Rough ride ahead for property managers as industry shakeout continues.

To many, the business of property management may seem like it's been on a roller coaster course lately, as the number of consolidations continue at a rapid pace and small players feel the squeeze and opt out of the market altogether. While some may find the ride far from amusing and think it's time for a breather, industry experts say "hold on to your hats"-- the frenzy of the past two years is far from over.

For the near term, merger and acquisition activity will be strong. Big companies say they will get bigger (and they hope better) whether through acquisition or internal growth. Meanwhile, small companies are struggling to find a niche where they can survive, whether it's providing local expertise or some special proficiency like, for example, environmental capabilities.

The big middle -- mostly made up of regional companies -- may have the roughest ride ahead of all. They may lack the flexibility of small local companies, but at the same time can't access a national network or benefit from the economies of scale enjoyed by the big companies.

Industry experts say intense competition in property management has put increasing pressure on fees to the point where assignments are being taken below break-even. Meanwhile, institutional property owners are demanding more sophisticated and consistent types of reporting, like on-line capabilities, that call for a heavy investment in software and hardware. Some think only the big companies with the capital to invest in these complex systems will prosper in the long run.

Institutional owners are streamlining their operations, too, and say they want fewer service providers, which is putting even further strain on small property managers. Owners also are looking at ways to increase the level of services provided by traditional property managers, often asking for assistance with assignments traditionally reserved for asset managers.

That blurring of the lines between conventional property managers and asset managers should continue, most industry experts say, with companies determined to survive aiming to build "seamless" organizations that can handle any task from getting a furnace fixed to property disposition.

How long the industry shakeout will continue is anyone's guess, but most peg the time frame at about two years. Eventually, what will emerge is a smaller industry with fewer, but larger service providers -- not unlike the pared down airline industry that saw a somewhat similar round of consolidations and profit pressures in the early 1990s.

"The trend toward consolidation is in real estate in general," says Charlie McBride, senior executive vice president, chief operating officer of management services for CB Commercial Real Estate Group Inc., Los Angeles. "There's a lot of economic pressure out there. Fees are down and that requires more efficiency."

Industrywide change taking place

McBride thinks property management isn't being singled out, but is a good example of how industrywide change is taking place. "We saw it with the purchase of Allegiance by Insignia and the purchase of Rubloff by Koll. And I think we will see more of that into 1995. You can also see the same trend in the pension advisory side with LaSalle [Partners'] purchase of ABKB [Alex. Brown Kleinwort Benson Realty Advisors]. The reasons are consistent," he says.

William Rothe, president of Koll Management Services Inc., Newport Beach, Calif., says consolidation is the result of over capacity. "Larger owners are reducing the number of service providers that they use, creating a smaller number of people with larger portfolios as opposed to more service providers with smaller portfolios," he says.

Most industry experts agree that investors are consolidating their portfolios.

"In the past, these large guys that had 300 million sq. ft. had 100 property management firms around the country," says Thomas E. Wynn, chairman and chief executive of Axiom Real Estate Management Inc., Stamford, Conn. "So they ended up with 100 companies using different software and financial reporting and that made their lives more difficult. Now they are reducing the numbers of people who manage their properties." This, Wynn thinks, is the biggest factor propelling consolidation and explains why his firm is contemplating the acquisition of smaller companies.

Since the glut of service providers has had the effect of driving down fees, Rothe of Koll thinks only the low-cost producers -- the firms that can provide all the services needed by an owner today at super-low competitive prices -- will persist. "Low-cost producers will survive and size creates its own economies in that case," he says.

A fairly typical example of the type of consolidation taking place today can be seen in the 1994 acquisition of H.G. Smithy Co., Fairfax, Va., by Cushman & Wakefield, New York.

"It gave us a presence in the Washington, D.C., Baltimore and Virginia corridor and put us in the top five in terms of management firms in that area," says Steve Ford, managing director, eastern region/management services, Cushman & Wakefield, New York. "We would continue to look in select markets for that type of opportunity. We are studying other markets and we are moving deliberately."

Another company pursuing acquisitions is Faison Associates, Charlotte, N.C., having bought five companies over the past four years. "We've had dramatic growth," says Dary Stone, now president of Faison-Stone, Dallas, and previous owner of a property management company acquired by Faison. "We've grown from about 13 million sq. ft. to 60 million sq. ft. through acquisitions of other companies and additional assignments from pre-existing client relationships. I think it is necessary to have certain economies of scale in all the markets you participate in to survive."

Growth occurs through several means

Big companies are not just growing via acquisition, however.

