Capital sources are forever changing real estate industry

By GARY CARPENTER
Bentall

By the time the millennium clock turns in the year 2000, globalization of the economy brought on by the "Technological Revolution" will forever change the way we live, play and work. For the commercial real estate industry, it means that what used to be the lifeblood of our industry -- local relationships, local knowledge and local banking -- will be of little or no advantage.

Prior to the 1980s, real estate investment was primarily local. A local real estate professional met a local company executive at the golf course, they developed a relationship and when the executive needed space he called his friend. The local professional had great local market information, financial savvy and probably a local banking relationship.

These tried and true ways of doing business are no longer the advantage one needs to succeed. In fact, for the most part, they are obsolete. Today development, ownership and tenancy are influenced by technology and global events that have little to do with the old ways of making decisions.

Globalization of business will dramatically increase demand for space in the Northwest. Photo by Sky-Pix

Technology has greatly impacted information with increased capacity, availability and audience. No matter where you are around the world, you have access to information through your PC at any time. The information is more reliable than ever before because there are significantly more checks and balances within the available databases and nearly anyone can access and/or contribute to the growing wealth of available information.

It has been said that real estate deals happen because one or both parties have a lack of information. This simply is not going to be the case in the future.

In addition, technology has sped up the decision-making process. Today, the business cycle doesn't stop -- it goes on seven days a week, 24 hours a day. Stock markets are always open somewhere in the world and money trades 24 hours a day.

A new wave of liquidity

Like technology, traditional financing and management of real estate has turned a corner that will not be rounded again. We are now in the infancy of a new wave of liquidity in the real estate business. Mortgage-backed securities and real estate investment trusts (REITs) are two financial vehicles that are rapidly changing real estate ownership.

Life insurance companies historically have been the backbone for debt capital, but Wall Street has provided a much more efficient way to provide the necessary dollars. Mortgage-backed securities accounted for $27 billion in debt in 1996. In 1997, $144 billion was placed. Although the amount of money seems significant, it pales in comparison to the total commercial real estate debt in the U. S. However, the total dollars and the exponential increases each year are not the real story.

Insurance companies are finding it much more efficient and less costly to hold debt securities rather than real estate loans. Why keep a large and costly real estate organization in place to administer loans and monitor properties when you can simply own and trade securities?

A substantial flow of this new securitized debt is going out the "back door" of insurance companies as product for Wall Street securitization. These companies are selling and packaging their own existing loans and buying them back as a security for their existing investment stock portfolios. The pace and volume will continue as all institutional investors fill their appetite for these mortgage-backed securities.

The REIT revolution

With 200 REITs nationwide and market capitalization that has risen from $8 billion in 1990 to $120 billion today, REITs are likely having the single most significant impact on real estate financing. The public real estate market is a phenomenon of revolutionary proportions.

The current growth of REITs in the $3 trillion commercial real estate market seems to have no bounds. Mark Decker, former president and CEO of the National Association of Real Estate Investment Trusts, predicts that by the year 2006, the market capitalization for all REITs will be $500 billion and REITs will have $700 billion to $800 billion in total real estate assets.

The growth of REITs has helped fuel the already competitive natures of the strong real estate market in the U.S. At the same time that REITs are searching for product, prices have been moving up and cap rates moving down.

Traditional purchasers of real estate (life insurance companies, corporations and investors) have either been left out of the process or come up short on price when bidding against REITs. As the search for product heats up, we see them buying large portfolios or simply swapping their stock for traditional real estate companies stock to gain control of product.

As product becomes scarce, the trend is moving towards the merger of REITs to provide for a greater liquidity. In addition to mortgage-backed securities, we're seeing insurance companies purchasing REIT stocks as an efficient way to hold real estate as an investment in their large stock portfolios.

In 1990 REITs were 90 percent owned by retail investors, today institutions have more than 50 percent ownership. And 95 percent of their income is distributed for the benefit of no corporate tax.

Locally, this means we will continue to see major changes in our area, including new and diverse ownership of our once locally coveted real estate market. Our growth will be slowed only by our inability to cope with it.

Residential demand will continue to increase and will be met with higher density housing both in Seattle and on the Eastside. As our infrastructure needs continue to lag behind our business needs, the lack of transportation links between Seattle and the Eastside will cause two highly distinct and separate economic bases to emerge.

And as the globalization of business proceeds we will continue to see the demand for space in the Northwest that is far beyond our current radar screens.

Copyright © 1998 Seattle Daily Journal of Commerce.