SHOWTIME: A look back at the year's top deals.
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It was a year that American companies and consumers rediscovered downtown, a time when the multifamily market still could not satisfy its appetite for new projects, and the industrial sector completed mega deal after mega deal. When Confucius wished that we live in interesting times, he had no idea 2000 would be such an era for the U.S. real estate industry.
The year 2000 was a time when landlords profited and office space tightened. In fact, the continued strength of downtown office markets and rental growth was unprecedented in some cities, according to Maria Sicola, senior managing director of research and analysis for New York-based Cushman & Wakefield.
“Look at some of the major downtown markets: Midtown Manhattan had rental growth of 36%; San Francisco, 50%; and Oakland, Calif., because of San Francisco's tight market and high cost, enjoyed 97% rental growth,” Sicola said.
“Will it continue? We think we will be seeing a slowdown,” she added. “The economy in general is beginning to slow down in many of these markets, especially those that have benefited from high tech and dot-coms that have vacancy rates of 5% or less.”
Although construction of office product is progressing at a steady clip, the growth in 2001 is expected to moderate, particularly in the suburbs. “I think we will still see rental growth both in downtown and the suburbs,” Sicola continued. “On average, we expect growth to slow to 6% in downtown and 4% in the suburbs in 2001. That compares with 15% average growth in downtown and 11% average growth in the suburbs in 2000.”
In fact, a slowing of the office sector toward the end of the year affected a number of companies, with economic uncertainty perhaps remaining the biggest cloud hanging over the real estate market.
“There were signs that the economy was slowing toward the end of the year, and the Federal Reserve's action to reduce interest rates confirmed that observation,” said Phoenix real estate entrepreneur Michael A. Pollack, echoing the sentiment of others in the business. “It appears uncertainty could squeeze the real estate industry further in 2001, meaning a leaner year for some real estate companies.”
The president of Michael A. Pollack Real Estate Investments — which owns, manages or has an interest in more than 100 commercial, industrial, multifamily and retail projects in three states — said that New Economy firms that delayed plans to grow in 2000 may continue to postpone expansion projects. “That could squeeze the real estate sector even more,” Pollack said.
“In addition, some growing storm clouds were created by bankrupt or [defunct] dot-coms and retailers that closed their doors,” he continued. “The dot-coms are expected to release their unused space on the market at rates that are more favorable to their creditors than to their landlords,” added Pollack. “There also will be quite a bit of space put back on the market by retailers who have gone out of business or downsized.”
Other industry professionals concur with Pollack's assessment. Jack Eimer, president and CEO of Chicago-based Transwestern Commercial Services, whose company underwent a major expansion in 2000, said that the industry faces an economic slowdown this year.
“The last report I read, we were looking at 2.6% (economic) growth, which will be the weakest in a decade,” Eimer said. “The good news is that it's still growth, and that supports the theory of a soft landing vs. a recession. So I think we're going to see a pretty dramatic return to the basics.”
Due to the predicted slowdown, the real estate industry is looking hesitatingly at the coming year — if only because 2000 seemed to be so robust. It was the year Wall Street rediscovered REITs, noted Michael Steele, COO and executive vice president of real estate operations for Chicago-based Equity Office Properties.
“In past years, REITs could not hold a candle to technology stocks. We were lost among all the dot-coms. But by the end of 2000, Wall Street had begun to take a look at REITs again as a good strategy for future growth,” Steele said.
Office market propels CBDs
One of the major trends of 2000 in many American cities — which is expected to continue into 2001 — was a rediscovery of the central business district (CBD) by office users, according to Richard M. Gatto, executive vice president of Skokie, Ill.-based The Alter Group.
“There's been a ramping up of major office development in major cities, based on the tightening of suburban vacancy rates,” he explained. “Within corporate America, there is an emerging belief that the infrastructure of the downtown area offers a more compelling location, particularly in comparison to suburban traffic patterns. The downtown areas have the infrastructure already in place.”
Last year was the beginning of a stronger relationship between tenant and landlord, as well as the introduction of new products for the real estate industry, added Equity Office's Steele.
“Market information had been very closely guarded in the past, but the information has become more transparent. What we've found is a willingness on the part of customers and landlords to share information, particularly in terms of what space is needed to meet their long-term business strategy,” Steele said.
Nationally, the office market was strong both in the CBD and suburban markets. The Los Angeles/Orange County area office market experienced phenomenal growth in 2000, which fueled a record-setting performance, according to Tong Saetia, the western region director of research for Delta Associates, the Alexandria, Va.-based national research affiliate of Transwestern Commercial Services. The high-tech/telecom and entertainment industries drove growth in 2000, but Saetia expressed caution about the future.
