Posted on | May 13, 2013 | No Comments
Are we there yet? The eternal refrain of children eager to get to a promised destination is a fair question to ask after years of uncertain market conditions, slow to recover labor markets and constant governmental stumbling. Unfortunately, it seems that the “parents” driving the economic car have less of an idea of how and when we will arrive than they ever did.
(For a print version of this report, click here)
Fortunately, as Abba Eban, the mid-twentieth century Israeli diplomat once pointed out, “Men and nations behave wisely once they have exhausted all the other alternatives”. If he was right, there may be hope that the past five years of economic roadblocks, confusing signs and political road rage could eventually give way to more stable, more prosperous and perhaps even less confusing times.
Meanwhile, real estate investment managers have to find their own path to wisdom. At NAREIM’s Spring Executive Officer Meeting this March in Santa Monica the focus of the discussion was on the landscape of economics, politics, technology and labor – and how these forces will affect smart investment strategy for the foreseeable future.
Insight abounded from thought leaders such as former White House Press Secretary Ari Fleisher on changes in the political climate over the past 10 years; from Los Angeles Mayor Antonio Villaraigosa on ways that big cities are reinventing themselves; and from physicist Geoffrey West on the surprising mathematics of urban growth and from many others. Despite the chaos at the macro-level, cities are growing, changing and evolving as overwhelming demographics and technology are re-shaping our world, and real estate’s role in it.
Were any definitive answers found during this meeting? No. But many questions and many more discussions illuminated how leaders will need to face the challenges of the next several years, known and unknown, if they wish to continue succeeding. A few points-of-view in particular are worth taking into account include:
The Economic View
The economy continues to be difficult to understand, much less predict, but it is not uniformly bleak. While describing the U.S. economy as “foggy with a crack of sunshine,” Doug Herzbrun, Global Head of Research, CBRE Global Investors, suggested that it’s possible to overstate concerns about the global economy. Any continuing weakness in the Eurozone will tend to “stay in the Eurozone,” and China’s recent economic lull is already reversing itself, he noted.
Herzbrun also dispelled the notion that the U.S. is in a jobless recovery, noting that growth has averaged about 50,000 new manufacturing and construction jobs and 150,000 new private services jobs per month. The stock market—still the best single indicator of economic sentiment–has experienced a repeating pattern since 2010, with a strong first quarter followed by a mid-year slowdown, he said. Although it is too early to tell if that cycle will repeat this year, The Labor Department’s April jobs report of over 600,000 new jobs created since January – and an overall unemployment rate of 7.5% suggests the economy may have sufficient momentum to disrupt this annual pattern.
That would be a good change since, according to Michael Zietsman, Managing Director, Jones Lang LaSalle, real estate and the general economy have followed the same pattern. “In the past three years the real estate markets have been schizophrenic,” he said. “They started out with a roar and ended with a whimper. I think 2013 will be different.”
Zeitman noted that there is currently twice as much capital chasing real estate than there are properties for sale. Total investment in 2012 exceeded $250 billion, outpacing the previous year by 19 percent. Today, many investors have aggressive acquisition targets and diminished disposition goals, indicating there is room for prices to rise further.
When analyzed by property type, there continues to be reason to believe that there will be continued growth prospects. In the past couple of years, retail and multi-family have been the clear winners. There is nervousness about some retail, given the continued disruptive nature of e-commerce, but high street retail is back to peak in many areas. Service and experience focused retail like the Apple Stores continue to deliver jaw dropping per square foot sales. But multi-family still seems like a safer bet going forward. According to Herzbrun, “looking forward I would expect apartments to continue to be top performers. They are really the only asset class now that has real, sustainable ability to increase rents.”
With office, it’s a bit tougher to see clearly. “The NCREIF index makes one wonder why so much money is plowed into office,” Herzbrun observed, “it had the worst return and the highest level of risk.” However, during an economic upturn office is generally the strongest property type and construction of new supply is at an all-time low. Depending on how businesses use office space for the next several years there may be cause to invest.
Industrial is about to get interesting. With the expansion of the Panama Canal about to be completed, there will be a rebalancing of market share across the port cities in the US – and according to Herzbrun, “manufacturing is recovering and the U.S. is more competitive than it has been for a while. As an economy we are producing more goods – albeit with fewer people.”
All this means a need for new and reconfigured facilities able to handle more automation, larger capacity and more efficient logistics. “The strongest demand right now is for the really big boxes – 1 million square feet or more for e-commerce fulfillment centers – and there will be further changes to space requirements. There is still a lot of functional and locational obsolescence in industrial space.”
At the same time, investors are also digging deeper for better cap rates, going into smaller cities with growth prospects, such as Seattle, Austin and Denver. Investors are also looking harder at Chicago and Houston, where cap rates on core office buildings are more than a full point higher than they are in New York and Washington D.C.
On the real estate fundamentals alone, New York City “prices defy logic,” Zeitsman said. Prices are setting new records at a time when many renewing legal and financial services tenants are reducing their space per employee by as much as 20 percent.
But Herzbrun observed that real estate prices are partly a function of the bond market. “There is a misconception that commercial real estate is expensive. If you compare the ratio of cap rates with bond rates, the US is experiencing the largest spread in history, making real estate extremely attractive as an asset class,” he said.
