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December 10, 2010
Five prominent CBA members joined me for a roundtable recently to share some insight into where the commercial real estate market is heading and how they have been handling the difficult economy. They included: John R. Miller, senior managing director at Cushman & Wakefield - Commerce in Seattle; Craig E. Hill, senior vice president at Grubb & Ellis Co. in Seattle; Les Boudwin, principal at Pacific Real Estate Partners in Bellevue; James L. Bowles, senior managing director at CB Richard Ellis in Seattle; and Peter Truex, senior managing director at Colliers International in Seattle.
(Editor's note: This story has been changed. John Miller is the head of Cushman & Wakefield - Commerce, not CB Richard Ellis.)
1. If not for this difficult economic climate, what is the most difficult obstacle facing our industry?
MILLER: Outside of the economy, the lack of young talent in the industry is a growing problem. We’re committed to hiring young prospective brokers, yet our colleges are experiencing a lower demand in students interested in pursuing a real estate career. Students are gravitating to the high-tech sector out of college, which is perceived to have more abundant and higher-paying jobs. That said, I’d say 99 percent of the obstacles facing our industry are economically driven from the banks imposing strict underwriting guidelines to the municipalities looking for new ways to close budget gaps through taxation.
HILL: If you strip away the economy, I suppose you’re left with the competition and where the industry is going. Has information become a commodity? If so, we are now in the consulting business, trying to add value by offering more service for less fee.
BOUDWIN: The lack of available financing is one of the most difficult obstacles facing our industry today. This lack of capital affects any ground-up, new developments that might be in the pipeline, any facility purchases that might be attractive to users and investors alike. It also affects, in a different way, the ongoing businesses that are the tenants in these projects. For the real estate industry, it is not only the lack of sources of capital but, more specifically, the more stringent terms associated with borrowing this capital that makes our industry stall. For our tenants, simple needs like ongoing lines of credit necessary to run a business are negatively affected by this same lack of capital and tougher terms.
BOWLES: Our biggest challenge is predicting what the future holds and positioning for the expected recovery. We anticipate that developers, lenders, investors and users will carry out their commercial real estate requirements in a different manner no more “business as usual.” Our challenge is to anticipate what the “new normal” is and adequately adjust to service our customers’ needs as they respond to the market and new opportunities.
TRUEX: One of the major challenges facing the industry is how we approach and manage growth in our region. The Puget Sound area is a fabulous place to live and work. Employment spikes will begin whittling away at the region’s existing residential and commercial property inventory woes and new construction will begin.
Because of this recession, we know just how vulnerable a growing regional economy is and our industry needs to band together and work with local government to facilitate and encourage growth in a responsible manner. Together we need to streamline the entitlement and permitting process to facilitate development when and where it’s needed. Sustainable development practices are in place and industry leadership is committed to building projects with the long view in mind, and it’s incumbent on our governments to ease the process rather than continue to make it difficult and expensive.
Our region’s governments need to refresh their approach to entitlement and regulation by acknowledging how vital construction and development are to our basic economic health, and to make it easier and speedier to hire people and build buildings.
2. What trends indicate that it’s no longer business as usual?
MILLER: We’ve experienced a significant reset in pricing that, in some cases, reflect sales pricing or lease returns consistent with deals completed 20 years ago. In fact, there are certain markets that are doing effective rent deals at less than $10 per square foot with at least an eight-year payback in an effort to create activity. We’ve also seen an inordinate amount of potential lease deals collapse after they’ve been fully negotiated and ready for signature, reflecting the hesitancy of companies wanting to make long-term commitments in this economy.
HILL: Technology and easy access to information was once the gold of those in the brokerage business who worked hard and developed the knowledge that drove their business. Today there is so much accessible information and so many resources that you need to work harder to differentiate yourself from the competition by providing unique service.
