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Securitized real estate continues its own bull run

CMBS and REIT markets boom, but concerns arise as to the quality of issues, narrowing spreads and lackluster returns.

The public market growth for commercial real estate securities, whether in debt or equity form, will continue, says David Jacob, a managing director and head of real estate research at Nomura Securities International Inc. "Not because Wall Street wants it to happen, but because the efficiencies of the public markets benefit the widest audience of participants."

Apparently, the commercial real estate securities markets are running on all cylinders as dealmaking continues at a frantic pace. The volume of commercial real estate debt offerings in the form of commercial mortgage-backed securities, and of equity offerings, as defined by real estate investment trusts, has been on somewhat of a marathon run. Volume last year for CMBS reached a record $30.5 billion, while the REIT sector boasted a record 225 offerings, raising $17.5 billion, just under the record $18.3 billion set in 1993.

And the pace has not let up through the first part of 1997. Through the first four months of this year, the REIT market pushed 109 issues through the door, raising $9.1 billion. Meanwhile, first quarter CMBS volume has been red hot, although slightly under last year's record pace. Through the first quarter, CMBS tallied $6.2 billion worth of deals, which was short of last year's blistering first quarter mark of $7.4 billion, as reported by Commercial Mortgage Alert, the Newark, N.J.-based industry newsletter.

"This year has shown today the securitization of real estate has arrived whether it be for the commercial mortgage or the REIT market," says Steven Kantor, managing director and head of the Real Estate Group for Donaldson Lufkin & Jenrette in New York. "Whether it be through REITs or CMBS, there are large and small transactions being done almost daily."

This is not to say there aren't concerns. Spreads have narrowed significantly on CMBS issues while REIT returns have been lackluster. There are also general worries about the quality of issues and if the mad rush of capital being thrown at the commercial real estate securities market means careful scrutiny has been tossed aside.

"For the first time in a lot of years we are starting to have discussions again about whether or not the industry really discovered the discipline we thought would happen after the debacle of the 1980s and early-1990s," Carlson notes. "And there is still a lot of debate whether we have developed that discipline."

If anything, the first half of 1997 has proven that the commercial real estate market is adaptive and, in many regards, the texture of the individual debt and equity components are quite different from just three years ago. CMBS deals have grown larger, conduits are more important than ever, and issuer teamwork is quickly supplanting the single loan issuer as the prime mover of the market.

On the equity side, REITs have figured out how to leverage acquisition activity by buying into operating companies or forming deals with corporate owners of real estate. So far this year, the commercial real estate securities markets skipped past the spike in interest rates barely stopping to catch its breath, and it has taken hold of the coattails flapping from the second quarter bull run.

If nothing else, commercial real estate securities spread the risk for those who fear the mighty Wall Street bull will finally trip and fall.

CMBS CIBC Wood Gundy Securities of New York maintains a pretty good niche business doing construction loans, acquisition financing and bridge and permanent loans. The company does a lot of repeat business having built up numerous relationships with developers and owners over the past years.This year will mark a change for CIBC as much of those loans will be securitized. The company established a conduit program.

"Right now we hold permanent loans, but the securitization market allows us to exit them at any time," says Michael Higgins, a managing director at CIBC. Presently, the company is in an accumulation phase and expects to do its first issuance at the end of the year.

The growing number of players on the conduit side of the CMBS market testifies to the shift going on in the industry. Back in 1993, conduits represented only 3.6% of CMBS volume, but those numbers have been climbing steadily. In 1994, conduits totaled $2.7 billion, grabbing 13.3% of the overall CMBS volume. By the next year, conduits totaled $4.4 billion and 23.4%. Last year was the great leap forward as conduits jumped to $10.2 billion and 33.5%.

In the residential markets, about 60% of all loans are now securitized. As a comparison, only about 10% of all commercial real estate loans are securitized. But, as Nomura's Commercial Real Estate Quarterly points out, residential also started slowly in the early 1970s and, in fact, the securitization of commercial mortgages closely tracks the historical pattern of the residential mortgage market.

Can commercial attain the same percentage of securitization as residential mortgages? At least one company doesn't think so. LaSalle Advisors' Investment Strategy Annual 1997 reports CMBS will finance an increasing share of the market. However, because of the heterogeneous nature of commercial real estate, securitization will not reach the levels found in the home-mortgage market.

While total CMBS issuance was running slightly behind last year, conduit deals through the first quarter are actually outpacing nonconduit transactions. In 1996, conduits in the first quarter totaled $2 billion or 27.7% of the total, but this year the conduits jumped to $2.5 billion, or 41.1%, of total, reports Commercial Mortgage Alert. In the past, a conduit was basically an alliance between an originator and Wall Street, where the latter would buy loans at pre-arranged terms. While the process is still basically the same, the lines of what is a conduit have been blurred, explains Tom Ferris, editor of Commercial Mortgage Alert, as investment banks such as Nomura and commercial banks such as NationsBank originate their own loans.