In the Midwest, real estate continued to be strong, particularly in large metropolitan areas such as Chicago, Detroit and St. Louis. Those in the real estate industry say the future is a bit cloudy because of the economic outlook.
“In 2000, we enjoyed a strong office market with high occupancies,” said David Farbman, president of Southfield, Mich.-based The Farbman Group, a full-service real estate firm. “If car sales continue to decline, it's safe to say there will be softness in the Detroit office market. A slowing in the automobile industry could mean an increase in the vacancy rate. Whenever car sales slow, it clearly has a slowing effect on our economy, but it also opens up new opportunities.”
Reflecting on 2000, David Meline, an Atlanta-based senior director in the financial services group of Cushman & Wakefield, pointed to some clear trends. “We can see that there was uncertainty in the marketplace with cap rates rising a bit, and a little higher spread on the bid-and-ask price. A couple of deals were pulled off the market by sellers,” Meline explained.
The 2000 real estate market was strong, particularly in the western states, said Dick Sim of The Irvine Co. based in Orange County, Calif. According to Sim, developers in 2001 will have to try different tactics to succeed in a more competitive market. “The dot-com shakeout has, and is, taking place,” Sim said. “I think it's concentrated in certain areas, including Northern California, which had the biggest concentration of dot-coms.”
Sim predicted that normalcy will be restored to the markets in 2001. “The frenzy and hype are over,” he said. “It'll be good because people are going to have to go out and work for it. We'll see rents stabilize. There won't be the rent spikes in 2001 that we saw in previous years.”
Last year was a time when retail real estate developers realized that e-commerce was not the future of retail — not just yet anyway. They also confronted the sobering news of a number of retailers who were either forced to close stores or file for bankruptcy.
In 2000, the retail industry opted to concentrate on the basics, said Drew Alexander, president of Houston-based Weingarten Realty Investors.
“Investors began looking more closely at good neighborhood and community centers, and consumers were also looking for value with stores such as Target, Kohl's and Old Navy among the hot retailers,” Alexander said.
“Grocery stores also did well in 2000 because I think people looked to the basics again,” Alexander added. “A couple of years ago, there was a lot of talk about entertainment centers and theaters, but that has been overdone. Developers have become leery of the risk associated with entertainment uses.”
E-commerce was another concept that was over-hyped last year, and while some form of e-commerce eventually will be associated with retail, investors and consumers learned that it's difficult to make money with a pure e-commerce model.
Mark Rivers, executive vice president of Arlington, Va.-based Mills Corp., a self-managed REIT with a retail portfolio of 16.8 million sq. ft. in 13 states, characterized 2000 as a “sunset period for technology mania.”
Pure play e-commerce players had a difficult time with their economic models, particularly with trying to create a three-dimensional shopping experience, said Rivers. “Now there is a sense that not only did e-commerce not win the war over bricks and mortar, it wasn't a war after all. It was a merger of bricks and sticks and e-commerce.”
Unfortunately for most retailers, 2000 didn't end up as well as it began, according to John Bucksbaum, CEO of Chicago-based General Growth Properties, a shopping mall REIT.
“You had a wonderful holiday season in 1999 that continued into the first 10 months of 2000, and then it slowed considerably,” Bucksbaum said. “It's pretty well documented what occurred with sales. Nobody expected the 2000 holiday season to match the previous year's sales, but retailers were hoping for a better performance than they ended up with.”
Consumers will continue to have paychecks as long as employment remains strong, so there will always be consumers and retailers continually looking for new space, Bucksbaum said. “We're at an all-time high with our occupancy levels,” he continued.
Over the past several months, a number of major retailers have closed their doors, including Chicago-based Montgomery Ward, which late last year announced plans to shutter 250 stores. During the same week that Montgomery Ward announced it was going out of business, Bradlees Inc., a Braintree, Mass.-based retailer, also announced that it would file for bankruptcy and said it plans to close its 105 stores within months. That comes on the heels of problems experienced by retailers such as Helig-Meyers.
“For savvy retail real estate developers, the closing of stores such as Montgomery Ward presents a golden opportunity,” said Pollack of Pollack Real Estate Investments. “Mall owners and shopping center developers now have the opportunity to fill the space with better operators that produce better profit margins. Like anything else, the strong get stronger, and the weak fade away.”
