While Russia initially may have been insulated from the impact of the global financial crisis — due to the once-high price of oil — the country is now feeling the impact of the slowdown. What does this mean for the Russian real estate market? How are real estate companies responding to the crisis? And what should international companies look for when doing business there? Bruce Gardner, managing director of MLP Russia and a participant in the recent Knowledge at Wharton Real Estate in Emerging Markets Forum, offers some answers.

An edited transcript of the conversation follows.

Knowledge at Wharton: Our guest today is Bruce Gardner, managing director of MLP Russia, a developer and manager of warehouse facilities in Russia. Bruce, thank you so much for joining us today.

Bruce Gardner: Thank you.

Knowledge at Wharton: The question on everyone’s mind these days is the world financial crisis and its impact on emerging markets. Could you tell me a little bit about what you think of the crisis and how it has impacted Russia?

Gardner: Russia in many ways was initially cushioned by the price of oil for the past six to seven months…. It saw itself as insulated and removed from what was going on in the world for the past 18 months. In our business, which is highly correlated with financing and highly dependent on development financing, we saw the first signs of the changes in the market at the end of [2007], when we realized that development financing would no longer be available. It was really only recently that things have started to creep up on Russia. Russia is right now still in a bit of a denial phase, going through the process of trying to understand what this really means for it.

The Russian government is also going through an understanding that this is going to be more protracted and more serious than initially perceived, [that] it has much more far-reaching impact in terms of the economy and in terms of the real liquidity in the economy. We are seeing a lot of signals today. Lending is completely frozen. In some cases, people are moving back into barter transactions in the regions. You are really just seeing, if you will, a bit of a recoil. In part, that is due to the fact that Russia has the experience of the crisis of 1998 and so it feels somewhat of a reaction to that, especially with the banks. That’s because the banks were really the source of the problem at that time. Banks have basically frozen all activity and have kind of pulled back completely even though they are sitting on enormous amounts of cash. The government has basically liquefied all the Russian banks that are sitting on billions and billions of rubles but are not willing to extend themselves until they understand that things are going to improve.

Knowledge at Wharton: How are real estate companies in Russia responding to this situation?

Gardner: Again, I think in a similar way. At first, there is an initial denial because people felt that they were just going to continue to do what they were doing because they had some sources of liquidity. But then, I would say, at the end of September beginning of October after the markets had their initial fall, people realized that this was obviously much more serious and that the amount of liquidity that was available in the system literally evaporated overnight. Because banks were unwilling to extend any more credit, developers absolutely had no means of financing themselves. And so, again, as you would see in a less developed market like Russia, the things that were liquid, which were basically fixed income securities and equity securities, were the most damaged because they were the only source of liquidity where people could actually get some real cash.

I always like the expression in Russia [that says] people in the Western world do not understand … what real cash is. Russia [has] a very clear distinction between real cash and, if you will, theoretical cash. We live in the Western world on theoretical cash. Nobody has to worry about what is actual because they have credit and they have, if you will, confidence in the system.

But in Russia, everything is based upon actual cash — who actually has the cash, the money in the bank…. When people do not feel they have that, then they lose confidence and their ability to do business.

Knowledge at Wharton: Could you tell me a little bit about your own experience doing business in Russia. What are some of the main lessons for international companies that are trying to do business there?

Gardner: I have been in Russia now 15 years. I originally founded an investment bank together with some partners called Renaissance Capital in 1995. I did that business for eight years. We went through the crisis in 1998, had to restructure that business and basically [entirely] rebuild it. I left that in 2003 to start up MLP. During that time, obviously, I have been involved in a number of transactions. I have been involved with a number of partners. It comes back to what I talked about today [which] is there are five lessons or five rules by which I live in the market in Russia. They are not say rules per se but they are questions that I ask myself if I am looking to do business or work with somebody.

