Portfolio: Let’s start by getting your take on the overall economy going forward?

Patterson: I expect more of the same funk we’ve been in for most of the last year. The primary driver for coming out of this would be increased corporate spending, but I haven’t seen it happening. So, I expect we’ll continue bouncing along the bottom.

Portfolio: A real optimist, I see. What is your outlook for the real estate industry?

Patterson: These are challenging times for real estate operators and owners, but nothing—I repeat, nothing—like the distress of the late 1980s and early 1990s. Rents are going down for most property types, but leverage is modest compared to that era. Because debt levels are lower, nothing points to major blow-ups in publicly traded real estate companies.

Frankly, real estate owners have been protected from this recession by low interest rates. Owners are not feeling the pain of this recession because interest rates have fallen faster than cash flows and this has given real estate companies some breathing room.

Portfolio: What happens to the real estate industry if interest rates start rising?

Patterson: I don’t anticipate rates going up until the economy heats up. Rates will stay flat for the next six to 12 months, which is a great thing for property owners. We haven’t seen rates this low for decades. There’s quite a spread between interest rates and yields on properties so it’s a terrific time to obtain financing for real estate. Capital has been plentiful from a variety of sources, including banks, pension funds, individuals and insurance companies.

Portfolio: What can REITs do with this plentiful capital given that property prices are so high?

Patterson: The situation has been somewhat frustrating to the public companies. It’s difficult to justify acquisitions at these price levels, so REITs are using this opportunity to cull their portfolios and sell non-strategic assets. Companies are using the money to pay down debt or retaining it to have capital available for future acquisitions. There have been some large trades in the retail sector, but nothing like the activity level of four or five years ago. Management teams have been very disciplined in this period in looking at acquisitions that make sense from both a strategic and an economic standpoint. They’re not just using a strong balance sheet to bulk up.

Portfolio: Where are you seeing the major real estate investment activity outside of the U.S.?

Patterson: Our investment banking business is global, and we’re seeing a significant amount of activity in Asia and Europe. We have a strong presence in Asia and have been in Japan for many years. In November 2000, Japan passed a REIT law. The law allows capital to flow for the first time from real estate companies to public investors without double taxation. As a result, we’re seeing the securitization of real estate in Japan, and J-REITs (as they’re known) give troubled banks and insurance companies that have troubled portfolios a place to sell their real estate.

It’s similar to the way troubled real estate found its way to market in the U.S. in the early 1990s, and we expect that this is just the beginning of a brand new real estate market. In the U.S., there was one REIT initial public offering (IPO) in 1991, three in 1992 and so forth until we reached a run rate of 10 to 20 a year. We expect events in Japan to unfold in a similar fashion.

Portfolio: Some commentators say there’s a glut of office space in Tokyo and that the building boom of the last year is unsustainable. Do you agree, and how do you think that will play out?

Patterson: No question, there’s an oversupply of prime-A office space in Tokyo and more than a hundred buildings are going up. But I don’t think the oversupply extends to retail, industrial or multifamily properties. Some J-REITs are in retail or mixed properties. There are office J-REITs, but the oversupply
doesn’t affect them at this time because their buildings are fully leased and in good locations. They have stable, long-term leases with strong tenants, and there’s very little lease rollover at the moment. However, it’s likely that the office J-REITs will be affected in the future when their leases do roll over.

Portfolio: Are there other opportunities in Asia?

Patterson: Singapore is the largest port in the world. It has an interesting and vibrant real estate market. A REIT law was passed there after Japan’s, and there have been two S-REIT IPOs. There’s a lot of high quality real estate in Singapore, so there are more REITs to come there, as well as in Japan.

Portfolio: A lot of eyes are on China: what’s happening there?

Patterson: Shanghai is a volatile place. There are some great developments but a lot of empty buildings going up, too. It’s not for the meek. Someday it will be a wonderful place to invest, but it’s a bit too dicey now for many investors. China’s government is unpredictable and that’s an added risk you don’t have in Japan or Singapore.

Christopher M. Wright is a freelance writer based in the Washington, D.C. area.