Why the Office Market is Recovering Slowly

I recently participated in a commercial real estate symposium where I was a panelist.  My topic was the state of the office market in Metropolitan Baltimore.  I was the last presenter so I had plenty of time to absorb the preceeding presentations. 

 

The one that caught my attention, unexpectedly, was entitled “Government Leasing Trends,” presented by a member of the team that provides real estate brokerage services to the State of Maryland.  Initially, I thought, how exciting can this topic be?  But, I was very surprised.  First I learned the state is driving the commercial markets with adoption of green building technology, which keeps occupancy costs low.  Next, I learned the state’s office space standard had decreased from 125 usable square feet (“usf”) per person to 75 usf.  A usable square foot is generally defined as one square foot of office floor space that can be occupied by a person, a desk, a file cabinet, etc.  The state’s new standard equates to floor space approximately the size of a rectangle drawn on the floor with dimensions of 10 feet x 7.5 feet.

 

I soon drifted off into deep thought pondering how my office space needs had changed over the ten years I have been in business.  I have moved twice.  First, I departed the central business district for Charles Village, a neighborhood just north of mid-town.  Paid parking in the former, free parking in the latter.  Second, I moved within my building, downsizing from an 855 usf suite featuring a reception area, two large private offices and a large conference room, to a 457 usf suite with a file room and one large open area for two desks and a conference table.

 

I have also changed the way I work.  Today, I usually insist on meeting my clients in their offices.  Their office space, after all, is the main topic.  By visiting my clients, I can better understand exterior factors:  the quality and image of the building, traffic patterns, visibility, pedestrian access, parking, signage and neighborhood texture.  Inside the building and their space, I can better understand how they use office space:  cubicles, private offices, teaming areas, conference rooms, technology and storage.  I can also assess the quality of the work environment:  natural light, fresh air, “flow” of the floor plan, ergonomics of the furniture and fixtures, filing standards and efficacy of mechanical, electrical and lighting systems.

 

I have discovered I need less office space due to my spending the majority of each day in the field.  I now use my office for the occasional meeting, for receiving mail and packages, for preparing reports, and for production activities such as printing, scanning, and shredding.  Finally, I use my office less and less for storing paper documents.  Increasingly, I store documents, communications and brochures in the cloud and on an external hard drive.

 

Returning to the decreased Maryland space standards and the stagnant Baltimore office market, I theorized that many businesses had changed their spaces needs as had I.  Technology, which had spelled doom for manufacturers of rolling file cabinets in the 1990’s, was now wreaking havoc among office building owners.  Multiple-terabyte capacity hard drives, scanners, email and cloud storage were all conspiring to reduce the number and size of offices, desks, file cabinets, fax and copying machines.  This unruly gang was even chasing employees away from the office party.  File clerks, secretaries, receptionists and administrative assistants were fading in number and value.  Now, I often pass an empty receptionist desk when entering a client’s suite.  Increasingly, my clients are turning to web-based phone answering systems that can answer and forward calls, or record a voice message - with or without transcription.  Fax machines are now virtual and send output directly to email. And with respect to multi-line desk phones and desktop computers, most of my clients use untethered smartphones and laptops with a Wi-Fi or cellular broadband connection.  That’s how I operate.

 

Just as my colleague was ending his presentation, I realized the current office market malaise would probably linger a bit longer as office users evolve, recalibrate and adjust to this new age of recession-induced, technology-enabled productivity.  Low-cost technology is the current alternative to real estate and employees.

A Meal or a Mess

Baltimore and New York City.  Two great American cities.

Two rival cities, as well.  I am not referring to the sports rivalries between the Orioles and Yankees.  Rather, I am referring to the intensifying rivalry for creative talent and thus a stake in the economy of the future.