BOUDWIN: The fact that new construction has dried up completely is a huge indicator that it is not business as usual. The absence of new construction affects the trades, which have no work for their craftsman; it affects the architects and engineers, who have no large-scale new projects to work on; it affects the landlord of an existing building, who on the one hand is happy to have no new supply with which to compete, and, on the other hand, is worried that the building-supply tenant in his facility might go out of business.
Even stranger, venerable, 5-star real estate developers like Opus are gone. Those developers that remain today have cut staff and are trying to re-invent themselves as their projects dry up.
BOWLES: Nearly everything has been altered. New, more-restrictive financing requirements are in place, new construction is minimal, there have been significant changes in the developer ranks, and bank-owned properties are often selling at prices below replacement costs. At the same time, we are seeing institutional investors with renewed interest in fully-leased Class A properties that are selling at relatively low cap rates and tenants who are renewing leases well in advance of their expiration date.
TRUEX: The most apparent is the difficulty in securing debt capital. Specifically, money for commercial real estate loans to fund everything from investment sales to tenant improvements. Capital is the fuel that powers the real estate market engine. Investors need to be able to borrow money to make acquisitions, developers need to borrow money to fund new construction as well as provide tenant improvements for new and existing tenants, and users need to borrow money to fund purchases of new equipment.
3. How are brokers running their businesses differently today than two to three years ago?
MILLER: We find that our clients are demanding more expertise and our brokers are utilizing our platform of services more than ever before. Whether it’s our financial consultants, our distressed assets resolution group, our project managers, or our research team, the brokers are leveraging them more to win and retain business.
HILL: Teaming is one of the major changes. It’s very difficult to be a lone gunslinger today. I can only think of one individual in the market that is at the top of the stack, who basically works alone. Additionally, specialization is a major change. It’s very difficult to succeed today, without being a specialist.
BOUDWIN: Brokers need to get back to the basics today more than ever. The focus needs to be on re-visiting your old clients and keeping in touch with your current clients as new business is hard to identify in this difficult recession. Teaming with a solid, veteran team of senior brokers is key for new broker candidates. This is too tough a business climate to start a career alone. Conversely, senior brokers are reticent to hire inexperienced candidates as the learning curve and road to being productive is longer, harder and more costly to the hiring firm.
Two to three years ago, brokers were servicing clients with new as fast as they could; financing was inexpensive; consumers were consuming; “irrational exuberance” was everywhere. Today, the business clients are hunkered down trying to weather the recessionary storm and long-time clients, like the major developers, are gone. Time to get back to basics.
BOWLES: Brokers are exploring and executing creative negotiating strategies to maximize value for their clients. The competition between brokerage firms is fierce and those with the best service offerings tend to separate themselves from the pack and elevate themselves to the elite producer position. At the same time, relationships still play a crucial role in retaining and gaining new business.
The “new normal” has senior brokers regularly working on smaller, more numerous transactions as they adjust to the market. Brokers who are technically proficient are distinguishing themselves as prolific agents and are representing some of the best customers in today’s market.
TRUEX: One of the first things many of us learned when we started in this business was that “it’s a relationship business.” What insightful brokers have gained from the recession and the ensuing crisis in confidence is that relationships are more important than ever before. For a time when there are fewer clients with fewer requirements, having acute skills and acumen is simply the “ante” that the broker must have to earn the business, along with a trusted relationship. Successful brokers today are the ones who nurture the client relationship, providing a memorable customer service experience when there is a requirement, and when there isn’t a requirement.
4. Without divulging any trade secrets, what initiatives are you are focused on to bring value to your brokers and your clients?
MILLER: We have focused our efforts on the growing demand for distressed assets and receivership services to help our clients optimize the value of their buildings. We are consistently evaluating the services that we provide our brokers that, in turn, provide added value to our clients. And we continue to make strategic hires that complement our brokers’ respective businesses as our company grows.
HILL: We have started or maybe restarted an REO department focused on the distressed assets in banks and CMBS (commercial mortgage-backed security) portfolios.