Developers and lenders must act responsibly in 2001, Pollack advised. “We're experiencing a substantial amount of consolidation, and/or the entire elimination of some large retailers. Developers need to be conservative and only build when there is a true need,” Pollack said.
The overscreening of the movie theater sector, evident by the numerous bankruptcies among theater chains, was one of the major trends in 2000, and one that will likely be dealt with this year, said Andrew Trachman, president of MBK Southern California Ltd., a subsidiary of Mitsui & Co., which concentrates on retail development.
“There will be a considerable number of theaters that are physically inferior to the new stadium-style, state-of-the-art facilities. They also are in inferior locations,” Trachman said.
There are about 38,000 screens nationwide, according to Trachman, or about 6,000 to 8,000 too many. “Those screens are going to be closed out as leases expire or as the bankruptcy courts reject leases or buyouts occur. What will happen to those movie theaters is the interesting retail question of 2001.”
Multifamily, steady as she goes
The multifamily industry posted a solid performance in 2000, concluded Jonathan Kempner, president of the National Multi Housing Council in Washington, D. C. “People in the industry feel, and I think with justification, that as an industry we have been relatively restrained. Compared with the excess [construction] of the late-1980s, the apartment industry seems to be in good equilibrium,” Kempner added.
Multifamily demand was strong throughout the country last year and continues to be strong in 2001, according to Kempner. “Most markets are healthy, rents are quite good and the industry has not raced to produce apartments at a pace that would be unjustified,” he continued. “Yes, there are always pockets or submarkets where there is more supply than demand, but I remember the days when the low 90s [percentile] were considered good occupancies. Now the averages are 95% and above.”
Douglas Crocker II, president and CEO of Chicago-based Equity Residential Properties Trust, one of the largest multifamily owners in the country, described the 2000 multifamily market as robust. Revenue growth increased by 4% to 5% across the country last year and by 10% to 15% in cities such as San Francisco and Boston, where market rents increased dramatically, Crocker said.
Although investors have pulled back from some other property types due to a more difficult financing environment, apartment investment remains strong in part because Fannie Mae and Freddie Mac continue to lend billions of dollars to the market annually, Crocker added.
One unknown factor that looms over the apartment market is the direction of interest rates over the next 12 months. The current interest rate environment is favorable to apartment owners, according to Crocker, but a dramatic rise or fall in interest rates could have a negative impact on the multifamily market.
“A big drop in interest rates would be bad, not only because developers would have more opportunity to overbuild the market, but also because more apartment residents would be able to afford single-family homes. The current interest rate environment is helping to keep the market in equilibrium,” Crocker said.
The conventional wisdom among hotel companies and industry analysts is that 2000 was a strong year for hotels. In fact, Eric Danziger, president and COO of Minneapolis-based Carlson Hotels Worldwide, noted that 2000 was a banner year for his company, which offers the Radisson, Regent International, Country Inn & Suites and Park Plaza and Park Inns brands.
Danziger is fully aware that the industry may experience the effects of an economic downturn, but he's convinced that good brands tend to grow more in economic downturns because owners want to associate and affiliate with the power of a good brand.
“If a downturn occurs, our brands become more global and stronger,” Danziger said. “I think 2001 will see more consolidation. There will be more gobbling up of hotels, and it's always better to be the gobbler than the gobblee.”
Hospitality industry fundamentals remained strong in 2000, agreed Art Adler, managing director of the Americas at Jones Lang LaSalle Hotels in New York. Adler doesn't foresee any major downturn in the lodging sector, although there could be a slowdown in new supply caused by illiquidity in the capital markets.
“Looking to 2001, we see tremendous opportunities for well-capitalized investors, as well as lenders who have targeted the industry to put out quite a bit of money,” Adler said.
Robert Mandelbaum, director of research/information services for the Atlanta-based Hospitality Research Group (HRG) of PKF Consulting, summarized 2000 as a year of moderate growth. “That is not too bad given the subdued expectations at the beginning of the year,” Mandelbaum said.
“While the 2000 lodging performance was characterized by a quick start and slow finish, we anticipate the opposite to occur in 2001. Look for a sluggish first quarter, followed by recovery during the spring and summer months.”
Mandelbaum emphasized that HRG is projecting a slowdown in growth, not a decline in performance. “We have seen similar signs of deceleration in previous years, only to be pleasantly surprised by the resiliency of the lodging industry. Look for U.S. hotels to endure through a relatively tough 2001 and come out profitable at the end,” Mandelbaum said.
