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Major leaguers tell SIOR: industrial/office opps. ahead

San Antonio -- Following an hour-long "pep talk" by Barry Asmus, Ph.D., senior economist with The National Center for Policy Analysis, members of the Society of Industrial Office Raltors[TM] (SIOR) who attended the 1995 spring meeting at the Hyatt Hill Country Resort in San Antonio were treated to explanations of the plans and expectations of two of the country's most active developers: Jeffrey Schwartz, managing director of Security Capital Industrial Trust, and John Goff, CEO of Crescent Real Estate Equities Inc.

For the past several years, the Security Capital REIT has moved quietly into 35 markets throughout the country and now owns more than 46 million sq. ft. of industrial space, making it the largest industrial real estate firm in the country. "I'd like to stress that we are extremely broker-minded and have done the majority of our business with the brokerage community," said Schwartz.

To do that, Security Capital uses three national service officers to call on major brokerage houses and major tenant representatives in New York, Chicago and in other markets to try to establish close working relationships with major users of industrial space.

"These people are not brokers; they are not trying to cut anyone out," said Schwartz. "They are solely out there to expedite transactions by working with our market group and our national development group." He noted that the number of national service officers located in New York, Chicago, Denver, Los Angeles and possibly San Francisco was slated to increase to six by the end of the year.

Security Capital now has 19 market officers who are local owners throughout the country. By year end, it will have 22 market officers, each of them serving one or two cities.

"One of our principal objectives is to create value from a generic concrete box," said Schwartz. "We're trying to provide a service locally, regionally and nationally and to build franchise value. We'll become known, not as a real estate company, but as a service and marketing company and part of our strategy includes working with SIORs and with the brokerage community as a whole throughout our markets."

Schwartz said he has dreams of becoming "The Walgreens of the industrial business. Last year, we built 4 million sq. ft. of industrial space. This year we will build in excess of 7 million sq. ft. of space in 20 cities. In fact, by year end, we will be in 25 cities throughout the country," Schwartz continued.

He cited cities with "high rates of employment, low-cost manufacturing and import/export cities" as those in which Security Capital was most interested. He also stated that the type of industrial building they were erecting was 22 ft. to 24 ft. clear, 6 ft. reinforced concrete slabs, state-of-the-art sprinkler systems and 120 ft. truck basins. "This type of building makes for a longer payback, but it is a functional product for years to come and increases the value of the product."

Forecasting the future of the industrial sector, Schwartz said: "I see the industrial market as a whole continuing to strengthen and be viable and vibrant. In some markets, the increase in occupancy will cause the rates to increase, but financial markets will continue to require that the developer put up equity in each of his projects."

Citing the total industrial market in the United States at 7.6 billion sq. ft., Schwartz said that 56 million sq. ft. of industrial space -- mostly build-to-suits -- was erected in 1994. "Of the entire total of 7.6 billion sq. ft., 50% is owner-occupied, 25% is single-tenant and 25% is multitenant," he said. "We are looking at absorption in the Pacific, Central and Mid-Atlantic regions and a continued very high rate of absorption in the Southwest."

Schwartz was particularly optimistic about increasing occupancy rates. In the Mid-Atlantic, occupancy has risen from 81% in 1992 to 88% today. Atlanta's occupancy has climbed from 90% in 1992 to 95% in the first quarter of 1995. He also noted that Las Vegas had an increase in occupancy in 1994 of 2.9 million sq. ft. "and in the Pacific sector, there has been a dramatic increase in the build-to-suit 100,000 sq. ft. type of industrial space."

So the trend is up, and Schwartz said it should continue. "We are hopeful that we have a lot of smarter lenders out there, a lot more prudent borrowers and very prudent developers."

Of all the factors that could "save" the industry, a dramatic increase in construction costs is worth watching. "We've seen costs go up across the board -- across the nation -- 15%, 20%, 25% during the last 12 months. Steel is up 28%, concrete is up 16%, everything has gone up. This has development slowing in some sectors, but the increases in cost raise the value of our existing portfolio and put upward pressure on rates for new projects for everyone," said Schwartz.

On the office front, John Goff, the COO of Crescent Real Estate Equities Inc. who has overseen the raising of more than $500 million in the public markets and is involved in buying office properties throughout the country, explained the historical perspective of office occupancy and why it started changing radically at the beginning of this decade.

"We were at a very healthy 94% occupancy rate prior to 1970," said Goff. "In the '70s that dropped down to the mid-80s, but that, too, wasn't all that bad and the demand began to pick back up. Then came the 1980s and we responded by adding about 76% to the office inventory -- in about a five-year period that was all construction starts, not completions. Since 1986, we have seen virtually no new office space constructed in this country. Look at the demand, occupancies fell to the low-80s, and we are just now beginning what we see as a fairly long-term recovery."