TransAtlantic Capital Co., for example, was formed at the end of last year to originate and securitize commercial and multifamily loans for Deutsche Bank North America, the holding company that coordinates North American activities of Deutsche Bank and Deutsche Morgan Grenfell. Like CIBC, the company expects to do its first issuance at the end of this year.

"Things have been going quicker than we expected," says Jim Howard, managing director of the New York-based firm. "Deal flow ramped up very quickly. We are seeing the transactions and having an opportunity to bid which is what we wanted to accomplish."

While there are continually new players coming into the conduit arena, that market has undergone a fundamental change. The deals are getting bigger and individual players are teaming up to come to market with bigger offerings.

Nomura's latest small-loan securitization was a $1.4 billion deal completed last March, but that single-issuer deal has become somewhat of an anomaly, as big CMBS deals are now mostly a result of multi-issuer transactions.

In May, Lehman Brothers and First Union got together to do the largest joint securitization, a $1.3 billion conduit issue. Through the spring and summer, another $6 billion of joint securitizations should hit the market. Among them are an $850 million Merrill Lynch, Daiwa Securities and GE Capital deal and a whopping $1.86 billion Credit Suisse First Boston and Goldman Sachs-Amresco issuance.

Teamed deals are now the wave, says Frank Keane, a managing director for Daiwa. "The advantages are that you can get into the market more rapidly, maybe two or three times a year as opposed to once a year. Also, when you have two or more trading desks behind a deal, you get better sales execution, investment banks support the deal in the after market, and it is viewed positively by investors," he adds.

Large deals attract more investors. Big investors may want $50 million or $100 million of a particular deal. For smaller issues that's difficult to attain. When managers market a deal, they attract a certain amount of interest. If the deal is oversubscribed, managers have to cut back on allocation to clients, which isn't a popular move.

"Some investors have told us they may choose not to go for some deals because they feel they wouldn't be able to get adequate allocation," says Mary Metz, a managing director at Fitch Investors Service, one of the rating agencies which applies ratings to the different tranches. She adds that even the analysis is potentially better because you have better diversification with a larger pool.

Daiwa contributed just under $200 million to its joint deal ­ and it is in almost every asset class, multifamily, retail, office and hotel. Daiwa intends to be very active in 1997 with another conduit deal later in the year plus a credit lease and a small multifamily securitization.

As noted, by its participation in two huge offerings this year, Credit Suisse First Boston also is having a busy time of it and, as Alan Baum, a director at the New York company, tells it, Credit Suisse First Boston has been progressing nicely. "Our origination geared up in earnest probably about 12 months ago," Baum says. "We are certainly one of the largest originators on Wall Street in terms of real estate financing, but this year we will be an active issuer."

The nice thing about the bigger deals, Baum says, is that it can accommodate the very large loans, but not everyone can handle that kind of business. Companies that have the balance sheets to accumulate product definitely have the competitive edge in doing the larger loans, he adds. "Obviously it's harder to do the $50 million and $100 million loans if you can only accumulate up to $500 million total. What you are seeing is the investment banks who have a larger capital availability are looking to do larger deals with larger loans. It is a 'cap' that Wall Street initially wasn't predicting."

As would be expected, Baum is very bullish on CMBS, and he expects a record year in 1997. "I haven't historically been a bull on this stuff but, seeing the market crank along and the conduit programs turning up the volume, I think we should exceed $30 million this year."

There is a tremendous amount of CMBS in the pipeline, adds Stacey Berger, executive vice president in the Washington office of Midland Loan Services L.P. "There is close to $6 billion that is going to come up this summer for pricing, and most of that is in the form of conduits."

By mid-year, the conduit market probably will tally $15 billion, which is actually a little ahead of the same time the prior year. Midland itself will probably do two securitizations this year totaling about $1 billion. The company securitizes its own loans and then uses a company like Prudential Securities to distribute the product.

Actually, Midland will be forming a new association this year and tying up with NationsBank. The plan is to do a joint issue of about $500 million later in the year. By teaming up, the company will be able to issue more frequently, which is the real advantage in co-issuing, Berger says.

The one cloud in the conduit market is the suddenly crowded playing field. Everybody wants to be in the business and the deals have gotten very competitive. "It is not unusual to be quoting on transactions where there may be as many as eight or more competing bids," says TransAtlantic Capital's Howard. "And it is not unusual to be competing with other conduits and life insurance companies at the same time."

Companies are "falling all over themselves to put money out," says Daiwa's Keane. Obviously from a borrower's point of view, this is the best of all possible worlds. Investors seem to be doing well also but, for the conduits themselves, the margins are low.

Profits are not near where they were a year ago, reports William Barry, a senior vice president and head of the Commercial Mortgage and Investment Property Services Group at Draper & Kramer Inc. in Chicago. "One of the potential problems is that some of the conduits have been formed with a large staff based on the fees and spreads that were six to 12 months ago, and now they are realizing the only way to earn enough money to cover the overhead is to do more business than they originally planned."

