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Corridor, Inc.: Q&A with Thomas Bozzuto

October 01, 2008

It was the kind of day developers dread.

The Bozzuto Group crews had been building and marketing a condominium complex in Germantown in the mid-1990s when the market went soft. Nearby townhouse developments slashed their prices to move units.

Suddenly a new Germantown townhouse cost less than a Bozzuto condominium. Sales slumped and forced Bozzuto to make deep price cuts as well.

When the project was complete, “I went to my [equity] partner and said, ‘Not only did you not make any money on this project, but it is going to cost you $1 million. It’s also costing us $1 million,” said Thomas Bozzuto, chairman and CEO. “My partner looked at me and said, ‘There are days like that. Let’s talk about the next deal we’re going to do.’”

Bozzuto said those kinds of business relationships have helped the company weather the inevitable cycles of the real estate market.

Founded in 1988 with 22 people and a string of plans to build apartment complexes, Greenbelt-based Bozzuto Group now includes six construction, development and facility management companies, employs 1,000 people, manages 25,000 apartment units and completes $200 million of construction annually. Its developments range from affordable housing to the swanky Spinnaker Bay mixed-use development on Baltimore’s harbor front.

One key to the company’s success, Bozzuto said, has been avoiding “hot money” — equity from Wall Street and other investors who view real estate as a commodity and require fast, large profits. Bozzuto partners with investors seeking longer term returns instead.

That approach has landed Bozzuto in partnerships with Cigna Corp. on seven developments, Northwestern Mutual Financial Network on four, the New York State Teachers’ Retirement System on another four and cushioned Bozzuto’s finances during the roughest real estate cycles.

Bozzuto sat down with Corridor Inc. to discuss challenges and trends in the Baltimore-Washington Corridor real estate market.

IT SEEMS LIKE A TOUGH TIME TO BE IN THIS BUSINESS.

It really is a tough time. However, America has this perpetual innocence. Every time we go through something, we say oh it’s the first or the worst or the best. When people tell me how bad this period is, I keep saying to them, where were you in 1978 when Jimmy Carter was flying helicopters into the desert and crashing them, Japan was buying everything in America that wasn’t moving, interest rates were 22 percent, oil prices were skyrocketing and everybody was going bankrupt? You tell me today is worse than that? I don’t believe it. Economies are cyclical. The real estate business is particularly cyclical. And shame on all of us, including us, for forgetting that from time to time.

HOW IS THIS ECONOMY AFFECTING YOUR COMPANY?

We’ve had to do some layoffs and that is very painful to layoff 25 people in the year when you are celebrating your 20th anniversary. But the volume of our homebuilding has been reduced substantially. We have had to adjust prices down by 20 percent from what our pro formas were. It’s tough to motivate any investor or lender to take a risk on real estate in an economy where real estate is being beaten up so unmercifully by the newspapers.

On the positive side, our apartment management and construction businesses are growing dramatically. Our apartment management has gone from 18,000 units under management to 25,000 units in two years. Our construction volume has increased from about $140 million to $200 million during the same period.

The rising cost of transportation sort of plays to our strength because we are not building way out in X-Urbia. We have historically built in planned communities or urban centers and they are usually places where transportation is right there. We have a project underway in Wheaton that is literally on top of a metro station. We have an apartment project in Baltimore that we are about to start that’s in the parking lot that people use for the Lyric. That is surrounded by the light rail and it is 150 yards from Penn Station and it is on a bus route, so it is a transportation node.

DO YOU THINK RISING ENERGY PRICES AND THE PUSH FOR GREEN CONSTRUCTION WILL INFLUENCE WHAT YOU BUILD IN THE FUTURE?

Yes. We were worrying about energy and doing the right thing environmentally a long time before it became fashionable. I suspect with this new Al Gore driven fad that every jurisdiction will come up with rules that will increase the cost of housing. One of my pet peeves is that the same officials who bemoan the lack of affordable housing the most, and that happens to be a subject I am passionate about, are the ones who impose regulations that hinder the creation of affordable housing … It drives me crazy.

WHAT REGULATIONS?

Every regulation has a cost. In Montgomery County today, before I can sell an apartment project, I need to offer it to the county. They have the first right of refusal to match any offer I get from the marketplace. Now what that means is when I go for money from one of my equity partners for a new apartment project, they are going to look for a little higher return because the county is meddling in the free enterprise system, and that translates into higher finance rates. And the county did that because they wanted to buy affordable housing.