But the question remains – how long can the differential between bonds and real estate returns be sustained? And how much will governmental forces continue to influence the real estate market in the months and years ahead?
The Political View
“Things are happening,” enthused Jeff DeBoer, President and CEO of the Real Estate Roundtable, “TARP, Obamacare, the debt ceiling and sequestration are all outcomes of the gridlock in Washington. It’s important to note, however, that this gridlock is really a reflection of the split in the country itself.” But there is more movement today than there was only a few months ago.
After years of frustrating inaction, changes in the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) might actually occur in the next several months. Currently, foreign investors can hold up to 5 percent equity positions without worrying about withholding considerations.
DeBoer noted that there has been cause for hope in recent months. Congress has discussed increasing the withholding threshold to 10 percent and in April President Obama’s proposed infrastructure bill included a measure exempting foreign pension funds from the extra tax on gains, designed to place them on an equal financial footing as domestic investors. If progress of any kind is made in this area, as is expected, there will likely be a significant impact on the amount of non-US capital coming into real estate. “We are right on the cusp of a major decision that would overturn the way distributions to foreign investors are treated.”
Discussion has waxed and waned since the election regarding government sponsored entities (GSEs) Fannie Mae and Freddie Mac. DeBoer observed that the GSE reform debate has extreme views on both sides, with some politicians believing Fannie and Freddie should go away, and others believing that a market where GSEs providing virtually all home mortgages is not a problem. “Neither of those views is right,” said William Walker, President and CEO, Walker and Dunlop. “What we need is more of a balanced long-term solution with these enterprises.”
Last year Freddie and Fannie collectively provided $33 billion to the multifamily market, representing 90 percent of all capital supplied to the sector. The GSE’s provided a much needed stabilizing force for the entire sector and the economy. Looking ahead, Freddie and Fannie are working on a joint securitization program and also looking at ways to bring more capital to single family markets.
By contrast, the $750 billion of TARP funds loaned to banks four years ago were supposed to increase market liquidity, but banks were unable to put that capital to work without the infrastructure in place, according to Daryl Carter, Chair of the National Multi Housing Council and CEO of Avanath Capital Management. “What people underestimate is the value of the infrastructure developed by the GSEs to deliver multifamily capital to the market. That infrastructure works incredibly well.”
Participants in Fannie Mae’s Delegated Underwriter and Servicer (DUS) program for multi-family—unlike most residential MBS loan originators—must hold the first-loss position and service the loans they originate. “It is the only securitization program where private capital holds the risk,” Walker said. “The alignment of risk between private and public capital is why Fannie Mae delinquency rates are very low.”
Multi-family investors pay a price premium for multifamily product that’s directly attributable to the liquidity provided by Fannie and Freddie, as the investors have confidence they can refinance at the end of the loan term, Walker said.
If the government stopped guaranteeing the GSEs and Fannie and Freddie disappeared, the economic disruption would be significant. “The government backed mortgage securities market is the second largest market in the world. If Congress did something to alter that market there would be a big global reaction,” Walker said. At the same time, with no risk retention by loan originators in the single-family market, “you have a system that is bound to fail again.” A better solution would be to bring single-family lending rules more in line with GSE multi-family origination practices.
The Technological View
While economic and political factors have always been central to real estate considerations, disruptive technological change is becoming far more important than ever before as the ways people live, work and play has only begun to shift.
Office in particular seems to be vulnerable to changes in technology. Trends like telecommuting, hotelling and a reduction in the space allocation per employee continue to drive demand for space down even as the population rises due to the millennial generation and immigration. In Q4 2012 the national office vacancy rate averaged 18%. As corporate profits increase and companies resumed hiring, the office vacancy rate has been stubbornly stuck in the high teens.
“I predict office vacancy rates will get even worse in the coming decade because the underlying business model for commercial office space is fundamentally broken.” said Jeremy Neuner, co-founder and CEO of NextSpace. For the first time in history people can work from anywhere they can access wi-fi. “One of the places they will work the least is in office buildings.”
By 2015, there will be 1.5 billion mobile workers worldwide. By 2020, 40 percent of the American workforce will be contingent or fractional workers, earning their income from multiple sources rather than a single source, Neuner said. But all is not bleak for owners of office buildings. Alternative co-working spaces can be offered to workers on a paid membership basis vs. a pure per square foot rental. Contingent and fractional workers often need a place to work that is flexible, convenient, and works much the same way as a Zip Car or country club membership. Neuner’s company has had great success selling memberships to workers in multiple locations – deriving a much higher return than any lease could deliver.
According to Neuner, we should, “Stop thinking about leasing space and start thinking about selling an experience.”
At the same time, there is some reason to believe that demand for more office space could be in the offing. “The cost of office space is declining as a percent of total operating expenses, now down to just 2.4 percent,” said Kerry Vandell, Dean’s Professor of Finance and Director of the Center for Real Estate at the University of California-Irvine. “If you add in some behavior finance thinking it may not be the case that Gen X and Gen Y really wants a hotelling work life.” In the war for talent, larger office space and more amenities could be an inexpensive tool for employers to attract and retain the best and the brightest.
Will office space demand rise or fall? Will businesses rent by the square foot or by the seat? The answers will likely become clearer over time, but today it is almost certain that there is change afoot in the way businesses and individuals use office space.