In December, Seattle-based GFS International and Houston-based Sovereign National Management Inc. merged to form Seattle-based Pinnacle Realty Management Co. The new entity, which manages more than $3.2 billion in assets for more than 230 different clients, has an apartment portfolio of more than 60,000 apartment units. Additionally, Pinnacle manages 6.5 million sq. ft. of retail, office and industrial space.

"A merger made a great deal of sense since both of our companies' customers will ultimately be better served by Pinnacle, which is stronger than either of the companies alone," says Lan Bentsen, formerly head of Sovereign, now principal in charge of new business development for Pinnacle. Stan Harrelson, former GFS president, is president of the new company.

"We're growing the hard way," says Joseph M. Hudec, chief executive of Premisys Real Estate Services Inc., Houston, which was formed to manage the investment portfolio for the Newark, N.J.-based Prudential Insurance Co. of America, and now manages 65 million sq. ft. of space, which includes third-party assignments. "We really haven't pursued the acquisition route because portfolios managed by the competition may present a conflict of interest. Instead, we're pounding the streets."

Compass Management and Leasing, Atlanta, which has 10 regional offices and manages about 100 million sq. ft. of space, also has decided to build from within. "We have had the opportunity to acquire a number of companies, but our strategy has been to build from the inside because we felt we can achieve the consistency of product that we needed to be able to deliver to owners we represent," says Bruce Ficke, senior vice president of management and leasing at Compass. "Our philosophy was we might be able to grow more quickly through acquisition, but then we cannot control the quality. We felt we could build it better than we could buy it."

Some prefer diversification

Another problem posed when acquiring another company is the complications of trying to merge two companies' different philosophies into the same, according to Van L. Pell, executive vice president and COO of Chicago-based Miglin-Beitler, a management firm which oversees 15 million sq. ft. in Chicago and Milwaukee. Rather than take the risk of acquisition, Pell finds diversification to be the surer way to grow.

In 1994, Miglin-Beitler launched a public facilities management affiliate, Public Building Management Co., which already manages the 1.2 million sq. ft. Richard Daley Center in Chicago. In addition, Miglin-Beitler has begun to offer asset management consulting services, such as the work it did for a group of four medical office buildings, totaling 500,000 sq. ft. Rather than providing property management, Miglin-Beitler established a strategic plan to improve the building and arranged candidates for the owners of the building to hire to manage the property.

The firm is also working on possible new assignments in the project management, construction management and corporate facilities management arenas, according to Pell.

Rothe of Koll contends that it's less expensive to buy a company, rather than build it. "Somebody will already have a market position that you can't develop over a period of time because they've been there longer," he says.

While it may be more cost effective to "buy" compatible companies, Rothe says there are no bargains when it comes to the systems and equipment needed to "tie into" owners. "Only in the 'economies of scale' that you have in the larger organizations do you have companies that can afford these systems. And the owners of real estate are demanding these systems," he says.

Others agree that the demands of institutional owners are becoming more complex.

"The sophistication in the industry has changed dramatically," says Ficke of Compass. "There is a requirement now for tremendous investment in technology and systems in order to compete and offer the services people are looking for."

Ficke says his company has developed a work-order system, a preventative maintenance program and also is using bar code technology to tie everything into the accounting system for an overall performance measurement. "Other firms are going to have to do this to compete. That's where the industry is headed," he says.

Mike Lutton, vice chairman and chief executive of PM Realty Group, Houston, which manages about 100 million sq. ft. nationwide, says consolidation will continue because property management is a capital intensive business. "If you don't have a critical mass, you can't afford to stay in this business and provide the hardware and software support necessary to be considered from the institutional side. Everybody wants a standardized reporting package that's very sophisticated and a format that can be rolled up into an investment analysis. That includes lease abstracts that roll up into pro formas and into economic analysis. That's an expensive proposition to buy the equipment and train the people, if you don't have enough income coming in to justify the capital expenditure," he says.

Chuck Esler, managing director, LaSalle Partners, Chicago, which manages about 150 million sq. ft. of space, says the only way the business can work is by achieving economies of scale in price and quality. "That's something building owners find desirable," he says.

Esler points out that LaSalle is big enough to have specialists on staff who can handle technical and environmental problems for clients when they arise. For example, Esler says, his company took over the management of a New York building whose cooling tower had not been maintained. When the tower "blew up" in July, the first estimate for a temporary tower to be installed on the sidewalk was $60,000. "But by virtue of having some mechanical systems design people on staff, we concocted a way to keep the building cool for about $5,000 until we could get a new cooling tower that we needed anyhow. We can offer the quality and service that the smaller folks have a hard time dealing with," says Esler.

