NREI's Forecast '98: What's in the cards for RE?

Will it be hot hotels? Multifamily mayhem? Sweet seniors success? Here's our annual real estate forecast, property type by property type. (Hint: We think you'll be pleased!)

What will 1998 hold for commercial real estate? That's the $64 question, and the person who can answer it accurately can name their price. We talk about the merits of negotiating and strategic planning, but isn't this really what it all boils down to: anticipating where space is needed, who is willing to pay for it and how high (or low) they will go.

Couched in the comfort of a year that has -- through the first three quarters, at least -- treated the real estate industry well as a whole, it's hard to imagine that things could get much better. But if the professionals we talked to really know their stuff, demand should continue to be strong in relation to supply, REITs will continue to be the players to watch and, hopefully, discipline will rule the roost, at least on the development front.

Yes, some do voice concern about overbuilding. But as long as the economy remains healthy, most see it as a spotty nuisance, not a call-out-the-lifeboats, women-and-children-first tragedy of Titanic proportions.

As Richard G. Carlson, managing director/real estate services at Deloitte & Touche LLP puts it, "Lenders have remained relatively conservative, but they have eased off of their disciplines somewhat. But not to the point that I expect a glut of overbuilding. Most of these buildings will probably be small to reduce the investors' risk."

Hospitality When Doubletree Hotels Corp. first announced its mid-market Club Hotels by Doubletree brand, officials said the strategy was designed to take an older property and renovate it into a new product. But thanks to the booming hospitality industry, that game plan is changing.

"The demand for our product was so great, we're now doing new-builds -- in Austin, Jersey City, N.J., and Las Vegas," says President Thomas W. Storey, who is also executive vice president, sales and marketing/Doubletree Hotels Corp. of Phoenix. "Our concept was so powerful and so different, we had real estate investors approach us and ask to build new. Our first ground up Club Hotel has already opened in Austin, built at $62,000 a key, with an average rate of $90. Since Club Hotels is partnering with three other well known brands -- Au Bon Pain, Office Max and Steelcase -- under one roof, we can compete with both limited-service and upscale hotels."

According to Storey and others in the business, the hospitality industry is hot -- and is expected to continue to be feverish in 1998 and beyond. Demand is strong, supply is increasing slightly, hotels are being bought and sold at higher and higher prices, and limited new development is occurring.

"I see nothing on the horizon that should make anyone nervous about 1998," says Robert Morse, president/ franchise of ITT Sheraton Corp. who is based in Atlanta. Morse says rates will continue to move upward, occupancy will continue to grow and demand will continue to outpace supply. Growth in full-service hotels, particularly in the luxury market, is expected to continue. "We've got markets that are doing well this year -- New York and Boston are very strong, Chicago is doing well as is Seattle," he adds. "But in Atlanta and Dallas, there has been a lot of supply, which has an affect."

He adds that one concern "some of us have is the fact that some hotels are starting to sell for prices equal to or maybe a little more than replacement value. But I still believe barriers to entry are still so high -- from not having a good location available to not being able to get new build construction financing -- that it is still going to stop a lot of new construction in the hospitality business."

According to PKF Consulting, an international hospitality consulting and real estate firm, the average room rate is projected to grow another 5.8% next year, following a strong growth of 7.2% this year compared with 1996. Of the 42 cities surveyed by PKF Consulting, 11 are projected to improve their occupancies next year, with 18 experiencing a decline and the remaining 13 staying flat.

"While increased hotel development has caused declining occupancies for several cities, the increased competition has yet to show a dampening affect on the prices charged by hotel managers," notes James A. Fox, senior vice president at PKF in New York. "Only two cities in the U.S. will not be able to raise their room rates in excess of inflation in 1998."

The average operating profit, measured on a per available room basis for U.S. hotels is projected to grow to $12,344 next year, up from $11,323 last year and $9,804 in 1996. Operating profits come after deductions for management fees, property taxes and insurance but before payments for rent, debt service and income taxes as well as non-cash expenses such as depreciation and amortization.

Fox notes that by the time a hotel reaches an occupancy of 70% or greater, it has reached a point of operating at efficient economies of scale.

"Hotel revenues are growing at 1.6 times the growth of expenses," he continues. "This has resulted in the highest operating profit margins we've seen in over 30 years."

Matthew J. Hart, executive vice president and chief financial officer of Hilton Hotels Corp. (HHC) of Beverly Hills, Calif., agrees the fundamental outlook for the hotel business continues to be bright. "Demand is very strong," he adds. "I've been in hotel business for 15 years and have never seen it stronger. A couple of months ago, the Waldorf-Astoria in New York instituted a minimum three-night stay requirement for check-ins later this year. Usually such a requirement is for something special like a presidential inauguration or Mardi Gras. But demand is so strong in New York that the hotel could do it. It's going to be a very strong fourth quarter and a great 1998."

Hart notes that about 65% of HHC's lodging division income comes from 10 big hotels in key markets such as New York, Chicago and San Francisco. "We see no real competitive supply coming into those markets for the next five to seven years, so we've been able to consistently raise rates this year, in the 9% range," he adds. "The bigger the properties, the higher the barriers to entry."

And Hart says it's not just full-service properties that are prospering. Hilton's Garden Inn offering -- described as four-star lodging at a three-star price -- is progressing on schedule, with seven open and 200 expected by 2000. "Hilton has the most recognized name in the lodging industry and yet we have the lowest penetration rate of any of the hotel companies," he continues. "Marriott for instance, has 1,800 properties. We have 240. We have tremendous opportunity to grow in this segment. There are still great opportunities to expand our brand in the limited service segment."

Hart says one of the few clouds on the horizon is the rapidly escalating prices paid for some hotels. "In the REIT market, we've seen quite a few situations where shareholders are rewarding growth and we're seeing properties that companies, in our opinion, have overpaid for. When your focus is so investor-driven you often don't focus on what the real market value is."

Dana Michael Ciraldo, senior vice president at Hodges Ward Elliott in Atlanta, agrees the investment market is very hot now with a tremendous demand for hotel portfolios. "Right now, we have 12 multiproperty portfolios for sale -- a high number compared to last year, when we had only nine," Ciraldo says. "That's a third more portfolios for sale. It's easier to close one portfolio with 10 properties than 10 separate properties."

Ciraldo says the selling is being driven by owners who want to exit the lodging business. "Sellers are saying, 'Now I can sell and get the price I need, so let me get rid of everything at once,'" he adds. "Owners who don't want to be owners any more are seeing an opportunity to clear everything out at once. It's a trend that will continue in 1998."

Also contributing to the strong sales of hotels is consolidation in the fragmented hospitality industry. "If you look at the hotel real estate industry today, it's where the auto industry or the oil industry was in 1920s -- a very fragmented field with lots of owners," he continues. "We'll go through a period of consolidation, where owners will tend to be larger and there will be fewer of them."