The first question is obviously the business model. What is being proposed? Is it realistic, is it not, are the assumptions that are there accurate? Is there presupposing something that is just theoretical that will never happen?

Secondly, is it scalable? Is the idea something that we can grow and we can replicate based upon the work that we do on the initial transaction. Many transactions in Russia are very much just singular transactions where you put in a lot of work, a lot of effort and you are going to get just a one-time return, whereas if you can grow something and you can expand on it, it is much more interesting.

The third question involves transparency. If you are trying to build the business and trying to create something that is sustainable, you want to be able to sell it, you want to be able to represent to somebody that there is something actually here. And so, in many cases, what you will find is a situation where there is some element of transparency which is lacking either in the title of the asset, as in the case of real estate, or the business is predicated on some relationship, etc. etc. And so you are going to have a problem at some point where that will not come to pass, and your whole business will basically falter on the basis of that.

The next two questions revolve primarily around management — if you have somebody on the ground who actually can manage your asset, can manage your interest. You cannot rely upon third parties, you cannot rely upon managing something in Moscow from New York or London. You have to be able to commit time and effort to keep that business alive.

And finally, how dependent are you on third party partners? Is your business something that will involve a joint venture or some type of extended relationship? And if so, how can you control that relationship or how you can minimize the amount of contact and the amount of work that you need to involve yourself with this third party. I think that any one of those questions is usually one of the faltering points in a situation where business goes bad and people lose money or break up with their partners.

Knowledge at Wharton: That is very interesting. I wonder in dealing with people who want to invest in Russia or want to do business there, what are some of the most common mistakes that people make about doing business in Russia? And in contrast to that, what are some of the most real risks of doing business?

Gardner: Again, I always say to people when they come to Russia, the first question is do you want to be in Russia, because I cannot answer that question, because the issues that surround being in Russia are political issues and general risks associated with emerging markets. People have to make that first step or that decision for themselves. They cannot rely upon anybody in the market or really anyone to educate them on those risks because I do not [think] anyone can measure those risks.

So if you can answer the first question saying I understand the risks, I understand the politics is uncertain, I understand the vagaries of working in emerging markets, and I put that to one side, then you have to ask yourself the next question which is, how do I work in this market? Because I understand there are all these problems but at the end of the day I am interested, I want to make a return, I want to make an investment. Then we go, if you will, back to those sorts of five questions because you can then say I can answer those questions but who do I work with? That is usually where I come in and say, okay, if you have made the decision to come into Russia and you want to do this, then you should work with me or I would like you to work with me because I believe I can answer all these questions and I can show you the level of transparency which you do not have with other people.

In many cases, a lot of people do not answer the first question correctly. They come in assuming that certain things are not the way they are and then they get involved in a complicated discussion about an investment and then they come back to the question of political risk. And you say, excuse me, before you came in the door, you should have answered that question for yourself, that political risk was no longer a consideration in terms of whether or not you were going to make this investment.

Again, this is a very common problem that people have. They do not really seriously consider the dynamics of an emerging market before they go in to make the investment. They are too focused on the total return and how it is going to look in terms of their overall investment portfolio. They have not really understood that first step.

Knowledge at Wharton: Considering the economic situation and some of the political changes that are taking place now in Russia and elsewhere in the world, where would you want MLP to be in the next 18 to 24 months?

Gardner: We have been really trying to position our business to sell it to a global strategic investor. The problem with our business is that as it grows larger and larger, there become fewer and fewer potential candidates to actually buy the business. On the positive side, we have got the financing to continue to grow the business but on the other side, as I said, with the demise of ProLogis and a few of the other large players, there are fewer and fewer candidates — which means that, for us, we have to rethink our business model in terms of how we organize our business and how we will actually go forward.

So for the next 18 months to 24 months, we will be reforming our model and be looking for longer-term capital that is comfortable with Russian risks and with that type of return.

Knowledge at Wharton: Bruce, thank you so much for joining us today.

Gardner: Thank you.