Property managers add responsibilities

While "bigger" may well translate into "better" service for owners, most industry experts see the role of the traditional property manager evolving into a higher life-form, more akin to that of the asset manager.

"Institutional owners are looking for a continuity of information from the property manager," says Rothe of Koll. "They are asking the property manager to do much of what the asset manager used to do. The property manager has to be more than a nuts and bolts property operator."

Rothe says property managers now are expected to prepare hold/sell analyses, valuations, capital expenditure forecasts and cash flow projections for multiple years. Increasingly, he says institutional owners are asking that these services be provided on-line. "They are eliminating the whole reporting system and demanding that they can tap into the system to get their information for a particular property," he says.

Ficke of Compass says he sees the emergence of what he calls the "super manager" who can come in and tell the chief engineer what needs to be done in the boiler room, go upstairs and show space to a prospective tenant, and then return to his office and run the financial pro formas for the client. "That's what we are training our people to do," he says.

According to Daniel L. Plumlee, president of L&B Institutional Property Managers Inc., Dallas, which manages about 20 million sq. ft. of large office and retail properties, his organization can't distinguish between asset and property management. "Even when we are hired for a commodity job of property management to collect the rent and pay the bills, we feel like the real reason they hired us was for real estate expertise. You don't need expertise to perform a commodity service, so you will see more blurring of the roles," he says.

Richard C. Scott, president of ARES and president of MONY Real Estate Investment Management, New York, says his firm is not organized functionally. "In the old days there were people who built, people who leased and owners. We are trying to eliminate the confusion and have a seamless organization of real estate professionals where each person knows asset management, leasing, property management and construction," he says.

Many industry experts concede there's a fair amount of confusion surrounding the issue of property vs. asset management. "It's very confusing. People have their own definitions and the definitions vary," says Ford of Cushman & Wakefield. "Our definition of asset management is when you start to take control of discretionary spending and setting the leasing rates for the property -- because those are usually done by the owner or the owner's representative."

Property/asset managers evolving

Last November, LaSalle joined with Alex. Brown Kleinwort Benson Realty Advisors (ABKB) creating the third largest U.S. real estate advisory firm (measured by assets under management). Some industry observers characterize this as a link between an asset manager and an operating company, calling into question the long-term prospects of pure asset managers.

"Alex. Brown is an asset manager and property management is what my people do," says Esler of LaSalle. "I don't know if there's blurring, but the issues leading to consolidation in property management and the issues leading to consolidation in asset management are similar. But I think asset managers with in-house property managers should be able to achieve significant economies and pass that through to their clients."

Another company hoping to leverage the combination of asset and property management is Heitman/JMB Advisory Corp., Chicago, also the result of a recent merger. "The merging of the portfolios are providing good complimentary synergies," notes Andrew C. Deckas, president and chief operating officer of Heitman Properties Ltd.

The changing, role of the property manager also includes demands from institutional owners for so-called "value-added" services.

"The industry is becoming more aware of who can add value and that will come into focus more in the next year," says Lutton of PM Realty Group. "There are a lot of companies that can manage or lease, but there are few who can look at an asset and reposition it, manage it, lease it and prepare it to maximize its value. That's what institutional owners are looking for."

Plumlee of L&B says an "anticipatory" management style will be the only way to add value beyond any normal appreciation. "A recovering market presents a lot of opportunities to add value. How do you differentiate your property and put it in a position to capture a disproportionate increase in occupancy, rent or both?" he asks.

For example, Plumlee points to a $10 million capital improvement program now being undertaken at a Midtown Manhattan office building managed by his firm. The plan includes facade restoration and window replacement. "We think that's appropriate in an upwardly moving market and demonstrates commitment to the property. That kind of opportunity can't be exploited by someone who is simply reactive," he says.

Steve DeNardo, executive vice president of ARES, points to the example of a parcel of land owned by MONY, located across from the Burlington Mall in Burlington, Mass., that was earmarked for office development. DeNardo says when it became clear that the office market was "going in the tank," his firm approached General Cinema about moving its theaters from the nearby mall and building a new movie complex on the vacant land. "We became the developer for them and built a 10-screen movie theater that was originally going to be a 280,000 sq. ft. office building. We've had a very good financial result," he says.

The evolving phase of property management is bringing about the possibility of many different changes in the industry.

In response to some of these changes in the industry, the Arnold, Md.-based Building Owners and Managers Institute International will be launching two new courses. The first course, Asset Management, will, according to BOMI, "educate managers on the do's and don'ts of sound fiscal management and help them maximize the value of their single property or an entire portfolio."

The second course, Ethics Is Good Business, is a one-day seminar that will draw upon ethical dilemmas property managers may face on the job. Contract negotiations, sexual misconduct and other potential sources of ethical conflict are among the issues addressed.

