>From synthetic leases to using the Internet, roundtable participants discuss new ways to do business in the '90s.
The NNCREW Roundtable was held atthe Westin Galleria Hotel in Dallasduring the group's Spring RegionalConference in early June.
Editor's Note: What are some new ways of doing business today? That's what National Real Estate Investor set out to learn as we sat down with a group of real estate professionals during the Spring Regional Conference of the National Network of Commercial Real Estate Women this past June in Dallas. The ensuing discussion ran the gamut from financing vehicles to innovations in technology. But as one roundtable participant pointed out: Along with these new solutions come some new problems, too.
NREI: Nancy, could you start by giving us the Reader's Digest condensed version of what a synthetic lease is?
Nancy Little: It sounds sort of like a fake lease, doesn't it? Synthetic leases have been extremely popular in the last few years as a way to finance real estate, particularly build-to-suit projects, though it is not used exclusively for those types of projects. It was a concept that came from the capital markets as capital markets became less willing to accept the residual risk of real estate and users wanted off-balance sheet financing treatment of their projects. Basically a synthetic lease, in its simplest form, is a financing arrangement. It is characterized as a lease for accounting purposes, which gives the lessee off-balance sheet accounting treatment, and as a financing for tax purposes.
Phyllis Riina: There's pressure on all different public companies now to increase shareholder value. And one of the ways of doing that is to either increase net income or decrease net assets. So one means of decreasing net assets is to use a synthetic lease.
In our case we have done several starting with 1991. The most recent one that we did was our new global headquarters in downtown Detroit, which is about 5 million sq. ft. We bought a 20-year-old facility [Renaissance Center].
NREI: As a user, have you found drawbacks?
Riina: I think they're fairly flexible because they have relatively short-term leases associated with them. In both cases where we've used them, we're the lessee. The leases are generally somewhere between three and seven years, and at the end of that period you have an opportunity to either sell the property, renew the lease at terms that, in some cases, are fixed and in some cases are negotiable, or you can purchase.
Little: I think that a lot of companies look at this as if they were using revolver funds, for example, because most frequently these tend to look like revolvers. I've done some that are five-year deals with annual renewals that get you up to 10, maybe 15 years, that essentially look like a revolving line of credit.
I think in terms of other limitations, there are a lot of people who are raising the question, 'What will the exit strategies be for these?' And I think that's going to be a tremendous opportunity for the capital markets to address that. Some of the things I've talked about with investment bankers include taking them out on a sale/leaseback basis. Because they're short-term, that is really one of the biggest risks that is out there. What do you do with this vehicle at the end of the three- or five-year term?
NREI: Let's talk a little about REITs.
Rose Wolfe: As everyone knows, the real estate industry in total has gone from being a privately driven industry to being a public industry. In 1991, REITs were really not that big a player in the real estate industry. I think they had $9 billion -- while that's a lot of money, in totality it was a fraction of the real estate industry as a whole. Today we see many more companies for a variety of reasons looking at the REIT vehicle as a way to either grow their business of financing, deal with estate planning, succession planning ... there's a number of reasons why you look at these, but I think the principal driver -- at least in probably 1993, which is when you see the big growth -- was really financing. Today I think the REIT industry is about $100 billion, which is a phenomenal growth over a four- to five-year period.
Elizabeth Trocchio: Woodmont Cos. has traditionally been retail powerhouse developers -- big power centers, Toys R Us, Barnes & Noble type-anchored centers. I am president of the property management company of Woodmont, and we have been looking this year at developing a REIT. Our main reason is capital. With that we want to keep control of management and leasing of what REITs we put together. But the main focus is capital, which allows us to do more development. I think it is a good opportunity; it's a good time to get into that market, and we've not finalized anything but we're close to it. It's the avenue, certainly, for us as a developer to go to.
NREI: What factors are you looking at as you're making this decision?
Trocchio: Well, there's a couple of things that you look at. Probably the first one is what type of REIT. Do you want to keep it strictly a retail REIT? Do you want to mix it with office and multifamily? A lot of people want to just do one type of REIT, because when you do that it opens up to you buying more of that type property to pull into that certain REIT. Of course your stockholders, their biggest interest is what are they going to get back for it. So it's going to be the value of the property that you're bringing into the REIT and then what type of investment, if you will, that those stockholders can get from that, and then the capital that you're going to generate to bring more into the REIT.