What made me think of the rivalry between New York City and Baltimore was an announcement on Monday, December 19, by New York City Mayor Michael Bloomberg.  Cornell University, in partnership with Technion-Israel Institute of Technology, was selected the winner of a global competition for the right to develop an engineering campus in New York City on Governor’s Island.  Seven proposals were submitted by seventeen institutions.  Stanford University, the presumptive front runner, pulled out of the competition last Friday.   The winner of the competition were offered the right, at no land cost, to develop an engineering campus on Governor’s Island in the East River plus a $100 million contribution towards the cost of building infrastructure.  The total cost of the venture is projected to be $2 billion, of which $350 million was sourced from Charles F. Feeney, the billionaire Cornell alumnus who founded Duty Free Shops.  The package includes a $150 million venture fund expected to spawn 600 new firms that will create 30,000 new jobs and generate $1.4 billion in new tax revenue.  Cornell also committed to training 200 teachers annually and annually supporting 10,000 students.  Finally, constructing this new, 2 million square foot urban campus will create 20,000 construction jobs.[1]

Amazing!  New York City, the largest city in the country and the financial capital of the world, pivots on a dime in the middle of a deep recession to make a large wager on the economy of the future.  New York City leverages vacant land plus a $100 million investment into a $2 billion initial investment in human capital.    

Looking south towards Baltimore, what do I see? Another large municipality making a similar size wager on the economy of the future.   I see the State Center project.  This is a planned $1.5 billion mixed-use development project that will offer 2,000,000 square feet of office space, 25,000 square feet of retail space and 1,400 housing units.  This project is slated to replace the 932,000 square feet of existing office space owned and occupied by various agencies of the State of Maryland.[2]  We will not discuss the pending lawsuits.

I ask the citizens of Baltimore City and the State of Maryland to compare the Cornell/Technion engineering campus project in New York City to the State Center project in Baltimore.  First, compare the public resources each jurisdiction has wagered:  New York City - $100 million plus some vacant land; State of Maryland/Baltimore City – up to $200 million plus some vacant land.[3]  Second, compare the goals of each project:  New York City – human capital development, economic development, and a new source of tax revenue for generations to come; State Center – a depreciating office building asset, housing units that may only be built if they are heavily subsidized for low income/Section 8 tenants, waived real property tax revenue for 25 years, up-front developer profits, and a free parking garage for state employees.

Is this the best Maryland can do?  Why aren’t we investing our scarce resources to secure a commanding role in the future economy?  Why are we not investing in human capital, the benefits of which are described by Edward L. Glaeser in his book, “Triumph of the City?”  Wasn’t Mr. Glaeser a guest lecturer at a recent meeting of the Downtown Partnership of Baltimore?

When I think of the proposed State Center project as compared to the Cornell/Technion project, Thanksgiving comes to mind.  Growing up, I always marveled at my mother’s cooking.  She was the best cook in a family of seven girls and four boys.  She could transform readily available ingredients into a spectacular meal using her superb culinary skills and vast experience.  As a single adult living on my own, I once tried to replicate my mother’s Thanksgiving dinner.  I stocked my pantry, cabinets and refrigerator with everything my mother used.  I bought similar pots, pans and utensils.  I even used her recipes.  My efforts resulted in a big mess, wasted ingredients and wasted time.  I realized that my mother’s skills and experience made the difference between my big mess and her exquisite meal.

Returning to my comparison of the State Center project to the New York City project, I am concerned that twenty years from now, the State Center project will a be pile of bricks and mortar at the end of its useful life, while the Cornell/Technion engineeering campus will have become Silicon Valley East, training world-class engineers, conducting research with global partners, spawning start-ups, producing creative products, and attracting the brightest minds from around the world.

New York City and the State of Maryland are both staring into a pantry looking at the same ingredients.  Who will make a meal?  Who will make a mess?  I believe we have New York City’s answer.

---

[1] The New York Times.  “Cornell Alumnus Is Behind $350 Million Gift to Build Science Schil in City.”  Richard Perez-Pena.  December 20, 2011.

[2] Maryland Daily Record.  “Md. moves forward on $1.5 billion State Center project.”  Andy Rosen. June 3, 2009.

[3] Ibid.

Sick and Tired of Being Sick and Tired

We are beginning to see a slow thaw in the commercial real estate markets.  This thaw is being driven by (1) institutions, (2) health care providers, and (3) small businesses.  While not enough to drastically reduce the high vacancy levels in retail and office properties, meaningful reductions in real estate could be apparent in the first quarter of 2012.

Arguably, institutions such as Johns Hopkins University, University of Maryland, Baltimore and University of Baltimore never slowed for the Great Recession.  With diverse funding commitments from large endowments, the National Institutes of Health (NIH) and wealthy benefactors, these three educational institutions continued their multi-billion building campaigns on their respective campuses.  Johns Hopkins Medical Institutions is nearing occupancy of Sheikh Zayed Tower and the Charlotte R. Bloomberg Children’s Center, a combined investment of $1.1 billion.  University of Maryland, Baltimore is constructing its $157 million expansion to the Shock Trauma Center, with its BioPark Building 3, a $40 million life science building, getting started.  Meanwhile, Mercy Medical last year completed its $400 million Mary Catherine Bunting Center.  In Mid-town, the John and Frances Angelos Law Center is being constructed at a cost of $107 million.  The growth of these institutional players will continue to anchor Baltimore’s economy and having a positive effect on surrounding real estate markets.

