The Corporate Climate
CCIMs explain how this niche is weathering the downturn.
Spurred on by the unyielding economic malaise, corporations have retooled their real estate portfolios along with their business plans. Some are capitalizing on a scarcity of competition by expanding operations, while others are weathering the storm by consolidating investments and renegotiating leases. In all cases, corporate real estate professionals face an urgent need to streamline portfolio performance, improve client relationships, and keep pace with an evolving marketplace.
And although this evolution will continue, it has its advantages, notes James M. Costello, principal and director of investment strategies at Torto Wheaton Research. “When there are changes, it gives you an opportunity to think about things in a new way.”
But how do companies keep pace with a rapidly changing environment? Commercial Investment Real Estate asked five corporate real estate experts from around the country to discuss how their companies are facing the current market’s unique challenges and advantages.
CIRE:What corporations do you currently work with? What factors shape your roles within these organizations?
Ryan M. Lorey, CCIM: I am embedded full time in the XO Communications office. I manage a 4 million-square-foot portfolio of office space and technical facilities as well as 1,800 building access agreements. A dedicated team handles the latter, allowing me to concentrate on the larger offices, major switch facilities, telco hotels, nodes, and pops that support our national fiber network. My schedule is filled with lease negotiations, renewals, and upgrades; building services augments; and heating, ventilation, and air-conditioning assessments.
One of the benefits of being in the client office is the ability to fully develop relationships with executives and business-line heads. Those one-minute conversations in the halls help me get the flavor of an issue. If you’re not part of the company culture, you risk becoming an order taker after the decision is made without your participation.
Lee Y. Wheeler, CCIM: I currently work with Steinhagen Oil, Sutherlands, Chase Bank, CVS, and TriCon. Our market is small — the metropolitan statistical area is only 350,000 — so we have to do a little bit of everything. We have aggressively sought out some of our regional corporate clients.
One such client has quickly become our best client. Steinhagen Oil has standing orders with its staff to direct all real estate matters to us. This is complete trust, and we value that relationship and want to build others like it.
David A. Wilkens, CCIM: I work solely for Service Corp. International, the world’s largest funeral home and cemetery operating company. From day one, two colleagues and I have worked out of its world headquarters in Houston. Being embedded, we have easy access to property information, support systems, and signatories.
The arrangement also is conducive to teamwork and group synergies. My client has worked hard to help us ‘look like, talk like, act like, and react like’ its corporate real estate directors. In fact, most client personnel find out about our contractor status years after we begin working together.
Peter C. Volas, CCIM: Since 2001, I’ve served as the director of real estate for Cleveland Clinic. The real estate department advises and supports Cleveland Clinic institutes and regional hospitals and its partners in an effort to maximize portfolio efficiency. The portfolio totals approximately 22.7 million sf in four states and Canada.
Primary departmental activities include transaction management, project development, strategic planning, financial analysis, due diligence, and philanthropic projects. Luckily, I’m supported by three staff members and three outsourced alliance partners.
Dennis Linville, CCIM: I find new Lowe’s store locations and manage the development process through entitlements until construction begins. My territory includes Colorado, northern California, and a portion of the southern California market.
CIRE:Based on your experience, what challenges are corporations facing in the current real estate market?
Lorey: Capital constraints are becoming a major factor for corporate users, landlords, and owners. Many deals are being negatively impacted by the lack of capital for developers to fund tenant improvements, which might entice tenants into their buildings. Lenders are unable or unwilling to fund tenant improvements except for the most secure transactions.
Many owner-developers are facing slow lease-up rates that are well below pro forma, and equity partners are now unwilling to fund further capital needs to facilitate deals. Coupled with many deals facing the refinancing of bullet loans and mini perms in a time when the capital markets are still frozen, this is very troubling.
I’m faced with the ever-present need to assess and improve portfolio performance, reduce occupancy costs, and reduce portfolio size.
Wheeler: The issues affecting some of our clients’ growth revolve around banking — or the lack thereof. And when we say banking, we’re not just talking about lending. We’ve seen banks lower property values based on the national economy and then try to renegotiate loan terms. We’ve been able to provide expert local opinions backed up by hard data to dispute this practice.
And while our market continues to be strong, our industrial sector has been under a much tighter market for several reasons. Two major hurricanes — Rita and Ike — hit our area and destroyed a lot of older inventory. The industrial service businesses quickly sucked up most of the remaining inventory, and now it’s much tougher to find buildings for sale or lease in the area — particularly in the Port Arthur, [Texas], and mid-county areas of Jefferson County, [Texas]. Some spec buildings are under construction, but the municipalities are under tremendous strain from area growth and can’t provide building permits in a timely manner. While this has slowed development, it hasn’t stopped it.
Wilkens: Due to the stalled development market, my client has decided to warehouse all excess undeveloped cemetery land. Since most cemeteries are exempt from ad valorem taxes, the carry costs are miniscule and are mostly used to blanket liability insurance costs. Accordingly, my client’s primary focus is the disposition of improved properties like closed or soon-to-be-closed funeral homes.
Volas: With more than 40,000 employees, Cleveland Clinic is the second-largest employer in Ohio. Additionally, Cleveland Clinic Health System received some of the highest credit ratings by the primary ratings agencies in a recent bond issue. So, financially, we are very sound.
In 2008 Cleveland Clinic completed over $1 billion in construction projects on its main campus, family health centers, and regional hospitals. A major hospital expansion and two new medical campus projects are now underway.