NREI: Another hot financing vehicle is commercial mortgage-backed securities. Tell us about your involvement.
Anne Burruss: I personally produce loans to be securitized for AMRESCO's partnership with Goldman Sachs, and I've been doing that for three years now.
I've seen a huge evolution in pricing. And you couldn't have enough multifamily to begin with; now it's not really the favored property. We'd love to be in office with everybody else. Thanks to Lehman and Deloitte and Travelers, spreads have just shrunk tremendously in the three years I've been in the market. It's grown exponentially as far as a never-ending money source. It's not like the old life company days when we all had our little pot of money to spend.
Sylvia Ferrell-Jones: I represent the investors in CMBS, and we find, as Anne said, the spreads today are amazingly tight, and one would think spreads and risk are supposed to be correlated, but our view of the market is that the ultimate owners of the commercial mortgage-backed securities, or the junior bondholders, are really not getting paid for the risk that they're taking now. And there's too much property being sliced up and going to people who aren't taking the risk that the junior bondholders are taking.
So we think that, ultimately, the market is going to shift, and Wall Street will end up being, sort of, the traders, just like they are for other kinds of corporate finance, but not the originators. We're already seeing today a difference in how securities trade based on who's originated them and whether the originator had a long-term interest in that security.
NREI: How do you think rating agencies are dealing with CMBS?
Ferrell-Jones: Well, the rating agencies' primary objective is to protect the investment-grade bonds. A lot of our investors are in the below-investment-grade category, not just investment-grade, so we're interested in the risk that they're assuming. Rating agencies, first of all, they have a conflict of interest. Because, the way this works is, if you're going to originate a CMBS, then you go to the four rating agencies and you say, 'Give us a preliminary idea of what level of subordination you require and how much it will cost us to have you rate this.' So now you have four rating agencies competing for the business, and not all four of them are going to get paid. Usually only two of them will. So the issuer will go to whoever gives them the smallest subordination, which means the junior bondholders are going to have the greatest risk.
Burruss: Fitch has a tendency to be more focused on real estate, where S&P, for instance, is very generic. I think that's been a huge education to me, because, starting out in institutional lending, there was nothing but the specific real estate, and now it's treated more like widgets.
Wolfe: Sylvia, on these large pools, how do you get information on the underlying security?
Ferrell-Jones: When you're a real estate company, you can have people who are in the real estate markets all the time. There's asset managers and brokers that you work with, and so you really do look at a lot of the properties individually, which the rating agencies just don't have the resources to do.
NREI: Let's move on to investment grade real estate...
Margaret Williams: I've recently made a career shift from being an institutional adviser at pension funds and insurance company clients to being a small business lender. At Heller we're trying to really diversify the products that we offer. We're definitely a middle-market lender. By going into the small business lending side of things, we're going into that to diversify and create opportunities for balance sheet options like securitization. We have origination capacity; we're trying to find new ways to use that capability.
Dorothy Cunningham: I don't know how we fit in this: 'new' solutions. We've still been doing things the old way in my shop. So we've been struggling this year trying to figure out where we're going to fit into this new increased competition. What niche are we going to provide? We've always, somehow, found our niche, and we've always been able to get out our $1.5 billion to $2 billion a year, but this year we're kind of struggling with where that's going to be by the end of this year. We have decided to stay, right now, with the quality and take lower spreads, because they at least have some risk-adjusted spread left in them compared to the BAA kind of level of investing.
One of the things that has happened at CIGNA that we wouldn't have done six, seven or eight years ago, are co-lending deals. And that was a direct response to Wall Street, when they came in and started taking away the $100 million+ deals, and the insurance companies were either not able to meet that lending amount or they couldn't beat the spread that Wall Street was, at that time, promising -- not necessarily delivering, but promising. And so a lot of insurance companies have now teamed up.
Williams: How do you underwrite those deals?
Cunningham: A lot of those deals that are done -- that $100 million+ regional mall or office building or hotel, even -- they're, believe it or not, low leverage, so it's generally easy to make them fit into your underwriting, no matter what your differences.
NREI: Arlene and Denise, what are you doing with the Internet?
Arlene Wysong: Even though Newmark manages 42 million sq. ft. of space in the greater metropolitan New York area, we really do not have our buildings on our website yet. We have a couple of properties on, but we don't have anywhere close to our whole portfolio on. I think that probably, we ultimately will do that.
