Changing Market Demands New Approaches

By STEVE KALABANY and BO PECK
Integrated Real Estate Services

Last year was a terrific time for the Pacific Northwest commercial real estate market and, by all accounts, 1997 forecasts call for continued steady expansion. Our vigorous local economy is sustaining unprecedented growth in regional employment, industry and population.

Boeing and Microsoft have clearly led the employment boom together they have added about 20,000 new workers to their combined payrolls during the past year. According to Economist Dick Conway, if they add between 20,000-30,000 new jobs to the region by the end of the decade as expected, overall employment in the greater Seattle area will grow by about 3 percent annually. Research studies have indicated that approximately 2.8 new jobs are created for every new Boeing position alone. This multiplier effect will have a tremendous positive impact on the local economy, which will further stimulate acquisition and new development activity.

This growth has and will continue to result in substantial increases in demand for office, industrial high-tech, retail, and residential real estate. Vacancy rates are steadily decreasing across the board to near record lows: downtown Seattle office is below 6 percent; Bellevue office is at 4.1 percent; Kent Valley Industrial is at 5.5 percent and regional apartment vacancies have fallen to 4.4 percent, a six-year low.

Absorption is expected to remain strong as high-tech continues its explosive growth and many tenants scramble to secure longer term leases in order to minimize the adverse effects of dwindling supply and escalating rates.

Office and industrial rents are predicted to increase 10-20 percent during 1997, apartment rents should increase by 10 percent this year and 12 percent next year, and housing prices are expected to increase approximately 10 to 15 percent in each of the next two years.

All of this robust activity is creating enormous demand for more sophisticated and specialized property management and advisory services. As a result, the role of a property manager has evolved well beyond its traditional definitions. Today's effective property management professionals bear less and less resemblance to their forerunners. Competent managers are shrewd business strategists, intimately familiar with their client's properties and all aspects of the market(s) in which they are located. They need to function not only as managers, but as accountants, financial analysts, tax advisors, brokers and visionaries all rolled into one seamless package.

Now is the time for owners and investors to take advantage of this hot market. Engaging the right managers will increase property performance by providing creative, non-traditional approaches to property management, such as focusing 75 percent of their attention on revenue and only 25 percent on expenses (as opposed to the reverse), strategically laddering lease expirations, effectively utilizing available technologies, more detailed evaluation of a prospect's business and financial strengths, and a firm grasp of the overall tax implications of major property related decisions.

Property managers have historically focused the majority of their attention on minimizing operating expenses, resulting in expense levels that are generally as low as can be reasonably expected. A more effective strategy today is to spend more time identifying opportunities to increase gross income, while still keeping a watchful eye on expenses.

Laddering lease expirations is an innovative method of maximizing value in strong markets and minimizing exposure in weak markets. If lease expirations are evenly staggered at the rate of approximately 25-30 percent per year, a property's performance will be significantly enhanced over the long term.

Advanced in technology have given managers access to vast quantities of data. However, managers need the skill and experience to distill, analyze and convey meaningful information.

In any market, it is incumbent on the manager to not only review and evaluate a potential tenant's financial profile, but to thoroughly understand all aspects of the prospect's business and its position in the marketplace. Applying evaluation skills and market knowledge prior to signing a lease will have a positive impact on the performance of the asset.

Finally, managers must have the capability to understand the impact of major decisions on the owner's overall tax position. Decisions involving whether to expense or capitalize expenditures, treatment of tenant improvement costs and other major capital improvement decisions have serious tax consequences that require thorough evaluation.

In addition to the above, today's managers need to be award of how new technologies and evolving business practices are impacting the "traditional" utilization of commercial real estate at the user level. Large and small corporations alike are becoming more and more fixated on bottom-line economics, striving to minimize expenses and maximize efficiencies and profit. Examples of how corporate paradigm shifts are influencing the conventional use of commercial real estate include downsizing, telecommuting and office hoteling. Without the advice of a skilled manager, all of these changes can impair an owner's ability to accurately project long-term revenues, assemble practical leasing strategies and ultimately, increase income and value.

Another example of change is in the explosive growth of high-tech businesses throughout the region. Their requirement for highly flexible lease terms and specialized tenant improvements poses a dilemma for owners, who may be faced with investing substantial sums on specialized tenant improvements which may not be adaptable to other types of uses, only to have the tenant go out of business due to unanticipated changes in their markets and before the investment is fully amortized. In addition, their typically high staffing densities can increase operating expenses and wear and tear on a facility.

Property managers today must use the broad range of resources and technologies available in order to realize maximum growth in income and property values. Understanding changing market and business trends is essential in achieving that objective.

The need to thoroughly evaluate all aspects of a commercial transaction, from a prospect's credit worthiness to how proposed lease terms will impact a property's long-range leasing objectives, is more critical than ever.

The best property managers possess an ardent entrepreneurial spirit, which allows them to evaluate markets, identify opportunities and make business decisions as if their own assets were at stake.

Bo Peck and Steve Kalabany are principals at Integrated Real Estate Services, a new commercial real estate management and consulting firm, combining property management, leasing and brokerage services with tax planning, tax preparation and financial reporting services.