GlobeSt.com: What are some of the challenges you face as president of USAA Real Estate?

O’Donnell: First, I’d like to address the challenges I don’t face. Our portfolio contained no distressed assets, no permanent impairments, foreclosures etc…. so, unlike many in my position, I have not been burdened by the resolution of troubled assets. Because of the quality of our portfolio and the financial strength and stability of our parent company, as well as our many institutional investors, our balance sheet is in great shape and we have significant liquidity to take advantage of market opportunities. I am very fortunate to be able to dedicate 100% of my energies to our future.

However . . . like many of our competitors we are faced with the challenges of growing our portfolio in the face of an uncertain political climate and an economy that has been very slow to recover. While we have significant capacity for growth, as demonstrated by the nearly $2 billion of investment we have completed in 2011, it is important to maintain discipline. We have focused a great deal of effort in researching those sectors of the economy and our industry that offer the opportunity for growth as well as those that will perform well as a recovery eventually takes hold.

GlobeSt.com: What seemed to hold up particularly well in your portfolio and what do you consider a non-core asset for the portfolio?

O’Donnell: To begin with, Pat Duncan and the management team did a remarkable job, first anticipating the downturn and then managing investments through the worst part of the cycle. We were a net-seller of assets at the peak of the market in 2007 and early 2008 and then did little or no investment, other than some strategic build-to-suit development, until the worst of the recession had passed.

We began investing more actively in early 2010 and from mid-2010 to mid-2011, took advantage of our liquidity to acquire and develop assets at a time when many companies remained either impaired or on the sidelines. Today those investments appear to have been extremely successful.

The company did retain much of its industrial portfolio because it was acquired at a very attractive basis and because of the high quality nature of the assets and that strategy has proven very successful. Like all real estate classes, it lost some market value during the downturn, but today that value has more than recovered and the portfolio stands at about 98% leased.

GlobeSt.com: Are there any particular markets or product types out there that are more appealing than others?

O’Donnell: USAA has two fundamental businesses. The first is the acquisition of properties for our various funds and co-investment vehicles in which we are always a significant investor. In this area we manage a portfolio of approximately $8 billion. The second part of our business involves funding development capital for developers and operating partners. Today we have nearly $3 billion of these transactions in our pipeline, including multi-family, industrial and office build-to-suits.

In regard to acquisitions, a flight to quality and core continues to dominate this part of the cycle, but we are uncomfortable with core pricing in some products and markets. Instead, we are looking for high-quality assets that range from just outside the criteria of the most core focused buyers, to value-add opportunities. We believe there are pricing inefficiencies in today’s market resulting from a lack of investor demand for assets that don’t strictly meet the definition of “core.” In fact, we believe pricing has receded in this area over the last quarter such that we are beginning to acquire high quality, well leased assets at prices that are well below replacement cost and that we believe will produce core-plus and value-add returns.

We are focused on growth sectors of the economy, such as energy, technology, certain sectors of manufacturing and as a result are drawn to the office and industrial markets that house those sectors. This includes various Texas cities, Northern California, parts of the mid-Atlantic, New York, Seattle and other key industrial centers. We are also building a very attractive national portfolio of high quality grocery anchored shopping centers and we would welcome opportunities to expand our mall portfolio.

We believe economic and demographic trends will continue to drive demand for multi-family and as such we are actively partnering with developers in a program designed to deliver institutional quality apartments in urban, infill and transit oriented location throughout the US.

Finally we have been and will continue to be an active buyer of distressed and discounted debt and we are increasingly a source of capital for owners trying to recapitalize troubled assets. While USAA has not traditionally been as active in this area, we believe the volume of these opportunities will continue to expand over the next 24 to 36 months.

GlobeSt.com: Without giving away any trade secrets, can you give me an idea of what your plans are for the near- to mid-term?

O’Donnell: As indicated, we do think some sectors of the market are fully priced and as a result we will be a seller of some of some of the assets we developed or acquired over the last several years, while enjoying the ongoing cash flow from many of the others.

In terms of new investment, we will likely be somewhat less active than we were during the last 18 months, but we will definitely remain active. In particular you will see a continuation of our value-add and distressed debt investment programs, acquisition for our Government Building Fund and there will be a continuation of our development programs for multi-family as well as build-to-suits in office and industrial.

GlobeSt.com: It’s crystal ball time now. What is your prediction for the real estate market during the next six to 12 months?

O’Donnell: It’s obvious that the future of the industry is inextricably linked to the economic recovery. For a full and sustained recovery of the real estate markets to truly take hold there must be meaningful and sustained job growth and the housing markets must begin to recover in order to restore confidence for the consumer and to fuel economic expansion, particularly in second-tier cities.

Unfortunately, there is little evidence we should expect these things to take hold over the next six months and thereafter we enter the election cycle, so we expect the status quo to continue for the next 12 months. The good news is, interest rates should continue to remain at historic lows for another year, thus supporting, perhaps artificially in some instances, real estate values.

It appears manufacturing may be building some momentum which should bode well for the continuation of the recovery in the industrial sector and corporate profits remain strong, such that if the political environment stabilizes, including clarity on the Federal Debt and taxation, it would appear companies are poised for employment growth that would accelerate the recovery of the office sector.

In the meantime we’ll continue a disciplined approach to investing in anticipation of a continuation of the slow to moderate recovery. We remain focused on sectors that are inefficiently priced as well as development opportunities that benefit from the continued uncertainty in the markets.