Primary health care providers, despite being unsure about the wild political climate in Washington, D.C. (remember “repeal and replace”?) find themselves no longer able to sit on the sidelines.  The U.S. Supreme Court announced this morning that it will hear the law suit challenging the Patient Protection and Affordable Care Act (Dept. of H&HS, et al. v. Florida, et al.) in mid-March, with a decision by early June.  Notwithstanding the pending U.S. Supreme Court case, many primary health care providers are proceeding with expansion plans, and have begun to commit to expanding clinical space and buying private practices to expand their networks.  It appears that the health care industry is betting on most of the Affordable Care Act being affirmed, thus creating more insured patients in 2014. 

Working on behalf of Total Health Care, Inc., our firm negotiated a lease for a new clinic at 700 Washington Blvd, in Washington Village.  This 4,000 square foot clinic opened on October 1, 2011.  Total Health Care continues to consider additional locations.  We are aware of three small physical therapy practices searching the Metro Baltimore region for new locations.  Our firm is also representing a physician in the acquisition of a building to be converted from retail space to medical office space.  As one more example, the former Bradford Federal bank branch located at the corner of York Road and Homeland Avenue was recently purchased by York Road Health Care, LLC and is being converted into medical office space.

Finally, small businesses, including our firm, are moving, renewing leases, downsizing and beginning to shake off the Great Recession with the blind faith that enough is enough.  Our firm is representing small (less than 3,000 square feet) tenants in the purchase of buildings and leasing of office space.  We recently negotiated leases on behalf of an insurance agent, a construction company and a non-profit.  Everyone is now sick and tired of being sick and tired.  May that attitude continue into the New Year!

Reality Case Study - Ripped from the Marketplace

Have you ever wondered, "What ever became of XYZ project?"

As a commercial real estate broker who either participates in or observes others participating in the hunt for real estate deals, I often wonder. Over time, every deal reaches its conclusion. Project A is sold to Investor B for $C. Asset D is withdrawn from the market because Lender E overpriced it and needed time to come to grips with reality. Project F dragged Developer G into bankruptcy, resulting in the unfinished project being sold to Investor H who plans to reposition it. Portfolio I sold quickly for a record high of $J. There is an ending to every story.

As an intellectual exercise and to have some fun, I have decided to select a current deal or project to follow. I will gather the facts and figures, offer my up-front analysis of the project and make predictions as to how it will conclude. I will rely on public records as much as possible. Where I cannot, I will make educated guesses based upon then current market conditions. Time will be the arbiter of my predictions.

Stay tuned while I cast around for an eligible deal for what will hopefully be an ongoing feature of my blog. Of course, I am always open to reasonable suggestions.

Move Over BRAC

At a luncheon for commercial real estate brokers hosted on May 25, by Corporate Office Properties Trust (COPT) at its newly acquired Canton Crossing Tower, COPT CEO Randall Griffin observed that while BRAC (the Base Realignment and Closure Act of 2005) may be heavily promoted as a big economic engine in the Baltimore-Washington, D.C. region, work being done by Federal government agencies and their contractors in cyber security may prove to be a far greater economic engine and anchor for our region. He further opined that with the construction pipeline for Class A office buildings near empty, 2011-2012 could see a spike in office occupancy levels along with a corresponding spike in Class A office rents. His friendly advice to the commercial brokers in attendance was to begin focusing more on office users who are involved in cyber security.


That is news we can use!


COPT's commercial real estate broker luncheon at Canton Crossing Tower was set in a former penthouse residence on the top floor of this 17-story, 474,000 square foot office building. The luncheon provided a unique opportunity for my fellow brokers and me to enjoy the exquisite culinary offerings of the Blue Hill Tavern. We dined while peering through the floor-to-ceiling windows at Baltimore's Inner Harbor, Fort McHenry, Harbor East and the working waterfront.


