Wednesday, May 27, 2009

Live within your means

One of my relatives recently admitted that for last six months, she had been afraid to open her monthly 401(k) investment account statements for fear of the certain very bad news. Ignoring them would make the bad news go away. When she finally opened the statements, she realized her fears and just cried. For many American workers who have worked hard, lived within their means, and saved religiously, the recent meltdown in the economy is almost a repudiation of the American dream. The worst is yet to come, in some instances. Decisions such as when to retire, whether or not one can afford to retire, and the life-style that will be enjoyed during retirement have all been pre-empted. Bigger issues such as job loss, loss of medical benefits, eviction and car repossession are more pressing.

I expect the current near-depression recession will leave its scar on the and “millennial” generation similar to the way the Great Depression scarred the generation of my 86 year old parents. Growing up during the Great Depression forced my mother and father to be extremely conservative with financial and physical resources. When I was growing up we rarely splurged on restaurants, except for the occasional McDonald’s. We ate well but my parents believed in buying in bulk, buying on sale and growing many types of vegetables in our large backyard garden. My parents drove the cheapest cars offered, all without air conditioning until the 1980’s. We wore the most practical clothes and enjoyed simple vacations. Once we splurged to see the World’s Fair in Toronto – what a treat, I can remember. The one area with relaxed spending limits was education - they placed very few estarints on books, magazines, educational experiences and college tuition.

So what’s this got to do with real estate? I believe the current near-recession depression will leave a lasting imprint on the real estate industry.

Some may say, “But have we been through down cycles before.” True, even recently: the high inflation of the early 1980’s, the savings and loan disaster of the late 1980’s, and the dot-com boom and bust of 2001- 2003. They were all pretty bad, but the damage they inflicted was localized.

The recession of the early 1980's resulted in high inflation and interest rates for cars and home loans in the upper teens. Didn’t work for or have money in a failed savings and loan? That’s ok. Your savings account, retirement, job and home were all safe. The greedy unskilled bankers and the greedy, crazy, real estate developers took the direct hits. Never heard of the dot-com boom until after it was over? That’s ok. Only venture capitalists and other investors in dot-coms took the direct hits. Oops, I almost forgot about the thousands of unskilled, inexperienced, naïve, young geniuses who got fired from made-up positions at shouldn’t-have-been-started companies.

As for average Americans, we still had our jobs, our houses, our savings accounts and our health benefits.

This time is very, very different, though.

Who hasn’t been impacted by the current recession? Those who were never directly involved have been equally decimated along with those who were very involved. Stock markets: off 40% [based on DJIA close of 8,473.29 on 5-26-09]. Home housing prices: off 25 – 50% [Case-Shiller Index, National Association of REALTORS®]. New home construction starts at their lowest levels since 1945. [Bloomberg.com] Domestic auto industry: 2 of the Detroit 3 producers in or near Chapter 11 bankruptcy. Banking industry: alive, but on a $1+ trillion lifeline from the U.S. Treasury. Retailers: sales have declined in 13 of the first 16 months in 2009 [National Retail Sales Estimate, ShopperTrak RCT Corporation] Dozens of retailers such as Circuit City, Linens ’n Things and Mervyn’s have closed. Commercial real estate: Nationally, sales volumes are down 80% and sales prices are down 17% year-over-year as of February 2009 [Real Capital Analytics]. Unemployment: 8.9% and rising. Jobs: 5.7 million lost since recession began in December 2007 [Bureau of Labor Statistics]. Job losses have been so large that the April job loss of 590,000 was celebrated as a positive sign. Bank failures: 36 to date, more than the last five years combined [FDIC].

In other downturns, we as a society learned crisp lessons writ large in the headlines of the day:

Savings & Loan Crisis: Speculative development is bad. Don’t start a project without at least 50% of the project pre-leased to financially solid tenants.

Dot-com Bust: Real sales, real earnings and real products are the only reality. Dreams are what you experience while sleeping. Adults must still be in charge.

What is the lesson this time?

