Heitman Symposium serves up new corporate real estate strategies

Every year, Heitman Properties Ltd. of Chicago gathers a group of America's top corporate real estate executives together in an intimate setting to discuss the pertinent is, sues affecting today's corporate real estate managers.

This year's sixth annual Heitman Corporate Real Estate Symposium, held in late February at the Four Seasons Hotel in Chicago, was appropriately themed "Strategic Directions for Corporate Real Estate," and once a brought forth today's major issues.

Participants are comprised of senior real estate executives from leading Fortune 100 companies.

At least two majoror touchpointswhich greatly impact the role of the corporate real estate executives'daily (and continued) professional lives were explored throughout the two-day conference:

* technology

* strategic planning

In addition, Symposium speakers covered topics including an overview of the capital markets, investor appetites, the political landscape and case studies.

Perhaps no other single factor is influencing the way real estate will be run in the future more than technology. What started as a word-processing platform, the computer, has quickly become an indispensable tool for the real estate industry. From e-mail to home pages on the Internet, role of technology cannot be understated.

At the same time, Corporate America's drive to cut costs and extract more efficiency from fewer total employees is forcing today's corporate real estate executives to integrate themselves into the goals and strategies of the corporations which employ them.

The competitive invironment in which these executives work is fierce, as the trend to outsource non-core services to third-party providers continues in earnest.

It is under these complex dynamics that the Heitman Symposium seeks to help some of America's to real estate executives seek appropriate answers. (see box for participants)

"The program focused on the emerging trends in technology and the influence of strategic planning on corporate real estate, said David Latvaaho, president and national director of leasing for Heitman Properties Ltd. "Increasingly, corporations are acknowledging the relevance of an efficient real estate department and its impact on the bottom line."

The Internet changes everything

So the big question on everyone's mind is, "How will technology change the business?"

As with so many things concerning real estate, the answer is neither simple nor readily known.

There's no question when it comes to the popularity of using the Internet. According to Peter Fraterdeus, president of designOnline, a Chicago-based developer of sites on the World Wide Web, as of Feb. 26, 1996, the Internet Information Center had recorded a total of 205,909 of the so-called ".com domains" or commercial addresses registered on the Internet.

"The Internet is important because we now have a single protocol for Internet working between different computers," said Fraterdeus.

The worldwide linkage provided by the Internet has some obvious, and not-so-obvious, opportunities for the real estate industry.

"In terms of the real estate world, you now have the potential to market a value-added building," said James Cicenia, president of The Planet Group, a Chicago-based consulting firm that provides digital access services to the Internet. "Most co orate buildings have the infrastruct in place to offer the Internet to everyone in that building for marginal cost."

Cicenia also discussed the ability to conduct "virtual walk-throughs" of buildings in different property types. This is a developing area of the Internet which has come open to quite a bit of debate between technology buffs and real estate purists. Both sides, however, seem to agree that the virtual tour will never replace onsite inspections, but it could be used as a valuable tool in narrowing a great many property offerings to a manageable handful which could then be inspected with an old-fashioned human site tour.

Another big question mark is who is using the Internet and what are users looking for. A number of contentproviders have emerged on the scene and. are busy trying to answer that very question for Corporate America and others.

"The Internet offers us an opportunity in the'90s," said Paul Barnett, president of Seattle-based Internet Power, which provides marketing consulting to web sites. "Information has always been power. Through downsizing and rightsizing, the revolution in Corporate America has forced us to be productive. The trend is to get more out of fewer people. The Internet can help you work smarter, not harder."

Recent studies have concluded that Internet usage is still on a dramatic upswing. In 1995, an estimated 1.5 million people had Internet access at their places of work. By the year 2000, that number is expected to grow to 14.1 million.

As usual with so many things technological, change is fast-moving. "We're watching a freight train screaming down the track. We're trying to talk about it today in a photograph. But that train is now a mile down the track. That is how fast things are evolving in this world of the Internet."

Of particular note for Corporate America is the recent development of more "Intranets," which are inter-company web sites. You can expect to hear a lot more about this in the future. As an example, FedEx handles 2.4 million packages a day and has 12,000 customers log on daily to check their package status. This system saves FedEx some $2 million a year, all because of the company's investment in 60 web sites, or intranets, which allow FedEx's 30,000 employees to get part of their information from them.