Landlords use broker events as marketing vehicles to let brokers experience a property that is being offered for lease. Landlords capitalize on the fact that brokers, being brokers, can seldom turn down free food, chances to win door prizes and the convenient opportunity to talk deals and market scoop with colleagues.

Rand Griffin wisely seized the opportunity to offer his thoughts on the big picture. He guessed correctly that his audience would be more interested in learning his perspective on the economy, financial markets and office markets than hearing a recitation of project details. After all, we had been mixing and mingling with the listing brokers and COPT's in-house leasing team throughout the luncheon.

Rand's expertise in the Class A office market is derived from his experiences developing and operating a large, high quality portfolio. COPT is one of Maryland's largest private office landlord, owning and operating 197 building with 13.6 million square feet. COPT owns 268 properties in six states (AL, CO, MD, NJ, PA and VA) containing over 20 million square feet. COPT's business model is to offer Class A office space to Federal government agencies having an alphabet-soup of names such as NRO, NSA, NGA, DoD, GSA, DISA and CIA. COPT derives 56% of its revenue from government agencies, 30% from government contractors and the balance from first class businesses such as CareFirst BlueCross BlueShield.

Thanks Rand Griffin for your insight. Your optimism is encouraging during these challenging, uncertain times.

Is Microsoft Becoming Irrelevent?

Say it isn't so!



Microsoft (MS) is becoming irrelevant - calcified to accelerating change in the tech market, reacting to yesterday's news, not actively participating in defining or divining markets for tomorrow's services and products. I have even read reports of the best and brightest college graduates spurning MS for Google and facebook.



How did that happen? Perhaps I am over reacting to just a slight lull in the marketing prowess of a tech giant. Or maybe not. In this era of the 24 hour news cycle, a BlackBerry tethered United States President, on-air correspondents Tweeting while cameras roll, and facebook eclipsing Google as the most popular web site, something is different.



I just read an interesting article on CNNMoney.com (a co-sponsored feature with Fortune) describing the state of the mobile computing world. (See the link.)

MS, while tarnishing the upgrade of Windows XP with the ill-fated Vista, ceded market leadership in search to Google, and then began ceding market leadership in mobile computing to Apple. Windows 7 has rescued the MS brand in desktop computing. Bing is making inroads in search. Will Windows Phone 7 be the next Vista or Windows 7? Windows Phone 7 is scheduled to be released, according to PC Magazine, during the 2010 holiday season. MS is promising a new experience, Hubs and Apps. Apple, meanwhile, is 75 million iPhones and 4 billion apps down the road. Android is gaining share. Palm had to seek shelter in the arms of HP. And Nokia's Symbian, what is the new release date, again? As of today, the stock market capitalization of Apple is $241 Billion, versus Microsoft's $270 billion and ExxonMobil's $325 billion. Something has changed.

What does this have to do with commercial real estate?

Has the cataclysmic shock experienced by commercial real estate in the Great Recession changed the course of business as usual? If so, how? Many suspect things have changed. We hear the terms "deleveraged," "falling valuations," "distressed assets," "workouts," "record high vacancies," and "bank failures." How has your commercial real estate business adapted to this new reality? What is the new reality? Who will be the next generation of winners, loosers, or has-beens? Has your service delivery platform migrated from desktop to mobile and then into the cloud?

Stay tuned.

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?

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.

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.

Advice for Novice Real Estate Investors

Sick from the sudden evaporation of wealth recently experienced in the stock markets? Some investors have sworn off equity and bonds investments, preferring to invest in “real, tangible investments” such as gold and, oddly enough, real estate. The logic is that when a stock’s value goes to zero, what's left? Only the paper the stock certificate is printed on or, nothing. If real estate markets suffer a severe shock, an investor will still be able, in most instances, to collect rent from the tenants in that handsome pile of bricks and mortar the investor owns. Yes, there’s something comforting about being able to drive by a neat, fully leased, 4-unit apartment building while so-called real estate professionals are claiming that cap rates have risen, the secondary markets for CMBS pools is dead and loan-to-value ratios have decreased to 60%.

If you would like to join the millions of ordinary Americans who successfully own and manage investment properties, then this blog entry is for you. Consider the following words of advice:

1. Pick your team BEFORE you pick your investment - Don't even think about making an investment in real estate until you have a team identified. At a minimum, the team should include: (1) an experienced real estate broker, (2) an accountant, (3) an experienced real estate lawyer, (4) your banker, (5) a general contractor, (6) an electrician, (7) a plumber/mechanical contractor, (8) a roofer, (9) a carpenter, (10) a painter/dry wall specialist, (11) a handyman/lawn service, and (12) a property manager.