In terms of real estate in general, we're all kind of trying to find our way. The Internet basically is a source of information and a research tool. I think that's what we've all been using it for. In real estate, we're all in the prime arena to use it to share information.
One of the big concerns that has been voiced to me by brokers about the Internet -- once properties will ultimately be online, and information will be online -- is, 'As a broker, if my client can get all this information online, what will be my role?'
Since I don't really see my primary role as a leasing broker as being a space finder but as a negotiator, I'm pretty secure that the role we play in the marketplace will still be there. There will always be a need for someone to interpret the information.
Denise Anthony: The website that people should be using, I think of it as enhanced visibility. It's not always necessary to sell, but it is the services adjunct to advertising, marketing and public relations. That's how I look at it. As a business tool, it's still in the very early stages. Is anybody making any money from their website? There's no way to tell. That enhanced visibility is great, but you've got to be aware that, if you're just going to give an 800 number and some documentation on what your services are, that will not hold the interest of the people who hit your site. You need the graphics. You need all the fanfare that goes along with it to hold people's interest. And you must always update.
Customer service, that's what we consider our Virtual Underwriter. We don't charge anything for it. It took millions of dollars to produce. This is for people in banking, for attorneys and lenders on underwriting. It has bulletins by state that affect real estate to help do your job. It's research.
Wysong: One of the early endeavors to put data on the Internet, in terms of market data and space available, and they were selling the service, just stopped because they found it was not profitable. They could not get enough subscribers. There is another service -- and I think this is one of the tricks with the Internet -- that is still operating, and they are financing their site through advertising in banners on their page.
So one of the questions everybody is asking is 'How do you make money?' Most media is financed through advertising, not subscription. And I think ultimately the Internet will be financed the same way.
NREI: Let's talk about technology's affect on real estate.
Kathleen Treat: We've got clients that want options, and they want them fast. That's what technology is doing for us with real estate. We're popping (site plans) out at an ever increasing rate. Take three hours, maximum, it's a whole new site plan. It's a new tenant mix on a retail site. You can instantly send that particular tenant prospect all the data that they want.
Architects have been using CAD for many years now, and that's only increasing in the future. Ten years ago, probably only 2% to 5% of the firms used CAD. Now 98% use CAD, and that's increased their speed dramatically.
When we're building buildings, we're going faster and faster. What used to be an eight-, nine- or 10-month project, we're now trying to compress that to five to six months. What does this mean for us in the office buildings of the future? I think some people want me to say, 'Office buildings are going to be totally different in the future,' and I really don't think that's the case. The office buildings that we're designing, the major change that we're making is that we're going to 14 ft. height floor to floor, where we used to do 13 or 13.6 ft. The only real reason were doing that is to allow any tenant who wishes to put in a 6-inch cable run and a raised floor.
Anthony: Is this going to make existing buildings obsolete?
Treat: It could. I think what's going to happen is we'll have a tiering, Class-A, Class-B, Class-C situation.
Kathy Nunnally-Anemogiannis: I head up our research center in our national real estate practice. There's been a lot of interest in technology among clients of our practice -- from users as well as investors. I think the topic today should have been 'Old risk, new risk,' because that's exactly where this concern is emanating from. Investors in real estate want to know what their exposure is. I think one of the main things that we're communicating is technology has created a whole new venue for conducting commerce. So if you think about commercial real estate in its historical context, it was buildings to house commerce.
We don't believe real estate is threatened. It's just that you have to be even more knowledgeable about your environment and who you're marketing space to.
Denise Anthony - Senior Account Executive, Stewart Title of California Inc. Nancy Little - Partner, McGuire Woods Battle & Boothe LLP Elizabeth Trocchio - President, Woodmont Property Mgmt. Co. Anne Burruss - Investment Officer, AMRESCO Capital Corp. Kathy Nunnally-Anemogiannis - Nat'l. Director of RE Research, Deloitte & Touche LLP Margaret Williams - Business Development Officer, Heller First Capital Dorothy Cunningham - Managing Director, CIGNA Investment Mgmt. Phyllis Riina - Corporate Real Estate Mgr., General Motors Corp. Rose Wolfe - Partner, Deloitte & Touche LLP Sylvia Ferrell-Jones - Senior Vice President, AEW Capital Management Kathleen Treat - Project Manager, Opus South Corp. Arlene Wysong - Senior Managing Director, Newmark & Co.