Editor's Note: The Rock & Roll Hall of Fame is just the latest and highest-profile file project in Cleveland, but it speaks volumes about the can-do attitude of this city's real estate executives. Recently, we gathered some of Cleveland's top players for breakfast at the Ritz-Carlton Hotel to talk about the state of the city's markets.
Q: What is the overall state of the Cleveland office market?
Ken Greene: The office market is one of the last of our markets to recover, but Cleveland has been in the recovery cycle for a number of years for all of the specialties. And frankly our markets overall are doing pretty good. Downtown office when we did have our big construction boom in the late-'80s we built it all at once. So we really did have a large glut of downtown office space. The vacancy rate was in the mid- to high-20% area. It's taken a long time for that to drain down. We're in a situation in 1996 where, speaking of downtown, most of the new Class-A buildings have now been absorbed. But downtown has been the last of the markets to see that absorption. Class-B and Class-C has still got substantial vacancy.
The suburban markets are considerably better. We really only have three major office markets, dowtown, an area south of downtown we refer to as the Rockside area, and one area on the east side of town down around the Union Boulevard area.
Probably the healthiest market in terms of vacancy, though it depends on which segment you're talking about and whether or not the space is in chopped up pieces or large contiguous spaces. If there is in fact an area of our market where new construction would probably be applicable it's Rockside. I suspect you'll see new construction coming out of the ground later this year.
The east side market is generally healthy. Supply and demand is in relative balance. It might be a little early for new construction, but on the other hand we don't have massive vacancies there either.
Most people would agree that downtown is definitely on the mend. Most of the big Class-A buildings are filled up.
David Browning: the excitement about downtown is that this past year we had 575,000 sq. ft. of absorption which was close to some of the record years that we had in 1988 and in 1992. Our firm had predicted that in 1996 absorption would be down a little bit and we'd just take a littel bit off the vacancy. But with the recent announcement of the KeyCorp transaction and expansion in this market, that will be pure net absorption of probably 275,000 sq. ft. in the market, to the point that I hink we will probably be right there in terms of another record year of absorption and really that vacancy rate down for both Class-A and Class-B space. So we're really starting to see vacancies come down and rates move up downtown, probably faster than many of us would have thought.
Q: In the Rockside area, is the new activity likely to be build-to-suits or any spec office?
Greene: Considering where we are right now, and considering the experience of the last few years, I don't think you're going to see any pure spec buildings, pure spec being defined as if you build it they will come. If a guy's going to build a 100,000 sq. ft. building and he doesn't have a 30,000 sq. ft. to 40,000 sq. ft. tenant or group of tenants in his pocket, I think the lenders are still going to be a little bit concerned. A couple of years ago if you had a 95,000 sq. ft. tenant for a 100,000 sq. ft. building it was not going to get built, but today it's not a problem. So it's not a pure build-to-suit per se, it doesn't have to be the XYZ Corp. Building, but there needs to be some leasing before it can be financed.
William West: There is an XYZ that did sign up for a transaction yesterday and there will be a new 100,000 sq. ft. building being announced in the next couple of months. The other significant change actually in that area (Rockside) is Duke Realty has just come in and bought a local developer and he is out buying land at this point and they will be building another building probably in the next six to nine months.
Sam Miller: Getting back to downtown for a moment, we just escrowed awith the federal government. They're putting up a million feet right around the corner from here. That building probably will be up and operating in the next 36 months. We are not the contractors nor are we the builders for it, however they've already let the architecturals and the mechanicals. That in effect will deplete some of the present leased buildings in the immediate area of downtown. They're enlarging the court system, they're emptying out the federal court building here now on Superior and they will empty out a few ancilliary buildings that they've been using, so we've got to put that in mind as far as any type of a building boom or anything like that in this area.