Full-service hotels are now more in favor with investors, he adds, with limited-service hotels "harder to move" than full-service. "It's more an investor psychology because it's easier to see the profit potential in full-service," Ciraldo says. "In the 1990s when we had a recession, people were trading down, staying at limited-service hotels instead of full-service hotels. Now the people who were staying in limited are booking a contrarian play. You can buy them cheaply right now."

Ken Wilson, national director of Horwath Landauer Hospitality Group in Boston, adds that from an economic perspective, demand will continue to grow at a moderate pace in 1998. "There is always that question, 'How much supply?'And in pure numbers, we're seeing supply growing faster than demand," Wilson points out. "But most of that supply is in the mid-to-lower limited-service hotels and extended stay concepts. Overbuilding may be going on in very tertiary markets but we're not going to see an industrywide, across-the-board problem."

The industry will continue to see the full-service, upscale luxury market do exceptionally well, Wilson says, adding that some new construction will occur. "There's a huge amount of competition for the sites that are out there," he says. "We're also going to continue to see aggressive consolidation in the industry. A lot of hotel companies, even extended stays, are going to face consolidation next year."

Gone will be the development deals by individuals, replaced by investment consortiums, or investment groups, coming together to provide equity for the development of hotels -- with a definitive exit strategy. "Once they have critical mass that makes them attractive to capital markets, then capital markets will structure them out, neither as a REIT or IPO," he adds.

It will be "interesting" to see what happens in the much touted, rapidly expanding extended-stay sector, Wilson says. "While extended-stay has the potential to be overbuilt, we're really seeing nowhere near the numbers people are saying that are out there," he adds.

Even so, Tim Sheldon, brand vice president for both Residence Inn by Marriott and TownePlace Suites by Marriott, emphasizes that the tremendous opportunities in the extended stay sector experienced this year will continue into 1998. He notes that Marriott International is investing $60 million more in TownePlace Suites, which will allow Marriott to drive the development on TownePlace Suites on an owned basis.

"Marriott sees the real value of business beyond just franchising opportunities," he adds. "This is the newest brand in a growing segment in the Marriott family of brands. It is wide open territory. The point is it's not saturated yet, there are a lot of opportunities for franchise partners."

Sheldon anticipates demand will continue to grow, particularly for the moderate tier. "I don't see it slowing down," he says. "We continue to see the main brands in moderate tier to continue to build and take advantage of demand supply imbalance."

Phoenix is really hot now for extended stay, he says, "and TownePlace has a number of projects in Denver. The Northeast is a great opportunity, but it's difficult to develop there. California is awesome, but we have development challenges there too. Atlanta is currently not a great market, but we're building there because we want to be there," he says.

In spite of an influx of new brands over the past several years, many in the industry say that trend may be over. Club Hotels' Storey, for instance, says he doesn't think there will be a proliferation of new brands next year.

"I don't see a lot of money coming in for building more mid-market or low-end product because it's getting over built very quickly," he adds. "So what that means is we'll see brands looking to solidify their distribution and their quality positioning. The question is, 'how do they leverage their brands,' Consolidation is one way to do it, and I think we're going to see a shift away from the real estate side toward operating side."

Observers say there is still a lot of room in the business for people to make a lot of money, one of the reasons capital flows into the industry at a rapid pace. Financing will continue to be available in the industry next year, notes Randy Heller, vice president commercial real estate Finova Capital Corp. in Phoenix.

"I'm one of the guys who says there is too much capital chasing too few good deals, and then some companies will wind up with some deals they shouldn't have done," he continues. "It's getting a little 'iffy,' out there, with spreads compressed. I don't think you should be loaning money at 200 (basis points) over Treasuries for a number of years. It's too thin a spread for the long term."

Heller says he doesn't expect to see a return to the craziness of the 1980s in terms of underwriting. "It's getting aggressive but not ridiculous," he says. "A lot of folks like us were doing 15-year amortization, now we're 25-year amortization, so that's one element where maybe in the 1980s, we were doing interest only."

Companies like Finova have been through this cycle before, he adds, and "we won't loan as much as we'd like; we won't be forcing it out the door at underwriting we don't like. We will get money out and stay very active with our existing customer base."

The industry will end 1997 on a tremendously positive and powerfully profitable note, points out Rodney G. Sibley, senior vice president of franchise operations, Choice Hotels International, and that will set the pace for 1988. Because the industry is making money it will continue to catch tremendous attention from Wall Street and other capital market sources. "We think we'll see some pretty significant supply growth that mirrors demand growth," he adds. "Will supply outstrip demand? Yes, I think it will. But the margin of difference will really be an equilibrium. In a very healthy industry, a number of people cry 'Chicken Little' but that's not going to be the case."

Sibley thinks oversupply will be spotty, more geographically- than supply-based. He adds that Atlanta is in the process of absorbing pre-Olympic inventory, but that won't present a major, long-term problem. Development opportunities exist from New England and New York down the coast to the mid-Atlantic, he says. "California looks wonderful too, but anything in between where you have low barriers to development, lots of cheap land and freewheeling zoning is subject to overbuilding."

Sibley says "the old tired economy stuff" is vulnerable because consumers have a bias for new fresh product. "We hate old, we love new, and new is going to continue to win," he adds.

With increasing occupancies, rising rates, limited new construction in the full service sector and a trend to renovation of older properties on the horizon, 1998 is expected to be another banner year for the hospitality industry.&

Industrial The forecast for the industrial market in 1998 is similar to that in other property types. Vacancy is down and expected to remain in the single digits in the top markets; rents are increasing at a steady pace; new construction is occurring but is not out of control; property values are strong as REIT interest continues to drive prices; secondary markets will become more popular as good opportunities disappear in the major markets; and capital on both the debt and equity side is readily available, although perhaps at less attractive terms than in other segments.

"The outlook for the industrial market is good for 1998," says Mike Brennan, chief operating officer with Chicago-based First Industrial Realty Trust. "The indicators look strong, but the only wild card is whether or not the economy will remain healthy."

"Nationally, we are seeing lower vacancy figures, steady construction growth and slow but steady increases in rents," says Thomas R. Martin, vice president with St. Louis-based Colliers Turley Martin.

The industry does appear healthy, Brennan estimates that national industrial occupancy rates are in the 94% range. "It is down slightly from the high in 1996, but only negligibly," he says.

"The demand has continued to be good," adds Tim Gunter, senior vice president and chief operating officer with Atlanta-based Industrial Developments International. He points out that the strong demand has come from two different quarters in the market.

"There are really two tiers of tenants," he says. "The first are those companies driven by consolidation or a need to reorganize their distribution system. And the second are firms that are growing internally and need more space."

"Bulk warehouse space is the property in greatest demand," points out Forrest Robinson, president and COO of the Weeks Corp., Atlanta. "Bulk space is further along the recovery curve and rent rates have stabilized, but in the service center or flex building sector, both rents and occupancy are rising."

