The problems facing commercial real estate CEOs at the dawn of 2003 are daunting. To begin with, job growth — the engine that drives the industry — is sputtering. That affects everything from office rents to mall vacancies. And there are few prospects that the economy — or leasing demand — will pick up quickly.
For public companies committed to delivering predictable returns and increasing shareholder value, that's a tough place to be. With slow leasing and transaction volume, CEOs of these companies are required to be precise operators and vigilant cost cutters. Their counterparts in private firms have only a little less stress. Against this backdrop, NREI tracked down five prominent CEOs to find out how they are handling the challenges facing their companies, their markets and commercial real estate in general.
The CEOs interviewed in this package represent a cross-section of disciplines and property types within the commercial real estate industry. Four of the five are leaders of publicly traded companies. Two of the CEOs, Stephen Siegel of Insignia/ESG (page 24) and Arthur Mirante of Cushman & Wakefield (page 28), are direct competitors in the brokerage business. The others either own, manage or develop properties.
Why these five? NREI used several criteria. In some cases, a CEO was picked because his company is making headlines. Stuart Tanz of Pan Pacific Retail Properties (page 32), for example, just closed a majorto purchase Center Trust Inc., producing an even bigger West Coast powerhouse. Others were picked because of the interesting challenges of their businesses. Thomas Toomey of United Dominion Realty Trust (page 35) has the tough assignment of maintaining earnings growth for his 78,000-apartment empire at a time when rising unemployment and record low interest rates are taking tenants out of multifamily housing. How will he do it? United Dominion is focusing heavily on operations.
Thomas Bell (page 20) like Toomey, has inherited a real estate empire built by a famous founder, Tom Cousins, and now must take the business to the next level. Unlike United Dominion, Cousins Properties Inc. has used development as a growth engine. But the number of projects in the development pipeline has slowed, leaving Bell to find other ways to sustain growth rates.
In choosing Mirante and Siegel, NREI picked two household names in the brokerage business. Both lead giant real estate services companies that are facing a grim leasing and sales environment that challenges their sales-driven organizations. The companies have distinctive cultures, but similar problems. They need to control costs and simultaneously retain broker talent and a deep enough bench to pounce when the market rebounds. Both CEOs have big ambitions for expansion into new lines of business and new geographic markets. How do they pursue those long-term strategies when they're being mugged by near-term reality?
Collectively, their stories are a microcosm of where the industry stands at the start of 2003.
Growth by Development Not Likely This Year
The CEO of Cousins Properties now focuses on keeping assets fully leased.
By Matt Valley
What do you do when you inherit a company known for its aggressive growth-by-development strategy and there is virtually no demand for major new projects? That is the situation that Thomas Bell Jr. stepped into when he was named president and CEO of Cousins Properties a year ago.
The diversified real estate investment trust (REIT), known for such marquee projects as the 55-story Bank of America Plaza in Midtown Atlanta, has churned out high-quality office buildings, retail developments and some medical offices, delivering an impressive 25.3% annualized return over the past quarter century. It's not that development has disappeared altogether. But only two major projects — one office and one retail — are in Cousins' development pipeline for 2003.
“What has historically differentiated Cousins is that we have been an aggressive developer for a REIT, and that allows us to grow faster,” says Bell.
But because job growth is stagnant, office vacancies are still rising and retailers are generally skittish about expansion, the development opportunities are few and far between. And Bell sees no reason to believe that will change anytime soon. The outlook for development opportunities over the next year, he candidly admits, is “pretty bleak.”
If building isn't an option, what about buying your way to higher returns? Acquisitions present their own challenges, Bell says, especially when it comes to pricing. “There are very, very few acquisition opportunities,” he notes. “There is too much money chasing real estate.” Unlike in previous downturns, when owners were forced to sell as vacancies rose, low interest rates have kept properties profitable even as the fundamentals deteriorated. “The idea is, ‘I'll borrow money at 5% and I'll get a 7.5% yield from the project.’ That's a pretty good arbitrage in this market,” Bell says.
The goodis that the company's office occupancy rate is a stellar 95%, well above the industry average of 85%. The typical lease in the Cousins' portfolio is for a minimum of 10 years and often longer, and Bell expects minimal lease rollovers in 2003 and 2004, when rents may be under pressure. “With regard to our dividend, that gives us more flexibility and less risk than some of our peers,” says Bell. The company's annual dividend of $1.48 per share represents a yield of approximately 6.25%, which is in line with the rest of the REIT sector.
Without development opportunities and few attractive acquisitions, Cousins is making tactical moves. “You look for potential transactions where the tenant has a specific need that can't be met,” he says. For example, even in a market where available space is abundant, a tenant may need 250,000 sq. ft. of contiguous space with another 100,000 sq. ft. over five years. But there may be no existing building able to accommodate such a large space request. “You look for those kinds of opportunities,” he says. “The difficulty, of course, is everyone is looking for those same opportunities.”