2. Don't expect immediate cash flow - There is a misperception held by many novices or would be real estate investors that magically after closing, cash will start flowing. Typically, this is not true. Typically, investment real estate is priced and should be purchased such that for the first few months, the cash flow is nominal as miscellaneous closing fees are recovered, deferred maintenance is corrected, neglected capital improvements are completed and vacancies are filled. I usually counsel investors not to expect positive cash flow until at least 12 months after closing.

3. Don't be cheap - Err on the side of fixing problems correctly the first time, by experienced, licensed and insured tradesmen who will stand by their work.

4. Cash is king - Don't jump in until you have enough cash saved to cover (a) the down payment, (b) all closing costs, (c) unexpected repairs during the first few months of ownership, and (d) cash shortfalls due to unexpected vacancies during the first 12 – 24 months of ownership.

5. Easy does it - Don't jump in trying to make a big splash. Invest carefully, incrementally and thoughtfully, building your cash flow, experience and comfort levels with your portfolio and your team. Don't rush. Remember, "Flip This House" is a cable television show, not a prudent real estate investment strategy.

6. Think synergy - Focus your investments by (a) asset class (retail, multi-family, office or warehouse); or (b) neighborhood. The objective is to develop expertise and experience that will help protect your investment. Focusing on one asset class brings you expertise in types of tenants, construction costs, rents, cap rates and income yields. Focusing on a particular neighborhood can bring a thorough awareness of community dynamics that can potentially impact your investment - good or bad.

Stay tuned! I will offer more advice for Novice Real Estate Investors in future blogs.

It's A Tenant's Real Estate Market

Seldom are businesses rewarded for procrastination. However, if your business leases office, industrial or retail space and your business has been hesitant about renewing its lease, relocating, or opening a new location, listen up! Today you have been put on notice that now is the time to begin taking action.

Thanks to what some observers claim are the worst economic conditions since the great depression, most primary and secondary real estate markets across the nation have softened to the point where tenants now have leverage over landlords. And they will continue to soften over the next twelve months, I predict, until the recession abates. We are currently in a “Tenant’s Real Estate Market.” What does this mean for tenants? The attributes of a Tenant’s Market include: (1) abundant choices; (2) discounted rents to previous asking rates; (3) increasing concessions such as free rent, free or reduced parking, and larger tenant construction budgets; (4) flexible terms and conditions in the lease document; and (5) respect from landlords, even for the smaller tenants.

Here’s a quick example. My firm was recently retained as a tenant representative to help a small law firm relocate its offices. The tenant had selected its then current location years earlier during a strong market when landlords enjoyed leverage over tenants. The result was this small firm could only afford to lease office space in a tertiary office location, in a Class C building. Upon being retained, we searched within that tertiary market, but were unimpressed.

My client then asked me to search a prime office market that she had always found desirable but previously could not afford. We were pleasantly surprised by the abundance of choices – both listed in CoStar, a national commercial real estate listing service, and unlisted but available due to various landlords knowing that certain tenants were struggling. The final deal we struck was for great space in a Class B building, well located within this prime office submarket. The negotiated rent was approximately $2.00 per square foot per annum below recent asking rates, including a turn-key build-out and several months of free rent.

The financial benefits dropped directly to the bottom line of this law firm. But as important, this firm was able to improve its image, thereby aiding its ability to attract clients and employees. This move in the commercial real estate industry in known as a “Flight to Quality,” whereby a tenant purchases higher quality space in a better location at no appreciable increase in rent.

In a later post, we will tell the other side of this story – the landlord’s side. Stay tuned.

Dead Men Walking

Every quarter, the FDIC publishes a "State Profile," which summarizes economic indicators, banking trends and a banking profile for the banks under the jurisdiction of the FDIC in each market. The Q4-2008 State Profile issued for the Maryland and Washington, D.C. markets reflects the doubling of past-due and non-accrual loans as a percent of the total outstanding loans, increasing from 1.81% in Q4-2007 to 3.87% in Q4-2008. That's an increase of $629.5 million in bad loans over and above the $611.3 million in bad loans at Q4-2007.

So who holds these loans? What is the underlying security? Why haven't they been sold?