A key factor in the loss of profits has been the dramatic tightening of spreads. The decline in spreads, particularly in the lower rated classes, is a sign of maturing market, suggests E&Y Kenneth Leventhal's Commercial Mortgage-Backed Securitization Survey 1996-1997. The company expects further tightening in the non-investment grade classes.

"Over the last 12 months, across all types of products, spreads have decreased anywhere from 100 to 125 basis points," Barry says. "We financed a portfolio of some limited-service hotels with the Best Western flag about 18 months ago, and now we are doing another portfolio of the same product and, basically, there is a 105 basis point difference."

Draper & Kramer is also financing a $30 million retail facility at a spread of 150 points, where one year ago the spread on a retail project of this magnitude was 250 basis points. "It is unbelievable what is happening," Barry says.

While spreads might be a short-term inconvenience for conduits, long-term the competitiveness of deals could cause a more lasting pain. Certain companies are choosing to compete in terms of aggressiveness on deals and are not keeping their underwriting parameters where they should be, cautions Credit Suisse First Boston's Baum.

Jack Cohen of Chicago-based Cohen Financial would agree. This competitive market is very interesting, he says, and a whole lot of issues are rising to the front, not the least of which is whether underwriting standards are being relaxed too much or too far.

The big question as Cohen sees it is, with the surge of capital being made available to the marketplace, what assurances exist that the markets are not repeating underwriting mistakes made by the billions in the last spending spree? Will the market maintain discipline?

It's trying, but the tide maybe shifting away from quality to quantity. "At the end of the day, there aren't as many skilled ballplayers as there are dollars that have to be placed. There is more money out there than there has ever been before as there are more new players lending out," he says. "People are buying business with poor underwriting. Now the question is, 'Will the smart people be disciplined to pass on the deal?'"

Maybe not. On the buying side, a lot of the investors are fixed-income specialists, and they are looking at CMBS as a similar type investment. "They are buying these things because they are getting better spreads than with comparable fixed income securities," says Donald Michael Blake, a vice president with Joseph J. Blake & Associates, a Woodbury, N.Y., appraisal and consulting firm. "They are trying to get a handle on this stuff as best they can, but they generally don't have lots of real estate people to be able to do that. Investors in CMBS have to be able to make these decisions quickly because of the competition. If they don't buy it, somebody else will."

Real Estate Investment Funds Stan Ross summed it up best when he wrote, organizations, including REITs, "are merging, acquiring, forming strategic alliances, entering into joint ventures, acquiring blocks of stock and buying portfolios of properties or real estate service companies."

When the national managing partner of the E&Y Kenneth Leventhal Group scribbled that sentence in his company's Real Estate Newsline he was talking about the real estate industry in general, but his comments could also sum up the REIT sector in particular. Underneath the placid exterior of the publicly traded companies, executives continue to rework and experiment with different forms of ownership and management. Take mortgage investments, for example.

While the world of CMBS and REITs appear as distinct and separate sectors, Criimi Mae and Ocwen Asset Investment Corp. have found a way to make the two work together.

Criimi Mae and Ocwen are REITs that have begun investing in noninvestment-grade commercial debt securities or CMBS. Since 1994, Criimi Mae has invested in $564 million of CMBS, and the company hopes to add about $250 million in new CMBS this year. Criimi has never had any losses on its CMBS holdings and mitigates the risk in its portfolio by actively monitoring the loans that back its securities, says Andrew Blocher, Criimi Mae's director of capital markets.

Then there are the cooperative efforts among different companies. In June, a fund managed by a subsidiary of Lazard Freres & Co. LLC, a leading global investment bank, invested $235 million in Alexander Haagen Properties, a California REIT. In exchange for giving up 38% of the company, Alexander Haagen gets to strengthen its balance sheet and fund acquisitions.

Earlier this year, Prudential Insurance Co. announced it would be exchanging properties for REIT shares, kicking off speculation that corporations and institutions will begin a trend to swap properties for shares of REITs. Prudential already completed one swap with Starwood Lodging, and rumor has it that IBM will exchange its $1 billion portfolio of shopping centers for shares of General Growth Properties.

Another interesting move has been the teaming up of REITs with Wall Street funds to buy real estate operating companies such as Crescent Real Estate Equities joining with the Morgan Stanley/DeanWitter/Discover fund to buy Woodlands Corp.

Crescent also did an interesting deal with a group of psychiatric hospitals. It bought the psychiatric hospitals and then leased them back to the selling company ­ pure sale/leaseback. "This is another example of a REIT gaining market share by pushing into private companies and pushing into deals with nonreal estate companies such as psychiatric hospitals," says Carl Kane, director of Real Estate and Capital Markets for KPMG Peat Marwick LLP in New York.