Training, education important

"Property managers are finding themselves faced with challenges from all corners," says Roger Kahn, senior managing director, property management group of Edward S. Gordon Co. Inc., New York. "We are contending with environmental regulations and tenant concerns, all while trying to protect and enhance the long-term value of our buildings. In order to meet these present day challenges, a property manager must be on the cutting-edge of technological developments, changes in the market and the regulatory climate, such as OSHA's indoor air-quality regulations, CFC refrigerant replacement and local fire and life-safety codes.

"Training and education have never been more important then they are now," he adds. "ESG's employees receive 75 to 100 hours of training each year in technical issues, financial and strategic planning, real estate market analysis, communications and many other areas."

Not only are some firms branching into asset management, some are looking into partial ownership. "An increasing number of management companies are now moving into property ownership through joint venture partnerships with pension funds, insurance companies and other institutional or private investors," says Alan Hayman, co-founder of The Hayman Co., a Troy, Mich.-based national full-service real estate firm. "One benefit of this arrangement is that the management company may not have to provide a large share of the purchase price in order to get in on the deal. Instead, it may be able to pay a fractional share and then fulfill its part of the joint venture contract by providing the management expertise for the property."

According to Hayman, a second benefit of a joint venture arrangement is that as a partner, a management company can expect to receive income from several sources -- the management fees, a portion of the general cash flow and a percentage of the profit from the sale or refinance of the property. "Even more important, being part owner helps assure that the management company will retain the management account as long as the joint venture partnership remains viable," he says.

According to Bob Cataldo, president of Hostmark Management Group, a Chicago-based hotel management firm with more than 50 properties in its management portfolio, the joint venture acquisition is something Hostmark plans to execute in 1995. Right now the company, whose principals already have part ownership in some of the properties it manages, is looking at five possible acquisitions. Last year, Hostmark had a net gain of five properties totaling 1,200 rooms.

The number of foreclosures and resulting institutional investors looking for management firms to handle properties has dwindled greatly from the pace of three to five years ago, according to Cataldo. Add to that the fact that institutional investors are no longer looking to divest,

rather hold on to their properties as occupancies and room rates start to improve. He expects occupancies to possibly improve 4% to 6%, while room rates may very well increase by as much as 3% to 5%.

Another kind of joint venture was recently formed by Colliers, Bennett & Kahnweiler (CB&K) and U.S. Equities Realty Inc., both of Chicago. The two firms have reached an agreement in principle to create a new venture specializing in property and facilities management. The new Chicago-based company, called Property & Facility Management Group LLC, brings together CB&K's experience in industrial property management and leasing and U.S. Equities' expertise in high-end commercial management and will be headed by Katherine K. (Katie) Scott, executive vice president of U.S. Equities.

U.S. Equities will continue to provide asset and property management, marketing and leasing services for office and retail facilities across the nation. CB&K will provide industrial leasing and brokerage services to PFM's clients, while continuing to offer leasing, acquisition, disposition and investment services to both industrial and office clients, as well as maintain its association with Colliers International.

Initially the new venture will manage CB&K's portfolio of industrial and office properties, but ultimately client services will include facilities and asset management ranging from day-to-day operations, preventive maintenance and quality assurance to construction management, leasing and acquisition/disposition of assets.

One problem that may result for firms that provide strictly asset management services, according to Malcolm W. Bates, 1995 president of the Chicago-based Institute of Real Estate Management, as well as principal of Harrison & Bates Inc., Richmond, Va., is that a downward pressure on fees and the demand for property managers to take on more asset management responsibilities may put the squeeze on some asset management firms, causing them to drop out of the business.

Corporate opportunities prove lucrative

Today, traditional property managers see corporate facilities management as a more lucrative, and secure, business than third-party assignments.

About two-and-a-half years ago, IBM's internal property management function was spun off to form Axiom Real Estate Management Inc., which now manages about 25 million sq. ft. of space occupied by IBM nationwide, plus another 45 million sq. ft. of space for other owners.

"The corporate facilities segment is becoming more attractive to us because it is much more stable than managing third, party properties for institutions. If you are an investor and you own a property, you are looking for a return. That area is much more price-sensitive than the corporate facilities business," says Wynn of Axiom.

Wynn adds that his company likes corporate facilities management because there's less of a tendency by corporations to turn over management contracts and single-tenant properties afford the opportunity to offer a broader array of services. "We could provide anything from operating the mail room and providing security to running the cafeteria," he says.