Hotel transaction volume accelerated in 2000 and is expected to gain even more velocity in 2001, said Sharon Lemon, vice president of marketing and communications for the Kansas City, Mo.-based HMBA: America's Hotel Broker.
“Our brokers posted nearly $1 billion in sales last year, up from $600 million in 1999,” she said. “In the transaction market, more parties were able to come to a better agreement on value. The challenge to finalizing transactions included locating and pinning down financing, largely because money became tight.”
Lenders' purse strings won't be as tight in 2001, Lemon predicts. Meanwhile, sellers are willing to divest and move into other areas. “Buyers are still looking at the hospitality industry, and some say that they have more buyers than potential properties,” she added.
Paul Sterbini, vice president of franchising at Silver Spring, Md.-based Choice Hotels International, summed up 2000 as a terrific year for franchising at his company, whose brands include Sleep Inn, Quality Inns and Comfort Inns, among others. However, 2001 may be a year of reckoning.
“I think there will be a shakeout in the industry in general, because there has been 40 to 50 new brands launched over the past eight or nine years,” Sterbini said. “So I think there will be consolidation in the industry.”
Industrial market bulks up
Michael Brennan, president and CEO of Chicago-based First Industrial, described 2000 as a very good year for the industrial sector. “We saw vacancies come down almost 100 basis points nationally, and demand was well in excess of what was predicted as we started 2000. There was also discipline on the supply side. All in all, it made for a very good year for our business.”
In addition, First Industrial benefited from space users who were intent on improving supply-chain efficiency, ranging from construction of new buildings to sales of existing structures to more comprehensive reconfigurations. Brennan predicts that business will continue to grow in 2001. “Our industry will continue to be strong, and we predict vacancy rates may rise to about 7.5%,” Brennan said.
“But that's still a good rate, and it indicates strong industry fundamentals. Supply-chain activity is going to accelerate because it's the necessary evolution in a corporation's quest to become more efficient,” he added.
On the supply side, the industrial real estate sector last year built comparatively less spec space, said Bill Linville, executive vice president of the Midwest industrial division for Duke-Weeks Realty Corp., Indianapolis.
“Prior to that time, in 1998 and 1999, the market showed signs of being too soft, of being oversupplied in spec space,” Linville noted. “Today, money for development is more disciplined. The financial markets have forced discipline on the developers, and in doing so the market has self-corrected.”
Plenty of build-to-suit activity occurred in 2000. Going forward, bulk warehouses will get bulkier, Linville predicts. Bulk has become super bulk. If you look at trend lines, 10 years ago a large industrial building was 350,000 sq. ft. Five or six years ago, 500,000 sq. ft. was top end. Now there are a number of deals out there that are 800,000 sq. ft. to 1 million sq. ft.”
For instance, Secaucus, N.J.-based Hartz Mountain Industries leased some 615,000 sq. ft. of industrial space in North Bergen, N.J., to Unisource Worldwide Inc.
Chicago, the nation's largest industrial market, continued its phenomenal strength in 2000. The fourth quarter alone was unprecedented for the Windy City, said Geoffrey Kasselman, senior managing director of the Chicago office of Julian J. Studley Inc. Transactions of 200,000 sq. ft. or greater accounted for more than 6 million sq. ft. of new activity during this quarter alone, he added.
REITs regain their pulse
One of the great turnaround stories of the year involved REITs. Having fallen out of favor for the past few years during the dot-com craze, REITs kept to their own business until being rediscovered as a hot investment vehicle in 2000.
The REIT industry is poised for increased activity, said E & Y Kenneth Leventhal Real Estate Group's Robert Lehman.
“As REIT share prices have rebounded, M&A activity has picked up. REITs also have unearthed alternative sources of financing,” he said.
He expects the industry to enter joint ventures with real estate capital sources, ranging from pension funds to private investors. He also predicts more stock buyback programs from REIT management.
Patient real estate investors will find good opportunities to buy in 2001, said Steven Ellenbogen, president and CEO of Chicago-based CMD Realty Investors, a national owner and operator of suburban office properties.
“Opportunity funds that have held properties for four to seven years are hearing from investors who want their money back,” Ellenbogen said. With REITs also selling assets that do not fit in their portfolios, he expects to see an increasing number of opportunities for value-added investors, such as CMD, to acquire properties at reasonable cap rates.
Mike Sheridan is a Houston-based writer.