Technology has also become an integral part of working life at GTE. "Internally my entire department relies on electronic meeting scheduling, e-mail and project reporting and scheduling," said Ronald Kulpinski, president of GTE Realty Corp. and vice president of GTE Service Corp. "When we interview possible service-providers for international markets, we are now focusing on how they plan to use the Internet or other electronic vehicles to expedite information transfer. Use of cell phones and pagers is now quite mundane; it's the future we are concentrating on."

What happens now?

Bridging the gap between the "virtual" world and the real world is one of the most difficult tasks facing today's real estate manager. Raymond Torto, principal of Torto Wheaton Research in Boston, addressed the impact of technology on the real estate environment, specifically in the office sector.

Torto pointed out three serious arguments on the table concerning office space and future technology:

1. There will be fewer office-related jobs in the future.

2. We will need less space per office worker.

3. Inventory management practices will eliminate the need for warehouse space.

"All of these issues depend on your perspective," said Torto.

Tackling the arguments one by one, Torto said all evidence points to a continued growth rate in total office employment of about 1%.

"By implication, there's growing demand for space going forward, said Torto. "So what's going on? I read about downsizing, but I wonder if what's really happening is there is an outsourcing of jobs to business services that are taking over those functions that are not corporate jobs. So corporate jobs are leaving, at least for the Fortune 500, but they're not vanishing from the economy. There's a vertical disintegration of jobs as they are outsourced."

As for the argument that office workers will require less space per person, Torto's research indicates that the long-term trend is for increasing occupied space per employee, not decreasing. Some companies are even expanding their space requirements. "Because space today is relatively cheap compared to the recent past, what economists would call the 'price effect' is dominating all the technology issues."

Torto even argues that firms might be taking more space now with lower rents in anticipation of adding more employees in the future. "The cost of technology will drop, while the cost of real estate will rise," said Torto.

"From the tenant point of view, if you're not locking down your space today, it's going to be very expensive tomorrow. By 1998 and 1999, as new completions come on line, rents may peak," said Torto.

An economic context

Mary Ludgin, managing director of Heitman/JMB Advisory Corp., explored the general economic factors that are affecting the real estate business. Apparently, the United States (except for California) recognized the end of the latest recession in early 1991. While the rate of employment growth has been slowing of late, "The reality is that there are more of us employed today than there were five years ago," said Ludgin.

Consolidation has been the order of the day for many key industries. In 1995, in the banking industry alone, there were 283 announced mergers and acquisitions. "It's a very difficult time in certain key sectors, and these are highly visible sectors. They make the front page of the newspaper, and they have an affect on the consumer that's quite unsettling. It means we're actually growing in jobs, but in many instances the jobs that are being gained are either jobs that are part-time replacing full-time positions or at much lower salary rates. So we may have more people employed, but we don't feel like it," said Ludgin.

According to Ludgin, the outlook for GDP growth in 1996 is about 2%. "The net result is that we're likely to avert recession in 1996."

In the key retailing sector, Ludgin said that Americans are continuing to shop, although promotionally. And of course sale have slimmed profit margins from their previous levels. As the nation's population continues to grow at 1.1% annually, last year retail space was delivered at a rate of 2.3%. "That's ahead of where we were in the early-1990s, but it's still ahead of the growth in demand. It's a real problem. We're not spending much at the malls, and that's not likely to change," said Ludgin.

Both the technology and economic outlooks have one commonality - they are set against a political context, which ultimately impacts all manner of real estate activities. Steven Wechsler, president of the National Realty Committee, which serves as real estate's roundtable for national policy issues in Washington, D.C., emphasized the importance of political observations.

"Watch what people do, not necessarily what they say," said Wechsler. "That rule applies to politics. The business I'm in and what I worry about has to be the business you're in and what you worry about."

And since government leaders are responsible for writing the laws of the land, their opinion of issues affecting the real estate industry counts. "How real estate can be operated, is valued and is used can all be tied to some extent to government policy," said Wechsler.

Changing capital structure

Capital, and more specifically the availability of it, has a dramatic impact on the buy/sell equation for corporate real estate executives. And as with real estate property cycles, the 1990s capital markets look totally different from their 1970s and 1980s predecessors.

In a nutshell, "Capital is back in a very big way, both equity investment and in lending, not anything close to the hey-days of the mid-'80s, but huge relative to the early-'90s," said Charles Wurtzebach, president and COO of Heitman/JMB Advisory Corp.