I would venture to say between that and the few buildings we have downtowm, in fact we were among the last to put up some of these downtown office buildings and we suffered plenty, because at this time we're down to anywhere from 8% to 10% vacancy. What you have to keep in mind is your biggest competitors today are going to be the downsizing of the various corporate entities throughout the country. Every time somebody lays off one office employee, you kiss goodbye to 250 sq. ft. that are now vacant that are now going to compete with the builder or the developer. When you take a look at IBM knocking off 135,000 people, or AT&T 40,000 people, there's tremendous amounts of forthcoming vacancies from major corporate entities who won't care what they have to lease it at. We saw what happened here with British Petroleum. They had their main offices in the United State right here. They emptyed it out and they were the toughest competition that we had in the city. They went down to $12 for what I considered first-class office space and put a hook into everybody else, and we suffered through that and they're not finished yet downsizing. It's not been an easy situation in Cleveland by any means.
West: This is a continually changing market. One of the major changes is the way yields are computed and what people are looking for in office space today. Sam's exactly right, the government and BP and other people who were downsizing created a tremendous problem for us, but we're also seeing the Class-C buildings which are no longer economical and functional are being eliminated from the market, and the people that were in C buildings have to move up to B buildings or move into a building which is a suburban-type of office building and/or an industrial type building that is converted into office space. So there's a tremendous change in the complexion of the marketplace, how the deals are put together, the kinds of deals that are out there, with TI (tenant improvements), without TI, and so. It's a significantly different market than it was in 1989 and 1990.
Q: Is Cleveland indicative of other major markets where there is an urban flight to the suburbs?
Jim Kroeger: I would say it's the opposite of that. There is a resurection of the downtown area. There has been a renassaince of downtown. I'm not telling you that people are flocking to downtown Cleveland. That's not the case. But there are a lot of people who are staying in downtown Cleveland for a variety of reasons that never would have stayed here before, that would have moved out for expense reasons and/or convenience or safety or something. Actually downtown Cleveland has the lowest crime rate of the whole community at this point in time. There are a lot of things like the new stadium, and the flats area and the Rock & Roll Hall of Fame and the National Science Center and so forth that are changing the complexion of downtown. People are saying,This is where the action is. This is where we'd like to be.'
So we're seeing some tenants who left downtown in the70s and are coming back downtown. They want to come downtown because their employees are downtown. There's a lot of excitement, a lot of energy, things to do after work. About half of our office market is downtown and about half in the suburbs. We haven't seen the kind of spillout that some other markets have even though we have an outer belt of sorts.
Browning: One of the things we're proud of as a group is this spring, we're bringing the Urban Land Institute meeting to Cleveland, and it's unique for that group to come to a city like this. One of the things they're really focused on is the urban renassaince and what's working here, iln public/private partnerships as well as some of the housing initiatives. So we're excited about that as a community.
BartWolstein: There's only one thing lacking in my estimation downtown and that's a renassiance in hotels. If we could et one or two major hotels down here with significant rooms so we could handle convention business this town would be hot on fire. It's got everything going for it. It's going back to where it was in the30s. The Marriott's nice and the Ritz is nice, it helped a lot, but we need more rooms. Maybe a signature building with 800 rooms, something you can sink your teeth into as being the convention hotel. What Sam has done with this complex (Tower City Center) and what Dick Jacobs has done is as fine a development as any place in the country.
West: Just like Bart said, the only hotel that can take care of the major conventions we have coming to town with breakout rooms and so forth is the old Sheraton across the street.
Kroeger: There are just under 3,000 quality hotel rooms in downtown, and we're used to seeing one hotel with that many rooms in other major markets.
Wolstein: Sam and I are going to meet after this and we're going to build a hotel! (laughter)
Miller: You've got to recognize that you have a mayor here that recognizes that you can't have a vibrant downtown without a vibrant neighborhood. Consequently based on his reelection, which I presume will happen, in the beginning of 1997, there will be more houses built, and already more houses have been built in the city of Cleveland in the last three years than in the last 20 years. In the next four years during his term, we are going to bring in 10,000 new houses into the environs of the city of Cleveland. There's a land bank where you can walk in and buy a lot for a buck.
I'm talking against myself now where we develop in the suburbs, where any kind of lot for openers is $45,000 and up. You will get financing, you will have a tax abatement for 15 years for any piece of property that you either remodel or build in the city Of Cleveland, residential-wise. To me, it will be a double-pronged sword as far as, No. 1, developing the total city, and No. 2, making certain that the downtown area remains vibrant.
