Boston Financial Managing Director M. Leanne Lachman isn't afraid to buck conventional wisdom. Although many say 1999 is the year of the CBD, Lachman points to long-term trends that indicate otherwise. She also touches on a few issues that building owners and managers have been hesitant to broach.
Lachman's knowledge of the industry spans three decades. She began her real estate career with Chicago-based Real Estate Research Corp., where she capped 26 years by serving as president and CEO of the company for eight years before joining Schroder Real Estate Associates in 1987 as managing director. Last year, Schroder was acquired by Boston-based Boston Financial, which manages nearly $6 billion in multifamily, retail, industrial and office properties. Few are as qualified to look at the present and future of office markets in the United States.
NREI: Give us your take on the office market.
LACHMAN: My overall assessment is that the office market is incredibly healthy across the country. Having said that, I'm not wildly enthusiastic about most central cities. A lot of people are saying that the great opportunities are in central cities because vacancy was a bit higher there, rents have been lower and they've gotten as hot as suburban markets. That's all true. But I think that the trends of people - companies - moving from the central cities to the suburbs is inexorable. Once more construction gets going in the suburbs and there is greater availability for tenants as their leases roll over in downtowns, they will be moving out.
NREI: Why do you say it's inexorable?
LACHMAN: Well, something between 75% and 80% of new jobs are being created in the suburbs, and employees wish to be in the suburbs. One of the great problems at the moment and the one thing that can inhibit the office market is a very low unemployment rate. Employers have to be more responsive to where employees want to be. The rule used to be that companies went to where the CEOs lived. That's much less true today. It's really where the mainstream employees are located that's dictating where employers are locating. And people want to live in the suburbs. With two-wage-earner households, people are just less willing to spend long commuting times, particularly when two-wage-earner households are sharing child care responsibilities and just looking after a home.
NREI: There are a few exceptions. What are they?
LACHMAN: There are four main exceptions: Washington, D.C.; New York; San Francisco; and Boston. It's different things in different places.
New York and San Francisco are really global cities. International business - in the case of San Francisco toward the Pacific and Asia and in the case of New York more toward Europe - is a major issue. For international companies, our office rents are inexpensive. Even high rents - which both New York and San Francisco have - look quite mild when compared with Paris or London or Tokyo. That's a significant factor for both San Francisco and New York.
New York also, increasingly, has both entertainment companies and silicon alley, the new Internet companies. Actually, the economy of New York City has become more diversified. In San Francisco, there's been more of a consolidation in finance, so Bank of America is now based in Charlotte. That's going to be an interesting trend to watch.
Washington, D.C., is the nation's capital, pure and simple. While there was a stagnant period for office space in the District of Columbia, that seems to be pretty well resolved. Rents have been spiking over the last 12 months. They had very much lagged Northern Virginia, for example, but now, if tenants move out of the District of Columbia they would have to pay more than they're paying now. So as a result they're staying. And there are many tenants that truly have to be near the federal government, and the suburbs are not a real option.
Boston is the mutual fund capital of the country, heavily driven by Fidelity, but there's a much broader group of companies centered in Boston.
All four really have geographic constraints in their tight downtown markets, whereas a lot of the automobile-oriented cities have sprawling downtowns. Also, they all happen to be major tourist cities, so they have restaurants and a lot of activities, as well as housing. They're fun places to be as well as work.
NREI: What are you telling your clients as far as investment strategies?
LACHMAN: Besides our strong suburban bias, our other big theme that applies not just to office but all real estate is when you're buying in the suburbs, particularly, you need to have a trading mentality. The population is moving steadily outward. It isn't just cities. It's some of the older suburbs that are being rejected as well. Locations don't stay super attractive for all that long. We represent pension fund investors, so we're concerned about people's retirement money. We're saying that five years is a long-term hold. There's much more of a trading mentality.
NREI: I guess that's radically different from 10 to 15 years ago.
LACHMAN: Right, the old mentality of long term investors buying and holding for 20 years. That probably was a mistake a long time ago. There's just such rapid change in every aspect of our society that five years is a long time.
An area that I've been watching is 24-hour use of office buildings, and this applies to both office and industrial. Global companies increasingly are having to staff their operations 24 hours. As the stock markets are getting closer and closer to being open around the clock, we have a lot of tenants that are using buildings 18 or 24 hours. Yet rents have not changed. There are additional charges for electricity and HVAC, but there is more wear and tear on buildings - the elevators, all the electrical systems, in the suburbs the parking lots. There's a lot more wear and tear if you use the building for three shifts instead of one. Yet landlords are not being compensated for that.
