By Sam Gould, President, Alter Asset Management
The Big Picture The year 2014 was definitely a buoyant one if you were in the right place. While the economy grew at a rate of 2.1 percent for all of 2014, activity picked up in the second half of the year with growth above 3%. And that’s where we should remain in 2105 which promises to be a strong year. There is heightened demand nationally for urban and transit-oriented outpost locations. Additionally, conversions to hotel and multi-family will take obsolete office out of the basis. The sectors driving our industry are healthcare, energy, tech and education. In each of these cases, the overriding factor motivating real estate decisions was the recruitment and retention of skilled labor. “Jobs chasing people,” is the key phrase of the labor market. Not surprisingly, three of the top cities to look at for commercial real estate in 2015 are located in energy-rich Texas: Houston ranks first on the list and is expected to offer the most significant amount of investment opportunity; Austin is No. 2 based on its “Keep Austin Weird” appeal to Millennials and the lower cost of doing business; Dallas-Fort Worth ranks fifth on the list, thanks to its economic diversity.
The Local Story In downtown Chicago, the story was much the same: in the suburbs, the story was about flight to quality with the average Class A asking rent ending the third quarter at $27.39 per square foot gross, up from $27.33 at the end of the second. The problem is that less Class A space will be available going forward with little new construction and the existing product not having the parking ratios to support the new, denser suburban requirements. The 4/1,000 parking ratios that were once standard are no longer adequate.
Downtown, the office vacancy rate dropped to its lowest level in five years — 14.1 percent — aided by strong downtown net absorption which allowed a 4% spike in rents. Also, the investment market was in the stratosphere this year: We saw the record disposition of 300 N. LaSalle to Newport Beach, Calif.-based The Irvine Company for $850 million this spring. The purchase price equals $654 per square foot for the 60-story trophy tower. Consider that KBS Realty Advisors LLC paid a then-record $503 per square foot for the building in 2010 to Hines Interests LP. And then, late in the year, Chicago-based real estate investment manager Heitman LLC agreed to pay just over $700 million for the 46-story tower at 353 N. Clark St. or nearly $600 per square foot. The price is more than 80 percent higher than New York-based seller Tishman Speyer Properties L.P. paid four years ago, amid the recession. Nationally, office sales in downtown markets totaled $20.1 billion year-to-date through the third quarter, up 39 percent from a year earlier, according to Real Capital Analytics Inc. Cap rates reached new lows in first quarter 2014, with the central business district (CBD) office sector at 5.7 percent and the apartment sector at 5.1 percent.
The question for property managers to ask is this: how long will this continue? While the market for institutional-grade properties with strong occupancies shows no sign of abating, some economic factors might affect it. Looking ahead, as long as interest rates stay low, investment dollars will continue to flood real estate from foreign investors; on the debt side, the CMBS market was a key player with close to $100 billion of issuances expected this year. With interest rates expected to rise however, the market will move from cap rate compression as the driver of returns to cash flow and building performance (principally rising rents and occupancies) to enhance returns. For the market, it means a stabilizing of ownership as a lot of these investors will be employing a longer-term hold strategy. And that’s where property management will become key. Remember that historically, about 75 percent of commercial real estate returns have come from the income component and the rest from appreciation. This turn towards property management has caused a move towards consolidation which will leave only two types of firms – the gigantic multinationals and the local players with deep market knowledge. That’s why a middle-market player like Cassidy Turley couldn’t make it on its own. Created in 2008 by four original partner firms and expanded over the years through mergers and acquisitions with local and regional companies, Cassidy Turley was merged into DTZ. The combined company, which will be branded as DTZ, will have revenues of more than $2.9 billion and more than 28,000 total employees.
Practical Advice So, what should tenants be thinking about as we move into 2015? Firstly, crunch those numbers to hit your 2014 approved budget. A good property manager knows and understands the specialty, spend the funds that were allocated and collected for the year. Avoid large refunds in 2015 or pinch those pennies and strategically decided what items can be pushed to the 1Q of 2015. You can’t forget if you are working on an accrual basis that you need to assure that you have accounted for all the 2014 expenses within the 2014 calendar year, so don’t forget those journal entries.
Budgets Property managers are compiling and completing their 2015 budgets for approval. Is it the year for Capex resurfacing or just a CAM sealcoat and stipe year? Is there Capex roof replacement needed or just minor R&M? Are the control joints failing? What about parking lot maintenance, janitorial services and supplies, and window cleaning? Make sure each and every expense is captured and that you are maintaining the integrity of the building, all the while fulfilling your fiduciary responsibility to the ownership.
In this new operational phase of real estate investment, property managers are no longer just responsible for day-to-day operations of a building but the overall achievement of ownership’s end goal.
Sam Gould has been President of Alter Asset Management for 30 years. He is responsible for the company’s 3,500,000 SF management portfolio of office and healthcare space, half of which is owned by third-party investors. Chicago projects include 20 West Kinzie, a major high-tech office tower in River North (www.20westkinzie.com). He has provided oversight for virtually every type of real estate asset, including more than 100 office and industrial buildings, retail and service centers in Illinois, Georgia, Pennsylvania, Kentucky, Arizona, California, Florida, Ohio and South Carolina. Information at www.alterassetmanagement.com