Retail, of course, is even more affected by Internet and mobility trends. Today, e-commerce comprises 4.4 percent of all non-grocery retail sales, which not only threatens retail bricks-and-mortar profits but undermines state and local tax bases, which are dependent on sales tax revenue. That market share is only increasing every year. Forrester, the information technology research firm, predicts that e-commerce will approach a 15 percent share in just a few years.
Retailers have responded to this growing threat with multichannel marketing initiatives designed to create a seamless experience for customers who may not differentiate between shopping online, by phone or in stores. Increasingly, consumers want to shop online but pick up merchandise in stores, or the converse—checking out products in stores but buying online to avoid tax or to seek a lower price. This strategy may involve changes to the layout and design of retail stores, but the more immediate revolution is in the distribution chain. Supply chain experts have found dramatic cost efficiencies can be achieved through fewer distribution nodes, equipped to handle e-commerce fulfillment and traditional store shipments under one roof.
Retailers are also considering ways to maintain traffic levels in the face of e-commerce competition by offering customer experiences that can’t be replicated online. Chris Macke, CBRE Senior Real Estate Strategist suggested there may be a growing real estate opportunity in the intersection of retail and one of the most reliable growth industries of our time: Healthcare. Specifically, small retail centers are beginning to integrate with and embrace health related service providers in their tenancy – and are creating remarkable synergistic foot traffic for traditional retailers.
Macke cited contemporary examples of “medtail” including Walmart stores with Vision Centers, CVS stores hosting Minute Clinics and Take Care clinics within Walgreens stores. “It isn’t difficult to imagine malls with 10 percent or more medical tenants in the future–not just doctors, but heading aid centers, medical supply companies, physical therapy centers, and wellness centers,” Macke said.
Medtail may be increasingly important to shopping centers as healthcare spending increases for an aging baby boomer population and displaces the share of dollars they used to spend on consumer goods. The marriage holds other advantages as well: doctor’s visits take place during the day when retail traffic is low and parking is convenient for patients; medical tenants will accept hard-to-rent elbow space; and physicians generally sign longer term leases and have higher renewal rates than other retail tenants. The successful retailers of the future may need to know as much about health care as they now know about fashion trends.
No Clear View to the Future – the True Test of Leadership
Discussions in March kept returning to questions of leadership, of human capital, and of how to navigate uncertain, even turbulent times with the right team of the right people. As Matt Slepin of Terra Search Partners put it, “Real Estate is a business about deals and capital…but increasingly, it’s as much a business about people, teams and vision. It’s imperative that we try to look beyond the immediate transaction, beyond the hiring of one superstar, and towards the development of a more resilient, more effective, more successful organization.”
How do you build a team for the challenges of an uncertain world? According to opinions expressed at the meeting, it is important to not only know what your investment strategy and thesis might be, but also to know what differentiates your firm and your team. There’s a need to not only how you will succeed, but why you will succeed – even when the path doesn’t go as planned.
There seems to be a shortage of human capital. Very few young people have come into the real estate business in recent years and the bench strength of many investment management firms falls off under the age of 40. But based on the level of talent represented by “NAREIM Fellows” Kyle Reardon of Cornell University’s Baker Program in Real Estate, Whitney Smith from McDonough School of Business at Georgetown University and Elliot Weinstock of USC’s Marshall School of Business, there is hope for our future. Investment management firms, however, need to take a leadership role in reaching out to University programs to find new talent, help develop real world skills and ultimately create a clear path for young people to take leadership roles in real estate firms of the future.
NAREIM board member Paul Bernard is taking the lead of an education outreach committee to connect with Universities and students around the country – and involve young people in NAREIM internships, meetings and research activities.
Fortunately, young people coming into our business have different experiences than current leaders do – they see things with fresh eyes, they understand intuitively how young people want to live, work and play. They may not understand how to make a deal today – but they likely have insight on what we will need to do tomorrow.
These are uncertain times, and it appears that no one is expecting the “easy money days” of years passed to return anytime soon. Leaders will need a level of intestinal fortitude, flexibility, and humility that may not have been required before. Just as guest speaker Mayor Antonio Villaraigosa, after shattering his elbow in a bicycle accident, went directly to his staff saying, “This is a teachable moment.” and set the impossible task of making Los Angeles a bicycle friendly city…with over 1,600 miles of new bicycle lanes to come – real estate leaders need to be able to jump back from the accidents and drive their future.
Shakespeare once wrote, “Wise men never sit and wail their loss, but cheerily seek how to redress their harms.” The road ahead for real estate leaders continues to be challenging, but we can and will handle it.
Posted on | December 26, 2012 | No Comments
Gunnar spoke at a recent regional TEDx conference in Naperville, IL.
Posted on | November 29, 2012 | No Comments
Posted on | November 1, 2012 | No Comments
Gunnar Branson is scheduled to speak at the Naperville TEDx event November 9th. Click here for more information.
Posted on | August 3, 2012 | No Comments
Almost four years after the collapse of Lehman Brothers and the beginnings of the most challenging economic recession since the Great Depression, it has become clear that our world has changed. More than a straightforward de-leveraging of the economy or a re-strengthening of the global banking system, (as challenging, painful and seemingly impossible those tasks are), it appears that some assumptions about how the economy works, how to invest successfully, and how to anticipate the future may have to be re-evaluated. The world is unlikely to go back to where it was before. But if that is the case, where is it going and how do we plan for the future?