The very fact that there has been such creativity on the part of the REITs is an indication of how difficult it is to produce adequate returns, Kane asserts. "Over the last couple of years, REITs have set a benchmark that is no longer sustainable because they can no longer buy properties at a deep discount. The only way to sustain an adequate level of return now is largely through mergers and acquisitions, which means building the bottom line by marketshare."

REITs, says Real Estate Newsline, will look for opportunities to enter into joint ventures with pension funds and other institutions to acquire or develop properties.

And, adds Richard Schoninger, the managing director and head of Real Estate Investment Banking for Prudential Securities in New York, "we are seeing very significant activity by the pensions and insurance companies, exchanging their assets for shares. It's changing the nature of their investment from a direct investment in real estate to a public markets investment in the common stock of an existing company."

Also wanting to work with the REITs are foreign investors. "There is an increasing appetite on the part of overseas investors to invest in the United States through the securitization format, whether it be just buying shares, doing private placement or forming joint ventures," says Garrett Sheehan, a managing director at Jones Lang Wootton in New York. "Several aspects of securitization are attractive to the overseas investor including transparency, corporate covenants, strong management and the ability to co-invest."

In 1997, former REIT trend lines were suddenly resurrected. Initial public offerings, rarely seen last year ­ there were only six, the lowest number since 1984 ­ came alive. By April of this year four companies had gone public and Boston Properties is on tap.

If all goes as planned, Boston Properties, which owns office and industrial projects primarily in Boston, New York and Washington, D.C., will be one of the largest REIT offerings in years.

Merrill Lynch and Goldman Sachs hope to sell 31.4 million shares at somewhere between $24 to $25 per share.

Not all privately held real estate companies believe the alignment of the stars or the position of the market is propitious for an IPO. Chicago-based CMD Corp. with about $800 million in assets ­ mostly office properties ­ has been mulling the IPO option but has decided that the crucial moment has not arrived.

"We have been taking a look at it," says Hugh Zwieg, a senior vice president at CMD. "But our portfolio isn't as mature as we would like it from a valuation standpoint, and we have a lot of embedded gain in the portfolio."

In addition, the better time to come public for an office REIT would have been back in January, Zwieg says, the pricing for office securitization has pulled back and the multiples are not particularly attractive.

The REIT market as a whole experienced a number of ups and downs, not to mention twists and turns in the early months of the year. By April, the market already raised $9.1 billion, more than half way to the $17.5 billion raised in all of last year. In addition, acquisition activity has also been good as the REITs acquired $9.58 billion of assets through the first four months.

The capital is there to invest in REITs, says Deloitte & Touche's Carlson, and the stuff in the pipeline is large. "In our own practice, we have got in excess of $10 billion that is in various stages of going public. We can easily see $20 billion this year either in the form of IPOs or secondary offerings. Even if the REITs raise a record $20 billion this year, which is attainable, it is a number the market can absorb."

Still, the market has not rewarded the sector. According to the National Association of Real Estate Investment Trusts, through the first four months, REITs were off -2.02%, as compared to the S&P 500, which was up 8.81%.

On an asset class basis, positive returns were only seen in diversified and specialty REITs, while health care, industrial/office, mortgage-backed, residential, retail and self-storage were all down from 2% to 8%. "There is an asset allocation issue that has gone on this year with REITs," says Michael Evans, national director for Real Estate Advisory Services for E&Y Kenneth Leventhal in San Francisco. "REITs have had a negative return to date, while the S&P stock index is way up. As a money investor, do I put my money in REITs or do I continue to ride the stock market? This is an allocation issue that has hurt the REITs so far this year."

Despite the erratic performance of the REIT market this year, it is not without bullish fans. "We had a correction early this year," says Schoninger.

"But that has pretty much run its course, and we see some real interesting opportunities in the REIT market." CMD's Zwieg concurs. "The REIT market is doing exactly what it did last year. It was in a stall from a pricing standpoint until the fall. There is a possibility the same thing will happen this year and REIT stocks will look good relative to what the Dow Jones and S&P are doing."

Steve Simon at Lynch Jones & Ryan in New York is the director of LJR-Radar, a top-down momentum product designed to reduce portfolio volatility. Simon has scanned his Radar and came up bullish on REITs. There are four major reasons, he reports, why REITs will outperform the Russell 2000 and S&P 500 over the next six months: Interest model is calling for a 1/2 point drop in rates; large cap equities have too much speculation premium in them and are due for a correction; REITs make up 14% of the Russell 2000, and small cap issues are expected to outperform large cap for the remainder of the year; and the defensive nature of REITs puts them at an advantage under certain market conditions.

"A lot of people think REITs are fully valued right now," Simon adds. "If you look at the big picture, there is a lot more room on the upside. They have pulled back, but they have had a nice run for the rest of the year; REITs should reach a much higher valuation."

