Downsizing slows, space efficiency remains a virtue Growth returns to corporate leasing, but most property management executives are mulling the impact of consolidation, technology and the future role of REITs

Downsizing has been regarded as the savior of Corporate America from the woes of the recession of the early 1990s but, as the new millennium speeds toward us, leaving the recession in its dust, parts of this streamlining philosophy may have outlived their usefulness.

Corporations continue to seek the benefits of more efficient operations with regard to real estate, but the improving markets are requiring them to increase in size to remain competitive.

"We are actually seeing a great expansion in space demand, although the square footage per employee is decreasing," says Bruce Ficke, president of Atlanta-based Compass Management & Leasing.

In other words, companies are reconfiguring their existing space to accommodate their new growth. "So corporations are not necessarily taking less space, but rather are redesigning what they have to better meet their needs," says Thomas Shuler, chief operating officer with Greenville, S.C.-based Insignia Residential Group.

"The space will be more densely populated so the companies are after more open, modular designs in the space," adds Ann Sperling, principal in the Denver office of Dallas-based Trammell Crow Co.

Property management executives expect corporations to retain their emphasis on the efficient use of their space and, again, overall economic growth and prosperity are encouraging them to take more space than in recent years. "I think the trend of downsizing is pretty much over," concludes Richard Muhlebach, president of the Institute of Real Estate Management in Chicago and the president of TRF Management Corp., Bellevue, Wash.

Others are less definitive. "There has been a bit of leveling off in the downsizing trend," says Leonard F. Helbig III, vice president/asset management with New York-based Cushman & Wakefield. "Overall economic growth, favorable interest rates, low unemployment, high consumer confidence, all of these things have corporations feeling pretty good about themselves today."

Indeed the numbers bear this out. For example, the average size of the corporate office leasing transactions at Chicago-based Heitman Properties has increased substantially over the last three years. They have risen from 5,100 sq. ft. in 1995 to 6,800 sq. ft. in 1996 and most recently to 7,400 sq. ft. last year. That is from a total of 10.5 million sq. ft. the firm leased in 1997.

"I believe that average will continue to move up," says David Latvaaho, president and national director of leasing with Heitman Properties.

So while downsizing may have run its course, it does still occur, though "not as frequently as in the past," adds Shuler.

But others feel that downsizing or the move away from it has simply become more industry specific. "In the early to mid-1990s it was a clear trend, but today it is hard to peg," says J.C. Pelusi, senior vice president of corporate leasing services with Compass Management & Leasing. "Some industries are on a trend for growth and others are not."

Bob Flannery, vice president of property management with Chicago-based CMD Realty Investors Inc., points out that many high-tech firms were growing, while downsizing was still the norm in most industries. As a result, "when the high-tech firms took their initial space, they were already being efficient, so they didn't have excess space to begin with," he says. "Now as they continue to grow, they need new space."

While it appears the trend toward downsizing may be on the wane, another trend in the property management industry is alive and well - consolidation.

And then there were ... The number of major national property management firms has declined significantly in recent years due to large mergers and acquisitions. CB Commercial's acquisition of Koll, then the fifth-largest property management firm in the country, had a big impact in 1997, and about two dozen firms were absorbed by others in 1996.

Most industry executives feel that more of these transactions are on the way. "I don't see any cessation of that trend," says Sperling.

In fact, some foresee a tremendous turnover in the industry through the 1990s and into the next decade.

Ficke says he has seen estimates that 75% of property management firms that were operating in 1990 will be out of the business by 2007, due, for the most part, to consolidation.

There are several reasons for this cannibalism among firms. Mary Marx, senior vice president with The Voit Cos., Woodland Hills, Calif., cites several reasons for consolidation: a reduction by clients in the number of management firms they work with, a need for increased technology is too costly for smaller firms, and the intense competition is leading to fallout of some firms.

Some of the acquisitions may come from unexpected quarters. "I think some companies not traditionally associated with property management such as accounting firms may take the opportunity to enter the industry," says Jana Turner, executive vice president of the Western Division with CB Commercial/Koll Management Services, Los Angeles. "But I definitely foresee more mergers and acquisitions."

But the primary factor may be the realization that "bigger is better."

"Real estate as a whole is still experiencing the benefits of the economies of scale that accrue to companies with large portfolios," says Shuler.

"Bulk buying and reducing redundancy all lends itself to growth," adds Latvaaho.

These benefits are derived in numerous areas from insurance costs, product purchasing and even greater efficiency in the volume of work done by the management team.

Helbig points out that Cushman & Wakefield has more than doubled its property management portfolio during the past two years from 90 million sq. ft. to approximately 200 million sq. ft. today. "But we have the same size management team," he explains. "And when you grow the portfolio without adding to the management overhead, the financial growth is obvious."

Consolidation is also a means to increase each management company's market reach and client base. These factors are becoming increasingly important as property management clients continue to reduce the number of service providers they employ.

Shuler says some of Insignia's clients have cut the number of property management firms they work with to as few as four. In the past, firms used anywhere from 20 to 30 firms.

"The fewer service providers the big institutional owners have to deal with the more efficient they are," explains Sperling.