As once explained by the 18th century Irish politician, author, and philosopher Edmund Burke, “You can never plan the future by the past.” Well understood by commercial real estate investors, this truism is prompting leaders to focus their thinking on what is happening now and what could happen in the future, not on what might have worked before. In early June of 2012, a small group of commercial real estate leaders assembled by the National Association of Real Estate Managers (NAREIM) gathered at a small hotel in Chicago for the first annual 2020 Investor Summit to discuss changes, big and small, and explore new ideas about real estate investing.
The following areas are discussed in the report:
- Real Estate Usage – technology and demographic shifts are changing how people use real estate – and will likely make this recovery dramatically different from past recoveries.
- Investment Capital – An exciting new development in defined contribution plans may represent a huge potential source for new real estate investment capital.
- Human Capital – As the economy recovers, fund raising, business continuity, risk and governance all have a significant and challenging human capital aspect to be considered.
- Regulations, Accounting and Transactions – Changes in accounting and structuring of deals will have a meaningful impact on how investment managers need to conduct their business.
- Information, Technology and Process – Is it time now for the real estate investment management firms of today to upgrade their approach by buying process rather than technology?
Posted on | June 4, 2012 | 1 Comment
In 1965, the co-founder of Intel, Gordon Moore, described in a paper what he had observed as a doubling in the number of components that could be fit onto an integrated circuit every year since their invention in 1958. That observation has become a rule of thumb for the entire computer industry, now described as “Moore’s Law” where processing speed and memory capacity double every 18 months or so. This exponential growth over the last 40 plus years has transformed our lives in remarkable ways. Computers in the 1950’s filled entire rooms but could only perform simple calculations. Computers that fit in a pocket today can make any number of complex calculations plus make phone calls, send messages, carry complete personal collections of books and records, and even play movies.
In other words, sitting in most people’s pockets today are computers, libraries, telephones, record collections, movie theatres, and file cabinets. Thousands of pounds and cubic feet of stuff now fit into a device that measures 4.5 inches by 2.3 inches and weighs less than 5 ounces. This tremendous shrinkage of the physical world has made it possible now to work, live and play anywhere and to access information and entertainment from anywhere. If the exponential “Moore’s Law” growth continues for the following 5, 10 even 20 years, the shrinkage of our material world will be unlike anything we can currently imagine.
But what happens when the things people use, collect and enjoy no longer takes up as much physical space? Does it change what we do with the space, how we value it, and where we want it to be? The implications of Moore’s Law are only starting to be felt by the commercial real estate industry, but investors, operators and users of space are already seeing meaningful impacts on their business that prompt them to challenge many assumptions about growth, obsolescence and value.
Change in Office Space
How much space people use for work is not constant. In an article published by RICS, (Revolutionizing Office Demand: Investor be Prepared, 2.24.2011), American companies in the 1970’s allotted 500 to 700 square feet per imployee for the typical office. Today’s average is approximately 200 square feet. According to Peter Miscovich, Managing Director at Jones Lang LaSalle, that allocation could shrink to 50 square feet in the next few years. Most leasing brokers point to a reduction of space requirements from all their tenants, but most interesting and most indicative is the 20-30% decrease of office space required by the most dominant users of high quality downtown office space – law firms.
What’s driving this? Ty Spearing, managing director of LaSalle Investment Management, puts it most succinctly, “Law libraries have become extinct. Document management and eletronic archiving have lessend the large storage requirements. According to Konstantino Armiros, partner at Arnstein & Lehr, “There is more emphasis on technology rather than space in the modern law office. Thanks to databases, mobile phones and cloud based servers accessible from anywhere we produce less paper and require less support. As an example, the partner to secretary ratio has reduced from 2 to 1 to 5 to 1 today.” A downtown high quality office is still essential to today’s lawyer, but they aren’t living in their office anymore. As Mr. Armiros describes it, “not so long ago, we all spent countless hours, seven days a week, in our offices – now we work from anywhere as the desk has been replaced by the device. We still need to be a cab ride away from the courts and clients, but we don’t have to be there all the time.”
The shrinkage of space requirements per person doesn’t mean that office buildings are going away, but it strongly influences what kinds of buildings will be more successful than others. As Doug Kintzle, Managing Director at Principal Global Investors, explains, “There has been a cultural shift to open office configurations and collaboration, which requires less space per person.” The need for collaboration suggests that centrally located office buildings, close to solid transportation, will have an advantage – even over less expensive space in less central locations. With less square footage requirements, companies will also be able to spend more on a per square foot basis for better quality buildings and locations closer to clients, vendors and employees. As Ed Glaeser, Harvard Economic Professor and author of The Triumph of the City”, describes it, “Knowldege has become more important than space.”
Change in Living Space
While office space has been steadily shrinking in the last few decades, living space has been increasing. In 1950, according to U.S. census data, the average American had 292 of square feet of personal living space. In 2006, that number was closer to 900 square feet. That growth in space per person has come about from a combination of smaller average family sizes and larger homes and apartments built in the last few decades. However, that growth in space may be more of a historical anomaly than is generally understood. With inexpensive transportation from affordable private cars and fuel, the sprawl of US housing to more and more distant suburbs allowed for an inexpensive expansion of living space.