Linville: The biggest challenge is the substantial difference in value expectations of buyers and sellers. However, I see many opportunities in this market. Lowe’s is still in expansion mode, announcing plans to add 75 to 85 new stores in 2009. In fact, I see more opportunities than I have need for. I attribute this to weakening retail demand, the contraction of the lending market for development, and less competition from non-retail developers for land. I also continue to see more price and term flexibility from sellers.
Plus, most cities are becoming more business-friendly by streamlining processes, reducing fees, and even offering incentives. These cities are re-evaluating their stance on large-format retail development and recognizing that, if done right, it can be very beneficial to the community.
CIRE:What strategies are you using to facilitate transactions?
Lorey: At XO Communications we are scrubbing our portfolio for lease renegotiation opportunities. In a recent deal that reflects the economic climate, I just renewed a lease on a foreclosed building in a major market. The new owner reduced the rent on the leased square footage and reduced the fee structure on the telecommunications space out of the need and desire to retain the tenants — especially credit tenants — and the cash flow from the building. We were able to obtain a five-year renewal at reduced rates and a five-year renewal option. This is starting to become a trend as I work through renewals for 2009 and 2010.
We’re always looking for consolidation opportunities, which we use to backfill quality properties when other companies contract and need to sublease and exit. We also watch and track interesting markets, so we’re ready to pounce on a landlord who has significant out migration or company failures that create vacancies.
Wheeler: Fidelis Commercial Real Estate Services is in the process of convincing our national clients that our market is strong and that now is the time to expand locally. Property tax consultation has become a very lucrative strategy for some of these clients. We were able to lower one client’s property tax values from $4.5 million to $2.5 million on two sites by doing an extensive broker’s opinion of value. They sent this BOV data to the county appraiser, who could not dispute the facts.
We have been successful because we’re always there for our clients. We have employees who will drop everything to assist a client. And that’s our goal: to be a single point of contact for all things — not just real estate.
Wilkens: Service Corp. International uses a specialized process to determine the true value of acreage being purchased for development. First, we inquire about the retail price of the proposed housing. Next, we factor in the infrastructure costs, housing density, and developer profit. Finally, we back into the value of the raw land to achieve the target sale or listing price.
This approach usually does not endear us to the development community, which normally relies on past sales data, but it does maximize the benefit to our client. In most cases, this practice results in sales prices that are 50 percent to 100 percent higher than historical appraised values.
Volas: At Cleveland Clinic, we leverage our credit rating to renegotiate everything. Most landlords like us as tenants, so we’re typically able to create win-win situations for new and existing leases. We may ask landlords to fund higher than normal tenant improvement allowances or secure flexible lease terms to align our business with the real estate occupancy. We also are looking at lease audits and real estate tax valuations to minimize our occupancy costs.
Our 2009 real estate initiatives focus on expense reductions, which translate into space consolidation, renegotiating existing leases, and disposition of non-strategic assets among other things. If the economic downturn is long and deep, other strategic projects will be considered.
Linville: Lowe’s self-finances, so we are still in growth mode. This philosophy, which the company adheres to for new store development, has become increasingly important in the current economic climate and requires a rigorous store development financial model.
And while self-financing gives us a distinct advantage as a buyer, it also allows deals to move forward. In fact, it may be the only way for an end user to close a deal right now.
CIRE:What does the future hold for your slice of the corporate real estate market?
Lorey: I currently have two office consolidation projects, each consisting of more than 50,000 sf. To proceed, I need good market intelligence on the ground. Whether the market is rising or declining, it’s critical to know about those movements in real time. During the next few years, understanding a landlord’s or developer’s underlying financial position will be vital — even when considering a property that has an owner on the brink of serious financial trouble.
When we begin the process of obtaining proposals from qualifying properties, one of the best tools is a well-grounded present value analysis. The critical component is a thorough understanding of every assumption set in each transaction and the setup of the program assumptions.
Wheeler: Our area’s petrochemical industry is in expansion mode, causing ancillary businesses to grow as well. While some of the expansion has slowed because of the national economy, I think this will draw out the plans over time, which could be more beneficial than the shorter delivery times that had been expected.
As we capitalize on this expansion, we’ll continue to rely on Business Network International. BNI was 40 percent of our business in 2008, and we are expecting it to be 50 to 60 percent of our business this year.
Wilkens: I’ve often been asked if there is a stigma attached to cemetery land. I asked the same question when I joined SCI but soon found out that not only is there no stigma, but in some cases it’s actually preferred. Why? Well, the new owners will never have to worry about what might be developed adjacent to their property — at least during their lifetime. I’ve even heard people cite the ‘peaceful, quiet neighbors’ as an amenity for their target market.
Volas: Cleveland Clinic’s total capital expenditures may reach $2.3 billion through 2013. Despite the current recession, the U.S. healthcare industry will continue to grow during this period. The primary drivers for this growth are an aging baby boomer population and continued medical innovations. And thanks to Cleveland Clinic and two other large area healthcare systems, northeast Ohio is where much of this growth is concentrated. If you have medical needs, Cleveland is a great place to receive care.
Linville: The rapid change in cities’ approaches to retail development has been remarkable to me, and the valuation in the commercial property markets has been stronger than I expected. However, no one truly knows the state of the market since there are very few (or no) comparable sales.