A consensus appears to be growing in the popular press and among my clients, friends and family: Live within your means and save for a rainy day. More and more people are beginning to admit that we, average adults in the United States, were not living prudently within our means. We spent money we had not yet earned using credit card cards and home equity lines. We drove cars that cost too much and were too inefficient. We saved too little. We lived in houses that were too large. Corporations borrowed up to their eyeballs on unrealistic expectations for future earnings and confidence in the ability to refinance debt. Businesses assumed that an economy fueled by extravagant consumer spending would endure for the ages. Commercial real estate owners, developers and investors assumed that prices, values, rents and demand for real estate would continue their upward spiral. So now we know.

Going forward, I predict that commercial real estate decisions will be driven by one simple question: does this decision support a society living within its means?

Monday, May 18, 2009

Opportunity for Rebirth from Two Days of Reckoning

The worst case scenario is now unfolding in the auto industry. On May 14, Chrysler, LLC announced it would be dropping 789 of its 3,181 dealers effective June 9, 2009. General Motors Corporation announced the next day that it too was reducing its dealer network. In the first phase 1,124 of GM’s 5,959 dealer base were told that they will be dropped as of October 2010. Another 1,400 GM dealers will be dropped shortly thereafter for a total reduction of slightly over 2,500 GM dealers. [Source: Detroit Free Press, 5-14-09 and 5-15-09.] Prior to these announcements, there were 20,770 franchised auto dealers in the nation. The closures may result in the elimination of up to 103,000 jobs. [Source: NADA.org.] This is just another shock, though not unexpected, to an economy already suffering through a severe recession.

But hope springs eternal!

This week, retailers and retail industry real estate professionals are convening in Las Vegas for ReCon, the annual global retail real estate convention hosted by the International Council of Shopping Centers (ICSC). Undoubtedly one hot topic of conversation will be how the real estate under the closing dealerships will be redeployed. Chrysler and GM targeted the closing dealerships because they had low sales volume or had other problems. Often the smaller stores sold one brand. In the case of Chrysler, the 789 dealers it eliminated represented 25% of its dealer network but only 14% of total company sales. The closing 1,124 GM dealers were 18% of the GM dealer network but only 7% of total sales for GM.

Anecdotally, many of the closing dealers were constructed on small parcels of land that when built 30 – 60 years ago, were located in less densely populated areas. Today, many of these locations are considered prime retail districts, in densely populated communities with strong demographics. Many sites offer prominent corner visibility at signalized intersections with great opportunities for signage. In other words, many are a retailer’s dream location. Perfect for a new community strip center or a Walgreen’s drive-thru pharmacy or a Wawa convenience mart featuring five gasoline pump islands or a new bank branch with three drive-thru lanes.

Consider several examples:

Schafer & Strominger Dodge, 1751 East Joppa Road, Baltimore County, MD. This dealership shares a four acre lot with its sister Hyundai dealership in a secondary retail district on the fringes of Towson, the county seat. The site is on a major thoroughfare, within one mile of the Baltimore Beltway and in a stable community featuring strong demographics.

Laurel Dodge, 10052 North Washington Boulevard, Laurel, Howard County, MD. Strategically located where Route 1 splits, this 2.95 acre parcel is a prime site for a new retail use given its high visibility and high traffic count. The site is in Howard County, which according the Maryland Department of Planning (MDP), has the highest median household income in the state.

Wheaton Dodge, 10915 Georgia Avenue, Silver Spring, Montgomery County, MD. Georgia Avenue is the major north-south thoroughfare leading into the District of Columbia. This 1.8 acre site is located one mile north of the Capital Beltway in a prime retail district, opposite a regional mall. Aside from great visibility and strong traffic counts, this location is in Montgomery County, the county with the second highest median household income in the state also according to MDP.