The desire for more collaboration and proximity to others has increased and for the first time in the history of the auto, young people are driving less. According to a report by Kiplinger, (Generation Y Giving Cars a Pass, Kiplinger.com – 9.14.2010) motorists aged 21 to 30 now account for 14% of miles driven, down from 21% in 1995. The other interesting aspect to young people’s lives today versus 20 years ago is the amount of square feet they require. The typical young person of the 1970’s, 80’s or 90’s might have taken up a third of their living space with milk crates filled with books and records. Today, it all fits into a pocket.
And it isn’t just young people that are shrinking their stuff. Americans of all ages have spent the last ten years substituting digital music files for records and downloadable books for the traditional bound books of the last century. As reported in the New York Times last year (“E-Books Outsell Print Books at Amazon” New York Times, 5.19.2011), “Since April 1, Amazon sold 105 books for its Kindle e-reader for every 100 hardcover and paperback books, including books without Kindle versions and excluding free e-books.” According to last Year’s BookStats, an annual statistical survey of raw sales revenue and unit data provided by nearly 2,000 publishers, E-books made up 13.6% of revenue from adult fiction in 2010. With a little calculation, it’s possible to estimate that 114 e-books were sold in 2010 versus a total of 724 million books. If one determines the average book dimensions to be 8x6x2 or 96 cubic inches – that means that in one year 6.3 million cubic feet of space was no longer needed for books. Essentially, 114 million pounds of new books were translated into electrons that take up almost no space at all.
There are also reasons to believe that today’s young people will be renting far longer than their parents did. They have the largest college debt load in history – averaging over $20,000 per student. They also face a very different labor market from their parents: a fifth of them will likely be self-employed following the trend for all employers to offer more and more short-term contracts. Renting may make economic sense, not just when they are beginning their careers, but for many more years to come. Since the end of World War II, the trend was for more and more young families to purchase a home in the suburbs, leaving rental apartments to young singles. Based on the economics today combined with a reluctance to drive and a cultural proclivity for proximity to others, that trend may shift towards more people renting throughout their lives.
According to Jim Smith, Managing Principal at Kensington Realty, “The demand for exurban, far out suburban housing is declining for both single family and multi-family. This is likely due to Generation Y’s preference for urban areas. Commuting expenses are excessive and likely to get higher. At the same time, Generation Y prefers apartments with less space, good transportation access and substantial common area amenities such as cyber cafés, fitness centers, and common meeting areas. There is now new apartment construction with lower average unit sizes and even units that are in the 300 square feet range in the mix. The depth of demand for the smaller units is still unclear.” It is clear, however, that less space may be acceptable for a younger person looking for affordable housing close to where they work and play.
According to research conducted by Christopher Leinberger, a professor at the George Washington University School of Business, (Now Coveted: A Walkable, Convenient Place, New York Times – 5.27.2012) the value of more urban areas may be strengthening while the values of more distant, car based suburbs (with larger houses) appear to be weakening. “Our research shows that real estate values increase as neighborhoods became more walkable, where everyday needs, including working, can be met by walking, transit or biking. There is a five-step ‘ladder’ of walkability, from least to most walkable. On average, each step up the walkability ladder adds $9 per square foot to annual office rents, $7 per square foot to retail rents, more than $300 per month to apartment rents and nearly $82 per square foot to home values.
As a neighborhood moves up each step of the five-step walkability ladder, the average household income of those who live there increases some $10,000. People who live in more walkable places tend to earn more, but they also tend to pay a higher percentage of their income for housing.”
Doug Kintzle of Principal Global Investors observed that, “tenants are definitely accepting smaller units. 20 years ago, most people looked for an extra bedroom to serve as their home office with room for a desk, computer and files, etc. now this office is carried around in a laptop and people are fine hanging out at the local coffee shop equipped with free wi-fi, to work on the computer.”
The way we live has changed as much as the way we work – and the location and size of the spaces we live in are already changing. Exactly how that will impact the future of location, configuration and value of the apartments and homes we live in is still uncertain.
Change in Retail
Just as the ubiquitous smart phones and mobile computers have changed our work and home lives, the sellers of those devices are changing the rules about how we buy them as well. E-Commerce and downloading of products with no physical presence – such as music, books, movies and computer applications have created a level of sales density retail has never seen before. According to RetailSails reporting on retailers, Apple retail stores sell more than $6,000 per square foot of space every year – double the amount of their closest competitor, Tiffany & Company. The average for regional shopping malls is only $341 per square foot. That means that Apple has figured out a way to sell seventeen times more per every square foot than anyone else. How do they do that?
To start with, they are an incredibly successful manufacturer of the one item everyone now must have: an iPhone. But it isn’t just because of their blockbuster gadget. Apple has also engineered a retail environment that sells at least as much knowledge and entertainment as they do hardware – if not more. They have created a compact marketplace of knowledge, of ideas, and of a few very powerful, very small products. Less stuff, but more value.
While e-commerce continues to grow at 14% a year (source: IMRG CapGemini e-Retail Sales Index), retailers are experimenting more and more with hybrids of on-line and in-store sales strategies that use less space to deliver more. The nature of the successful retail space is not unlike that of successful residential space: located in high-density areas, close to as many people as possible, and of a higher quality design. Ty Spearing of LaSalle Investment Management points out that, “E-commerce and social networking have changed the retail landscape, and it continues to change rapidly. While more electronic transactions will reduce the overall need for retail space in non-strategic locations, we believe there will always be a need for space in strategic locations. At the same time, distribution and warehousing facilities will see increasing demand due to those electronic transactions.”