LaSalle also is expanding its role as a corporate facilities manager. According to Esler, the company was awarded the industry's largest management contract last year when it, along with Johnson Controls as facilities manager, was hired by Ameritech to manage its 45 million sq. ft. of space. (See NREI, August 1994, p. 30.) Ameritech, Esler says, has everything from 1 million sq. ft. office buildings to 100 sq. ft. garages.

Esler thinks companies like Ameritech aren't just talking about outsourcing but are making long-range business decisions about their core business and where they should devote their time. "These companies will take advantage of managers who can deliver and take on large portfolios," he says.

Formed to manage the investment portfolio for Prudential, Premisys is concentrating its efforts on large corporate users. Some of the corporate properties now being managed by Premisys include: The Xerox Document University, a 1 million sq. ft. office and training facility in Leesburg, Va.; First Chicago Bank's head, quarters facilities; BMC Software's headquarters in Houston; and Revlon's world headquarters in New York.

Hudec says big companies that have downsized need help managing their properties now, but he warns that this type of facilities work may surge only for the next 12 to 18 months.

Ficke of Compass says his company recently received an assignment from The Mellon Bank to handle their headquarters properties totaling 5 million sq. ft. in three cities. Compass also handles facilities management for Amp Inc. of Harrisburg, Pa., the world's largest maker of computer connections. "We are a real estate services company. Our core business is management and leasing, but we offer all the other services around what our clients need," says Ficke.

Industry shakeout to continue

Property managers agree that the industry shakeout isn't over yet, and they expect more tough times for the next several years.

George L. Lippe, president and chief executive of the Midwest Region for Trammell Crow Co., Tulsa, thinks the majority of repositioning by national players is complete. "I think those that have wanted to expand have made their major acquisitions. We will probably see some in-fill acquisitions where a major player is looking for two or three markets to round out their delivery system," he says.

Lippe thinks mergers will continue in the smaller cities until the top 20% of the firms in a marketplace represent 80% of the properties. "The problem with a market that is fragmented is that nobody is making any money," he says.

Also, Lippe is watching to see if the big companies that have seen their revenues grow primarily through acquisition can make money over the next two or three years. "If they can't make money, there could be a lot of splintering from these companies and there might be a move back to fragmentation instead of consolidation," he says.

Whether or not companies will make money remains a big concern.

"My guess is that very few companies have made money in the last four years and a lot of people, including the big ones, have lost money," says Rothe of Koll. "I think for 1995 and 1996, everyone has gone as far as they can go. Now there will be rapid consolidation in the next two years, and it will start with a couple of big guys getting together."

Scott of ARES thinks there may come a point where "bigger" is not "better." "Size does give you certain economies of scale, but size that depreciates quality and productivity, we want nothing to do with. Larger seems to be stronger, but that is only true to a point, because we are talking about a service industry," he says.

Lutton of PM Realty Group thinks there will be a place for strong small managers who can serve local ownership. "There's room for the little guy and the big guy, but not anything in between. The middle group will go out Of business, or get acquired," says Lutton.

Corrigan Real Estate Services, Dallas, with offices in the major Texas cities and Milwaukee, plans to continue as a niche player.

"We don't want to be any bigger," says David Corrigan, president and chief executive of die firm, who wonders whether big companies can remain focused on any .one particular asset. "Our philosophy is you have to know your own backyard. If you try to know everyone's backyard, you'll lose the details."

Some experts believe brokerage services will be an important ingredient for survival.

"There will be more emphasis on adding brokerage services to traditional property management. At this point in the cycle -- an uptick -- institutions are placing a higher value in finding product," says Lippe of Trammell Crow. He noted that his company is rapidly adding brokers -- a total of about 100 last year in Chicago, Detroit, Atlanta and Southern California.

Ford of Cushman & Wakefield says being connected to a brokerage network is a big advantage. "We have relationships with every major institution across the country. Our feeling is that big companies with access to broker networks will survive and thrive," he says.

In the near future, Plumlee of L&B thinks the industry will reach a "breaking point" and service providers will start refusing to "give away" real estate expertise below break-even costs. "In a recovering market, a lot of talented people will devote themselves to assignments where they can add value, not only for the owners' but for themselves too. That basic entrepreneurial drive will dampen too much more fee cutting. Otherwise, talented people will lose interest and that's not good for anyone," he says.

McBride of CB Commercial thinks what will evolve eventually is a property management business that looks a lot like today's airline industry. He says: "You will have a small number of very large national companies on one end, and on the other end you will have some small boutiques that are nimble and able to operate in a single market and change rapidly."

Jane Adler is a freelance writer based in Wilmette, Ill. A frequent contributor to NREI, she also writes regular real estate features for The Chicago Tribune and Crain's Small Business.

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