"If the institutions could find one firm to do it all, it would make their lives easier," adds Charles Esler, president and CEO of Chicago-based LaSalle Partners Management Services.

Something that is lost in the square footage numbers and increasing income totals of many acquisitions is the personnel involved. But often the talent gained in a merger is just as important as the properties, if not more important.

"In our acquisition strategy the people we bring in are our No. 1 consideration followed by the quality of our portfolio," says Helbig.

He stresses that Cushman & Wakefield's 1997 acquisition of Houston-based Premisys Real Estate Services, "gave us talent in the Texas market, where we admittedly were lacking, as well as a good portfolio."

So management firms often want the entire company and not just the portfolio. "We want to eat the whole apple," says Ficke. "People are a primary motivation for us in an acquisition. The firm's corporate culture and the dynamics of the key leaders are very important in our acquisition decisions."

At any rate, to compete in today's competitive property management market, firms must continue to grow. "The way we see it," says Helbig, "for us or any other firm to continue to invest in the people and technology required to compete effectively, the portfolio has to be bigger."

More demanding clients Increased investment in personnel and technology by management firms has become a must to keep up with the increasing service demands made on them by property owners.

"The principal thing clients want today is a property manager that thinks more like an owner," says Esler.

Indeed they want property managers to take on responsibilities that in the past were more asset management functions. And in fact, many of the functions are being outsourced by overworked asset managers.

"The asset managers that work for real estate owners are finding they have less and less time to do some of the functions they have handled in the past and are pushing some of that work down to the property management level," says Sperling. "Corporate America is looking for ways to drive shareholder value. So they turn to property management firms to help them realize their business goals."

These functions include methods of increasing NOI (net operating income) by reducing expenses, tenant issues and more financial analysis, among other services. Also included are ways to create added value such as upgrading a property's telecommunications system with rooftop satellites or adding amenities such as first-floor retail to an office building to help with tenant retention.

"They are looking for property managers to be more sophisticated in all of these areas and in all of their property types," Sperling says.

"We are making more capital decisions, particularly for pension funds and other institutional owners," adds Helbig. "So we have had to increase our menu of services. Now we are very much involved in the economic side of the business."

Today's property management firm needs to offer a full scope of real estate services: the ability to handle marketing capabilities, construction services, environmental issues, utility deregulation, recycling, indoor air quality and parking ratios, among others.

"Again it is the ability to focus on the properties from an ownership perspective," adds Shuler. This closer relationship requires more knowledge of the client's business strategy and needs.

To gain this degree of knowledge, most property managers put together management teams for each individual client.

"We have a client relationship manager who heads up a team for each client," says Bill Norwell, senior vice president of institutional and property management services at Chicago-based Draper & Kramer. "These team members are dedicated to understanding and servicing the needs of these large institutional clients. The client knows that our people are taking the time to learn the idiosyncrasies of their business and are totally dedicated to how we can best serve them."

In addition to providing high quality services, management firms must offer a consistent quality of service throughout the firm's offices. Large owners usually will be working with a number of the management firms' offices around the country, and they want the same procedures and quality standards to be met at each location.

"The owners demand a consistent level of service, regardless of what region of the country or the world their properties are located," says COMPASS' Ficke.

Indeed property management is growing into a worldwide market. Many firms have already opened offices or started joint venture relationships with local firms in South America, Europe and Asia.

Muhlebach says firms are choosing between locating in developed countries where competition already exists or in underdeveloped nations which often have more opportunities. "The markets in the developed nations are more stable, but the underdeveloped nations hold more potential if firms are ready to meet the challenges, which can include currency devaluation and corrupt local business practices," he says.

But whether national or international, the hope in the property management industry is that the increase in their responsibilities will also translate into higher fees. The keen competition in the industry has resulted in downward pressure on fees in recent years.

Some in the industry think that as clients grow more dependent on their property managers, the quality of the work will become more important than the cost, resulting in better quality work being able to command higher fees.

"Our clients see the value of our services," says Latvaaho. "We don't want to be the cheapest; we want to be the best at the services we provide."

Sperling agrees that quality should reduce the emphasis on price. "Downward pressure on fees may be abating as the need for quality goes up," she says.

Others feel that after the industry consolidation is complete, the smaller number of players will lead to higher fees. However, Esler is not among them. "I think they are dreaming," he says. "Fees are a one-way street."

Technology keys service Regardless of its impact on fees, the property management firm's increased role in the development of the client's business strategy has placed added emphasis on their reporting methods.

In order to use the data in a timely manner, clients want the information in the most convenient form as quickly as possible. This means reporting in the client's own software.

"Clients need the reports in their own software packages, so they can be easily consolidated into their computer systems," says Norwell.

This is not necessarily an easy task considering the wide variety of software packages available.

Large national property management firms with a lengthy and diverse client list soon discovered the problems in keeping up with their clients' software choices.

For instance, LaSalle Partners operates 10 software systems, while Trammell Crow operates eight separate systems in its Denver office alone.

"Also, clients may have different versions of each software, which only increases the complexity of the situation," adds Esler. "We are making a substantial investment in this technology."

