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By: John Boyer
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Table of Contents
Over the first decade in the 21st century, there were several key events / factors that
had a major impact on the commercial real estate business. This document examines
the following topics:
Dot-Com Bubble…..4
Technology’s Effect…..9
Industry Happenings
During the early part of the 21st century, mergers and acquisitions
are the key words that come to mind. Several firms either merged
or were acquired by others, causing the commercial real estate
market share to shift dramatically.
Now, lets take a look at the first major event that effected Commercial real estate in the 2000s: the Dot-Com bubble.
3
Effect on NYC
In NYC, 13.4m SF of Class A office property was destroyed and another
14.4m SF damaged. This would negatively affect the national absorption
numbers for the office sector. Lower Manhattan lost approximately 30
percent of its office space. This was more than the total vacant space in an
already tight New York City office market. After 9/11, some tenants spread
to multiple locations, including suburbs, and, in many cases, moved to low-rise buildings. In New York City, about $2.8 billion in
wages were lost in the three months following the 9/11 attacks. The economic effects were mainly focused on the
city's export economy sectors. The city's GDP was estimated to have declined by $27.3 billion for the last three months of 2001 and
all of 2002.7
View the complete World Trade Center study by FEMA. View a Detailed report on Tenants that were effected in NYC
The 9/11 attacks had a profound impact on the attitudes among corporate real estate executives. Most firms were adopting a
number of new security and safety measures, revisiting all communication procedures and engaging in general disaster and business
recovery planning. Some firms moved their business to more suburban areas. Total occupancy costs, as a result of security and
insurance costs, were said to increase by 1% to 3% on average with greater increases on central business district high-rise properties.
At the same time, it appeared that lenders would not finance property if terrorist insurance was not part of the coverage. The cost of
insurance for office space went up from $0.24 to $0.40/SF. Some of these costs were pushed down to the tenants.
Security
In 2001, the cost of security in privately-owned office buildings was approximately $0.50/SF. By 2003, that cost had doubled to more
than $1.00/SF. The increased expenditures covered items such as: identity cards, scanners, security cameras and personnel. In
government-owned buildings, which have installed security codes, concrete barriers, structural reinforcement, wider stairways and
enhanced communication systems, the costs go as high as $2.00/SF. On the other hand, the cost of office security in the suburbs is
considerably less than it is in the cities. Moving just 15 to 20 miles outside of the city can reduce the cost of security by as much as
60 percent. Moreover, studies show workers feel safer when situated just a few miles outside the urban areas, so several firms did
move their shops to suburban areas.
Back-Up Sites
Another result was the potential need for some firms to create back-up sites. Firms were wary of concentrating their data in one
place. The cost, time and manpower to research catastrophe preparedness, and the investment in additional real estate and
equipment to set up dual locations can be considerable.
Millions
where it seemed like everyone was prospering within
commercial real estate. As shown in the graphs to the right $200,000
or in the later part of this document, across all property
types, sales were up, vacancies were down, CAP rates were $150,000 Industrial
at historic lows and rents were rising. Development was Office
fast paced – construction and other bridge financing was $100,000 Retail
readily available and inexpensive – the market was Apartment
enjoying quite a ride. $50,000
$0
Debt capital was abundant. Not only for home purchases,
2004 2005 2006 2007
refinances and other real estate related financial Source: Real Capital Analytics
transactions—but for corporations and private equity. Many
Buyers/Users looked to future projected income (in most
cases excessively optimistic) to justify present values that In 2007 $423B of commercial real estate
were unsound. assets traded hands.
Housing Market
The ―Housing Market Boom,” a period between 2003-2005;
where home prices dramatically increased, bidding wars
were frequent, contracts were above asking prices and
houses remained on the market for short periods of time.
For a while, it seemed you could pay almost anything for a
home, wait a few months and make a profit selling it.
(000s)
4.0 $145
3.5 $125
3.0
During the ―Housing Market Boom,‖ inflated confidence in 2.5 $105
prices led lenders to give mortgages to unqualified buyers, 2.0 $85
1.5 $65
which led to spectacular short-term gains. These "subprime" 1.0
loans were packaged into groups that were traded like 0.5 $45
securities and purchased by some of the largest investment 0.0 $25
20002001 200220032004 20052006 200720082009
houses including Citigroup and Merrill Lynch.
U.S. Homesale Units Median Home Price
Then, in 2007, home prices began a rapid decline. This occurred as mortgage loan terms changed and interest rates rose,
causing homeowners to begin defaulting on the loans that they never should have qualified for in the first place. Many homes
went into foreclosure and the excess supply of homes put downward pressure on prices. The relaxation of real estate valuation
standards and real estate finance underwriting guidelines inflated loan to value ratios beyond levels that can be refinanced. The
banks had to write down the value of their mortgage-backed assets. This created huge losses for banks in 4th quarter of 2007,
and also restricted their ability to borrow and lend capital, which greatly reduced the capacity of banks to loan money, spurring a
“liquidity" crisis. It came to a head when Wall Street hemorrhaged losses. Lehman filed for bankruptcy, Goldman Sachs and
Morgan Stanley became bank holding companies, Wachovia merged with Wells Fargo, and Congress passed the Wall Street
bailout package.