2000 post-game wrap
The year 2000 may best be remembered as the year the bubble burst on the dot-coms. However, there were plenty of positive developments in the real estate industry, including the phenomenal growth in the office sector and the REIT revival. To help us mark the milestones of 2000, NREI asked industry experts from the major sectors the following question: “What do you think was the single most significant event and/or transaction in 2000 in your sector of commercial real estate?”
Executive Managing Director
Julien J. Studley Inc.
“The Columbus Circle deal that will become the new world headquarters of AOL Time Warner was the biggest office deal of the year. The project will cost more than $2 billion. The loan is $1.3 billion, which is one of the largest construction loans done in the world for a commercial office property. When the mixed-use project is finished, it will be one of the most visible sites in New York, changing the skyline. The AOL Time Warner headquarters will be a major economic boom for New York.”
John ‘Jack’ Corgel
The Hospitality Research Group
“Although a number of interesting hotel transactions occurred during 2000, no single event was more important to the hotel sector than the passage of the REIT Modernization Act. Hotel REITs make up a fairly small, but visible part of the industry. The ability to avoid the agency costs associated with the original law will enable hotel REITs to maximize the profit potential of their hotels. The new law removes a sizable barrier to securitization of hotel real estate.”
President and COO
General Growth Properties
“Last year, the most significant event was very simply the economy. If you look back at the 1999 holiday season, it was the best we had seen in 10 years. That continued up until May of 2000 when the tide started to slow substantially. As a result, 2000 holiday sales were off approximately 2.5% to 3%, compared to what forecasters were predicting.”
Panattoni Development Co.
“I do not believe there was a single, most important transaction in the national industrial real estate marketplace. The most important event was the constriction of capital for the New Economy businesses, which has not only lessened their demand for space, but also has relieved the pressure on Old Economy companies to expand to keep up with them.”
The Jamesan Group
“The influx of investment brought an awful lot of attention to the tech sector, even though we saw a number of failures. The volume of investment has opened the door and, ultimately, history will show it to be the beginning of the next generation in the commercial real estate market.”
Henry D. ‘Greg’ Gregory Jr.
President and CEO
“The most noteworthy event in 2000 in the industrial real estate sector was the emergence of a new kind of customer. These are the technology-based companies that leased facilities that were designed for distribution and warehousing, and instead used them for data centers, such as server hotels or call centers and the like. These new customers didn't exist as industrial real estate prospects in 1999, and they aren't likely to exist as prospects in 2001.”
Executive Managing Director
“The fourth-quarter slowdown in the tech sector and increase in energy costs were the biggest events of 2000. Early in 2000, we saw that demand for office space was being driven by ballooning equity prices and unprecedented growth plans of the New Economy companies. Later in the year, with subsequent correction and revaluing, their ability to raise capital and execute business plans was severely impeded. As a result, their space needs also were reduced. Despite the fallout, the downtown office market seems to have absorbed much of that space quickly.”
“The evolution of the Application Service Provider (ASP) business model within the commercial real estate sector was the biggest tech event. The birth of third-party companies that manage the software and hardware costs, as well as upgrades and maintenance on their servers, will create major structural change in the industry. No longer does it take millions of dollars to build proprietary in-house technology platforms to compete. ASPs will help to level the playing field, since a wide range of real estate applications can be obtained at a very low cost, with either monthly or desktop fees. Small- and medium-size real estate companies now can obtain competitive technology platforms.”
“To me, the biggest event in the multifamily sector was the tremendous spike in rents that we saw in the California markets and the Northeastern markets in the second half of the year, driven by the exceptionally strong demand for rental apartments. We really saw unprecedented growth because of that — 40% growth in San Francisco, 20% in Boston and lots of others in the teens.”
Capital Markets Group
Jones Lang LaSalle
“180 Maiden Lane, a 1.2 million sq. ft. building in downtown New York, was purchased by Paramount Properties for $330 million, about $300 per sq. ft. This was the most significant building that sold in downtown because it was the first building that sold for $300 per sq. ft. in that cycle. Most were sold for an average of $200 per sq. ft. In Midtown New York, the Seagram's Building acquisition by RFR Holding also was important because it was one of the highest paid prices per square foot ever paid in the Midtown market. The building sold for $380 million, but I think it was a little bit of a disappointment because it underperformed everyone's expectations in regard to price.”
President and CEO
Equity Residential Properties Trust
“There was no single event or transaction worthy of note last year for the multifamily sector. What was worthy of note was the overall health of the industry. We had one of the best years ever in terms of rental and NOI [net operating income] growth. Furthermore, with most markets in equilibrium, the multifamily sector is in an excellent position to produce strong results this year in the face of an economic downturn.”