Part of the credit for that long-term recovery can be placed on migration, "something that is not talked about a lot. This is a special component in the increase in occupancy in office space, especially in the Southwest," said Goff.

"What is interesting is that the bulk of office space built in the 1980s is in the Southwest and the Rocky Mountain regions. And, what we've seen over the last five to 10 years is not only companies, but also work forces, in a major movement from the Northeast to the Southwest -- the Sun Belt."

Also, Goff cited the movement of people from California toward the east, particularly to Phoenix and Denver. Will that migration continue? "I would suggest that it will, for a particular reason," said Goff. "If you look at the average rent paid last year for new leases signed in the United States, the average is $40 per sq. ft. Now, look at the markets where the migration continues to occur, and you see the other end of the graph-- $16, $17, $18 per sq. ft. in Denver, Dallas or Phoenix. Atlanta is close at $22 per sq. ft. This is not only the cheapest office space in the United States -- it is the cheapest office space in the world! There are only two cities in the world that have cheaper space than these markets -- two cities in New Zealand."

Goff said he is grateful that the days of easy money and over-development are potentially a thing of the past. "We now have the return of disciplined capital coming primarily from the public markets, and that will continue because disciplined capital requires the developers to put up equity. We want to see that we have a network tied to the company. We're putting up money right beside the public in each and every transaction, like we're signing our own check when we acquire an asset. I think that will continue."

What the future holds is anyone's guess really, but Goff said there will be many opportunities for winners and losers ahead

"The driving factors in the future are going to be a continued migration of companies and employees into the growth markets," said Goff. "There are going to be net winners ... the winning markets are those that can offer a well-educated workforce, a convenient transportation system and 24-hour cities where there is retail, residential, entertainment and office all mixed into one area. Those 24-hour cities, as opposed to the eight-hour cities we have today, will be a major key."

Information also is likely to have a major impact on the formation of future office space across national markets. "I think we have seen a lot of the migration of businesses as a result of the fact that information is so easy to obtain. You can be linked by a computer anywhere. For example, 10 years ago mutual fund managers were always located in Boston or New York, maybe a few in San Francisco. Now they have relocated in Denver, in Dallas, in Phoenix or other cities because they link into what's happening in New York and there is no reason for them to pay the high occupancy costs in New York City. That will continue."

Goff also pointed out that the real estate industry would continue to see a recapitalization, with banks and insurance companies unloading assets and creating attractive opportunities for office buyers over the next five to 10 years.

He noted that there is still some $4 billion to $5 billion in mortgages that were created in the 1980s that have yet to be restructured. "Those will be coming due over the next three to four years, and, in most cases, the mortgages are well above the true economic value of the property today. Lenders are going to want to get out and they are going to have to look to an equity source to take them out -- again an opportunity for us."

Goff sees pension funds and REITs as the major contributors to the capital flowing into future real estate markets, pumping $130 billion and $45 billion to $50 billion, respectively, in equity capital into real estate.

"All these changes are very healthy for this industry -- it's a very exciting time to be in it! This is not unlike what we have seen occur in Europe over the last 50 years -- the dominant nature of the public markets in real estate in most European countries. The bulk of the real estate over there is already held by the public markets, and I think you will see the same thing occur here."

NREI editors' favorite piece of mail this past month was from the New Mexico General Services Department, which announced the distribution of RFPs to lease the 1,300-acre Fort Stanton, N.M. The letter tells us that the site, which is one of only two U.S. military forts that have been in continuous use since it was built in 1855, was at one time controlled by Kit Carson, and Billy the Kid awaited hanging in the guardhouse.

What caught our eye, however, was the following list of the "Top 10 Reasons Someone Would Want to Rent Fort Stanton"

10. You found out the Brooklyn Bridge is already taken.

9. Fort Knox is too heavily guarded.

8. If you have a party, you don't have to worry about the neighbors calling the police.

7. Because you could camp out in a new acre each day, for the next five years.

6. You'd be in the front row for the filming of City Slickers IV.

5. There's no better place to re-enact your favorite F-Troop episodes.

4. "If it's good enough for Billy the Kid, it's good enough for me."

3. Because you could say, "Hey, I'm runnin' this fort!"

2. Weird Aunt Tillie has to live somewhere. And, the No. 1 reason to rent Fort Stanton is ...

1. Kit Carson's ghost makes a wonderful strudel.

We didn't realize the government had such a good sense of humor.

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