The accelerating growth of e-commerce suggests that physical retail spaces have a different purpose now than before. Instead of being a distribution outlet for products to consumers, they are becoming marketing ventures that provide education, service and an immediate experience of the value of their products. Shopping is now focused on the entertainment of consumers more than the fulfillment of product and the need for large warehouse shopping experiences are diminishing. Doug Kintzle of Principal Global Investors believes that, “successful retailers will offer the ease of the Internet for ordering products from home but maintain a storefornt for customer service, returns and display of products. We are already seeing smaller demand for larger spaces.”
It’s imporant to understand, however, that retail is changing, just like office and residential space, but it is not going away. Occupancy rates are actually going up nationwide, with the best quality shopping districts and malls able to charge rents comparable to those before the economic recession. George Pandaleon, President of Inland Institutional Capital Partners, explains that, “Any reports of retail’s demise because of technology are greatly exaggerated. People continue to need brick and mortar stores to meet their needs…even Internet centric retailers like Amazon and Ebay have opened physical stores to have a physical presence and better serve their customers. Retail has always been a continuous process of creative destruction. The successful retailers will be those who can better adapt to and develop processes and technology to grow their sales. There were no Apple Stores a decade ago. As one retailer fades, another one grows. Dematerialization certainly seems to be taking place, but it will not eliminate the need for real estate but properties and how we use them will have to adapt.”
Less Stuff Means A Brave New World for Commercial Real Estate
George Carlin, the late comedian, once said, “That’s all you need in life, a little place for your stuff. That’s all your house is: a place to keep your stuff. If you didn’t have so much stuff, you wouldn’t need a house. You could just walk around all the time.” Is it possible that by shrinking our stuff, we may be freeing ourselves to live, work, and play in places that are more attuned to our needs? Will we become more free to simply “walk around all the time”? If so, it is likely that people will have less and less tolerance for real estate that doesn’t provide for their needs and less willing to trade volume for location and quality. Commercial real estate investors are already starting to see small but important changes in the behaviors of tenants that suggest a need for a strategic shift. Simply providing inexpensive storage for a growing mountain of stuff will be more challenging to execute than it has been in the past.
What will happen in a world dominated by the exponential shrinkage of material goods made possible by Moore’s Law? Perhaps there will be less stuff and better real estate.
Posted on | May 30, 2012 | 3 Comments
Apparently, Sir Richard Branson has issues with people who decide to wear ties. In his latest blog post titled Why it’s time to say bye to the ties, he writes:
“I often have a pair of scissors in my top pocket to go cutting people’s ties off. It is time to say goodbye to the tie. Why was the tie ever invented? Everyone in business looks the same and dresses the same. I’m sure they only exist because bosses, after being forced to wear ties all their life, are determined to inflict the same fate on the next generation.”
In a similar article just published on entrepreneur.com entitled, Richard Branson on Office Ties and the Company Dress Code, he describes how the necktie is an enemy to innovation and that the elimination of all neckties in business settings would encourage a more open, more productive environment. Despite my respect and admiration for much of what Sir Richard Branson has accomplished, I disagree – but I encourage you to read his articles anyway – and perhaps to read my response to his article below:
Sir Richard Branson,
Like most business people the world over, I follow your exploits and business philosophy with excitement and admiration. Sharing a surname with such an accomplished entrepreneur has long been a topic of party small talk and a source of guilty pride. Thank you for your willingness to engage in a dialogue online regarding entrepreneurship and business.
I enjoyed your article on office ties – but I may have to take some issue with your assertion that ties have no use or that the removal of all ties in a business meeting will lead to a better outcome (or at the very least not adversely affect that outcome).
Allow me to explain:
I grew up in a relatively progressive and casual environment on the far west coast of the United States (Anchorage, Alaska). When I saw photos or movies of people wearing interesting and often fanciful pieces of fabric around their necks, I longed for an environment where wearing a necktie was not viewed with suspicion. Your story of London school children modifying their neckties to express both their individuality and to undermine authority could be viewed as a reason why dress codes are not terribly productive – but also as a demonstration of the innovator’s need for ridiculous rules to undermine. The rebellion itself is what creates inspiration. But what happens when there is nothing to rebel against?
I wear ties. I have worn ties since I was in college. None of my colleagues or friends have worn ties by choice. In fact, I often am the only one in the room who might have to apologize for wearing a tie. I am not following rules by wearing a tie, I am breaking them for the following reasons:
I find ties to be quite practical and comfortable: In winter, nothing will keep you warmer than a wool tie around the neck.
I find ties to be attractive: Like an interesting hair style or bit of facial hair, it is a way to present an image to the world that I find interesting and somewhat representative of who I want to be.
I find ties to be innovative and rebellious. This may be the most difficult assertion for many to understand. Here’s why – if I am the only person in a room who has decided not to wear the modern uniform of an open necked shirt, casual trousers and a dark jacket – have I not – like the school children in your story – discovered a way to subvert the prevailing customs and challenge closely held (and perhaps even silly) assumptions?