The other good news is that the supply of new industrial space has increased only moderately relative to the increase in demand, according to Brennan.

Mark Doran, chief financial officer with Dallas-based Prentiss Properties Trust, says vacancies remain in the single digits in most major markets. He cites Chicago, Dallas, the Baltimore-Washington Corridor, Kansas City, Milwaukee and Southern California, particularly Los Angeles, as some of the healthier and more active industrial areas.

"Demand is very good," explains Robinson. "There are a lot of companies expanding and new companies entering the market."

"Currently I am less worried about the supply of space than I am about maintaining the current demand, and that surprises me," says Brennan.

The reason for the confidence in controlling the supply of new space relates to the shorter construction window required in industrial development. "It only takes about nine months to plan and develop an industrial building," says Doran, "That time period gives the developer a good view of the dynamics of the market and helps him to better gauge the supply-demand side of the business."

In addition, the industry has more checks and balances than ever before.

"With REITs having such a large ownership position in today's real estate markets, there have never been more groups acting as watchdogs for the industry," says Brennan. Ratings agencies, and the REIT stockholders have now been added to the commercial banks and the press as interested parties when it comes to warnings about over building.

As would be expected, the good balance of supply and demand is having the desired effect on rents. "We have seen 4% to 6% annual increases in industrial rates across the board," reports Doran.

"Rental rates have continued to experience strong increases in nearly every single market," adds Brennan, "particularly those markets that are dominated by a particular company or REIT, and as a result have less price competition."

For example, Brennan says Detroit, where fewer major players have a stake, rents have increased roughly 10% in the past year, while in Chicago, where nearly every major player has interests, rents have only moved about 3% during the past 12 months.

And others do have a more conservative take on rents and the market's balance of supply and demand.

"There is more competition for the tenants because of the new construction," states Gunter. "Instead of one or two properties for the tenants to look at, there are now about five or six." He says Atlanta, Chicago, Dallas and Memphis have all seen large amounts of new industrial product come on line recently. "I have even heard that one owner in Atlanta is offering free rent to attract tenants."

But most industrial executives don't expect overbuilding as long as the economy remains robust. "Because of the shorter construction period we can stop developments sooner and prevent rampant overbuilding of space," says Gunter.

In fact, Doran says, "most new construction is being leased prior to completion."

He adds that most of the new product that is and will be coming on-line in 1998 is distribution space on busy thoroughfares, in the suburbs of major markets. "Every corporation in the country is evaluating its supply chain costs and this includes warehouse operation," says Brennan. They need larger facilities and often in different locations.

A few years ago 300,000 sq. ft. was considered larger in industrial development, however, now it is not unusual to see buildings range from 400,000 to 700,000 sq. ft.

The buildings include large clear heights, advanced sprinkler systems and other technologic advances, with functionality as the key design component. Developers include knock-out panels and footings to support additional loading docks in their structures. "This gives them leasing flexibility," says Gunter. "If they lose a large tenant, the space can be sublet to multiple tenants."

This functionality also makes the properties easier to sell. The reason is if the building can accommodate multiple tenants as well as large users it is easier to lease. "As a result you can sell these properties with shorter lease terms because the new owner will be confident he can rent the space if the tenant does not re-sign," Gunter adds.

In addition, some industrial developers predict that tenants will require more office space in their industrial projects. "Companies will be putting more of their office personnel in space at their industrial sites," says Martin. "It is a good alternative to the rising costs of office space."

"This is what is driving the service center sector," adds Robinson.

"With the landscaping and additional parking that are characteristic of industrial parks today, the office employees will not feel as though they are in an industrial building," adds Gunter.

Brennan says new development constitutes about 30% of First Industrial's investment total each year. "And about 90% of that is build-to-suits," he says.

He adds that 70% of the corporation's investment is the acquisition of leased facilities. And other investors are following suit.

"Historically, industrial property has been a good place to invest," says Gunter.

"There is a lot of industrial property that is changing hands," adds Doran. "And there is no question sellers are enjoying better pricing than they did six or 12 months ago."

As in other property types, REITs are credited (or blamed) for increased property values, although Brennan says REITs probably don't impact the market as much as some think.

He explains that the national office market (about 20 billion sq. ft.) added 156 million sq. ft last year. "But only about 90 million sq. ft. was purchased by investors," he says. "So we are not even keeping up with the amount of new space that is being added to the market."

Property value on the industrial side is also affected by the size of the portfolio being purchased. Since industrial properties are usually cheaper than most other property types, investors look to make large purchases at once because the economies of scale of a large purchase reduce transaction costs.

"In general, the more square footage that is for sale the more aggressive the pricing," says Doran.

But many feel that the good opportunities have already come off the market in most of the major cities.

"Nationwide, as the trend toward the securitization of real estate continues to grow the number of attractive deals gets smaller," says Martin. "In general, in major markets there is a feeling that all of the existing opportunities have been picked over."

Martin adds that this is driving many investors into secondary markets where he says the rate of change is faster in the smaller market which can result in greater returns for investors. "In St. Louis, for instance, we see sharper increases in rents," he says. "We have experienced 5% to 7% growth in the past year."

Duke, Security Capital, First Industrial and CenterPoint Properties have all invested in the St. Louis industrial market recently, according to Martin.

He cites Memphis, Nashville and Kansas City as other markets where investors are looking for better investment opportunities. "I expect that to continue in the future," he says.

Regardless of the market, money for development and acquisition is obtainable.

"A lot of capital is available," says Doran, but he adds that lenders appear to be more prudent in their industrial loans. "They usually require anywhere from 20% to 40% equity on the part of the developer, depending on the amount of pre-leasing, the sponsoring entity and the deal parameters."

Brennan says the equity problems can be easily overcome in today's lending market. "In general you can obtain both debt and equity funds more easily than in the past," he says.

There are lending options available allowing developers to get additional loans for the equity funds. Brennan hopes this will not lead to projects with little research to back them up.

"I suspect that underwriting standards are not as stringent as three years ago," he says.

"But we hope enough discipline remains to assure that funded projects are all supported by good due diligence efforts," adds Doran.

Others feel lenders need to be particularly diligent with loans to firms new to the industrial market. "Some developers without development track records are finding it very easy to get loans," says Robinson. "So I think we need more constraint on the part of lenders."

Traditionally a strong market, the industrial sector, though slowing in some areas, should continue to grow in 1998.

Multifamily Housing Ask Jonathan Kempner what the outlook for the multifamily industry is for 1998 and he'll answer in two words: Restrained exuberance. "Generally speaking, the apartment industry has been on a nice run, and I have every reason to believe it'll continue," explains the president of the National Multi Housing Council based in Washington, D.C. "I think the industry has had controlled growth, with generally good returns. Most importantly, the exuberance in the industry has been restrained. I get very nervous when there is too much exuberance but I see no reason to believe there is going to be an over reaction to the general healthy state of the industry."

