Corporate Users and Developers Embrace Secondary Markets

The mantra in Corporate America today is expense control, and employers increasingly are turning to less costly labor markets to accommodate their needs. Metropolitan Las Vegas, which continues to benefit by the economic fallout in California, posted job growth of 4% to lead all markets between January and November 2003, according to Property & Portfolio Research.

It's no accident that Tampa and Jacksonville, Fla., also rank among the top 15 markets in terms of job growth. Corporate real estate transactions increasingly are being driven by labor costs and workforce availability, which has helped fuel these burgeoning markets. “Labor-based portfolio strategies are in vogue right now in Corporate America,” explains Richard McBlaine, president of strategic consulting for real estate services giant Jones Lang LaSalle. “The question is: where can you acquire the most cost-effective talent, particularly for back-of-the-house operations?”

And in a global marketplace, the options are wide open for employers. Forrester Research Inc. estimates that by 2015, 3.3 million U.S. services industry jobs and $136 billion in wages will have moved offshore to countries such as India, China and the Philippines. The information technology industry will lead the exodus, Forrester predicts. Approximately 400,000 U.S. jobs already have moved offshore, according to the Cambridge, Mass.-based research firm.

CEOs and CFOs have long recognized the importance of reining in labor costs, but the most recent recession and spotty economic recovery have effectively accelerated this migration toward lower-cost labor markets, say commercial real estate experts.

Reducing labor costs is not the only reason secondary markets continue to remain attractive, explains George Slusser, president of Coldwell Banker Commercial. “There is also a solid indication that this smaller market size provides a more stable business environment as there is typically less volume and activity, helping to minimize risk.”

Everyday deals involving corporate space users reflect this emerging trend. Waste Management, for example, is in the process of relocating customer-service operations from Chicago to Phoenix. The Houston-based company recently signed a five-year, 50,000 sq. ft. lease at the Desert Canyon office complex developed by The Alter Group, ranked No. 5 on National Real Estate Investor's 2003 list of Top 25 Office Developers. It's estimated that Waste Management will employ 300 workers at Desert Canyon.

“They [Waste Management] chose Phoenix because it's truly a diversified city that is expanding in a growing business climate, and they can get labor at about a 10% cheaper rate,” says Richard Gatto, executive vice president of The Alter Group, based in Skokie, Ill. Phoenix is one of a growing number of markets in the Southeast and the Southwest that attract Corporate America, says Gatto.

These population-growth markets also are a magnet for commercial real estate investors seeking refuge from the over-saturated commercial real estate markets of the big cities, says David Frosh, president of Sperry Van Ness, which specializes in investment sales. “At the end of the day, in commercial real estate where the jobs go is where the opportunity for [asset and price] appreciation is.”

Study Highlights

To gain more insight into the plans of corporate space users and developers/owners/managers over the next 12 months, NREI and Coldwell Banker Commercial conducted an exclusive market study in November and December 2003.

The majority of respondents are involved in multiple property types, but corporate users are most likely to own or lease office space (64%). On the supplier side, respondents are most likely to own, manage or develop retail properties (56%), followed by office properties (51%) and multifamily properties (45%) [Figure 1].

The size of commercial real estate portfolios among respondents varies. Corporate real estate user respondents are mostly likely to hold large portfolios of owned and leased commercial real estate. The median size of corporate respondents' portfolios is 2.6 million sq. ft. The median portfolio size of developer/owner/managers is 609,756 sq. ft. [Figure 2].

Among the study's key findings:

  • Respondents are most likely to have plans to move into secondary markets in the next 12 months. Among corporate users, 41% plan to enter secondary markets compared with 45% for developer/owner/manager respondents [Figure 3].

  • Corporate users of real estate are most likely to renovate or redevelop existing sites (48%), lease commercial real estate as a lessee (43%), or sell commercial real estate (43%). Meanwhile, among developer/owner/manager respondents, 69% plan to purchase real estate over the next year while 63% plan to develop commercial real estate.

  • Corporate users are most likely to acquire, lease or dispose of office properties (45%). Meanwhile, developer/owner/manager respondents are most likely to acquire, develop or dispose of retail properties (49%).

  • Nearly 80% of developer/owner/manager respondents plan to increase their real estate holdings over the next 12 months. These respondents plan to increase their holdings by a median of $7.56 million.

  • Corporate users plan to lease a median of approximately 100,000 sq. ft. in new space in 2004, but this group is shedding space as well. Approximately 16% of corporate users plan to dispose of 100,000 sq. ft. or more in the coming year.

  • The majority of corporate respondents (69%) anticipate new hiring over the next 12 months, but only 12% expect significant new hiring. Less than 10% anticipate downsizing.

Space Users: Back to the Basics

As Figure 4 shows, corporate users are most likely to renovate/redevelop their existing space. Simply stated, they're reconfiguring their space needs and tightening up as necessary. Industry experts say such a step is warranted to keep costs under control.

That's quite a contrast to the go-go days of the late 1990s, when corporations had a voracious appetite for office space to accommodate future growth. In those days, some employers felt compelled to offer amenities such as fitness centers and spacious cafes to attract and retain workers, says Gatto of the Alter Group. “The New Economy companies led us there, but even the old-line companies bought into the idea that you had to pamper the employee.”

