Industry in ’09: Take a Deep, Cleansing Breath; And Look for Opportunities in Dislocation

[ By Ellen Rand and Ron Derven ]

2009 will bring many changes including a new NAIOP Chairman as 2008 NAIOP Chairman Alan J. Beaudette (left) passes the leadership gavel to incoming Chairman, Douglas Howe.

Is this a repeat of the early seventies? The early nineties? Something entirely different? There may not have been a consensus among speakers and attendees at NAIOP’s recent development ’08 conference in Las Vegas, but there was an abundance of reflection – and a sobering resolve to both batten down the hatches and look for opportunities for what is roundly expected to be a very bumpy 2009.

As for the glory days of the middle of the decade, conferees were equally wistful, chastened and as fervent as the newly temperate that a more sensible, back-to-fundamentals approach to financing, acquisitions and development has at last taken hold.

Seasoned developers and owners sought to counsel younger industry members – who may not have experienced a major downturn yet in their careers – that every cloud has its silver lining. Incoming NAIOP chairman Douglas Howe, speaking at the Chairman’s Breakfast, for example, pointed out that “This is a challenging and opportune time in our industry. The industry has the ability to remain solvent.” He said NAIOP would focus on “G4” [Green, Global, Government Affairs and Greatness] to move the industry forward in 2009.

Las Vegas provides an exciting backdrop for conversing with colleagues and information exchange between various industry professionals.

Al Beaudette, outgoing chairman of NAIOP for 2008, also speaking at the Chairman’s Breakfast, addressed younger members of the audience with a message to find opportunities in the current market. Some of the major successes in the industry started their businesses in ’90 and ’91. “Money is made in our industry when the market is going up or down, not when it’s level,” he said.

Bob Sulentic, group president, Asia Pacific and Development Services for CB Richard Ellis, the keynote speaker on “The Past, Present and Future – An In-Depth Review of Commercial Real Estate,” asserted that “this is a great time to be in real estate and the services business.” He explained that not only do economies tend to cycle in unison, but also all product types in the industry tend to cycle together, in synch with the world economy. This year, there has been a 50 percent decline in the value of sales transactions around the world. South America, Africa and Asia are growing much more rapidly than mature economies but growth is slowing down everywhere.

Sulentic noted that “the picture is not pretty, and probably worse than 2000, but not as bad as 1991 to 1993. In 1992 the delinquency rate on office loans was higher than nine percent, representing one of the great asset buying opportunities. Dire times are the beginning of great times.”

Currently, there is “a lot of uncertainty about where this will end,” he said. Will there be eight percent unemployment? We may have gone from an overabundance of credit to a dearth, but not as bad as 1991 to 1993. He also pointed out that there has been a 75 percent year-to-date drop in office sales in the U.S. Office rents are coming down in the U.S. and around the world, including Asia. Construction costs are 165 percent of what they had been in 1998.

“We got through that with cap rate declines, not rent rate increases,” he said. “Now cap rates are rising and will call development into question. There won’t be new development for the next two to three years. But we will need to get ready. The services business will be characterized by consolidation and globalization.” This year, he noted, for the first six months, service companies’ revenues will be roughly the same as in 2002.

development ’08 attendees, representing the diverse face of the development industry, take advantage of networking discussions including time with industry veterans in between information sessions.

“Uncertainty makes things seem worse,” commented Sulentic, likening the yearning to know when the economy will start improving to being sick, or taking finals, or jogging along an unfamiliar road, not knowing when they will end. “We must run our businesses, capitalize conservatively and manage cost structures on a conservative basis,” he advised, concluding that we should “feel good because when we’re in bad times is when we’re about to have good times.” Dr. Peter Linneman, principal of Linneman Associates, speaking at the Developer of the Year luncheon, addressed the key question hanging in the air: “Is this the worst ever?” Probably not, he suggested, stating that in the last 40 years, there have been five recessions and a difficult 2001. By 15 measures of the economy, the period from 1973 to 1975 was the worst. Then again, “the movie may have just started,” he said, referring to the current economic climate, which has affected all sectors.

For some time, Dr. Linneman had been predicting a recession in 2009 because of government policy errors; hubris on the part of the business community; and enormous political uncertainty. He observed, “The Federal Reserve is no better at its job than you are at yours,” adding that “six weeks ago we had the culmination of 10 years of awful bipartisan leadership.” When the stock market tanked after Round One of the TARP legislation failed, the market understood: “There’s no one home,” he said. The crisis was a result of “complete lack of confidence based on complete lack of transparency.” The answer: “Open kimonos. Disclose every asset and liability. What we need is solvency and transparency.”

Quintin Primo, chairman and CEO, Capri Capital, discusses how demographic shifts and trends from other cultures will change “business as usual” in the future.

Dr. Linneman noted that “we’re in a minefield of losses,” explaining that if you’re in a minefield your tendency is to stop or panic. “Most of us have just stopped,” he said. “But in the U.S. economy, if we stop we drift backward. It’s fair to say our government panicked. A great leader would calm the troops and find the mines. We’re going to lose a million jobs in six or eight months and we still don’t know who’s solvent.”

The good news is that the country is growing by three million people a year, thanks to more births than deaths, and immigration. He has great faith that although consumers have tightened their belts, they will return. Linneman also believes that we won’t know for a long time if financial institutions’ mortgage-backed securities and other losses are real losses or not. Losses could amount to a half-trillion dollars to three times that amount representing “a half a day a year for five years to pay off, a small price to pay in a $14 trillion economy. We will get out of the minefield, but it will take transparency.”

Peter Linneman, principal, Linneman Associates, gives an entertaining and informative look at the state of economy telling the audience, “There’s alot of bad news in the near term but we will get out of the minefield and ultimately things will turn around.”