"Such a restrained response by the nation's multifamily industry is a welcome relief. In the past, when the good times rolled in, developers embarked on impressive expansion plans," says Kempner. "The fact that they remember it and are talking about it is a good sign. Generally, there aren't any major problem pockets. California looks good, and the Bay area is just roaring back."

Industrywide consolidation is one trend nearly all multifamily soothsayers agree on, particularly among high profile public real estate investment trusts (REITs). "When we do our annual survey of the industry, it'll be very interesting to see how each company's position has changed," says Jack Goodman, vice president of research at the National Multi Housing Council. "I would expect the REIT share has changed significantly."

Douglas Crocker II, president and CEO of Equity Residential Properties Trust based in Chicago, doesn't have to wait for a survey. He already knows the market dynamics have changed. As the second-largest U.S. real estate investment trust, Equity Residential has been on the prowl to acquire units since its IPO three years ago. The REIT has acquired some 33,000 apartments, as of October 1st, and has another 20,000 units in the pipeline. It is expected to close on a $1 billion deal to acquire Evans Withycombe Residential Inc. of Scottsdale, Ariz., in December.

The deal comes after Equity Residential, controlled by the infamous Sam Zell, completed the purchased of New York-based Wellsford Residential Property Trust in a deal worth $1 billion earlier this summer. "Consolidation is what this industry is going to be about this year, next year and beyond," says Crocker. "The reasons? Bigger is better, especially with economies of scale. We want to run a real estate company like any other corporation in America. We're not just a collection of assets. We have a detailed operating strategy. We are not developers. We will typically acquire existing real estate."

At the same time, analysts say demand will increase, spurred by nothing less than recent changes in the tax code. In contrast to prior years, the first $500,000 of capital gains on homes sold by joint filers is now exempt from the tax (for single filers the cap is $250,000). That change may eliminate one of the reasons a number of mature homeowners have said they didn't want to switch from owning a home to renting one.

Now, those over 55 years old with more than $125,000 of capital gains could become renters, primarily in the luxury sector of the market. "We're keeping an eye on the recent elimination of homeowner's capital gains, but in my judgment it's going to be a significant plus for consumer demand in the top-end rental market," says Kempner. "But it's going to take a while for consumers to adjust to the new rule. And the first pieces of evidence of that won't be a big wave. We'll start to see it empirically."

Kempner adds that repositioning of apartment properties will become more important next year and beyond primarily because of the new units that have been built or under construction. "It will make sense for many owners of older communities in Class-A locations that don't have all the amenities to redo properties," says Kempner. "People today are asking for more space and the demand for additional electronic gadgetry and wizardry is getting greater. Obtaining access to the Internet from their residence is something you hear a lot about today, as well as two, three or four telephone lines in a unit. The trend is toward higher technology."

Fannie Mae's White agrees increased rivalry will change the multifamily product. "In 1998, there will be intense competition for assets across the real estate sector, and multifamily will continue to be a highly competitive world," he says. "Everyone will be studying the market to determine the next steps. For example, to stay competitive we may see new construction developers turning to rehab." Contributing to the good times in multifamily real estate next year will be plentiful funds. "I think conditions will continue to be favorable for apartment financing in 1998," says Doug Moritz, executive vice president of finance at Washington Mortgage Financial Group in Vienna, Va. "Competition will be fierce for good apartment deals. There will still be plentiful capital, but it'll be the low cost, creative providers who will win the business." Moritz and others say multifamily demographics on apartments will still be strong. "You have the traditional band of renters in the 21- to -35-year-old bracket growing again," says Moritz. "As a result of the tax bill, you have a lot more empty nesters who are going to be interested in renting. Plus you always have high demand for affordable housing."

Kingsley Greenland, president of Boston Capital Mortgage Co., a Boston-based lender for commercial and multifamily real estate, notes that the demand for multifamily financing is reaching a frenzy. "We continue to see lenders reducing rates and many are breaking even just to lend for multifamily, because the rating agencies think it's more stable," says Greenland. "The loss ratios have been less and they go through stress tests better."

Carol Friend, senior managing director at Parallel Capital in New York, a broad-based lender that focuses on real estate loans with the average being $4 million, says she expects the industry to be awash with cash again in 1998. "We're going to see a lot of money thrown at the market from various sources," she predicts. "REITs are accelerating their expansion drive and new conduits are coming on board. There's going to be a lot of money available. Hopefully it won't go out of control in 1998." She adds that Parallel Capital expects do $500 million by the end of this year and expects to increase that figure by 15% in 1998. "We'll have 20 offices operating at the end of this year, and we'll have 25 to 30 by 1998."

AMRESCO's and Fannie Mae's reaction is to remain competitive on price. "We've always had a fee advantage, the conduits just recently evened it up," says Ed Hurley, vice president at AMRESCO, a real estate financial services firm based in Dallas. "But we chose not to compete on debt service coverage. Although we have attempted to make other enhancements and process as we can, we're not going to lend more dollars on the same income."

Others see banks getting back in the real estate business, and predict the increased competition will squeeze life companies to a certain extent. "At some point, there may be something that happens, a scare or whatever, and investor spreads may widen, and that translates into higher rates," says Hurley. "But I don't know what it would be. We have as much as a couple of years left in this current business cycle."

1998 will bring a continuation of low interest rates and increased competition among lenders. "In 1997 there was an enormous amount of capital chasing multifamily product," says Harold C. Rose, executive vice president of Calabasas, Calif.-based ARCS Commercial Mortgage Co. "That will continue for several reasons. First, fixed rates are very attractive and secondly, with the advent of the conduit program, multifamily is very desirous. Apartment buildings are viewed by rating agencies as very stable. If Wall Street has 25% of their product in multifamily, they have a better product line to sell." Rose expects 1998 to be a good year for multifamily, adding that ARCS has offices in San Francisco and Nashville, Tenn., that specialize in affordable housing. "We'll do $150 million of that product line this year," he continues. "We're a Fannie Mae DUS lender and the only DUS lender with a division devoted exclusively to affordable housing. We have a special division because affordable housing is likely to become more important, as we enter the next millennium, and affordable housing requires more specialized knowledge."

Marilyn R. Brandt, vice president at GMAC Commercial Mortgage in Denver, notes a move away from exclusively tax credit deals to bonds which is expected to continue in 1998. "What I am seeing is a trend away from 9% affordable projects that are exclusively tax credits to tax-exempt bonds, where a 4% credit is more competitive and difficult to obtain by borrowers and becoming more restrictive."

"Housing authorities are becoming more restrictive while making some borrowers do 50% median income, and in some cases all the way down to 40%. They are making it more difficult to work," says Brandt. "Housing authorities know they can make developers jump through as many hoops as they want because there's a lot of people chasing after very few dollars. But if the numbers don't work, we can't finance it."

