Development Magazine Winter 2011

Development - Ownership

Insider Info from Development ’11 - Forecast ’12: Recovering

Are we having fun yet? Just when the recovery seemed to be taking hold – particularly in more robust coastal markets – the summer of discontent and uncertainty began. But as many speakers at NAIOP’s recent Development ‘11 conference in Scottsdale assured attendees, fundamentals are improving, manufacturing has been growing in certain areas, and the likelihood of a double-dip recession seems remote.

Of course, the likelihood of a “V”-shaped recovery seems similarly remote. As Brian Nottage, executive director of JP Morgan Asset Management explained at the opening session on the economic outlook, “One of the lessons, with deleveraging, is that we don’t get a big bounce-back after recession. The last two recoveries were relatively jobless.” He predicted “slower below-trend growth for an extended period.”

Glenn Mueller, Ph.D, professor at the Franklin L. Burns School of Real Estate and Construction Management at the University of Denver, agreed, stating, “We’re in a 10 to 20 miles per hour recovery, not 60. I care more about employment than unemployment. If confidence returns, we’re up to 40 miles per hour.”

Hessam Nadji, senior vice president and managing director, Research and Advisory Services for Marcus & Millichap, moderated the session. Nadji presented a summary of “positives and headwinds” for the economy, saying the biggest cloud hanging over the economy was Greece and Europe. But among the bright spots: employment growth in Houston, Dallas, New York, Boston, Seattle, Phoenix, San Jose and Detroit.

NAIOP Medical Life Science National Forum

The Medical/Life Sciences Forum discusses the state of the healthcare industry and medical development at their inaugural meeting.

In a theme that echoed throughout the conference, the speakers observed that the economy -- as well as individual markets and Class A versus lesser-quality assets -- could be summed up as “a tale of two cities,” or a case of the haves and the have-nots. Nottage pointed out that high-income consumers have resumed spending; college graduates are faring much better than non-college graduates; and technology will be the sector defining the recovery. “It’s Tiffany versus Walmart. That portion of the economy with weak balance sheets will impact the economy. We continue to like Boston, San Francisco and New York City. People have been far too optimistic about Washington, D.C. real estate. Occupy Wall Street notwithstanding, New York will find a way to latch onto the next bubble.”

For secondary markets and B quality assets, CMBS has been a major factor in the past. It was, as Dr. Mueller noted, “the best financial innovation to come along in decades. Now we need to tinker with it. Derivatives created problems that overhang the market.” Nottage explained that with U.S. GDP growth at 1 ½ percent, we may not have another recession, but the economy is susceptible to shocks. The oversupply of housing doesn’t help either; Dr. Mueller predicted that housing will not come back to “some form of balance” until 2016.

Strategic Asset Management and Positioning

How should developers, owners and asset managers grow their businesses, maximize the potential of what they own and find opportunities in a climate of slow growth? Patrick Devine, first vice president, Brokerage Services/Office Group at CBRE, noted “In Phoenix we’re definitely seeing signs of recovery this year. We have six times the absorption of last year. But we still have a 26 percent vacancy rate. Most absorption is in Class A space.”

Kurt Rosene, senior vice president of the Alter Group, agreed that there has been a flight to quality. “Almost everything in our portfolio was built within the last five to 10 years. We sold off some big industrial product, some office.” The company’s strategy is to court creditworthy tenants. “We have vacancies because we are waiting for the right tenants, to hold value.”

Albert Corr, senior vice president of KTR Capital Partners, commented, “We’ll ‘white box’ a particular space so that if a tenant moves out, you can move in a new one quickly.” Devine concurred, advising, “For less than 5,000 square feet, get it ready to go. You want to be competitive for smaller tenants. For larger deals, there is a disconnect between asking rents and what gets signed.”  

Attendees at a Development ’11 session

Development ‘11 attendees learn about the many benefits, resources and educational opportunities that NAIOP offers, along with how to get involved on corporate committees.

Tenants today want maximum flexibility, the panelists said. That means requesting to decrease or reconfigure their space, or to cancel their lease. Devine remarked, “We try not to concede on the more onerous provisions and never compromise on credit.”

Rosene explained, “We did three-year deals,” adding wryly, “We thought we would be out this mess by now. We’re back to seeing long term leases.” Panelists also agreed that leases take longer to achieve these days. Asked by moderator Craig Tagen, managing director and head of asset management for Clarion Partners, how to get to the finish line, Corr said, “We try to streamline the process, get all hands on deck and work as a team.”

Paul Torosian, executive director of Cushman & Wakefield, remarked, “The broker’s role in the current climate is to keep owners from being too aggressive. We’re trying to be very strategic, understand what levers the prospective tenant has and focus on getting better rents.”