We have a retail section in downtown that even now, in spite of the boom and the comeback of Cleveland, you go down Euclid Avenue and it's a desolate mess. We've got empty stores, we've got fly-by-night merchants there who can't come out because the people aren't there. But once the people get here and they're going to stay here, you will have a decent downtown.
Jeff Friedman: Sam's hit on a real important point. For at least 15 years, those of us in the housing business have had a constant push-pull with those responsible for directing the development of the downtown area as to what comes first, the office buildings, the hotels or the housing. From a housing perspective until recently, the thought has been on office space, and the thought was that if we build the office then people will come. As Sam mentioned, giving away the office space that was one of the first really high-profile developments, we don't believe really did anything to create the vibrant kind of neighborhoods and community that is important to continue this growth. These changes on both a single-family basis and also from a rental standpoint will make a difference to the downtown in years to come. We're just seeing the beginning of that.
Harry Henshaw: The other piece of the puzzle that I think the city is working hard on is creating jobs, which you need to create the housing market and create shoppers and so on. One of the strong points we're seeing now is the redevelopment of industrial sites. The city is taking a fairly leadership kind of a role in redeveloping several sites on both the east and the west sides. The Urban Land Institute just had one of their panels here a couple of weeks ago on the redevelopment of a large industrial area on the east side. The state of Ohio also owns a major site there and they're working on the redevelopment of that.
All of which is requiring some changes in how people approach used industrial sites and how you deal with some of the environmental issues. There's really a change taking place in that whole arena which I think is very positive because it will create an opportunity to bring jobs back into the city. This goes back to something jim said. We see in the industrial area in some cases companies that fled or moved to the far suburban areas in the70s and the early-'80s area now expanding and they're looking for sites back in Cuyahoga County and even inside the city because of the infrastructure and the job issues that exist in the more far-flung suburban areas. So that job creation effort is maybe trailing the pack, but it's taking place now and I think that's a very positive thing for the area.
Kroeger: We see good demand from the manufacturing side, we've had good success in bringing companies in from outside the region. We have a really strong cadre of local manufacturers, and most of them are small- and mid-market type firms. Our average size is probably 15 employees, which gives us a lot of stability in the base. These are the companies that are growing. Our difficulties we've outlined are our lack of product in the city. Our objective also is to create more industrial product so that we have a wider range to offer companies that are locating in the city and want to stay in the city. We have an inner-city comany that wants to expand and they're landlocked. Their search criteria is such that they don't want to move any farther into the suburbs than their labor force can move. They have an investment, these people are hard to replace and they want to hang onto them.
West: That's one of the keys. I know Jeff had a piece of property that he developed with another gentleman out southeast of town in the Streetsborough area and had tremendous succes with that property. There has been a flight to those kinds of properties, but I think a lot of individual may come back into downtown Cleveland if there is a labor force, if there was a site that was clean, that was big enough. That's the only reason really they're going to come back. Our problem in trying to get sites in the greater Cleveland area is significant.
Joe Bobeck: The environmental hurdle is significant. The one site Harry referenced that the State of Ohio owns, they've probably invested $30 million in remediating that particular site. Now obviously the market value of that site won't cover that, so it's going to take some type of public sector involvement. There are a number of bills in the legislature now to make it easier for nonprofits as well as for individual companies to get some relief in terms of the investment they make in cleaning up the environmental situation, but it's not enough.
West: The problem up until now has been they've been giving everybody what we call a yo-yo letter, which is you're on your own. Now the state is giving tax incentives. The problem now is the attorneys are saying,This is not going to be valid as far as the federal government is concerned. It's only going to work as regards the state government.' So you still could have a tremendous environmental problem. It's confusing at best. As soon as it starts to get a little cloudy the guy who was going to buy that piece of property says, 'I've got better things to do than fool around with this. I need the plant now, not five years from now.'
Q: How is the local retail market?