On the other hand, tax-exempt bond financing provides more favorable financing, at below-market rates, and also gives an automatic 4% credit with no competition. "That means you don't have to go into the same pool and compete with other developers for the same credit," adds Brandt. "Fannie Mae is the biggest player in this market with one of the best programs. HUD (Department of Housing and Urban Development) has a similar program. Fannie Mae is the best in pricing and terms of underwriting, and all I see is them getting better. They changed pricing in July that is more favorable to the borrower, reducing spreads on tax-exempt deals."

Brandt predicts strong activity in the multifamily financing market in the months ahead. "I don't see any slowdown in affordable housing," she adds. "(U. S. Rep. Bill) Archer was trying to get rid of tax credits, but that was shot down, at least for the next two years." White of Fannie Mae says that in the affordable housing sector, there will be a great deal of interest in creativity shown at both ends of the affordability scale. The focus will not be on the middle markets. "Major players on the high end will determine how far they can go to attracting the optional renter and perhaps create a strong niche for multifamily rental units," he adds. "Additionally, at the other end of the spectrum, the restructuring of the 236 program and the public housing revolution, up to three million units will be affected by these changes over the next few years." This year was a very good one for the industry, but many predict 1998 could be even better.

Office The office market in 1998 promises to continue the industry's move along the recovery cycle with areas at the head of the line continuing to grow, although at a slower pace, while those bringing up the rear should begin to improve more rapidly. Also, as the number of opportunities in the primary markets have begun to decrease, investors are seeking space in secondary markets feeling that companies will look to these locations as the occupancy costs in big cities continue to increase.

The competition between the suburbs and the CBD will continue to be a rout as office developers follow the wants of the space users who prefer the shorter commutes, spacious parking and quality of life away from downtown. But the CBDs are showing some signs of life, particularly if they are -- or at least have some potential as -- a 24-hour city.

Additionally, the shrinking of Corporate America, while it still may provide a few jolts to particular markets, has likely run its course in most of the country which will allow absorption to have a bigger impact in improving market conditions.

These are among the predictions office real estate executives are making about the office market, in general, for the coming year. The basic idea seems to be that with the current pent-up demand on the office market, next year should be a good one.

"I am very optimistic about 1998," says Gerald Haddock, president and CEO of Fort Worth, Texas-based Crescent Real Estate Equities Ltd. "I think tight suburban markets will result in significant rate increases there and in the CBDs."

The most obvious market indicator is vacancy rate, and it continues to improve across the board. "We are seeing a decline in vacancy in almost every market we work in, and that should continue into 1998," says Jimmy Gunn, president of the Eastern Division of Houston-based PM Realty Group.

More importantly, Gunn adds, the taking of space is being driven by demand which will continue to push up rents.

"The growth of the economy is driving the demand," says Jim Nugent, vice president of leasing with Cranford, N.J.-based Cali Realty Corp. "Expansion has been particularly strong in the telecommunications, pharmaceuticals and biotech industries."

Another important aspect to the growth is that it is not at the expense of another class of property. "It is not companies upgrading to better space, and leaving vacant space in another class," he says. "This will create a balance in the market with A tenants in A properties and B tenants in B properties."

Nugent points out that by achieving this balance the market will become stable, since higher rents will not be chasing tenants to a lower class of space.

Others agree, the markets will continue to improve.

"In 1998 we see further tightening of space and acceleration of rents," agrees Dick Schaller, executive vice president with CMD Realty Investors Inc., Chicago. "Rents are even in excess of equilibrium in some areas."

"Vacancies will continue to drop across the board," adds Mark Doran, CFO of Dallas-based Prentiss Properties Trust. "Dallas has an overall vacancy rate of 10%, and Class-A space is at around 6%."

Some feel demand will still prevent new construction levels from greatly affecting vacancy rates in most markets.

"Most of the new construction is being taken by large corporate users," explains Haddock. "But as that sector grows, more service providers and smaller support firms will be needed. And they will pay higher rents because location will be important to them."

"I don't see any market that is already [at single-digit vacancy levels], going above single-digit vacancy in the next year," says Kurt Rosene, who is a vice president with The Alter Group in Lincolnwood, Ill. "There is plenty of pent-up demand to fill the space, so I don't think we can build above absorption capacity."

While the number of construction projects may be increasing, the square footage may not be rising at the same rate. "More smaller buildings are being built, so more projects doesn't necessarily mean more space," says Mike Steele, executive vice president and head of real estate operations with Chicago-based Equity Office Properties.

Tighter markets and higher rents have drawn more investor interest. "Office seems particularly attractive," says Gunn. "Dramatic rental increases are occurring in the South and there are strong upturns in rents in New York and Chicago and even spikes in the suburbs."

As a result, plenty of capital will remain available for office projects.

"So much cash is coming from Wall Street through the REITs that banks are having to compete to place money in real estate," says Rosene. "Banks are still cognizant of the underwriting, but their attitude toward office product is different. Five years ago no banks were calling us. Today, I have seven or eight banks calling each day wanting to know where we can go next."

With banks aggressively looking for office projects the capital should not only be plentiful but available at better rates as well. "Lenders that were crushed in the 1980s are aggressively lending again and reducing preleasing and equity requirements," says Gunn.

He points out that both the Atlanta and Dallas markets are seeing speculative projects get financing with less than 15% preleasing. "I never thought I would see that again, but the properties are leasing."

"I don't think the lenders can become much freer," adds Rosene.

However, this varies from market to market, in northern New Jersey, a market with about 140 million sq. ft., lenders are willing, but only with significant equity by the developer. "There is money for new construction, but the equity requirement is in the 25% to 30% range," says Nugent.

But, while lenders may be seeking out office projects, there are no assurances they will continue to favor particular developers. Only those with successful projects will remain popular with investors.

"The capital markets are still disciplined and they are unlikely to go out on a limb twice," says Schaller. "If a company's first project is not successful, lenders will not be lining up to put money in their next development as many did in the 1980s."

But the demand is out there and well-thought-out properties will find tenants. Nationally, construction levels are as high as they have been in several years. Through the second quarter of this year, Cushman & Wakefield reports that approximately 22 million sq. ft. of new office space was under construction across the U.S. with another 5.7 million sq. ft. under way in the CBDs. "That is more than we have seen in quite a while," says Maria Sicola, managing director of research services for Cushman & Wakefield.

Sicola says she expects the volume of new office construction to continue to increase in 1998, but only slightly. While the overall volume may be growing slowly, one indicator of the confidence in the market is the growing percentage of the new construction that is speculative.

"Last year's new construction totals were about 50-50 spec to build-to-suit," says Sicola. "Through June of this year about 75% was speculative construction."

The build-to-suit market will also be less viable for many companies in the coming year because management now has more options due to the new projects and existing space. "Office build-to-suit will drop off," predicts Rosene.

In real estate the rise in speculative construction is always preceded by, and in fact is a result of, rising property values.