BOUDWIN: Our firm is focused on expanding our service platform into the teeth of this challenging business climate to benefit both our brokers and our clients. We have expanded geographically to Tacoma and Olympia, setting up branch offices in both markets. We have added significant personnel to our research and graphics department. We have added a retail service line to the existing areas of practice. This has all been made possible because of the tremendous talent pool of prospective employees that are looking for work. It is a good time to hire great people.
BOWLES: Knowledge is key, so we are big on ongoing training with tools designed to help our agents learn, improve and adjust to the changing market.
The abundance of web-based resources has allowed our brokers to provide premier services to their customers. For example, we have developed and maintain a comprehensive historical market research and analysis report, a national database of self-selected investors, and access to an outstanding proprietary library of presentations, analysis templates and marketing resources.
By fully integrating our service offerings, we provide our brokers the ability to advise their customers in virtually all facets of the real estate process. These services include debt and equity finance, appraisal, asset services, project management, research, and corporate service outsourcing.
TRUEX: Darwin’s theories of evolution are being proven in our markets today; brokers and brokerage firms must evolve and adapt in order to survive in a rapidly changing environment and, even then, only the strongest survive. We, along with our clients, have had to make prudent adjustments to adapt to changes wrought by the recession.
To provide the right services for our clients’ changing needs, we are paying closer attention than ever to providing services our clients tell us they need instead of selling them the services that we think they need. Clients have successfully adopted new economic realities, globalization and more rigorous regulatory/compliance requirements, and so must we. As a result, we’ve refocused our business to deliver an expanded array of distinct services lines delivered by specialty groups, in an expanding geographic footprint.
5. What changes in the industry have you noticed?
MILLER: The biggest change that will affect the industry in the near-term is the new accounting rules that are being instituted over the next couple of years. The Financial Accounting Standards Board currently has plans to incorporate lease accounting changes that would transfer almost $1.3 trillion in leased assets from a company’s income statement to its balance sheet, essentially reporting them as long-term debt. This could alter debt covenant ratios and reduce the borrowing capacity of many companies, potentially prolonging an economic recovery.
HILL: Because there has never been such an economic hit to the industry, it is hard to see any major new initiatives. Everyone has had to cut back or cut out all non-essential expenses in hopes of being able to bridge to a market upturn.
BOUDWIN: A significant change in our industry is the shift of real estate decision-making away from the traditional practitioners over to the banks and special servicers. As commercial foreclosures increase, the “new” owner is the REO department of the bank that once held the debt or the special servicer that handles the non-performing loan for the virtual owners of the commercial mortgage-backed securities (CMBS).
Decisions are now being made by bank officials, often in far away states, that just absorbed a portfolio of bad loans; and they are in no rush to transact sales or leases until they understand what they have. This has, in turn, spawned a new breed of opportunists: cash buyers looking for that deep discount available on properties being sold by the FDIC, for example. The delta between the “bid” and the “ask” is still substantial, but narrowing.
BOWLES: There seems to be a separation occurring between the largest service providers and the smaller “boutique” firms. The larger organizations are being structured to offer a wide array of comprehensive services aimed at providing the broadest and deepest level of services with “economy of scale” playing in their favor. At the same time, the boutiques have carved out a competitive niche that is narrow and focused and can be very effective.
TRUEX: Financially underwhelming tenants are not “bankable,” thus preventing owners from being able to borrow the money needed for new construction. We are experiencing the consequences of this trend. Deals take much longer than most of us can remember, investors must provide over a 50 percent down payment in order to even be considered loan worthy, and tenants must build in much longer lead times before their lease expires in order to secure the right deal and cover all their bases.
The manifestation of the reality that it’s no longer business as usual is evident in the lack of new construction, a dramatic falloff in investment sales activity and in the way leasing is done today. Even as tenant-improvement allowances have grown as incentives to commit, most landlords’ capacity to borrow the money and deliver on the allowance is contingent on detailed scrutiny of prospective tenants’ financial condition.
Barbara Travers, owner of BT Marketing, is a marketing consultant for commercial real estate companies.