Wolstein: The local market is no different than the national market. There is an awful lot of retail that has been built. The survival factor is location. For example, we're doing some of that. We're tearing downexisting properties. We're doing one in Canton, Ohio, where we bought a center and we're just going to level it and rebuild it. In Cleveland we did something like that where we took an old Builders Square and demolished the theater next door and rebuilt it. The site's good, but the use isn't attractive. There's going to be a lot of that - tenants moving out, retenanting, bringing in new boxes and so forth. As far as new development in Cleveland, Sam screwed it up. He's built so many centers around here there's no more room. You will find some major tenants that want to enter the market, like Home Depot which will probably be here and is circling around. They will maybe precipitate some new development or maybe some retenanting of some existing centers, but there is no need to go out and build shopping center in greater Cleveland.
Q: How does the financial health of the tenant base affect the real estate?
Wolstein: It's hard for people to understand it, but this is pretty much a boom time for us. Times are better now than they were because there are a lot of new tenants that are increasing their sizes, the big box tenants, the sporting goods that are going up to 50,000, 60,000, 70,000 sq. ft. You've got the media people going up to 40,000, 50,000 sq. ft. And then you have a lot of these tenants that are dying on the vine. What you have to do in our business today is be very proactive. You start looking at who's not doing well and start figuring out what you can tear down.
In Wilmington, N.C., we built a center which was a big U. We had some people in the back and we just couldn't lease it and before we even finished it, we tore down some stuff that we had built and put in a department store. And then a year later, the center is three years old and we tore down a new Lowes department store and rebuilt them a new big store. So you've got to be very proactive because they'll pull out and go down the street.
What's happened on a national basis is WalMart has developed sort of a crazy state of mind in that as soon as they had a store that did real well they closed it to go build another store. They just throw it into their inventory. I think the investors on Wall Street have figured that out and their stock is way down and going nowhere because they have this huge glut of $15 billion of real estate on their books and they're paying rent. That has caused a lot of anxiety in the marketplace because if you don't have a quality site and you bank your development on Wal-Mart and they picked up and went down the street and your site isn't that good, then you have a serious problem. The old story of location, location, location is really coming into play. If you have a good site, it's ok because you can put somebody in at more money and take the store back.
"It's a very proactive business, and that's why the institutions are all looking to get out of ownership of real estate. We've been contacted by many many pension funds who've said,Look, take our real estate and give us stock. We don't want to own real estate' because they've got to be very proactive. Every day they've got to worry about what's going to happen with this tenant. They want to be more liquid and they don't have the staff. They used to just collect the rent and pay the mortgage, but today you can't do that. Real estate in our field has got to be in sophisticated hands where people are out there every day and have a cadre of tenants and can reach the tenants.
There's a lot of turmoil coming up.
Q: Several shopping centers, such as Southpark Center, which is the first new enclosed mall in 20 years in greater Cleveland, are under way. Is the demand sufficient enough to support these new developments?
Arnold Eisenberg: At Southpark, the demand is there. That center was planned 20 years ago. They've got the anchor tenants and they're leasing up the stores inside the mall. That center will do very well. That whole area is booming right now.
Q: In this current shakeout in retail, who are going to be the winners and the losers?
Eisenberg: Who knows the answer to that?
Eisenberg: Who ever thought that Kmart would be having the problems. You read in the paper that Wal-Mart had their first loss in 99 quarters.What Bart was saying, if you've got a good location some of these vacancies are going to be a bonanza for developers and brokers.
Meller: Shopping centers and so forth, like politics, is local and also national as Bart has explained. I for one think the country is totally overstored today, but in the wrong locations. I really feet that the shopping center business, the malls in particular, are due for a severe shakeup. Now when I say malls, I'm talking the intermediate, not the Beechwood, or the Palmertown or the one Dick Jacobs is doing (super-regional malls). I'm talking the in-between are the ones that are going to get killed. You can't pick up The Wall Street Journal any day and not see another major retail chain in trouble. Just think about it, Sears was on the edge. Kmart I pray to God will come through. All the big guys from all the years ago, guys that you would bet your last dollar on are all gone. So consequently I think that the large specialty shopping center, for example with a 40,000 sq. ft. sports store next to a 60,000 sq. ft., store is going to do well. If you take a look at Florida, they have to control the crowds going into Sawgrass Mills. Then look within three miles of there and you've got guys in dire trouble.