I have worked for many years helping companies innovate and create new products. What I have discovered is that the existence of codes and rules can often help true innovators create a competitive advantage by revealing how those codes are unnecessary or counter-productive. Innovators, by nature, like to subvert existing systems of rules. Your career has been an inspiration for everyone who thinks differently and who tries to create new growth.
At one time, you were the only man in the room without a tie. But if everyone else puts away their neckties, is it possible that someone with a tie might redefine business, culture and life once again? Should we be careful about imposing an equally restrictive code of casualness upon others?
Just a thought.
Thank you once again for your work, and your inspiration.
Posted on | March 14, 2012 | No Comments
Two months into 2012, and it is still difficult to see what kind of year real estate investors can expect. General sentiment may be improving. A recent quarterly pulse survey of investors conducted by the National Association of Real Estate Investment Managers (NAREIM) and FPL Advisory Group shows a significant turnaround in confidence since the final quarter of 2011. A majority of respondents are increasing their hiring this year, and over 90% expect an increase in transaction volume in 2012.
But how can that be? The economy, though no longer on life-support, doesn’t quite feel robust. 8.3% unemployment, though an improvement compared to last year isn’t exactly wonderful. The European debt problem hasn’t been solved, though there are many working on it. The cost of energy is getting jumpy, debt problem in the U.S. aren’t exactly behind us and we’re facing an election year, with all the hyperbole, uncertainty and inactivity associated with that. Why so positive?
I recently spoke with a few members of NAREIM to get their perspectives on the state of investors’ confidence at the beginning of 2012. Ryan Krauch, Principal of Mesa West Capital immediately took the long view, “I think these sentiments reflect the fact that there was not really anywhere else to go but up. That said, I think that although we will see a relatively better environment this year than previous years, it will still be far behind any normalized standard.” Ryan didn’t see significant improvements in the near to mid-term. In his words, “We need a lot more job growth and spending to kick in before real estate will see any sort of meaningful recovery in fundamentals.”
Scott Onufrey, Senior Vice President at Kimco Realty pointed out that improved confidence was justified if one considered the entire investment environment. “Real estate offers terrific risk adjusted returns relative to other asset classes today. Treasury yields are 2.0% while good real estate can be acquired yielding in excess of 6%. In addition, financing properties is getting easier, so if you need a mortgage, there are lenders that will provide capital at 4.5% for ten years.”
And there may be signs of an improved CMBS market. According to Greg Michaud, Senior Vice President and Head of Real Estate Finance at ING Investment Management, “The recent Deutsche Bank AG/Morgan Stanley CMBS deal was a huge success – indicating that there will be ample liquidity in the market for the wave of refinancing coming to the market. Another good sign is that rates from CMBS lenders are coming in from 5.5% to 5.75% by 100 basis points – that will help challenged deals refinance.”
At the same time, there may be signs that investors are gaining confidence in non-core assets. According to George Pandaleon, President of Inland Institutional Capital Partners, “Investors are moving beyond core to secondary markets and value-added investments. Cap rate compression seems to have abated (albeit holding at very low levels for the best assets).” There may also be a long awaited improvement in fundamentals in the offing. According to George, “ In apartments, retail and CBD office (depending on the market) we are seeing clear signs of improving operating fundamentals ahead.”
Jeffrey Newman, CFO at IDS Real Estate Group also sees signs of improving fundamentals, “Landlord leverage is gradually getting traction…not huge traction, but some: lease concessions are diminishing, lease rates are strengthening. Obviously this is market and product dependent, but we are seeing interest in spec industrial from capital and some demand from tenants.”
It is logical then, to expect some improvements in deal flow, and several NAREIM members have seen an increased amount of deals in the first quarter.
There are still reasons to be careful. Kim Woodrow, Global COO at LaSalle Investment Management is cautiously optimistic given the improvements noted above. However, there are reasons to be concerned, including the cooling of Asian investment markets, the continued Euro-zone problems and “we are all holding our breath regarding the U.S. Presidential election.”
Paul Nasser, COO of Intercontinental Real Estate Corporation agrees with Kim, “There are a number of issues that remain unresolved, which could derail any recovery and even throw us into another recession such as the Euro Crisis, the Middle East issues, true unemployment, cost of oil, rising interest rates and political unrest in the U.S. So while I am hoping for a strong recovery, I remain very concerned about the immediate future.”
Jeff Newman pointed out one more reason to be concerned this year, “Outside of the tech driven markets, what is the future of office leasing demand and how far tenants will be able to go with their interest in lease flexibility, (i.e. lease termination and contraction rights)? This negatively affects value and reduces financing options, sometimes significantly. I’m not sure that this issue is getting the recognition it deserves.”
While not conclusive, the picture drawn by real estate investment managers for this year suggests some reason for optimism, tempered by a real wariness. Bill Carlson, Senior Managing Director of Cigna Realty Investors, summarized it well when he said, “We can operate our real estate businesses in any environment – good or bad – as long as it’s rather stable. Things have stabilized a little, values don’t appear to be falling, debt is cheap where it can be had, and trades are happening. Only the economy remains unclear and unsettled…but it may be inching forward slowly.”
These are interesting times to invest in real estate.
Posted on | January 30, 2012 | No Comments
I recently hosted a discussion at the CIO Corner with IT leaders Dave Patzwald| , who’s the CEO of Coach America; we also have Tim Mather| , the Chief Technical Officer of PMA Consultants, along with Brandies Dunagan| , who’s the social media specialist at i.c.stars and Ronald Coleman| , a resident at i.c.stars.