When Tagen asked the panelists what they might have done differently, looking back, Rosene said, “Building on the periphery. That’s the first thing that gets hurt. We’re looking at urban infill; it works better.” Torosian noted that several New Jersey clients are sitting with brownfields parcels. “While those acquisitions seemed strategic, it took way longer than they thought it would to get development under way and the carry costs are higher than they thought.”

Several panelists reported that spec building has not disappeared from the landscape totally. One or two big boxes are planned for the Phoenix area, and the Alter Group is pursuing spec office in several markets around the country. Torosian commented, “Tenants are out in the market,” along the New Jersey Turnpike and into Pennsylvania, but cautioned, “Spec works well if everyone has discipline. Whether rents are supportable is debatable.”

CEO Insight Session with Philip Hawkins and Thomas Roberts

Moderator John Guinee III, managing director, Stifel Nicolaus, drills down on investment strategies, downside planning and the cost of capital with Philip Hawkins, president and CEO, DCT Industrial Trust and Thomas Roberts, executive vice president and head of real estate investments, Cole Real Estate Investments.

Corr noted, “Over the past 18 months rents didn’t justify new building,” but KTR is now looking at land parcels in South Florida, Los Angeles and New Jersey.

Asked for their outlook for 2012, the panelists were uniformly “cautiously optimistic.” Rosene said, “It will be a couple of years before we realize profits from deals today. I’m not sure we’re out of the woods yet.”

Raising Equity for Your Business

Four pros offered their take on “Fueling Your Business for Growth: Raising Equity”: John Thomas, chief investment officer, Panattoni Development Company; Robert (Bob) J. Walter, senior vice president - capital markets, First Industrial Realty Trust, Inc.; Tom Grier, managing director, JP Morgan; and Jeffrey A. Scott, senior managing director, Eastdil Secured.

As for who is able to raise equity, Tom Grier said: “If you look back over the past couple of years, it is pretty apparent who has been raising most of the capital. Public companies have been the beneficiaries of transparency. In 2009, they raised $25 billion of equity capital; in 2010 they raised another $25 billion; and in 2011 they will raise $20 billion in equity capital.”

There are two key elements when it comes to raising capital, according to Bob Walter. The first is access and the second is cost. “The last couple of years have taught us and others that access to the capital markets is key. You may not like the pricing, but when you need it you have it.”

Conference attendees network

Breaks between concurrent sessions provide opportunities to strategize on current market issues and industry challenges.

Real estate is attracting capital because there are few other games in town. Jeff Scott commented: “What we are hearing from CIOs of large pension funds in North America is that they are supposed to produce eight percent actuarial returns. But in this environment, Treasuries are 2.0-2.5 percent and the bond market is indicating that it will not get above three percent for four to five years. We all know what the stock market has done over the past 10 years: if you put $100 in the stock market 10 years ago, you would have $100 today. So you look at real estate with a current return of four to six percent and a good shot—with some degree of leverage-–to make eight to 10 percent. This explains a lot of the capital flow in.” 

What to Do About the Recap Gap

What about all the properties – particularly those in secondary and tertiary markets, that once depended on CMBS for debt financing — whose loans may be coming due in the next several years? Even if banks or insurance companies are willing to restructure loans, more capital investment will be required. So, not surprisingly, among the panelists at Development ’11 whose businesses are bustling were investment managers whose funds provide mezzanine debt, preferred equity and other types of gap financing.

At a session on “What to Do About the Recap Gap,” Mark Witt, managing director, Pearlmark Real Estate Partners; and Chris LaBianca, president, RCG Longview, outlined how borrowers can get from a 60 percent to 80 percent LTV. Both said every situation is different, and they can be extremely flexible in structuring financing. Neither wanted to be in the “loan-to-own” business. “The last thing we want to do is foreclose,” said LaBianca, noting that some of RCG’s best deals were done in 2009. These funds achieve high current returns, typically in the low to mid-teens. Terms are typically for three to five years at an interest rate in the 10 ½ to 12 percent range. There are also points to be paid up front and at the back end.

Distressed Real Estate panel speakers

The Distressed Real Estate: Where Are the Opportunities? panel discusses special servicers and the kinds of deals developers are structuring in today’s market.

Pearlmark lends in the $4-$5 million to $25 million range. They want to understand the borrower, know the real estate story. For RCG, there are three important metrics: Debt yield, asset basis and loan-to-cost ratio. They will go anywhere in the lower 48 states and have done transactions in North Dakota, Peoria, Louisville, Queens, New York, and Los Angeles. Pearlmark will go anywhere in the U.S. and lend on all property types except condominiums.

Asked where he expects RCG to be in a year, LaBianca commented, “We’re a small fund, and it’s still a big market. In the past six months, with the capital markets disruption, portfolio lenders are the lenders of choice. That leaves room for our product.” The fund has good deal flow in the $3 to $10 million range and $300 million yet to deploy from its current fund.