For multi-tenant buildings, it's a subject that just hasn't been discussed and it's very important.
NREI: Do you think owners are just hesitant to be the first ones to raise rents?
LACHMAN: Right. Also, this has kind of crept up on people, and I'm not sure they've really thought about it. A lot of the call centers are triple-net leases. So what? They run the electricity; they pay for it. But the parking lot is the responsibility of the owner and it does get used a lot more with three shifts.
NREI: Where are we in the cycle? Did the events of last fall and last summer keep things from getting too crazy?
LACHMAN: I really think that was the pause that refreshed. My phrase for the overall real estate market is, "balanced but boring." That definitely applies to the office market. As a result, the smallest little blip and it gets blown out of proportion because there's nothing for you guys to talk about. Last fall got really blown out of proportion with the result that lots of projects that were ready to start didn't. Underwriting tightened up incredibly, and we had a four or five month hiatus in transactions. I think that was just wonderful. That enabled this high point in the cycle to stretch out. Instead of a peak, we're on a plateau. There's going to be a correction in the general economy before there's a real estate correction. Real estate is incredibly healthy now. We suffered so terribly in the early-'90s.
NREI: Let's talk about capital markets. How do you see those shaping up through the end of 1999 and beginning of next year?
LACHMAN: There's plenty of capital available to buy buildings. The construction money is being rather carefully parceled out, and underwriting standards are pretty good. So that means developers are having to put up substantial equity. That's restraining new construction in a very positive way.
NREI: Do you see another capital-markets correction on the horizon, and what could result? What is the overall effect of CMBS?
LACHMAN: It's very short run if it does happen. We are seeing - I'll use inexorable again - an inexorable move toward commercial mortgage securitization. It had a blip in the fall, but it's growing nicely. We're seeing a replication of what happened in the residential markets in the early-'80s. The effect of all this securitization is that money remains available. It's just the price fluctuates. What has happened in prior real estate cycles is money totally dried up. I don't think we'll see that going forward. It may become expensive, but you will be able to get it. That's what securitized markets do for you. That's very healthy for long-term capital in real estate.
NREI: What is the effect of immigration now and over the next few years?
LACHMAN: We have to maintain immigration in order to keep our labor force growing. It's actually the cities that are the gateways for immigrants that have the most promising labor forces going forward. That's actually just a handful of cities, but it does include the four where we like the downtowns. Los Angeles is also a major gateway city, and I would not be an advocate of downtown Los Angeles. But that's a sprawling, automobile-oriented city.
We're getting to the point where unemployment is below 3% in a third of the metropolitan areas across the country. That includes a very high proportion of the hot markets. That's very scary because a lot of those markets are not attracting immigrants. It's hard to know how the businesses are going to keep expanding when you have unemployment of 1.8% or 2.3% or 2.5%. I'm talking about places like Raleigh/Durham, Indianapolis, Columbus, Austin, even Denver.
I feel very strongly that we cannot afford to change the law. What's happened - there certainly has been a Republican push to limit immigration - in the end, companies like Microsoft and mayors like Giuliani have said, "Please, we can't do this." Reason has prevailed so far, but it's a continuous worry. It's very important that people come to understand how significant immigrants are to our economic growth. If you look at places like Germany and Japan and Italy, they're moving toward negative population growth. America's willingness to supplement our native-born population enables the economy to keep growing.
NREI: A lot of people may look at immigration and think it's mostly low-wage, low-skilled workers coming into the country. Is that really the case?
LACHMAN: Actually, the immigrants are bifurcated. Compared to the native population, they are both better educated and less educated. There really are a lot of people coming here now with high technical skills and very good educations. Actually, we need both ends of the market. We're having a terrible time in the construction trades. We need the unskilled and semi-skilled people as well.
When we look ahead, the Baby Boom echo kids will start to enter the labor force in the last half of the next decade. We really have a good six to seven years of very low entrance to the labor force because it's the Baby Bust generation. That's my single biggest concern about the office market. Where are employers going to get new employees? Even when the Baby Boom echo kids start to enter the labor force at the end of the next decade, then we'll start to have Baby Boomers start retiring. For the foreseeable future, there's a tight labor market, and thank goodness computers are pushing up productivity.