"Competition for existing office product, by the REITs and other investors, has driven prices up a great deal," says Gunn. "So it is a good time to sell, if you bought low."

Despite strong price increases in the last year, office property values still have room to rise in many markets. "Prices are still 20% below replacement costs," says Rob Stuckey with Washington, D.C.-based CarrAmerica.

In other markets prices seem to be closer. "Sale prices are reaching replacement costs, so new construction makes sense," says Michael Baum, vice president, commercial property services division at Chicago-based Draper & Kramer.

However, construction costs are also rising, a larger factor in this increase is the price of land in some markets. "Land costs are on fire is some markets, such as Phoenix," says Rosene. "There are only so many sites that make sense for development and I have seen land prices double and even triple in the past year."

Another factor that is inspiring investor confidence in the office market is the perceived end, whether correct or incorrect, of corporate downsizing. "I think [downsizing] has run its course," says Schaller. "Most companies have discovered the size they need to be. And the impact of hoteling and telecommuting will not be that great. I don't think corporations have or will go overboard in those areas."

Some think the cutbacks served their purpose, but now that the economy has improved Corporate America may be letting its belt out a notch or two. "They lived through enough of the downsizing and now management understands they have to give some of the perks to attract good people," explains Rosene. "So I think Corporate America may even grow a little in the next year."

It appears that most of that growth will continue to be in the suburbs, however, the motivation for flight to the suburbs on the part of management appears to be shifting.

Cost used to be an advantage of the suburbs, but in recent years suburban occupancy costs have outpaced that of the CBDs. "Unlike the early-1990s there is no great advantage to doing business in the suburban markets," says Baum.

But in the end it may be a lack of space that sends tenants back downtown. "The downtowns will improve because vacancy is so low in the suburbs," says Stuckey.

But companies still see advantages to locating outside of the city. "Jobs will continue to move to the suburbs as will development," says Schaller. "Corporations have clearly indicated that is where they want to be."

"The economy is such that you have to compete for employees," adds Rosene. "There has been a shift on the part of companies from trying to attract people with their corporate image to concentrating on how much they are going to have to pay them and how close am I to where they live."

Although office users have found new reasons to prefer the suburbs, the CBDs have made significant improvements in 1997 and this should continue into 1998.

"The downtown markets have done very well this year," says Sicola. After experiencing negative net absorption nationally last year, the CBDs absorbed 8.6 million sq. ft. during the first half of 1997, according to Cushman & Wakefield. The way was led by the downtowns in San Francisco and Boston, but other seriously challenged CBDs showed some improvement as well.

While no one can argue with the fact that the suburbs have driven the recovery in the office market, this success has pulled the downtowns along as well," says Steele. "Today, companies are looking for young workers just out of college and these young people are flocking to the major cities into areas at or near the center of town," he explains. "So downtown is where these companies' workforce is located."

"The CBDs are improving," agrees Baum.

"The next big play will be in the downtown markets," agrees Haddock.

"But," stresses Sicola, "the suburbs still have the edge."

The real benefactors of the rising suburban occupancy costs and limited interest in major CBDs are the secondary markets. Many firms are coming to the conclusion that they can find what they are looking for at less cost in smaller markets. And as the space users' interest shifts so does that of the office investor.

"The competition for existing office space is getting so great and REITs are driving the prices up so high that a lot of investment will move to secondary markets like Orlando, Denver, Detroit and Seattle," says Gunn. "Because as prices go up returns go down."

In fact Rosene predicts speculative development will pick up in most of the top 50 U.S. office markets. "Detroit and Pittsburgh are two of the markets that will see more speculative office development in 1998," he says. "And most of the projects will get under way without any preleasing."

Schaller agrees that a two-tiered market has formed with the larger players still focused on the trophy properties in major markets. "These are the ones that are getting most of the attention," he says. "So the larger players are dictating to the rest of us what we have left to deal in. However, a large part of the office opportunities are in the second-tier markets and in second-tier properties so there is activity."

So, although the market may be changing the views of both office tenants and investors and broadening the type of opportunities they consider, the market should remain active and healthy in 1998.

Demand driven by the growing economy is expected to maintain the status quo in the office sector at least through the next year.

Retail Over the past nine months, real estate entrepreneur Michael A. Pollack has doubled his Phoenix retail portfolio to an impressive 1.25 million sq. ft. by giving old shopping centers a new lease on life.

He is on track to double his holdings again over the next 12 months.

"We see tremendous opportunities to create investor value in renovating shopping centers," says Pollack, who has 25 years of national real estate development and redevelopment experience. "We are taking centers that were built in the 1970s and 1980s and now barely 40% occupied and transforming them into viable retail properties that are nearly 100% leased."

Retail redevelopment is one of the major trends of 1998, says Mitch Roschelle, a partner in the New York office of Coopers & Lybrand. Street-smart developers like Pollack who can turn lemons into lemonade are having a tremendous effect on the retail industry, he adds.

"Aesthetically, no one wants to shop in a place that looks run down. Everyone wants a fresh clean store," Roschelle says. "It's creating great opportunities for national redevelopers who can take functionally obsolete properties and make them productive once again."

Refurbishment of retail centers is but one of the trends for the retail industry for 1998, say those in the industry. Others include an expansion of the retail concept to include other venues besides shopping centers, more niche locations for centers, industrywide consolidation, and seeking new locations outside the U. S. for development.

The retail business will remain solid in 1998, with steady but not spectacular sales growth, says Stephen E. Sterrett, treasurer of the Indianapolis-based real estate development and management company, Simon DeBartolo Group Inc., the largest public real estate company in North America.

"In our sector of the mall business, we seem to be in equilibrium between department stores and specialty stores," Sterrett continues. "Neither has the upper hand. We have seen a clear slowdown in retail bankruptcies in 1997 and our expectation is that the slowdown will continue in 1998, allowing retail operators to increase occupancies."

Consolidation is clearly occurring, he continues, with that consolidation skewed toward public operating companies, with mall operators, strip center operators, continuing to own a larger and larger piece of the real estate pie.

Andrew "Drew" Alexander, the chairman of the International Council of Shopping Centers, adds that the national retail real estate market will grow moderately in 1998, taking a breather from the hectic construction pace of the last few years.

"The bankruptcies of companies such as Montgomery Ward and others will take some of the pressure off new retail building," says Alexander. "There's also a lot of big-box space out there too that is searching for tenants."

Alexander, who is also president of Houston-based Weingarten Realty Investors -- one of the Southwest's major shopping center developers -- adds that the slowdown in new retail construction is occurring as more and more publicly traded companies focus on the bottom line instead of battling for market share.

At the same time, the retail industry is refining and rethinking the business -- reaching beyond the typical mall or center, says Lee H. Wagman, president and chief executive officer of Toronto-based TrizecHahn Centers "We have a very significant development pipeline of non-traditional malls," he adds.