“Extend and pretend is ending,” he said. “Values haven’t recovered dramatically. So opportunities are real over the next two to three years. Loans that have been extended are running out of options.”

How the Office Market Is Faring

Karl Rove and conference attendees

NAIOP’s annual meeting provides engaging access to leaders in business and government such as political strategist and author Karl Rove who enjoys some conversation with conference attendees before giving his keynote address.

While the office market lags other major property types, there is no shortage of capital for high quality assets. At a session on the state of the office market, Al Pontius, senior vice  president/managing director, Marcus & Millichap Investment Services; Bill Rogalla, senior vice president/director of acquisitions - central United States, KBS Realty Advisors; Brian McAuliffe, head of transactions - America, RREEF; and James Street, vice president, transactions, Prudential Real Estate Investors, explained what is happening in the office market today.

The bottom line, according to these experts, is that office fundamentals are actually better than all of the negativity would indicate. Remarked Al Pontius: “We have had a very nice rebound in transaction activity quarter-to-quarter. Right now, from an office point of view, we are at about a 2003 level. Some might say, ‘Wow, we have a long way to go.’ I want to point out that 2003 was a record year at the time. To be at a 2003 level and away from a 2009 level is movement. Los Angeles, Dallas and Washington, D.C. are at the top of the transaction count list. In terms of aggregate dollar volume, you have New York, Washington, D.C. and Boston.”

Opportunity Knocks: Meeting the Changing Needs of Industrial End Users

cost of industrial spec building chart

From a construction cost standpoint, now is a great time to build, according to Jeffrey A. Raday, P.E., president, McShane Construction Company, who compared costs at a Development ’11 session.

At a session on meeting the needs of today’s industrial end user, it was clear the growth of online retail sales is creating fresh opportunity, according to Jeffrey Turner, executive vice president/south and west regions, Duke Realty Corporation; Douglas Den Adel, executive vice president, Jacobson Companies; Matthew Powers, senior real estate manager, Walmart Realty; and Mark DeFabis, president/CEO, Integrated Distribution Services, Inc. The speakers said that while brick and mortar retail sales are down, e-commerce buyers increased 16 percent in the second quarter. Mark DeFabis said: “The Internet is continuing to be dominated by middle market companies. More than half of the top 500 e-commerce retailers have less than $50 million in sales.”

Defabis noted that many of these companies with between $5 million and $30 million in sales have core expertise outside of supply chain management. “It means that there will be a continued demand for logistics services for this market segment,” he said. “Continued development of multiple e-commerce channels will require unique services such as drop shipping and packaging. Traditional logistics companies need to adapt to the flexibility, seasonality and multiple product configurations that you see in the direct selling segment.”

2011 Developing Leaders Award Winners

Chairman Alex Klatskin with the 2011 Developing Leader Award Winners.

Why You Have to Push the Envelope

Perhaps the last word should go to the famed sports owner (and now developer) Jerry Colangelo, who was a keynote speaker and offered the real estate professionals in attendance some sage advice on going forward in the business:

“I spoke to a group of real estate people recently and I was surprised to feel the pessimism in that room,” he said. “Everyone is aware of all of the news we receive every day and it is pretty negative. Economists are saying that this last decade was terrible; some are saying the next decade will be just as bad. I don’t buy it; I don’t believe them. We need more people that feel that way to make a change.

Public-Private Partnerships panel speakers

Meeting attendees benefit from one-on-one interaction with industry leaders, including former Pennsylvania Governor Edward Rendell (left), a panelist on the Public-Private Partnerships in Trying Times panel.

“When they say that the turnaround in real estate will take place six years from now, I say that doesn’t have to be. I understand supply; I understand all of that, but it is a self-fulfilling prophecy. If there is anyone who needs to be optimistic, it is you, the real estate professional. You can make the difference, you can push the envelope. You can make things happen. Don’t be afraid to take the risk. Don’t wait for the guarantees. Make a difference.”

From the Archives: Development Ownership Articles from the Previous Issue

Ford Motor Company Campus

2011 Developer of the Year – CenterPoint Properties: At the Center of Hub-Based Intermodal Development 

The downside of a real estate cycle is no picnic, but it is often the time when the best-managed, best-focused companies gain market share and emerge stronger as the economy heals. Such a company is Oak Brook, Illinois-based CenterPoint Properties.

700 Sixth Street exterior view

700 Sixth Street: A Strategic and Adaptive Blend 

In July 2009, 700 Sixth Street opened with a ribbon-cutting celebrating not only the completion of a project but a vision brought to life. Washington, D.C.’s Mayor, officials from the city’s economic development and environmental agencies, the project’s Tokyo investor, and its lead tenant were all in attendance.