Two markets that deserve a closer scrutiny are office and retail. The office market has been the last sector to gain momentum following the real estate recession in the early-1990s. As a testimonial to how far it has come back, of the $9.11 billion raised this year, $3.3 billion in 20 offerings has been with office REITs, by far the largest of any sector.

Besides Boston Properties, the year started with Kilroy Realty Corp., an owner of office properties, going public.

As CB Commercial notes, things could not be much better for office markets than they have been over the past year and into the first quarter of 1997. Since 1993, when the national downtown and suburban office vacancy rates were bubbling under the 20% mark, vacancy rates steadily decreased. By the end of the first quarter, downtown office vacancy had dropped to 13.2% and suburban office vacancy to 10.6%. Strong demand through 1996 and into the first quarter of 1998 is driving the decline in vacancy rates, reports CB Commercial. Net absorption in the office sector was 16.3 million sq. ft. for the first quarter, and forecasts suggest 65.2 million sq. ft. will be absorbed this year, an increase of 5.5% from the year before.

Another lagging sector had been retail. However, retail REITs raised $1.4 billion this year in 20 offerings, which was the second largest raised by any sector so far in 1997. Some of the interest has been regional. Schoninger suggests the Lazard Frere's deal with Alexander Haagen Properties shows a strong investor interest in West Coast retail, which "is coming back very strongly."

The larger picture for retail remains cloudy. Although retail REIT returns through the first four months were at -2%, retail outperformed almost all other asset classes. "Retail has shown a tremendous recovery," says Evans. "It was a dog in 1995, but in 1996 the whole sector recovered except in the factory outlet area. The recovery goes to three things: a strong economy which produces retail sales, REIT consolidation has largely been focused on retail, and institutional capital has invested a great deal of money in retail REITs."

"Market analysts indicate the national retail market is being impacted by bankruptcy filings and store closures even as new retail centers are being developed," reports the Greenwich Group in its research publication Retail Real Estate: Marked Up or Marked Down. "At present, institutional investors are reported to be most interested in acquiring upscale regional malls with four or more anchor tenants, power centers with five or more anchors and community centers anchored by the dominant local supermarket chain."

REITs have become one of the preferred vehicles of real estate ownership, but they really own just 8% of the commercial real estate universe so, in theory, there is still plenty of room to grow.

Steve Bergsman is a Mesa, Ariz.-based writer who covers real estate issues.

Alliances offer greater efficiency, create value-added activities and leverage expertise. Even competitors are working together.

CB Commercial has been involved in some of the real estate industry's major acquisitions over the past two years. In 1996, it bought L.J. Melody & Co., the Houston-based mortgage banking firm, and now it is in the process of completing a merger with Koll, the big real estate service company based in Newport Beach, Calif. Acquisition is, however, just one part of CB Commercial's strategy to expand nationally and globally.

CB Commercial also partners with other companies. Internationally, CB Commercial formed strategic alliances with local companies in Europe, Asia and South America and, domestically, it will have 25 similar alliances in cities in which it doesn't have a presence.

While CB Commercial desires a complete national and global presence, it realizes that economically it is not feasible to buy into every market. "To open another 50 to 60 offices from ground zero is extremely expensive," explains Mark Donahue, senior executive vice president with CB Commercial in Los Angeles. "More importantly, the time involved in entering a market, getting an office up and running, and becoming a force can take three to four years."

In the United States, CB Commercial formed partnerships with local real estate companies in such markets as Milwaukee, Pittsburgh and Memphis. Its goal is to open 25 offices by the end of the year. As Donahue sees it, both companies get something from the alliance. CB Commercial gets local market knowledge and local presence without the investment expense while the local companies get a larger perspective, an infrastructure of services, technology, data, in short all the things that are important to clients who are looking for seamless service. "It's a win-win situation," Donahue asserts.

Internationally, CB Commercial's partners include DBZ/Debenham Thorpe Zadelhoff in Europe, the Middle East, South Africa, Australia and New Zealand; C.Y. Leung & Co. in China and Southeast Asia; Ikoma Corp. in Japan; LJ Ramos in Argentina; and P&G Larrain in Chile.

When it comes to international placement, a company like CB Commercial has to determine where the client needs it to be, says John Ollen, a senior vice president at CB Commercial in Los Angeles. "When you learn where your clients want you, then you can figure out where you should be. You spend some time, energy and money researching the best and most capable firms, and then you go through a venting process to find the best in the marketplace." The quality of service abroad is every bit as good as in the United States, Ollen says. "If we can provide our clients with the competence in London or Paris that we can in the United States, then we don't have to go through the tremendous expense of putting an office in those cities. The client still gets the same level of service."

CB Commercial isn't the only U.S. real estate service company with international alliances. Many other big companies are using a similar strategy as well. Landauer Real Estate Counselors in New York, for example, holds strategic alliances with Grant Samuel in Sydney, Australia, and Fuller Peiser in London. Grant Samuel is one of the largest investment banking firms in Australia, and it is also considered to be very strong in real estate.