But in today's no-frills corporate climate, where executives preach the importance of being lean, the amount of office space per worker appears to be shrinking. Large employers that previously dedicated as much as 225 rentable sq. ft. per worker now may only allocate 175 sq. ft. “Corporations are not worried about whether the design is fresh and exciting,” says Gatto. “Their attitude is: ‘If you want the job, you'll go into that cubicle.’ End of story.”

A substantial number of corporate respondents (43%) indicate that they plan to sell some of their assets over the next year, as Figure 4 shows. For companies burdened with a glut of unwanted space, paring it down continues to be a top priority. After all, it doesn't make sense for companies to pay for space they're not using.

Developers' Game Plan

The survey results show that developer/owner/manager respondents plan to be net acquirers of commercial real estate in 2004. Specifically, this group plans to acquire a median of 156,410 sq. ft., while disposing of a median of 91,666 sq. ft. [Figure 5]. What product types will they be adding to their portfolios? Retail definitely figures into the mix. In fact, developers/owners/managers are most likely to have plans for retail properties [Figure 6]. For example, when asked the reasons behind plans to increase their holdings in secondary markets, some developers/owners/managers cited chain store development opportunities. Linking rooftops to retail, one respondent wrote that “housing growth tends to be outside the primary MSAs (metropolitan statistical areas), creating more retail development opportunities.”

Industry experts say that the widespread interest in retail is being enhanced by the limited opportunities in other product types. Indeed, the office market is burdened by a glut of available space due to corporate downsizing. The national office vacancy rate climbed from 15.1% in the third quarter of 2002 to 16.8% in the third quarter of 2003, according to CB Richard Ellis. Furthermore, rents in the office sector remain flat or are still falling in some cases.

Meanwhile, the apartment market is struggling with a set of different issues. Incredibly low interest rates have enabled prospective renters to purchase homes. “Multifamily developers will need to keep a watch on the economic indicators to cap the supply of new units, so as not to saturate the market,” says Slusser of Coldwell Banker Commercial.

Several factors have led to concessions by apartment owners and put downward pressure on rents. The 10-year Treasury yield was hovering at 4% in mid-January of this year. In addition, the apartment supply pipeline keeps growing. New York-based research firm Reis Inc., which tracks apartment fundamentals, reports that a total of 103,358 units are expected to come on line this year.

While that's lower than the 163,069 completions in 1999, it's too much supply for a market that experienced two years of negative absorption in 2001 and 2002.

The write-in responses reveal that several developers and owners want to establish product diversification within their portfolios. Additionally, some respondents indicate that they are attracted to secondary and tertiary markets because competition for quality product is not as fierce as in primary markets.

Short-Term Expectations

Only 12% of corporate users plan any significant hiring in 2004 as indicated in Figure 7, so it will be difficult to burn off the so-called shadow space — office space that is leased but not utilized — anytime soon. But any talk of hiring is good news for the commercial real estate industry, whose fortunes rise and fall based on the performance of the job market. “What space users are telling real estate professionals is that they are getting some money to hire people,” says Gatto. “Their message is, ‘We shrank and survived and now we're coming back.’”

The emerging consensus is that job growth and corporate expansion will be minimal in 2004. Gatto says it will take another 12 to 18 months to absorb the space that's on the market before corporations pull the trigger and take new space.

What's still lacking, many commercial real estate experts agree, is widespread confidence that the economy is experiencing significant, consistent job growth.

Ongoing corporate consolidation also dampens the prospects for any near-term recovery for the office sector. J.P. Morgan Chase & Co. announced in mid-January plans to purchase Bank One Corp. As a result of the merger, approximately 10,000 workers, or 7% of the combined workforce, will be eliminated.

McBlaine of Jones Lang LaSalle acknowledges that a combination of factors could limit the pace of recovery. “Some of these corporate trends, including offshoring and finding ways to become more efficient, will limit the speed of job growth and any uptick in real estate.”

Survey Methodology

Data for the 2004 Corporate Real Estate Survey conducted jointly by National Real Estate Investor and Coldwell Banker Commercial was collected between November and December 2003. The purpose of the survey was threefold: to investigate which markets — primary, secondary or tertiary — will experience the most growth over the next 12 months; to determine the commercial real estate holdings of corporations and their near-term plans; and to assess potential opportunities for commercial real estate owners, managers and developers in these markets.

Both providers and users of commercial real estate were surveyed. An e-mail link containing the survey questions was sent to 6,500 NREI subscribers, including 5,300 developers/owners/managers and more than 1,200 corporate users. The results are based on responses from 391 industry professionals. This report, prepared by Matt Valley and Elinor Rice, also can be viewed online at

NREI covers trends in commercial real estate with an emphasis on finance. Approximately one-third of the publication's 33,000 qualified readers are developers/owners/managers, while lenders, corporate users and brokers make up the balance of the readership. This special report also appears in Trusts & Estates, which along with NREI, is part of Primedia's Financial Services Group.

The Coldwell Banker Commercial system has more than 500 commercial real estate offices and nearly 3,300 sales associates throughout the world. Coldwell Banker Commercial provides commercial real estate solutions for tenants, landlords, sellers and buyers in the leasing, acquisition, disposition and management of all property types. Coldwell Banker Commercial® is a licensed trademark to Coldwell Banker Real Estate Corporation. Coldwell Banker Real Estate Corporation is a subsidiary of Cendant Corporation.

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