For years now, capital market watchers have been predicting increased investment in real estate by the nation's pension funds, and now there is evidence that the hope is becoming reality.

"There has been a huge shift in the way that pension funds look at real estate, what they're looking for real estate to do going forward in their portfolio, how they make that decision, and to invest or not to invest," said Wurtzebach.

Pension funds have also increased their "risk profile" for real estate, said Wurtzebach. Both corporate and public pension plans are reaching for higher returns.

"The public plans are all broke," he added. "Their expected returns were determined in the'80s. If Corporate America increases its contribution to the pension plan, that's a direct deduct off the earnings per share and that's bad. So they are changing the risk profile of the kinds of investments they will make, not just in U.S. direct real estate, but adding international stocks and bonds to the mix, opportunistic real estate, and more challenging, riskier real estate that offers a higher return."

This has led to the four-quadrant theory of real estate investment - public debt, public equity, private debt and private equity.

"This framework really defines the way capital has shifted and the way it will be delivered to real estate going forward," said Wurtzebach.

So who's investing?

Though the promise of significant pension fund investment in U.S. real estate has largely failed to materialize, die funds wave a big stick in the market that can't be ignored.

"Real estate is still a relatively small part of the asset allocation of U.S. funds," said Richard Kateley, executive vice president of Heitman Financial Ltd. "The real winner has been on the international side because that is where the money has flowed. However, that allocation belies the importance of the pension funds to our business. If you look at investmentgrade equity ownership, pension funds control about 43% of that market, twice as much as the life companies at 21%."

And the funds have been anything but sideline players.

"We're seeing the pension funds back in the market buying property," Kateley said. "We're seeing simultaneously pension funds beginning to sell. The sell signal comes from three areas - looking to re-balance portfolios, looking to get rid of the dog properties, and selling properties which have turned up and the funds are now reaping some of the rewards for good performance."

Kateley also sees a significant swapping of equity in fund properties into REITs. "Two of the largest pension funds in the country, CALPERS and CALSTERS, have active programs now where they're looking at their entire privately owned real estate equity portfolio and trying to swap the properties into REITs or create a REIT."

As far as other major real estate investment players are concerned, the commercial banks are back, but in a different way.

According to Patricia Goldstein, division executive with Citicorp Real Estate in New York, super-regional banks are taking a larger role in the real estate lending market. "They're very active and very aggressive in this business. They've been consolidating and aggressively out there doing deals," said Goldstein. "We're seeing an overlap between commercial banks and the investment banks that's been developing since the early-'90s."

At the same time, the money center banks have slowed down their lending. "Citibank has reduced lending to this business," said Goldstein. "The reason for that is coming out the90s debacle and the great losses that the commercial banks had, a lot of them decided, particularly the money center banks which have the capacity to go into commercial mortgage-backed securities, that they wanted to originate mortgages but they didn't necessarily want to hold them on their balance sheets."

At Citicorp, Goldstein is in charge of an $8 billion U.S. loan portfolio and is the real estate manager for Citicorp's global relationship bank, spending time in japan, Europe and North America.

"Everybody's trying to bring their balance sheets down. We had $24 billion in the United States and Canada in 1990. Now we're down to $7 billion, which is still one of the larger balance sheets in real estate," said Goldstein.

Another leading real estate player these days is Teachers Insurance & Annuity Association (TIAA). The Teachers' real estate portfolio includes 700 buildings with a total of 45 million sq. ft. b worth $4 billion on the wholly owned side, and another $3 billion in hotels and joint ventures, and $23 billion in mortgages.

"The trends are telling us that we ought to get back to some basic underwriting considerations when we're doing deals. Really, you've got to get away from the trends and not be influenced by them to the point of making decisions based upon them, but getting back to some of your core business requirements," said Philip DiGennaro, managing director of TIAA.

In the last four years, $4 billion of TIAA's foreclosed real estate has been turned into investment-grade real estate. According to DiGennaro, those properties have earned, on average, over 10%, and Teachers retains the residual value of the properties.

But that's not all TIAA has accomplished.

Last October, it won approval to create a separate real estate account offered to constituencies at universities. The account was seeded with $100 million initially, but it is expected to reach an investment level of $500 million to $5 billion, depending on its acceptance and returns. DiGennaro says that $70 million has been invested so far, with good response. Another $60 million has been committed. The fund is buying properties worth $5 million to $20 million that are fully leased, including industrials, apartments and some office.