"On first blush, the focus of our alliance with Grant Samuel was on valuation, but we are now taking it to another level where we are looking at jointly working on transactions and how we can develop a greater presence in the Asia arena," says Steven Kaplan, president and chief executive officer of Landauer in Dallas.

Fuller Peiser boasts a strong corporate clientele, and Landauer works mostly with institutional investors, so there is an easy fit with little overlap. "The partnership allows us to continue our development efforts in the corporate arena, which is becoming more and more of a focus of Landauer," Kaplan says. In addition, Fuller Peiser stands in as Landauer's office in London, which means it doesn't have to build a new presence from scratch.

When Chrysler Corp. decided it needed to sell nonessential real estate assets, it turned to Chicago-based Equis Corp. but, as a global company, Chrysler needed information in markets as widespread as Europe and Asia. In response, Equis formed an alliance with the Knight Frank organization, which boasts 88 offices throughout the world.

With no additional development and expense, Equis, for all practical purposes, now has the global reach it didn't have before. "When Chrysler wants space in Asia, we are the ones with the requirements and knowledge of business needs, and they are the ones with local knowledge," says Michael Silver, president of Equis. While Equis and Knight Frank have kept their strategic alliance for two years, Silver cautions strategic alliances are not always successful. These things fail because the two parties don't invest the time equitably, or they are coming at the partnership from different motivational perspectives.

New York-based Williams GVA is a member of GVA Worldwide, an international strategic partnership. Companies joining together, either through acquisition or partnerships, is a reflection of changing client expectations, says Rand A. Diamond, president of Williams Real Estate Co. of Illinois. "It's a shift in the way major clients want to do business. They want to deal with fewer vendors."

Two companies that historically have been coming at the industry from different and competitive perspectives have been Cushman & Wakefield and its long-time rival CB Commercial. Yet, Cushman & Wakefield and CB/Madison of Los Angeles have teamed up to form Alliance 2000, which subsequently joined with Ford Motor Land Services, a Ford Motors subsidiary, to handle the worldwide real estate needs for the automotive giant.

"This is an industry first. Two historical, major competitors form a joint venture to create a single-service entity. The new entity will serve one client globally and draw on the resources of both firms," says O.B. Upton, an executive managing director at Cushman & Wakefield in San Francisco.

Alliance 2000 was formed Jan. 1, 1997, and there are alliance employees (from Cushman & Wakefield and CB/Madison) currently located in Ford's headquarters in Dearborn, Mich., as well as in Ford's European headquarters in England.

The odd partnership came out of the bidding process to do Ford's international real estate work. Late last fall, Ford issued an RFP to a real estate service firms for the purpose of providing global services to Ford business units. At that time, the automotive giant previously outsourced domestically. Cushman & Wakefield was doing Ford's work in the eastern United States, while CB/Madison was doing Ford's work in the western United States. Meanwhile, Ford was also using a variety of service providers internationally. Ford's intention was to have one alliance. "Cushman & Wakefield and CB were doing their work successfully in the United States which represented 70% of Ford's total portfolio. It was logical to drop our competitive shields to work together," says Upton.

In 1996, Atlanta-based Bullock, Terrell & Mannelly and Prudential Real Estate Services formed a strategic alliance to manage commercial real estate properties in several southeastern cities. The assignment has grown in just one year from 11 PREI properties totaling 2.7 million sq. ft. to 17 properties totaling 4 million sq. ft. The buildings are held by PREI on behalf of the firm's institutional clients. The alliance with BTM was one of 18 that PREI established after cutting back from 150 service providers two years ago.

According to Les Horsager, senior managing director for Prudential's Private Asset Management Group, the goals of the program are to create greater efficiency in operations; enable PREI asset managers to focus on strategic, value-added activities; leverage the expertise of certain property management and leasing firms; and ensure consistent quality on a cost efficient basis.

Strategic alliances work because of existing long-term relationships and trust, says Joe Terrell, a partner with BTM. "PREI gets the benefit of lowering its personnel and cost overhead by eradicating a lot of fat in the organization and focusing on their primary business. We provide the expertise they otherwise duplicate in its institutions."

PREI also adopted strategic alliances in other parts of its businesses. Years ago when it wanted to acquire hotels, the company first looked at opportunities and then decided what management company to use. That paradigm has been completely turned inside out. PREI first picked its management companies and then together decided what opportunities were worth investments. PREI eventually chose HEI Hotels out of Westport, Conn., and Davidson Hotel Co. of Memphis. Both companies are also investment partners, which gives comfort to PREI that all partners' goals are aligned.