“The economy will return; it always does,” he said. What to do in the meantime? Don’t expect any help from the capital markets for the next six to 12 months, or from the demand side of the real estate equation, for that matter. Work on your assets, he advised.

Going Green to Remain Strong Trend
Regardless of the state of the economy, the trend toward building green will continue to strengthen. Rebecca Flora, executive committee chair of the U.S. Green Building Council and executive director of the Green Building Alliance, noted that the majority of attendees at the Green Development Award Breakfast session indicated working on some form of green development. “The next new frontier is existing buildings,” she noted.

The LEED for Existing Buildings: Operations & Maintenance Rating System provides a tool for building owners, managers and practitioners to maximize the operational efficiency of their buildings, while minimizing environmental impacts. In addition, the new LEED for Existing Buildings: Operations & Maintenance Reference Guide provides a section overview for each credit category, the number of points per credit, summaries of referenced standards, recommended operational strategies and technologies, potential design synergies and trade-offs, submittal documentation lists, calculation methods and formulas, environmental and economic issues, resources, definitions, and case studies.

Educational session participants enjoyed interactive panel discussions on a broad range of topics such as capital markets, emerging port cities and industrial redevelopment.

In January 2009, LEED for Existing Buildings: Operations & Maintenance will be aligned with the other long-standing LEED rating systems. USGBC will publish a new version of the reference guide that will incorporate the version 2009 point and percentage scales.

Greg O’Brien, LEED AP, senior vice president, Transwestern, Atlanta, commented, “There is a widely accepted definition of green that now includes not only design and construction but also maintenance practices that significantly reduce or eliminate the impact of buildings on the environment.

O’Brien said that sustainability is the key to present and future development due to critical population issues: “When my grandparents were born at the turn of the last century, there were fewer than two billion people on the planet. By the time my grandchildren are born, there will be six billion additional people. With that kind of population coming, it screams out to us that we must all be as sustainable as we can be.”

And Speaking of Population Growth…
The need for greater diversity in the workplace in general and in commercial real estate in particular is not only the right thing to do but it will be demanded by powerful demographic trends in the not-too-distant future. According to Quintin Primo, chairman and chief executive officer, Capri Capital, Chicago, Ill., there are nearly 6.7 billion people in the world today including 1.3 billion Chinese, 1.1 billion Indian, 1.8 billion Muslims and 2.1 billion Christians.

Moderator Scott Beggs leads a panel of entrepreneurs who shared lessons learned and valuable insights in the session on starting your own development company. From left: Brad Logan, Steven Schwarz, Steven McCraney II and moderator Scott Beggs.

“The growth rate of people of color in the world is extraordinary in terms of population growth,” noted Primo. “Clearly, over the next 32 years that 6.7 - 6.9 billion number will grow to nine billion. Here in the United States similar demographics are found. Today we have approximately 305 million people and by 2050 that number will grow by 120 million. Approximately 90 percent of that growth will be Latino, African-American and Asian. By 2050, over half of the U.S. population will be groups that are currently under-represented. It will have significant impact on our workforce. In fact, our workforce will be largely people of color.”

He said that organizations that do not make an effort to diversify their work forces and reflect the broader trends of society will have a tougher time doing business with many of the larger companies and institutions in the U.S. in the future.

Emerging Port Cities
Changing trends and the evolution of where products are manufactured and how they get to the consumer are constantly creating new opportunities for real estate developers. One major rising trend is the opening of the Panama Canal in 2014-2015. In speaking about emerging port cities in the U.S. and supply chain evolution, Steve Crosby, president, CSX Property, Jacksonville, Fla., said that indeed, the opening of the new Panama Canal will be the biggest event over the next several years. “That will allow much larger ships to get to the East Coast,” he said. “Since the East Coast is the primary consumption base in the country, it is expected that the East Coast ports will grow dramatically. For example, there are a number of port facilities with small population bases like Charleston, Savannah, Norfolk and Jacksonville, so a lot of freight will land in those places but have to be shipped to other locations. The big question for real estate is how much of that freight will stay in those markets long enough that it has to stay in built space or some value-added activity.”

Curtis Spencer, president, IMS Worldwide Inc., Houston, Texas, said that it is great to have a port strategy but no distribution center is ever going to get built because of the port. He explained that part of the difficulty of a port strategy for many developers is to determine how much of the goods coming into the port go through that port and end up somewhere else. “So the real strategy should be where does the box get opened, not where does it go to a port,” he asserted. Aaron Paris, chairman and CEO, Paris Development II, Chicago, warned developers that looking ahead to 2014-2015 may seem like the distant future but it is actually sooner than you think: “When you think about the new Panama Canal opening in 2014-2015, it is a long time away, why should I even be concerned about it? That is five or six years away and when you think about purchasing property, getting it entitled and building the structure, you get close to that date.”

Opportunities in Ground Leases
In tough times like these, it is often difficult to find good development deals and some developers are opting instead to go with unique structured deals such as ground leases on publicly owned land or Indian tribal land. James S. Backer, president, JSB Development Inc.; Daniel Corfee, partner, Preferred Capital Advisors; Kevin M. Ehrhart, partner, Allen Matkins; and Kurt Rosene, senior vice president, The Alter Group, noted that these unique structures can become very complicated and drawn-out but they also provide significant opportunities in softer and tighter markets.

Ehrhart was asked why a land owner would choose to ground lease instead of selling the land outright and why the lessee would agree to the ground lease rather than buying land. “The majority of land lease deals we see are typically with a university, a government agency, or a foundation—somebody who is counting on a relatively stable income stream over a long period of time. They are not developers themselves so they want to work with a developer. Usually they are not in the market to sell the land. If they are, typically the price is not attractive to the developer.”