By the way, Wal-Mart didn't lose money, they only made less. I wish that kind of misfortune on all of us.
West: Our mortgage people just came back from the Mortgage Bankers Association convention in San Diego, and what used to be the top investment property, retail, is now at the bottom, and what was the bottom, office, is now at the top as far as property types to be financed. Bart, wouldn't you say that Wal-Mart is looking at this as a business? \Wen they go down the street from your past location, they're moving because the business is better down the street and they have the horsepower to do that. Their real estate is a throwaway item. It's almost like manufacturers who look at industrial buildings. They don't care what that building is worth anymore. They're worried about what can they produce out of that building, what kind of income can they get out of that building.
Wolstein: No that's not it at all. If they have a store taht approaches $40 million, $50 million. That's phenomenal sales. So they go ahead and build a superstore which is now not 100,000 sq. ft. but 160,000 sq. ft. And now what they have to do is all of the sales to attribute to the value of the market cost today of 160,000 sq. ft. And now they have this store, where not only do they have to pay the rent, which is higher per square foot, but they also have to eat this. And now they have to do all of this more business to make that store more profitable. I think they're reevaluating that program. They may have gone a little too fast. There's a point in time when so big is big enough.
Miller: That brings up the other point as far as office buildings are concerned. That overlays with the corporate entities that are losing employees. They are competitors of developers. The same way as an empty Wal-Mart store is. If a corporation wants to get something off their hands, they're not interested in the bottom line. They're interested in the price, and that immediately creates a competitive factor for anybody here at the table who's thinking of doing something else. That's your competition that nobody even knows about, but it's there all the time.
Greene: You've got a lot of companies coming to Cleveland now that historically have not been here. We're doing churning, but we're also doing these new deals.
Q: Is there enough room for all of the new big box players?
Greene: All of them? The answer is no. There's going to be fallout.
Browning: It's a series of issues that make the retail market here tricky.
Q: The talk earlier was about a convention hotel.What are your thoughts on that?
Mark Bishop: I'm going to take somewhat of a contrarian position to what was said earlier. The renaissance of Cleveland has been going on for 15 years, and where we are today was a cumulative effect from steps along the way. We have momentum going, but much like with the retail discussion, I'm curious why everyone wants to come to Cleveland in terms of the retailers, because I'm not aware of any expansion of the population base here.
Cleveland as a hotel market is strong in 1996. Three years ago and the previous 15 years, people were crying in their soup about it. You don't build a church for Easter Sunday, and if you were to interview the owners of the hotels in town and the person who's going to build an 800-room convention center hotel, six months out of the year I think they'd be very happy with the cashflow. I question seriously whether or not this town can support on an annualized basis an 800-room hotel. What will happen in the November through April timeframe when Cleveland is going to have a hard time being a convention city. You've got three top-tier convention cities in the north - Chicago, Boston and New York. Is the AMA going to come to Cleveland in February or are they going to go to Scottsdale?
I think we're going to have to continue to build a bed base here incrimentally in 200, 300 and 400 rooms. But it's also a component of the net absorption of office space. In Chicago, Boston and New York, the office market there is 10, 12, 20 times as large or more. So when the conventions aren't in town the hotels do business. We're getting the tourism base here which is phenomenal conpared to where it was 10 years ago. But you can't be profitable filling your rooms four nights a week. You've got to run 70% occupancy year in and year out.
Kroeger: Competitively we're going to have to upgrade. Our downtown convention center is obsolete. You've got pillars all over the place. It definitely needs to be enlarged and made more functional.
Wolstein: Back before the war, there were 5,000 hotel rooms in town. Cleveland. This was a convention city. McCormick Place and Las Vegas weren't there and air travel wasn't so easy. We had huge conventions here. Now we're a town with 3,000 hotel rooms.
Q: Four new hotels are likely to start construction in Cleveland this year, and two new ones opened in the last 16 months. What's driving that development?