"Typically the alignment of goals is a challenge in this business, because the managers have different motivations than the owners," says Alan Tantleff, vice president-hotel investments for PREI. With its partners, PREI developed strategies to acquire full-service hotels that are in need of renovation, positioning and flag change. In partnership with HEI, the company bought 12 hotels valued at approximately $400 million. PREI and HEI eventually sold 10 of the properties to Starwood Lodging Trust and, in the exchange, became Starwood's second largest investor. PREI has also bought seven hotels with Davidson worth about $200 million. Another three hotels valued at $100 million are in the pipeline.

"We felt the alliances would be more effective for us, because we could leverage the resources of the managing company," Tantleff says. "These organizations are very attuned to the industry and see a ton of deals, many of which we hadn't seen because we are not in the hotel investment arena. In addition, these guys know the hotel management, the operations and therefore can put together a pro forma that is much more credible and achievable than we could sitting in an office."

Dallas-based Corporate Real Estate Service Advisors, or CRESA, bills itself as the largest real estate service provider with a focus on tenant advisory services. It is also a strategic alliance of independent commercial real estate firms. Founded in 1994 by five firms in seven cities, CRESA now tallies 34 members with offices in 42 cities throughout the United States. Recently, the group changed its name from Corporate Real Estate Service Alliance, and the companies have added CRESA to their names.

"Unlike our competitors, CRESA is not a referral network," says Gerald Porter, president of Metrospace\CRESALos Angeles, and chairman and president of CRESA. "The client's original contact remains the point person on all assignments, even in multiple markets." For instance, Dreamworks is an exclusive client of Metrospace in Los Angeles, but Metrospace just completed a film marketing distribution facility in Manhattan for them. It was able to do that by using its CRESA partner in New York, Friedman Realty Group\CRESANew York. The advantage for CRESA members is that they can keep their individual corporate relationships while handling corporate needs all over the country. "With them I have a joint venture in each city. I keep my hands on all the deliverables and know the needs that have to be met for my particular client," says Porter.

While most real estate alliances involve service companies, some smaller players in construction and computer software also use alliances either to aid development or boost marketing. In the mid-1990s, The Alter Group, a Lincolnwood, Ill., development company, working with architects and designers pioneered a concept called ReadiDesign, a fast-track corporate office development model. Now The Alter Group is partnering with a number of companies such Atlanta-based Ruys and Co. to develop a ReadiDesign model to cater to the call-center market. The Alter Group has an entirely different team of architects from its first ReadiDesign project plus telecommunications and power specialists, says Richard Gatto, senior vice president for the company. "We are doing the same thing as with ReadiDesgin, but we have assembled a team of architects and consultants who are better versed on the needs of a call center building."

Throughout the 1980s, Fischer & Co., a Dallas-based real estate consulting and brokerage company, developed a software program to help manage real estate portfolios. The programs proved so popular, the company spun off Fischer Systems as an independent company to provide software to companies managing real estate. Fischer Systems now holds alliances with such companies as Dow Chemical and Federal Express to help organize real estate portfolios through the use of its software tools. "It has been an evolutionary process the last five years for all the parties in the relationship," says Cliff Fischer, president of the company. Fischer Systems is "perfecting its processes to make the alliances work short term and long term."

PM software users are demanding products that make integration easier, and developers are responding.

Last year Chicago-based Heitman Financial decided to discard the in-house property management system it had used for 15 years to find a system that provided both the ability to interact with various basic financial software products and an increased access to the data within the system.

"We knew with the scope of our business we would never be able to limit our system to using just one type of accounting software," says Lloyd Cole, Heitman's information officer. So the company needed a system with the ability to interface with the various types of software used by its clients.

The next question was, "How do we pull this information together and give our people the ability to use it to make better financial and business decisions?" Cole says. "We were looking for strong basic financial systems along with a good open information system."

Heitman finally chose Northridge, Ill.-based Quantra Corp.'s Real Estate Management System. "It was a good match of what we were looking for and what they had to offer," says Cole.

The big issue for Heitman was improving client reporting. They wanted to get monthly and quarterly reports to their clients faster and more efficiently.

In the past, to create these reports required pulling data from several different databases and then putting the data into a spreadsheet application to finish building the report. But in the Quantra system, each of the databases and the spreadsheet applications are integrated, allowing the data to be shifted from one to the other. This eliminates duplicate data-entry requirements and speeds the creation of the report.

Quantra had met the specific needs of their client, Heitman, so the capability of the software and the need were a good match.

Corporate expectations Similarly, the expectations of other corporate real estate executives, with regard to property management software, have greatly expanded in recent years. Once thought of as simply a means of assisting with the accounting functions within the real estate business, today the software is looked upon as a communication tool that can assist management in many areas.

"Five years ago property management software was just seen as a way to manage the dollars," says Stephen Casner, vice president of product marketing for real estate systems with Quantra. "But today executives need a single set of tools that can help them with every aspect of the company."

"Property management firms all just limped through the 1980s with dissimilar systems," says Robert W. Fahey, senior vice president with Yardi Systems Inc., Santa Barbara, Calif.