On the sell side, DiGennaro says TIAA is not a big seller of real estate. "We're more likely to be characterized as opportunistic sellers of real estate."

Like many other funds, TIAA has seen its share of refinancings and restructurings: "It's been a tough five years, and it's still going on. In 1996, another $200 million of foreclosed real estate will come in. Striking quickly and decisively, I think, is the best approach. But the rating agencies don't consider real estate a terrific asset class. They don't like you to have 10% of your assets in real estate. Being sensitive to those considerations, we've been very patient with borrowers and work deals out."

Fundamentally, Teachers believes in investing in its own properties.accounting requirements, depreciation, all tend to downplay the importance of real estate as a long-term quality asset class, which we're very much in favor of. You get caught in the middle of real estate."

Growth is the watchword. "We'll put out $35 billion to $40 billion in real estate-related investments in the next 10 years, mostly in mortgages. Where will we find quality investments? In the brokerage and investment banking communities," said DiGennaro.

However, the biggest piece of TIAA's real estate funding will be in the public debt markets. "Securitization is the biggest growth element in the near future for us in terms of where we're going to put our money out," said DiGennaro.

Foreign investments will also figure prominently, he said.

"What Teachers will do as a continuing participant in the real estate markets, as a lender, as a buyer, as a seller, as a capital resource, will be to maintain its flexibility. Our long-term view of this industry is such that we will have the $3.5 billion to $4.5 billion to invest in this year after year. We're here to stay. I'd like to think that our company will continue to grow and that by the end of the Century our asset base will be $200-plus billion, that by 2001 our equity real estate ownership will probably be back up to $10 billion. Time will tell."

Corporate case studies

Some of the most valuable components of the program, by far, were the case study presentations given by Symposium participants. Hearing first hand - from colleagues - is a rare opportunity.

Last month, stock investors were treated to the largest initial public offering by any public company, the $3.1 billion IPO by Lucent Technologies Inc., one of the three companies formed with the recent AT&T trivestiture.

Understandably there were (and are) major corporate real estate issues involved in such a large restructuring. On the front lines of the Lucent real estate deals is John Peace, district manager of real estate transactions.

"The splitup has been an incredibly big job," said Peace. Out of the 8,000 consolidated AT&T locations, every one of them had to be assigned to one of the three new companies, then deeds transferred and leases assigned. Lucent now has a 61 million sq. ft. portfolio and on day one started life as a $21 billion (revenue) company.

Part of Peace's new job (a big one) is to help cut more than.200 million from Lucent's existing $1.2 billion in annual real estate expense." Much of those savings will come from creative thinking, and some savings are likely to be realized from telecommuting options. For years, AT&T has embraced the "alternate office" concept for many of its employees, and it has moved many of its offices to the suburbs.

"I think the move to the suburbs has shown that you can get a good labor force for a better overall price, people are closer to home and they like that," said Peace. "I think that's the first phase of it. The second phase is if they work from home. AT&T has had as many as 30,000 people working in alternate office situations on a full-time basis.

"You're going to see more alternative officing," said Peace. That philosophy comes from the top down. "We've got an edict from our president that he wants more of the sales force to use alternate office concepts, including working out of their homes or hoteling operations where they'll share conference rooms and technical support. I think you'll see a lot of that across our industry.

"The gains are dramatic when senior management says, Let's go do this' and understands how to support it. Then the real estate team has the ability to support the transition and make it work," said Peace.

Another company that knows how to "make it work" is General Electric. In 1980, the company earned $23 billion, had $1.4 billion in revenues and employed 405,000 people in approximately 300 different units. In 1995, GE saw $70 billion in revenues, earned $6.7 billion and employed 221,000 people over 12 business components.

Harry Stein, GE's director of corporate real estate, and his staff close 50 to 60 major projects a year, and they usually have an average of 100 to 125 projects in process at any one time.

One of Stein's latest challenges has focused on GE's foreign real estate. A year ago, his group did four or five projects in Europe, but they found it difficult working with European operations, sort of a culture clash. But today, it's a different story.

"The cultures have changed and the people have changed," said Stein. "We now have 45 to 50 large projects in Europe and another 10 in Asia." Stein recently hired a new member for his team and is using the resources of two people in Ge's headquarters in Hammersmith, outside London.