Tune in and hear their practical approaches to making innovation happen.
Posted on | October 10, 2011 | No Comments
September 26 – 28, 2011
The Broadmoor Hotel, Colorado Springs, Colorado
(click here for a print version) When we look back on the third quarter of 2011 from a comfortable distance, it is unlikely that many will remember it as a time for reflection. Uncertainty in debt markets, murmurings of another recession, stubborn unemployment and a wildly gyrating equity market are not conducive to careful and rational consideration. And yet, with such uncertainty, heightened risk, and dropping confidence, reflection may be precisely what is required.
While the aspens began to change their color outside a meeting room in Colorado Springs, NAREIM executive members discussed and considered – not just where we are right now or where we’ve been – but where we are likely to go in the next ten years and what we can all do to prepare. The 18th century Irish statesman and philosopher Edmund Burke once pointed out, “You can never plan the future by the past.” Guided by that notion, NAREIM members challenged each other with new ideas, new data, and new insights for planning their own futures.
It is difficult to report all that happened during the meeting, but this briefing attempts to share a few of the key thoughts. As to be expected, the state of today’s economy prompted quite a bit of discussion, including:
- No one is certain if the economy will fall into another recession, but at a GDP growth level of around 1%, it won’t take much to push the US economy off track. US consumers, however, overwhelmingly believe that we are already in a recession.
- The Eurozone debt problems will continue to be an issue, not just for Europe, but for the rest of the world as well. If the new Eurobond initiative becomes a reality, it could become a significant competitor for U.S. treasury investments.
- Despite long-standing concerns of a continued population explosion, population growth rates throughout the world are starting to decline – not just in Europe and Japan, but in emerging countries as well.
- China, one of the fastest aging countries in the world, is facing considerable challenges to their continued growth, ranging from environmental degradation, resource constraints, political difficulties, and the stress of being both a wealthy economy (in coastal cities) and an impoverashed and primitive economy in the interior. Over the next ten years, China may not be the geopolitical and economic threat we imagine it to be today.
- Fast emerging economies such as Turkey and Poland will grow significantly in political and economic importance. The size of the global middle class is fast growing along with their consumption patterns. Retail sales this year in Egypt and Turkey were up by 10% this year despite the anemic growth in the US and Europe.
- Retailers will only shrink their footprint in the years ahead – not just because of consumer behavior, but because with digital point-of-sale technology and on-line distribution they need less space to sell the same amount of goods.
- Affluent households are back to pre-recession spending levels, everyone else is down and will likely continue to be down.
What does that mean for investment fund managers? Throughout the two days, discussions ranged from operational and human resource issues to investment strategies, but a few key issues touched on include:
- There is overcapacity in the industry – many general partners can’t raise their next fund. But for those who are strong, it’s a terrific time to be in this business with slower growth than the last15 years, but better than a couple of years ago.
- It’s all about execution now – limited partners can’t just rely on “cap rate execution” – the GP’s operational expertise is far more important than before.
- Having a global strategy may be the difference between a 7X and a 10X valuation for a management platform.
- Despite problems with some non-traded REIT’s and their fee structure, in an environment where defined benefit plans continue to be replaced by defined contribution plans, this is a model to pay attention to. Instead of relying solely on broker dealer networks in the future, new plans allowing for participation through warehouses like Fidelity or Schwab will likely grow.
- There is still some price discovery going on and time-frames for closing a deal are stretching out, while rental growth assumptions are also getting elongated.
- Taxes on foreign investments are forcing investors from outside the U.S. to move into secondary markets to get higher than 6 or 7% yields.
- The time of extend and pretend is starting to change, but it is very slow. The market is 15 to 20% overlevered compared to historical norms. It will likely take 5 to 6 years to return to that norm as we work through all the 2006 and 2007 deals.
- When looking beyond core or gateway cities, it may be the cities with the highest concentration of knowledge work that will thrive enough to drive employment and ultimately leasing. Markets such as the Research Triangle in North Carolina or Austin, Texas may very well be the growth markets of the next ten years.
There is an astonishing amount of volatility, uncertainty and change for commercial real estate investors to navigate. This latest meeting gave members a chance to reflect on just a few of the issues, trends and changes affecting the near and long term future of the industry, and perhaps refine some of their strategies for the future.
A lot of what will happen in the next few years may be impossible to predict, but as the famous country music singer and sausage maker Jimmy Dean once said, “I can’t change the direction of the wind, but I can adjust my sails to always reach my destination.” The discussions that took place in Colorado Springs may have helped a few of us adjust our sails.
The National Association of Real Estate Investment Managers (NAREIM) is the leading association for companies engaged in the real estate investment management business. NAREIM members manage investment capital on behalf of third party investors in commercial real estate assets. Investment sectors include office, retail, multi-family, industrial and hotels.
NAREIM members serve the investment goals of public and corporate pension funds, foundations, endowments, insurance companies and individuals — domestic and foreign. Collectively, they manage over $1 trillion of real estate investment assets around the world.
NAREIM members range from the largest institutional firms in the world with fully integrated service platforms to specialized entrepreneurial firms.
For more information contact
Gunnar Branson, NAREIM CEO