scratch, they also must overcome firmly entrenched, anti-capi­talistic attitudes. Some of these attitudes derive from 70 years of relentless exposure to socialist dogma and centralized planning, but they also reflect centuries of conditioning by a pervasive and persistent Russian culture. Throughout Russian history, someone in charge - a czar, patriarch, nobleman or dic­tatorial government - not only owned everything, but also told citizens what to do, plus when and how to do it. Thus there is no tradition of private initiative, no work ethic comparable to that of Europe, Japan or the United States.

UNDERCURRENT OF SKEPTICISM

And profit is still a dirty word - “Russians are quick to count their neighbor’s money.” They still bridle at the notion that, in a mar­ket economy, some people get rich while others don’t. Even more unnerving is the potential for unemployment.  Underlying all of this is a sense of despair and pessimism. Despite the promise of future ventures, there is an undercurrent of skepticism, a disbeliefin a better tomorrow.  These attitudes are reinforced by worsening economic problems - chronic shortages of goods, falling currency value and outdated technologies. The desire to transform the former Soviet Union is there, but not the means, and perhaps not the patience or the willpower.

The Russian mentality, with its tendency to allow pessimism to triumph over optimism, will be the greatest impediment to “pere­stroika.” After all, only an optimist can venture into real estate.

Nippon Life Insurance Co. has made arrangements to buy 32.7 percent of the Forum des Halles shopping center, a busy multilevel underground complex in Paris, for $80.8 million, the French state bank Credit Lyonnais announced.

Martin Sumichrast noted that the sale needs the approval of the Japanese Finance Ministry. The complex, built in the 1970s at the site of Paris’ old central food market, was report­ed by the International Herald Tribune to have “local emotional associations akin to Rockefeller Center in New York and the Biltmore Hotel in Los Angeles.” The Forum des Halles, officially opened in 1979, is described as Frances’ largest shopping center, with more than 200 boutiques as well as stores and movie theatres. The Paris Metro and a station for suburban commuter trains are below the shopping complex.

The tight market for institutional grade properties in the U.S. has forced most of the major foreign investors to consider some creative alternatives to their typical mode of invest­ment. We have noticed a distinct depar­ture from the types of real estate invest­ments considered by the British, Japanese and Dutch in the past.

Some of the market characteristics influenc­ing these foreign investors’ decisions are:

• Institutionally acceptable properties in the United States have essentially been bought up. The demand for such properties greatly exceeds the supply.
• The U.S. market is overbuilt in virtually every segment and market, under traditional stan­dards of measurement.
• Price competition for quality properties is fierce, with auc­tions for such properties com­monplace. In today’s world, a portfolio is more valuable than a single property.
• Traditional sources of financing for real estate are in a state of flux, with banks and thrifts having significantly pulled back in their involvement.

Foreign investors are finding that they must now consider other ways to increase the level of their real estate investments. They may move toward different products (e.g., industri­al arid mixed-use projects), different geo­graphic markets and new types of investment.

The two most evident trends are the emer­gence of innovative investment techniques, such as the use of participating debt and convertible debt, and the willingness of for­eign investors who demanded full equity ownership in the past (e.g., the Japanese) to accept partial ownership as a means of expanding their portfolios.  These trends are illustrated by some major transactions which have occurred recently.

The much publicized investment by Mitsubishi Estate Co. in the Rockefeller Center is indicative of the recent willingness of Japanese investors to accept less than full equity ownership in existing properties. The Rockefeller Center properties are owned by a U.S. corporation, but the properties are also subject to a convertible mortgage from a third party lender. If the lender exercises the conversion privilege, it could obtain up to 71.5 percent of the ownership of the Rockefeller Center properties. Mitsubishi acquired a 51 percent interest in the corpo­ration that owns the underlying property. Therefore, Mitsubishi’s ultimate interest in the properties could be as low as 14.5 percent (51 percent x (100-71.5 percent)), if the lender exercises its conversion privilege. Of course, the stock acquisition could be the first step in a staged acquisition of the underlying property, assuming Mitsubishi attempts to acquire the convertible mort­gage from the third party lender. Although this particular transaction may have been motivated more by the Rockefellers’ desire to sell than by investor demand for the prop­erties, the ultimate structure of the transac­tion highlights the fierce competition for quality properties among investors.

- Martin Sumichrast

A proposed Chicago transaction involved the purchase and leaseback of land coupled with a convertible/participat­ing loan to the seller/lessee for the purpose of renovating a major office building which occupied the land. The principal amount of the loan was for approximately 80 per­cent of the fair market value of the proper­ty and the fixed interest rate component was approximately 100 basis points below the market rate. This transaction is notable for the following reasons:

• It combines equity ownership with convertible/participating debt.
• It is for the rehab of a partially occu­pied property as opposed to the acquisition of a fully leased property.
• The financing structure is attractive to both the lender and the borrower in that the borrower receives cash from the transac­tion nearly equal to the current fair market value of the property, and the lender receives an opportunity to participate significantly in the appreciation of property with a modestly reduced fixed interest rate.Similar transactions are being syndicated and offered institutional investors in the European and Japanese markets.
• A recent large unit syndication of a mixed-use project in  Houston, which was jointly marketed to both U.S. pension funds and Japanese investors, illus­trates several other interesting trends:The emergence of the Japanese syn­dication market, as an alternative to direct equity investment.
• The competition between U.S. pen­sion funds and foreign investors for similar types of investments.
• The expanding focus on non-office properties.
• A growing interest in the right prop­erties in previously distressed markets.

These are just a few examples of the current direction of the marketplace. This move­ment toward different product and geograph­ic markets and away from outright equity ownership will continue as the major foreign investors and U.S. pension funds realize that they must continue to seek out innovative investments if they are to maintain the growth of their real estate portfolios.

David Semas, VP of Stanwill Properties in Los Angeles, CA, says “Look for the Japanese to become increasingly interested and involved in multi-family housing, as they can see as readily as we can the soft Office/Hotel market.”

Martin Sumichrast

Taisei’s Mount Fuji City

Japanese construction companies continue to think big. Taisei Corp., the industry’s largest group with housing, road construction and real estate subsidiaries, has come up with plans for a futuristic city that would be shaped like Mount Fuji and would tower 4,000 meters (13,000 feet) — 739 feet higher. The structure, X-SEED 4000, would provide living space for 500,000 to 700,000 people on 5,000 to 7,000 hectares (12,350 to 23,100 acres) of livable floor space, company spokesmen said. The base would be 6 kilometers (3.6 miles) in diameter and rest on the bottom of a lake or ocean. Construction would take 30 years and cost Y150 trillion ($1.2 trillion).

The structure would be built around a core containing administration offices and facilities for cultural exchanges.

Business and commercial facilities would comprise a central frame surrounding the core. Living quarters would be above the central frame but below the 2,000 meter level. The upper reaches would include a nature and space observa­tion center, an energy

plant and a “sky resort” recreation center.
January 15, 1991.    Martin Sumichrast