A series of government measures to rescue ailing companies like AlG, Fannie Mae and Freddie Mac followed. The ―big three‖ car
companies (General Motors, Ford, and Chrysler) asked Congress for a bail-out to prevent the auto industry from going bankrupt.
Fearful Americans stopped shopping, and the retail industry hit a 40-year low.
Timeline of the entire Crisis12
Effect on Commercial Real Estate
250,000 In August 2007 on the commercial side of the business – as a
CMBS Issuances result of the subprime mortgage debacle – the securitized debt
200,000 markets became virtually non-existent. See CMBS Issuances Chart
150,000
Credit became unavailable due to the global financial meltdown.
100,000
As such, virtually every aspect of the commercial real estate
50,000 industry was impacted. Establishing current values was near
impossible due to lack of market activity, comparable sales and
0 short sales.
2005 2006 2007 2008 2009
Investors were basing investment decisions on pure cash returns
vs. using leverage to bolster yields. According to Real Capital
Analytics, values declined considerably, by as much as 45% . Many
would-be sellers were holding properties off the market and in
many cases, find themselves today in ―negative equity purgatory‖.
There was a huge gap between buyer and seller expectations.
Many distressed properties started to come to the market (with more slated to hit), and some commercial real estate 8
professionals were taking advantage of this new-found opportunity.
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Technology
Technology
Technology seemed to explode in the 2000s. Devices such as portable MP3 players, Nintendo Wii,
Xbox, Netflix, DVR, Blue-Ray and iTunes all revolutionized consumer behaviors. Let’s examine some of the
major technological advancements and their effect on commercial real estate.
Availability of Information
The Internet explosion took the commercial real estate business by storm. Information become
more readily available. While sites such as CoStar and LoopNet (which went public in 2006,
although both technically launched in the late 1990s) became increasingly popular, and in fact,
became the ―norm.‖ It seemed as if commercial real estate companies needed access to one or
both. Information such as comparables, that were traditionally coveted and indeed, a professional’s
differentiator, were now readily accessible, and leveled the playing field for professionals. In residential
real estate, this has become more prevalent with Listing Hubs, Zillow and Trulia; because now the
information is accessible to the general public instead of agents controlling what their clients see. The
question to ponder is, will commercial real estate follow in residential’s footsteps, as it typically does, in
making information even more readily available and accessible to the public? Read an interesting
LinkedIn conversation about information becoming more accessible.
Internet Shopping
Internet shopping wasn’t developed in the 2000s, but its popularity grew by leaps and bounds over the
last decade. From a commercial real estate perspective, this had a direct effect on the retail sector.
Music downloading sites such as Napster and iTunes severely damaged the CD industry, causing such
stores as Tower Records to close their doors. Netflix has really put a dent in Blockbuster’s market
dominance; and online discount shops have hurt retail sales, causing stores to close. View the list of
companies that have recently closed shops. It isn’t all bad news though. There has been a recent shift in
these shops requiring more warehouse space and shipping needs to house their internet distribution goods.
Smartphones
Without a doubt, the single technological advancement that changed commercial real estate the most in
the 2000s was the advent of the Smartphone. The nature of the business is persistent and consistent
contact with clients. The Smartphone allowed the convenience of being more accessible and ability to
retrieve and send emails while on the go, instead of at your desk. These days, it’s rare to see a commercial
real estate professional without a Smartphone. If you do see one, would you conduct business with him?
Social Media
Social Media exploded in the 2000s, especially the latter part of the decade. I don’t think we’ve
fully experienced the ramifications of Social Media yet for commercial real estate, but it is
coming. Social Media created a shift in the way we traditionally think about marketing. Typically,
you would market your properties to your sphere of clients via email, which was very localized and
had little interaction. Also, Social Media created a shift in the way we think about networking.
Typically, most networking took place at an industry event. You handed out a couple of business cards and
talked shop with a limited number of people. Most of the people were from your market. With Social
Media, these boundaries can be broken. You can network with and market to thousands of people on a
local, regional and national basis; at the click of a button! You can also reach many more people with your
marketing efforts.
Video
With the launch of YouTube in 2005, videos became more accessible to the public. Like Social Media,
Video hasn’t quite translated into the commercial real estate world, but many in the industry believe it will.
As video gets cheaper and easier to produce, you will see more ―virtual tours‖ and less flyers of a building.