But the challenge is not just the cost of the software system, but also the cost to upgrade the systems and to train employees.

"Training has become more and more important," says Norwell. "What is state-of-the-art today, may not be next week."

"The cost of training and upgrades is huge," says Sperling, adding that Trammell Crow has a full-time management information systems administrator in each of its offices.

Ficke points out that Compass' training regimen includes 40 hours annually for its employees, and the firm even went so far as to found its own independent software training company, National Real Estate Standards Corp.

While the investment in this technology and training is substantial, it is deemed a necessity to compete in the property management industry.

"The cost of technology and training is almost a barrier to entry for the industry," says Sperling. "You have to be willing to be on any software. Clients are going to require it."

But as the software types begin to differentiate themselves in quality, the market may pare down the number of quality software systems to a more manageable number. "The best will become the software of choice and make things a little easier," says Sperling.

Cheaper by the dozen With the industry's fee base declining in recent years and the substantial costs involved in implementing technology, companies have begun to place more emphasis on developing economies of scale by adding clients with large national portfolios.

"We prefer to deal with an owner with multiple properties in multiple markets," says Latvaaho. If these properties fit in geographically with others in the firm's portfolio, then the overall cost to manage them is less.

Most property management firms say they still go after individual properties as well as the large portfolios. "We do both," says Shuler, but he admits that proximity to their other properties is still an important criteria.

"I don't want to compete for one property with 15 other companies, some of which are local and can manage it for less due to their other properties in the area," says Latvaaho, adding that profit is the best motivation.

"No one works for nothing, and if it is not a profitable assignment, then the manager will not serve the property properly," he points out.

Facilities management on the rise One sector which seems to provide a number of large portfolios to be exploited by management firms is corporate campuses. This management of space occupied by the owner or a single lessor is called facilities management and is a rapidly growing segment of property management.

"It is such a financial coup for corporations," stresses Turner. "It allows them to outsource a truly noncore competency of their business. It is a win-win scenario for everyone involved."

"It is a significant growth area," adds Ficke.

Helbig reports that Cushman & Wakefield has more than doubled its corporate business in the last 12 months to about 60 million sq. ft.

Facilities management involves more specialized and intensive services than traditional property management. "Service levels in investment properties are determined by the market," says Ficke. "However, we provide a corporate client in a campus setting with any number of services which we feel can make them more efficient."

In addition to maintaining the building, the roof and the parking lot, facility managers also assist the tenant with space planning and other occupancy issues as well as operating other service outlets on the property such as the cafeteria, reception area, mailroom, delivery and daycare center. "Clients want seamless service in all of these areas today," says Helbig.

"For a while we were skeptical of how facilities management would catch on, but outsourcing is not just a trend," says Esler.

A major reason management executives expect continued growth in facilities management is because of a series of practically untapped opportunities such as hospitals, universities, colleges, and even government buildings and military bases.

"All of these institutions are focused on their specific area of expertise and need someone that understands real estate and real estate operations," says Esler.

Impact of REITs One reason that management firms are expanding their menu of service and looking for new areas of market growth is that their traditional inventory of management properties has been on the decline.

Real estate investment trusts have become the dominant buyers of real estate in today's market, and REITs usually self-manage their properties. "So as REITs grow, our market share is shrinking and third-party managers are competing for less opportunities," says Marx.

But many third-party managers believe that REIT management will eventually see advantages to becoming a client rather than a competitor of third-party managers.

"We have lost some business to REITs, but we might see some of that come back in the future," says Helbig. And the reasons will be purely financial.

"At some point when REITs look to operations for returns, I feel they will find they can do better outsourcing," says Marx, who adds that the Voit Cos. is already managing for a number of REITs.

"I think you will see more outsourcing by REITs sooner than many think," adds Latvaaho. "Buying and selling properties is what the REITs do best, and that is what they should concentrate on, not management."

"REITs are operating companies, not managers," agrees Turner. "In my opinion, it makes more sense for them to concentrate on trading properties than managing them."

"The only part of management that ought to stay within the REIT is strategic, not the hands-on operations," says Esler.

This realization by REIT management may be on the horizon.

"Five years from now, all of the headlines will be asking if the REITs are cost-effectively managing their properties," says Muhlebach, adding that the more forward-thinking REITs will already be looking for more efficient methods of management.

Some say the current roadblock to more REIT outsourcing of property management is the perception of the move on Wall Street.

"In general, REIT managers know that third-party management could help them increase their FFO (funds from operations)," says Esler. "But they have a problem with financial analysts."

Muhlebach says that analysts feel that REITs have to manage everything in-house or else they have surrendered some degree of control.

"That kind of reaction is rooted in history and reveals a lack of understanding of real estate," says Esler.

Whatever the time frame, most property management executives feel that management business from REITs is heading their way.

The property management industry has undergone a great deal of change in recent years -- its own ongoing consolidation, the global expansion of the areas it serves, the types of ownership involved, and the services companies must provide to remain competitive.

But through it all, the industry has shown a great deal of resiliency, rolling with the punches as they are thrown. This type of survival instinct should serve the industry well into the next century.