The answer to these questions will not be found by the listening to Treasury Secretary Timothy Geitner who is busy performing stress tests while the patients rapidly die. Let's 'fess up. A lot of the American banking system is insolvent. New FASB rules on "mark to market," while providing a bump to the stock markets, won't suddenly bring current the $1.24 billion in bad loans in the Baltimore-Washington, D.C. region as of Q4-2008.

So what to do?

Sheila C. Bair, Chairman, FDIC Board of Directors, has the proper approach. Under her leadership, the FDIC has picked up the pace of closing failed banks. The FDIC has closed 21 banks year-to-date, versus 25 in all of 2008 and 3 in 2007. Someone should conduct a pool as to how many will be put down by year's end. I am guessing 200. Only when these insolvent are closed can the banking system return to normal. In a capitalist, democratic society such as ours, operating under fair rules, profitable enterprises live long and prosper, while failed enterprises close their doors and have their remaining assets, people and inventory scattered to the winds.

There is an abundance of equity capital standing on the sidelines today looking to acquire the real estate securing many of those non-performing loans. Let's put that equity to work! Every day this process is delayed is another day that the employees in those failed banks aren't working in another profession. Its another day that the depositors of those banks aren't sleeping soundly knowing that there bank is solvent. Its another day that the bankers who created the mess are collecting a paycheck trying to perfect a cover-up. And another day that a failed bank is sitting on the sidelines quaking at the thought of being outed as a dead man walking.

Hello Blogosphere!

Hello blogosphere! This is my very first post to my very first blog. While late to the party, I hope that I can contribute to the dialog about commercial real estate during these most distressing times.

I am a commercial real estate broker who has been in the commercial real estate industry since 1986. But really, my experience is much longer. That's if I receive credit for performing maintenance and property management services in my mother's portfolio of five multi-family buildings in Baltimore City beginning in 1967. Over 42 years! And I have loved every minute of those years, though some of the experiences were not so pleasant in hindsight.

So that readers can understand my perspective, I would like to share a little about my path to this blog. I grew up in the Windsor Hills neighborhood of northwest Baltimore City, one of five children. I attended public schools, ultimately earning a high school diploma from Baltimore Polytechnic Institute, A-Course, Engineering Option. Back then, I was convinced that my future lay in designing and racing automobiles. Upon entering the University of Pennsylvania, I majored in Bioengineering with a Mechanical Engineering concentration, receiving a BSE in 1981. By the time I graduated, the country was racked by runaway inflation, US hostages in Iran and 18% interest rates for car and home loans. I secured a job at Westinghouse Defense near BWI Airport as Reagan's defense buildup had resulted in great salaries for new engineers.

As the years clicked past, I became very interested in business, but couldn't satisfy this need at Westinghouse while working on classified projects. From my low level, I seldom knew the ultimate end-user, or received feedback on cost, performance, and quality. Those were critical components that every businessman ought to know. In reality, Westinghouse managers knew those facts but my clearance was not high enough and I didn't have a "need to know."

Oh, well.

I left Westinghouse after five years to earn an MBA in Finance with a concentration in Real Estate from The Wharton School at the University of Pennsylvania. My experiences at Wharton opened my eyes to a whole new world. The flow of international capital, risk adjusted returns, arbitrage! Amazing!

Next stop, USF&G Insurance where I worked my way up to running the corporate real estate department after five years. Again, my experiences were eye opening. This time in understanding national real estate submarkets, construction costs, commercial property management, asset management, and the direct impact of real estate - both used and held for investment - on the bottom line of a corporation. I also learned a thing or two about downsizing a large corporation during a recession and while in a dire financial crisis.

Next stop was a small regional brokerage shop in Baltimore for two years and then on to Cushman & Wakefield, on of the world's largest international commercial real estate brokerages. During my seven years in the Tysons Corner (McLean) Virginia office of Cushman & Wakefield, I learned every aspect of large, complex, commercial transactions. You could say I learned how to be a broker and a businessman.

Finally, in 2003 while in the middle of the dot com recession, I founded Kington Commercial to focus on commercial real estate within the region. My goal was to offer to a select group of clients - both large and small - the same quality of commercial real estate counsel demanded and enjoyed by Fortune 500 firms. That has proven to be a winning strategy.

My goal with this blog is offer thoughtful commentary to the blog's followers on current issues in Commercial Real Estate. I hope that you find this blog both interesting and informative.