Bishop: There's pentup demand. Those are pretty well, conceived properties. Availability of capital is driving it. Developers develop. From 1991 to 1993 there was probably a 95% decrease in the construction of hotels nationwide. The Wyndham Hotel in downtown was the only full-service hotel done in 1993 in this country in terms of a financing, other than a Las Vegas, New York or Orlando. There was no capital. Now there's capital.
Bobeck: What you're really seeing, you're seeing capital enthusiasm for ClevelandFive years ago, there were some people around this room like Jeff Friedman, Bart Wolstein and Sam Miller who were really putting some significant dollars back into real estate deals because the capital markets weren't putting dollars into this marketplace. Now they're flooding this marketplace.
Wolstein: Wall Street has gotten fascinated with REITs in the hotel business. It's very easy to raise capital if you're in the hotel business because it's the darling of Wall Street, but we don't know how long that will last.
Q: Does the easy money scare anybody here?
Bobeck: The thing about Cleveland is, if you look around this room, the developers are local. We don't have national developers. Associated Estates in the late-'80s did a deal in the University Circle area where it was a 50% first mortgage to total cost. It was a local developer that did that deal. That was kind of the springboard to what you're now starting to see in the warehouse district of downtown Cleveland. You're seeing FHA, Fannie Mae, Aegon Insurance and Freddic Mac finally coming into this marketplace to do 70% or 75% financing deals for, again, local developers.
Miller: Cleveland has never been a boom town nor has it ever been a bust town. It's been a very conservative city. It's never as good as they say it's going to be, but it's never as bad as they say it's going to be. We run almost contrary to the national picture. Don't look at national figures, they don't mean anything.
Browning: We are seeing a who's who of pension fund advisers and insurance companies that are looking to come into this market and are paying very good prices for particularly suburban office product. We see that continuing and spreading to other sectors.
Bishop: The money is on its way back in a big way.
Q: How is the multifamily market holding upunder all of these dynamics;
Friedman: From an apartment standpoint, the business that we're in, 70+ of our 80 properties have no mortgages. We have 35% debt to market capitalization. The benefit we have is not being over leveraged. The only thing that can affect a great location is overleveraging a property. Those of us who have made it successfully over the years have learned the right way to leverage those properties so that in the tough times they're still able to pay whatever debt service or whatever dividends we have to pay.
When we talk about Cleveland from a residential standpoint, we're talking about more than just the city of Cleveland. For example, with Akron and Canton, there are over 5 million people within in a 45-mile radius of Akron. Cleveland is home to the fourth-largest number of Fortune 500 companies in the United States. Our properties in what we call the Cleveland market are in over 30 governmental jurisdictions, and each of those governmental jurisdiction has separate school systems and police departments and their own reputation within the greater Cleveland market.
We also have a very affordable community. Our rents which average in the greater Cleveland market at about $580 a month are still significantly below what the principal and interest payments would be for a first-time homebuyer, where the average price is $108,000. I've been trying to figure out where I t the lineW never had a bust because we've never had a boom,' but it's really true. Even in the most difficult times in this market, in the mid-'70s, we were still over 93% occupied on an economic basis.
Another important point is that 70% of our residents come from within the market. They do not come from the creation of jobs or by population inflow. The facts are, people who live in apartments are moving from one bedrooms to two bedrooms, from two bedrooms to rooms, from $600 a month to $800 a month and out of someone's home into an apartment. That's the bulk of the renter community.
Q: Which property types are generating the most interest with investors?
Bobeck: Clearly apartments and industrial. In 1995, retail was part of that mix, but now it's fallen a little bit out of favor.
West: We're down to 3%, 4%, 5%, depending on what market you're in, for industrial. There's virtually no space. We need additional product.
Friedman: We still believe, those of us who have a significant amount of our net worths tied up in the real estate market, that we're only as good as our last deal. That's a very important perspective, whether the source of borrowing is from an insurance company or a pension fund on a specific property or from the equity market in the form of stock. Those of us who have lived and grown up and worked in these communities have taken that pride of ownership. 4*>