HOW DO YOU EXPECT THE MARKET TO CHANGE IN THE NEAR FUTURE?

I think we will see the homebuilding market stabilize in the next 12 months. I think it will stabilize at a lower price than it was two years ago, and I think builders are going to have to figure out how, despite higher cost material, to build at lower prices. And I think Americans are going to have to adjust to the fact that they can’t afford as much home as they thought they could with these silly mortgage products.

I have said forever that we do people a disservice when we encourage them to buy a home first and foremost as an investment. Homes are shelter and sanctuary and no one should buy a home if they think that either their social or physical circumstances are going to change in the next three years. The home is an illiquid asset as a lot of people are discovering today. People need to understand that owning a home is no more a guarantee of getting rich than buying the latest dot com stock.

I READ THAT YOU MET YOUR PARTNERS WHILE YOU WERE ALL WORKING AT OXFORD DEVELOPMENT. WHAT MADE YOU DECIDE TO GO OUT ON YOUR OWN?

In 1986, Oxford’s business model ended up running into the teeth of a changing law. When the tax act of 1986 was passed, the entire methodology on which Oxford had founded its business was undermined. The tax law prior to 1986 had accelerated depreciation. It made it attractive to invest in apartments not because of the economics of apartments but because of the tax benefits. But the tax benefits were stripped away and they were stripped away instantly.

We in our region had the benefit of good economics underlying our developments. We had started doing business in a different way. We had started doing financing of projects with institutional joint venture partners and not putting excess debt on our projects. We were not overleveraging our projects.

So when Oxford got into trouble, our region was very profitable and our methodology of doing business continued to make sense. So we started proposing to Oxford that we be allowed to buy our region. Finally in early ’88, they agreed. They had a bunch of projects under construction and we, in our new company, took enough construction people with us to oversee the completion of those projects. So we had income from day one.

Secondly, we had in our region a pipeline of projects that we were trying to get started. And the people at Oxford agreed to sell us those projects.

So we entered into what I always described as a reverse leveraged buyout. They paid us to go away.

SO WHEN YOU GOT THIS DEAL WITH OXFORD, DID YOU THINK, I’VE GOT IT MADE?

No, you never think you’ve got it made. Fear of failure is a greater motivator for an entrepreneur than anything else. And we were all terrified.

I think every entrepreneur who succeeds has fears, particularly if you worked for somebody who was very smart, who still saw his company get into financial trouble. You worried a lot about making mistakes in judgment, specifically you worried that projects would require more capital than you had to get started, you worried that projects wouldn’t lease up, you worried that you wouldn’t get financing. We still worry about the same things today. The difference is we have done it now a number of times and we now have the benefit of our experience.

SO DID THE COMPANY GROW THE WAY YOU EXPECTED?

Our business model when we started our company is different than where we have evolved to. Initially our strategy was to develop, build and manage apartments that we would own in joint venture with equity providers. Over the years, we have modified that in two respects. One, we got into the homebuilding business in 1991. About the same time, we decided that we needed to provide services to other people, that we could grow our company fast in a way that would minimize layoffs by offering services that we had created for our own account to other people. So we started managing properties for other people and we started building properties for other people.

1991-92 was a tough time in the business. Getting capital for new projects was very difficult. We were still small and new. 1991, the company was still only three years old. There were still only 50 people in the company. What we saw in 1991-92 was in order to survive, in order to thrive, we believed you had to either become a national company and build homes or apartments all over the country, or if you were going to be a regional company, you had to be diversified. We decided we would rather be diversified and regional.

HOW DO YOU SEE THIS COMPANY CHANGING IN THE NEXT 10 YEARS?

One of the things I am most excited about is we have this second tier generation of partners who are in their 40s and 30s, who are full of energy, enthusiasm. I would suspect that we will over the next five to seven years transition the leadership of the company to those people. I suspect that they will probably expand our focus on creative design. That’s a hot button for my son. And they will want to do more downtown and core urban product, I think.

I suspect our geographic reach will expand and deepen. We already have a toehold — an employee — in Boston. I suspect that office will get larger. We have an office in suburban Philadelphia. I suspect that office will grow. And I would not be at all surprised to see us have an office in the southern states. And lastly I wouldn’t be surprised to see us diversify beyond residential real estate over time.

But right now, I just want to get us through this cycle, through this economy and have us well grounded going into the next phase.