As part of his corporate real estate duties, and to increase his group's corporate presence, Stein created a quarterly newsletter called Best Practices to communicate his group's message to other internal groups which are potential space users. "This is working very well and I expect we'll be on the Internet in the next couple of months," said Stein.

Up until january 1995, Stein's group charged for its services by the hour, plus T&L. But it found that it could incorporate as GE Realty Inc. and offer its services for free, thereby eliminating the need for other corporate divisions to use outside brokers.

One of the true turnaround stories of the last year was the IBM Corp. As with most other large corporations, IBM is significantly outsourcing much of its corporate real estate functions and has been consolidating its real estate use for several years.

John Byrnes, regional manager of IBM Real Estate Services - Operations West, said the company has cut its occupied real estate from 44 million sq. ft. in 1993 to just 21 million sq. ft. at year-end 1995.

"We have really been on the path toward more effective use of space," said Byrnes. "The real emphasis we had in the downsizing was the pressure on costs. One of the real advantages our users had was we provided them with an opportunity to significantly shrink their real estate costs. We have been heroes the last couple of years inside IBM."

Byrnes' department consists of approximately 20 people. "We empowered the people out there to do transactions. Four years ago it took 13 levels of signature, and many of them had to go all the way to the management review committee. The authorization to do transactions works extremely well."

The company also has signed onto more efficient use of space and technology. We are very aggressive in the hoteling concept, now utilizing high-tech centers. We've given out laptops and applications so that folks could work from any location. You have the same systems capability from that laptop as you would if you were sitting in a branch office. We've received good feedback on this practice," said Byrnes.

While IBM is one of the largest companies in the world, the U.S. General Services Administration (GSA) in Washington, D.C., is among the largest users of owned and leased space in the nation, with 290 million sq. ft.

Kenneth Kimbrough, senior adviser to the administrator of the GSA, provided an interesting study in how the public sector can learn from the private sector by increasing the efficiency of operations.

"GSA, like most of the other agencies in the government, was highly focused on maintaining its own bureaucratic process and its own identity, so it satisfied its own needs first, and, it satisfied the customer second. That was the problem by and large," said Kimbrough.

Under President Clinton's National Performance Review initiative, the GSA downsized by about 20%, and began to model private-sector structure. It became customer-focused, began using benchmarking and best-in-class practices.

"At the end of the day, we discovered how to reduce the cost of operations by about $1.3 billion per year on a $5 billion budget," said Kimbrough.

The GSA also instituted an asset management group to oversee its assets, and proposed legislation to allow those government agencies with real estate assets to turn them into the GSA in exchange for a credit toward their operations and ongoing agency programs.

Public/private partners

In keeping with the public/private sector theme, Richard Hanson, managing director of Chicago's Stein & Co., provided a brief of its work at the new McCormick Place, downtown Chicago's huge new convention center addition.

"Cities are going to have to do things to revitalize themselves, to create new sources of revenue. Places that can accommodate people make the city alive during the day and also at night. This all happens in places like McCormick Place, and other economic drivers in Chicago like Soldier Field, Comiskey Park and the Shedd Aquarium."

McCormick Place is scheduled for completion in fourth-quarter 1996. According to studies, four million visitors are expected to attend conventions at McCormick Place per year.

Hanson also discussed the proposed McDome, a domed, 73,000-seat stadium now under proposal to be built next to McCormick Place, which could complete the area's campus setting.

Wilhelm keynotes dinner

On the political front, and with the upcoming presidential election in full swing, the Symposium's keynote dinner speaker, David Wilhelm, treated attendees to a lively discourse on the crop of Republican presidential hopefuls.

Wilheim is senior managing director of investment banking at EVEREN Securities Inc., formerly Kemper Securities. He also is the former chairman of the Democratic National Committee in 1993 and 1994, and was President Clinton's campaign manager. He also managed Richard M. Daley's campaigns for mayor of Chicago in 1989 and 1991.

"Does anybody here know the true definition of politics? Poli is many, and ticks are blood-sucking insects," said Wilhelm.

After poking fun at his own former profession, much of Wilhelm's discussion focused on what he cited as two basic facts, one political and the other economic, which he believes have been driving American politics for the past decade: We live in extremely volatile times, and there has been a consistent and prolonged stagnation of middle-class incomes.

Wilhelm said what is ahead in the presidential election and its affect on property owners is still anyone's guess, as it becomes harder to focus on clear messages from either political party.

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