TrizecHahn has embarked on a $145 million entertainment destination along Hollywood Boulevard in Los Angeles. The development stretches along two blocks, will be anchored by a renovated Mann's Chinese theater, and includes 135,000 sq. ft. of studio and specialty retail, 100,000 sq. ft. of unique entertainment uses, 70,000 sq. ft. of restaurants and food courts, and 210,000 sq. ft. of common area.

"No one would say Los Angeles needs another new retail project, but what we are offering is a unique entertainment retail project and specialty center," Wagman continues. "While some retail markets in the country may be overbuilt, well-located, well-thought-out retail projects will still prevail. You have to know where there are market opportunities to access them."

TrizecHahn sees strong growth for the company in 1998 through new development and acquisitions. "This is one of the most active markets that I've seen in my career," he says. "There is a tremendous swing from private ownership to public, of owning shares of companies that own real estate."

John Bucksbaum, executive vice president of Chicago-based General Growth Properties, says there is no question that some areas of the U. S. are over-retailed, "and we'll probably see more consolidation and the closure of smaller shops. Weaker, poorer performing retailers will continue to go out of business, which ultimately strengthens those that are left. Retailers today are in stronger and better shape because they are rid of the weaker ones."

New retail development will occur, Bucksbaum continues, but it will primarily be in under-served locations. "We believe there are opportunities out there in mid-market areas that are good strong markets," he adds. "We're opening malls in Waterbury, Conn., Iowa City, Iowa, and Grand Rapids Mich. But we're not building a mall for the sake of building a mall. Iowa City, for instance, doesn't have a regional shopping center and we'll be relocating a lot of retail from downtown. In Grand Rapids, there's only one mall, so we feel there's an opportunity."

At the same time, the retail industry will continue to reinvent itself in the years ahead, says Joseph A. Ciardello, executive vice president/acquisitions at Commercial Net Lease Realty Inc. in Orlando, who adds he also expects not only more retail consolidation but also a continuing trend toward freestanding development.

"We think there will be consolidation in a lot of segments," Ciardello continues. "There will be further consolidation in electronics, for instance, with Circuit City and Best Buy undergoing some re-tooling. They've gone from opening 40 stores (a year) to about 16, but they may gear back up at the end of 1998 and 1999. We see most of the regional players in that field dropping out."

An equity real estate investment trust, Commercial Net Lease Realty invests in high-quality, freestanding retail properties subject to long-term net leases with major retail tenants. Accordingly, Ciardlello sees a major trend today toward freestanding facilities. "One of the hottest freestanding concepts is drug stores, which are moving from in-line locations to outside corner locations," he says. "Back in 1987, shopping centers accounted for 55% of all retail development, and freestanding was 30%. In 1996, it was reversed, with shopping centers at 29% and freestanding at 53%."

Ciardello sees this freestanding retail trend continuing for a number of reasons, ranging from timing (a retailer can get into the space more quickly and doesn't have to wait for the entire center to be completed) and operations (retailers can control their own site, setting hours of operation, controlling their CAM charges, and merchandising the exterior of the facility) to changing shopping patterns (a recent study showed that nearly half of today's shoppers are not browsing: they know what they want and where to get it).

Yet all the activity in retail next year and beyond won't be new. Many shopping center developers see an opportunity in redevelopment, saying the location of many centers is excellent but the physical product needs to be improved. ICSC's Alexander agrees. "There'll be some new development, of course, but I think the major emphasis will be on redevelopment," says Alexander. "There's an awful lot of shopping centers out there that were built in the 1960s and 1970s that need to be remodeled. In retail, as in life, time keeps marching on."

Yet merely renovating a shopping center doesn't always guarantee economic success. "Yes, there are many shopping centers built in the 1970s and 1980s that are now in need of repositioning in the overall marketplace, but no, not all renovated centers will be a success," says Pollack of Mesa, Ariz.-based Michael A. Pollack Real Estate. "What people have to remember is that the economics are very important. If you overpay for a center and spend too much money in the redevelopment process, you won't be able to get the rents necessary in a tougher market."

Pollack, who is one of the largest independent owners of strip shopping centers in the Phoenix area, adds that renovation is not the solution for every center. "In this business, you have to realize there is usually no way to fix physical obsolescence," he says with a sigh. "Some strip shopping centers should not have been built."

Shopping centers -- renovated or not -- will continue to attract the interest of investors in 1998 and beyond. Retail, which fell out of favor as the oversupply of centers and malls reached a peak in the 1990s, is now back in the good graces of investors, as demand has finally caught up with supply says Roschelle of C&L.

"The outlook for retail is more opportunistic buying and repositioning and the continuing slow absorption of some vacant properties," he says. "Retail remains overbuilt with some retail product a little obsolete. Where people live has changed over the last 10 or 20 years, and what may have been the line of growth has changed and that might not be in the pattern of growth."

Institutional holders of real estate will continue to sell or securitize their real estate in 1998, adds Bucksbaum, which is consolidating the ownership of regional malls into fewer and fewer hands. "I don't see it slowing down next year, in fact we could expect to see the pace of activity pick up, particularly in institutionally held real estate," he adds. "Pricing for properties is also creeping up. Our preference is to see it remain where it is."

He notes that General Growth purchased the Homart portfolio of 45 shopping centers two years ago from Sears, Roebuck and since that time, there "haven't been that many large portfolios that have come to market. But there are expectations there'll be more," he says.

Alexander of Weingarten Realty says he expects to see the continuation of sales of shopping centers owned by institutional owners, either to REITs or large public entities, as the industry consolidates.

REITs such as Weingarten Realty, which has been an investment trust for the past 13 years, will continue to seek opportunities to add value for shareholders. "Right now there is a lot of pressure on public REITs to grow," Alexander says, "and that's a concern because it may be causing some to stretch too far for properties."

At the same time, more retailers will also be looking at the industry differently in the coming year, says Sterrett of Simon DeBartolo, and will follow the company in providing goods and services directly to customers to enhance their shopping experiences. "We've introduced a Visa card applicable to our mall where shoppers earn cash back from spending in our malls," he says. Simon Debartolo has also formed other strategic relationships like the one it did last year with AmeriCash, the premier national network of Automated Teller Machines (ATMs), SMARTALK Teleservices, one of the nation's largest providers of prepaid long distance calling cards and Diebold, the nation's leading manufacturer of ATMs.

The purpose was to create a first-of-its-kind electronic concierge machine with multiple dispensing capabilities to not only dispense cash, but SMARTALK prepaid long distance phone cards and mall gift certificates as well. Some 300 ATMs are planned in Simon DeBartolo malls.

"We're trying to provide goods and services to the shopper above and beyond what the traditional mall merchants do," he adds. "It's a huge potential revenue source for a company like ours with the size of our portfolio."

Wagman of TrizecHahn sees more international growth as well. "We're looking at Europe, South America and Asia, where we feel there are terrific growth opportunities and strong economies," he says.