What’s Next
There are a couple of new technologies on the horizon that could have a dramatic effect on commercial
real estate such as Augmented Reality and QR Codes to be aware of. You will have the ability to include 9
more information on building signs, business cards or property flyers; that a user can download directly to
their Smartphone. View other sections: www.crereview.com
Office 2001—2009
Trans
01' 02' 03' 04' 05' 06' 07' 08' 09' CAP -100,000,000
Source: Real Capital Analytics Source: CoStar
11
13
1,000 2% 20,000
0 0% 0
Trans 01' 02' 03' 04' 05' 06' 07' 08' 09' CAP 01' 02' 03' 04' 05' 06' 07' 08' 09'
-20,000
Source: Real Capital Analytics Source: Reis
15
Trans 01' 02' 03' 04' 05' 06' 07' 08' 09' CAP -100,000,000
Source: Real Capital Analytics Source: CoStar (Flex & Warehouse combined)
$0 $0 $0.00 0%
Millions 01' 02' 03' 04' 05' 06' 07' 08' 09' P/SF Rental
01' 02' 03' 04' 05' 06' 07' 08' 09' Vacancy
Source: Real Capital Analytics Source: CoStar (Flex & Warehouse combined)
17
More Information—Increased sophistication of marketing tools via the internet along with "user-friendly" software and sites
allowed more users access to materials that were easy to understand, increasing the public's awareness and exposure to
deals that were typically only available to "A" list and institutional clients. We can no longer use our ―possession‖ of the
information to attract clients. Instead, we must focus on how clients use the information - helping them - understand it,
interpret it, analyze it, simplify it and utilize it.
Less Localized—The internet has paved grounds for wider dissemination of marketing material and improved communication.
We are doing more regional and national business than we’ve done in the past. Networking is also much easier. You can
connect with many more professionals and potential clients on the various social media sites in a matter of minutes. This
would have taken years in the past.
Shift in what they need—Clients don’t need someone who is just going to complete the transaction. Sites such as Craigslist
are assisting small property owners to market their property without the help of an agent. Clients now need an advisor. On
the leasing side, they are using space more efficiently and using an open plan "bullpen" set up more and more. They are
getting smarter with the amount of ―actual‖ space they need.
Due Diligence—Since information has become more readily available, clients are spending more time "crunching the
numbers.‖ They are being extremely patient, waiting for the right opportunities. Many clients are only buying when the seller
and buyer can make a deal without the banks participating; or, there is a deal below a reasonable market price. Many are
also purchasing based on cash flow rather than appreciation. Clients are pre-qualifying professionals they hire by visiting
websites which include personal sites, national websites, listing database sites and social media sites. They expect more and
won’t work with you if you are not qualified!
Expect You to be Prepared—As a result of the client's due diligence regarding professionals, clients now expect their
professionals to know something about their property and/or their corporate structure at the initial meeting. Professionals
must be prepared to discuss various strategies with their clients before their first face to face meeting or first conference call.
Feeling the effect of the Credit Crunch—Most transactions only occur when the sellers are willing or able to sell at steep
discounts compared to the asking price of a couple of years ago or are able to provide some form of owner financing or some
combination thereof. As a result, most sellers with better options are sitting on the sidelines while waiting for values to
return. Even when sellers have sufficient motivation to sell and they and ability to lower their price, buyers often times 18
cannot secure sufficient financing to complete a transaction with loan-to-value ratios being as low as 65% or lower. While
owner financing is usually an option, many
View sellers are not inwww.crereview.com
other sections: a position to offer it which results in many deals that fall through.
What the Future Holds
What the Future Holds
Although the last two years of the decade saw historic lows in property
transaction volume due to the Credit Crunch, according to Real Capital
Analytics, 2010 has started off on a positive note.
The first and second quarter results show the progress made in the
investment markets and the overall change in attitude from just a year
ago. Sales volume increased from Q2’09 with every property type
registering higher volume. Core rather than distressed sales were
primarily behind the volume gains despite the huge overhang of
distressed situations. Analysis also reveals that lenders are far more
likely to restructure and extend rather than liquidate troubled assets.
When speaking of the future of commercial real estate, there are several
questions to ponder:
Sources:
1—www.thepeoplehistory.com/pricebasket.html
2—Dot-com bubble
3—www.commercialpropertyinfo.net/images/Office_Market_Report.pdf
4—Vacant Dot-Com Sites in San Francisco Turn Into New Apartments
5—Web 2.0: A new dot-com bubble in the making? Mar 19, 2007
6—Data Center Development Flying High Again In New Era of Cloud Computing. June 9, 2010
7—The Implications of September 11, 2001 New York attacks on U.S. Cities’ Urban Functionality and Corporate Location
8—9/11/2001 impact on trophy and tall office properties
9—The Economic Impact of Heightened Security Measures on the Commercial Real Estate Market, Post 9/11
10—Base Realignment and Closure, 2005
11—Final updated BRAC list
12—Economics of Crisis: Timeline of the entire Crisis
19
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