What had been projected to be a sedate, poorly attended RECON convention may end up being the biggest swap meet for auto dealership real estate in history. Don’t weep too long for the small town auto dealer who will soon be closed. Revisit him in 12 – 24 months as the construction crews scramble to complete the latest reincarnation of America’s main retail strips. That dealer’s former employees may have the opportunity to find employment with any of the new retail establishments. Employees of architectural firms, engineering firms and construction firms will have earned good wages to replace the old facility with a new one. Finally, the local jurisdiction will have a newly assessed property generating tax revenue occupied by a business providing jobs.

Hark! A glimmer of light is flickering at the end of this very dark tunnel.

Saturday, May 2, 2009

It's Cheaper to Keep 'em

An economic ill wind is blowing a darkening cloud over most commercial real estate markets. Vacancies are rising in the retail, office, industrial and multi-family sectors. Retail stores are closing at a faster pace than new stores are opening. Net absorption is stagnant or falling. Signature development projects are being increasingly mothballed, delayed or cancelled. Sales of investment grade commercial real estate have swooned. Finally, commercial real estate finance markets are effectively closed to all but the most conservatively underwritten deals, investment properties that show strong existing net operating income, and borrowers with the most pristine balance sheets and income statements.

The rules and assumptions of the commercial real estate game have changed. How should property owners and property managers adapt? The best strategy for these difficult times may be summarized by the words of an old soul song, “It’s cheaper to Keep ‘Em.” Specifically, given the tremendous uncertainty in the overall economy, it is cheaper to keep your best tenants than to seek replacement tenants. Here are three specific strategies that I recommend:

1. Listen to your tenants.

Tenants are businesses. Do you, as the property owner or property manager know anything about your tenants’ businesses? If you don’t, then you should begin closing your knowledge gap by meeting all of your tenants. Visit their web sites. Walk through their office space, or stores, or warehouses, or factories. Learn how they find business opportunities, produce their work product and then receive payment. With this knowledge, a proactive landlord can tweak building operations to greatly aid a tenant’s productivity. For example, a video intercom system connected to an electric door strike may facilitate after-hours customer visits and deliveries. Increased customer loyalty and revenue due to increased convenience may increase your tenant’s revenues and competitive stance while cementing that tenant’s commitment to remain in your building. Your tenant's business is your business.

2. Pay attention to “Curb Appeal.”

Tenants, clients, customers and employees generally enjoy visiting properties that have a certain class A quality, appearing to be professionally managed and cared for with great attention to the details. I call this the “Disneyland Effect.” Why? In 1993, my young family visited Disneyland near Los Angeles. My daughter was terrified of Mickey Mouse but loved the Tea Cup ride. Her father, on the other hand, was amazed that this amusement park, originally opened in July 1955, featured grounds and infrastructure that were maintained immaculately. Even the 1950’s vintage lavatories were bright, spotless and fresh. As an owner or property manager, do you know if your property exudes the Disneyland Effect on tenants, visitors and neighbors? Curb appeal can be a strong reason for existing tenants to renew or expand in your building. Curb appeal can also work magic in attracting new tenants.

3. Thou shalt cover thy expenses.

Having recently come out of a real estate bull market where owners enjoyed leverage over tenants and buyers, some owners and property managers are having a tough time transitioning to the current near depression-level economic conditions. The owners and property managers who will best survive these challenging times are those who understand that “thou shalt cover thy operating expenses.” More specifically, now, unlike at any other time, owners and property managers need to understand that lease-up risk is very real and very risky. Just as the average number of days a house sits on the market unsold has increased in some markets, so too has the average lease-up period required to find a qualified commercial tenant. Don’t wistfully look back after a twelve month vacancy period and wish that you had agreed to that request for one more month of free rent or another 50 cent reduction in rent or a three year rather than a five year lease term. For example, a prominent multi-family property owner had a large one bedroom apartment that had not leased after being marketed for ten months. Prospective tenants didn’t think the unit was worth the $1,190 per month asking rent, when the market for slightly smaller one bedroom apartments was $950. Recognizing this market perception, the owner reduced the price to $995. Better to receive $11,940 in annual rent (83.6% of pro forma rent) than receive nothing. The unit was leased after being marketed for one week at the reduced rental rate. Be flexible and cover your expenses.