Alexander adds that he wonders about some of the new concepts in retail and whether they will be successful.

"There is currently a lot of talk about entertainment centers," he continues, "but to me a lot of entertainment concepts have yet to prove their uniqueness and stability to be good long-term anchors for shopping centers. Movie theaters have been around for quite a while, but some questions remain whether all the theme restaurants can last long enough to provide an acceptable rate of return. There is always a question mark when it comes to cutting edge restaurants, for example."

Even so, most in the retail segment of real estate say most of the bad years are behind them, and they lookat 1998 and beyond as an exciting -- and profitable -- time for the retail industry.

Seniors Housing Seniors housing will remain one of real estate's more active and interesting segments in 1998. Abundant investment capital, attracted by favorable demographic trends for the industry, continue to finance new projects, most of which are presently in the assisted living segment. Also, management is expected to change its focus from the upscale developments to more volume-driven affordable facilities. The investor interest is driven by the potential demand expected to be created by the aging baby-boomer generation.

On the investment side, it has been the willingness of capital markets to invest in the industry on both the debt and equity side that has sparked the growth in the industry. However, next year will be a watershed for many assisted living companies that went public based on projected 1998 earnings. Few industry observers believe that they all can meet Wall Street's expectations. As a result, consolidation, which already had an effect this year, is expected to continue.

Capital is the catalyst in every real estate segment and in the seniors housing industry the streets appear to be paved with gold. "The industry had a good year in 1997 and investment interest is up, resulting in more capital being available at attractive terms," says Robert Kramer, executive director of the Annapolis, Md.-based National Investment Committee. "Seniors housing came into its own as an asset class."

Although the numbers look good, some seniors housing firms may have gotten too far ahead of the demand curve. Several public companies in the industry were acquired by others in 1997 and more of the same is expected in the months to come. "The demographic trends show a good upward slope in demand through 2005 and it gets even steeper through 2030," says Ray Anthony, managing director of the seniors housing division at New York-based Nomura Capital, which recently signed a $100 million line-of-credit for Chicago-based Brookdale Living Communities. "The biggest impact on the industry has been the large amount of investment capital available," says Renee DuBois, in the Washington, D.C., office of Birmingham, Ala.-based PRN Mortgage Capital. "Most loans provided to the industry currently have an 80% loan-to-value ratio. These numbers have improved for the borrower and that trend should continue."

The slower-than-expected results have hinged on two factors. First, occupancy of properties has been slower than anticipated in some regions, and secondly, operating the facilities has required more staff than initially thought. "Earnings projections of several of the assisted living companies that went public in the last two years may not be achieved," says Mel Gamzon, president of Newton, Mass.-based Senior Housing Investment Advisors Inc., a national consulting and real estate brokerage firm. "Those that don't will probably be absorbed by stronger entities. Assisted living facilities are very management intensive businesses. As much as 30% of residents may have some degree of Alzheimer's Disease or dementia, which can have a significant impact on staffing and the bottom line financial results."

Clearly seniors housing requires more than a knowledge of real estate and finding executives with the right mix. So much so it is another reason for consolidation. "Too few of the developers getting into seniors housing understand that it is not a real estate business," says Scott Reid, president of Irvine, Calif.-based MBK Senior Living Communities Ltd. "It is an operations business with real estate as a side component. You have to be a caregiver and you have to have a passion for what you are doing. If not you are going to fail."

"In the past, the key barrier to entry into seniors housing was access to capital," says Kramer. "But today it is management talent, and there is a limited supply. Getting it means acquisition." Of course, in any industry as fragmented as seniors housing, many accept consolidation as a natural occurrence. Estimates report that the industry's top 30 firms represent only 2% of the assisted living product in the country.

"Property values are very strong for most stable projects which average 93% to 95% occupancy," says Gamzon. "This is an excellent time to be a seller of a stabilized seniors housing property." One problem is too much development of high-end projects. "85% of new developers in the industry are building for the affluent segment of the market that comprises only about 5% of the population. This has even led to overbuilding in a few markets," says Anthony. "In the next three to five years, some high-end properties will trade at prices lower than what they were built for."

"Making these projects work is difficult, so naturally many developers gravitate toward the larger margins on upscale developments," explains Reid. "But there definitely needs to be more sophisticated studies of these projects in the future."

Karen Wayne, president of the Assisted Living Federation of America (ALFA), says affordability is the most important policy issue for her organization's 4,600 members. "Hospitals are recognizing that assisted living facilities are good places for patients who no longer need hospital care, but do need a place to recuperate from surgery, or go through rehabilitation before returning home," says Wayne. "Hospitals are under pressure from the insurance industry to control costs by shortening patient visits and this gives them another option. The relationship also benefits the assisted living facility by giving them access to the hospital's doctors and clinical facilities for its patients."

Kramer expects a whole segment of seniors housing to develop around this service niche. "There is an enormous demand at lower income levels," says Kramer. "To meet this demand, nursing homes are opening wings for assisted living patients. And increasingly hospitals are forming strategic partnerships with assisted living facilities." Another direction seniors housing is expected to take is toward the concept of "aging in place." The idea is to create senior care facilities that cover a wider range of service needs, allowing the residents to move from one part of the facility to another as their individual needs increase. This means facilities that combine property types such as seniors apartments, congregate care, assisted living and other extensive care options, on the same campus. "The concept is convenient for the residents, since they do not have to seek out new facilities when their needs increase. And from a business standpoint the facility retains a good tenant," says Kramer... "Turnover is very detrimental to the assisted living business."

>From another standpoint it is diversification of product type. "You can market to a broader segment of the service marketplace and you are not putting all of your eggs in one basket," says Gamzon. "The seniors housing industry is still in its infant stages, relative to when its latest round of explosive growth began, about five years ago. Thus it is unencumbered by federal regulations, but this could be about to change." The General Accounting Office (GAO) is currently conducting a study on the industry focusing on assisted living quality. The report is due out next spring and should shed some light on, if any, when federal regulation may be coming to the industry. "At some point the federal government is going to start regulating the industry, providing some sort of reimbursement to make assisted living more affordable," says Reid.

But most of the demand is at the moderate income levels and more new projects should be designed for these price points. "The largest volume of seniors are in the middle and moderate income segment," says David Schless, executive director of the American Seniors Housing Association (ASHA). "Assisted living is expected to become a larger part of the coverage provided by insurance companies. Currently, 50% to 75% of long-term care insurance has some sort of assisted living provision. However, I expect that figure to be near 100% within a short period of time."

Schless adds that more regulatory variables are possible at the state level, where regulations are not uniform from state to state, and points out that numerous states are conducting studies concerning how they handle the assisted living industry. "I am sure there will be many legislative proposals to modify assisted living at the state level," says Schless. "Demographic trends and the amount of capital being directed at the senior housing market promises it will be active in 1998 and beyond."

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