"However," adds Casner, "today they have recognized that information systems are an important part of their business strategy ­ and that accessing all of the information about the real estate business is important and not just the billing process."

Keeping pace with Corporate America This evolution in the thinking of software users in reality may be more a matter of a change in the firms and who is heading them up.

"Clearly the users have changed," says Perry Levine, product marketing specialist with Timberline Software Corp., Beaverton, Ore. "Today they are more sophisticated and, as a result, they expect more from vendors. It doesn't matter if the vendor is a software provider or a janitorial service. They want you to show them what you can provide to improve their bottom line."

In other words, the user wants the software provider to not only create the technology, but also show them the best way to use it. "Real estate management firms have made it clear that they want software vendors to provide solutions to their problems not just technology," explains Levine.

Real estate investment trusts are a prime example of the more sophisticated users. "There are many more REITs in real estate today and, as public companies, they have a great deal more responsibility for reporting," says Charles Kessler, vice president with Exton, Pa.-based Colonial Systems Inc. "It is critical that accounting data be in an open environment to make it easier to use in other areas such as reporting."

This open environment technology, or Open Data Base Connectivity (ODBC), is clearly the most recent major breakthrough in property management software.

"Our main thrust is providing access to data in as many modes as possible," says Kessler. This seamless integration allows electronic documents to be attached to particular computer files. For instance, lease provisions can be added to a tenant file for easy reference.

The capabilities of ODBC technology can have more relevant uses in specific real estate environments.

In multifamily property management, for instance, the volume of transactions is higher, there is a higher turnover rate among tenants (67% turnover every year), shorter lease terms and fewer legal recourses in case someone stops paying rent. "The eviction process is long and drawn out," says Natalie Tefft, director of marketing with Rent Roll Inc., Carrollton, Texas, a firm that specializes in multifamily property management software.

As a result, applicant screening is an important part of the business. ODBC technology has helped automate the process. With the open architecture of the systems it can be online with all three credit services as well as with the Apartment Index, a database which keeps up with the previous rental histories of tenants at 28,000 apartment communities.

"By taking the screening process out of the hands of individuals fewer mistakes are made," says Tefft.

Customizing for the user In addition to the open architecture of the systems, management companies want more flexibility in creating their reports and presentations. "Our clients tell us they need a way to differentiate themselves from the competition," says Ron McComas, vice president of marketing with Management Reports Inc., Cleveland. "They want more options in how they manipulate and present the data. A way of putting their personality into it."

"The management firm wants to customize each report for the reader. For instance, a lender will want to see different information than an investor," says Levine.

Part of this is achieved by information systems that can interface with numerous brands of off-the-shelf software. "In the past, there has been a reluctance on the part of software producers to let their product interface with others," says McKean. "But I think that is changing."

Software companies see the advantage of creating development software that interfaces with other systems. This way, at least, the user has the option of using one of the products rather than none of them, he says.

Of course no system will be efficient if employees have a difficult time operating it. So ease of use is an important issue with the software companies as well.

Standardization in the industry is one way to make life easier for the software user, and the industry has one large corporate policeman to oversee this beat.

"Microsoft has set certain standards, and that pretty much dictates where we are going," says Levine. "They are the operating platforms that we work on."

Windows come to the forefront He adds that with Windows technology used in about 90% of the market's computers, any software company looking for a decent marketshare had better have a Windows format.

"Microsoft is definitely forcing the issue of standardization," says McKean.

With its choose-and-click technology and help feature Windows is easier to operate than past systems. In addition, most employees already have a head start on learning how to use it. "There is a great talent pool of people that have grown up with Windows products," says McKean.

Levine cites the 32-bit technology of Windows 95, which allows multitasking, as an important cog in ease of use and efficiency of systems.

Working the Web When it comes to where the property management software industry is heading, there doesn't seem to be much argument. The easy response is the Internet.

Tracy Dean, Rent Roll's director of product marketing, says management firms will be able to use on-line connections for clients, who will then have access to real-time property information. "Currently we use phone connections which are updated only once a day," she says.

"Eventually everything will go through the Web," says Fahey.

Not only for the efficiency of a reduced paper trail, but cost as well. "You can get on the Web for $20 a month," says McComas. "It is a lot less expensive than high-speed phone lines."

Data warehousing, where vendors store data for companies, also may have several applications. First, companies would have vendors store their data for them. The advantage being the company would not have the expense of maintaining the hardware.

The vendors would be able to offer access to the overall database, including information from hundreds of firms, to individuals and companies needing average statistical data on particular business topics.

Others feel existing technology such as ODBC can be exploited further and will be the focus of most new research. "It is in its infancy and will provide greater capabilities in the future," says McKean.

But in the software industry the future is measured in weeks not years, so it could get here faster than many expect.

"Things are happening every day to help business perform better and faster,"continues Levine. "Things are popping."

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