Up to the Task
Given the strong track record of Cousins' financial performance and the current market slump, Bell admits that the company has a steep hill to climb. In many ways, Bell represents the new blood that's emerging onto the real estate scene. He has considerable experience in leading publicly traded companies but is a relative newcomer to commercial real estate. He spent 10 years at advertising agency Young & Rubicam, retiring as chairman and CEO when it merged with WPP Group. Before joining Cousins, he served as a senior advisor to Credit Suisse First Boston, overseeing the company's real estate activities. He's also held executive positions in the airplane and manufacturing industries.
“I've always liked going into new things because it's a great learning curve,” says Bell. “You get to use the lessons that you've learned in your previous lives but you get to learn new things, too.”
Bell's business background also has taught him that how individual companies make money and how they're valued can vary dramatically. Whereas Young & Rubicam concentrated on trading at high multiples to earnings, in the REIT world the emphasis is on funds from operations (FFO) and net asset value (NAV). “The marketing services business is basically a fee-for-service business,” Bell says. “You are selling people's time. In the real estate development business, you create value through making real things.”
Challenges to the Growth Model
But creating new things has gotten tougher of late. Among Cousins' major office markets — Atlanta, San Francisco and Austin — there is no demand for new space. The job climate in the capital of the South is particularly troubling. Atlanta, which Lehman Brothers Equity Research says accounts for 56% of Cousins' funds from operations (FFO), lost more than 61,000 jobs in the 12-month period ending in October, more than any city in the nation.
In light of its negative outlook for the office sector, Lehman Brothers in late October rated the stock as “underweight” and reaffirmed its price target of $22. Net income for third-quarter 2002 was $12 million, down from $13.3 million during the same period a year ago. The share price of Cousins stock (NYSE: CUZ) hovered just below $24 in mid-December, down 13% from its 52-week high of $27.32.
Meanwhile, the company's FFO per share in the third quarter of 2002 increased 15% to 61 cents from 53 cents in 2001, due to increases in rental revenues on new properties as well as increases in management fees.
Austin: Space for Rent
The company could face a development hangover next year in Austin, where the tech wreck has had a major impact. Cousins is developing Congress at Fourth, a 33-story, 525,000 sq. ft. speculative building. The $137 million project is scheduled for completion in the fourth quarter of this year, but it is only 17% leased. Grubb & Ellis reports that third-quarter office vacancies hit 19.3% in downtown Austin and 23% in the suburbs.
However, Cousins says it has six letters of intent that would bring occupancy to 37%. Rents under negotiation are in the low-$20s per sq. ft., significantly below the $26 per sq. ft. assumed in the original underwriting, according to Lehman Brothers. Even the lower rate is above the market average, which ranges from the mid- to upper-teens.
In a third-quarter conference call, Bell said that the firm is committed to completing the project despite rumors to the contrary. Long-term, he believes Austin is a technology hub with an infrastructure well positioned to stimulate job growth. “They're not going to move the state capital, and they're not going to move the University of Texas,” Bell says.
According to Lehman Brothers, Cousins could achieve an 8% to 9% return on the $137 million development cost if the tower achieves 96% occupancy. That return assumes the following: 17% of the space is leased at triple-net rents of $26 per sq. ft. and the remainder at $22 per sq. ft.
“I think the company underwrote the project conservatively, but the market has performed even worse than we had anticipated,” says Bell. “We'll get a nice return on the building, but it's not the return we hoped to get when we started.”
The Avenue is on Track
The news in the retail sector is somewhat more upbeat for Cousins, particularly due to the success of its open-air lifestyle centers. Phase I of the 200,000 sq. ft. The Avenue West Cobb outside Atlanta already has commitments from Barnes & Noble, AnnTaylor Loft, Linens 'N Things, Chico's, Pier 1 Imports, Cargokids and Talbot's. The center could be expanded by as much as 210,000 sq. ft. depending on market conditions, according to Cousins.
Bell says lifestyle projects such as The Avenue are the hot concept du jour. “It's got a lot of legs. Will it last forever? No.”
The lifestyle concept isn't bulletproof either. For example, The Avenue of the Peninsula, a $93 million Cousins development in Rolling Hills Estates, Calif., has been plagued by weak tenants who may be unable to meet lease obligations. Cousins estimates net operating income (NOI) at the property for 2002 will be $4.1 million, according to Lehman Brothers. That's at the bottom of the $4.1 million to $5.1 million range projected by the company. For 2003, the company expects NOI to range from $4.1 million to $4.7 million.
Despite the lull in the development market, the company's long-term strategy isn't likely to change under Bell's leadership. He says the firm has no desire to become a big REIT and prefers instead to focus on producing high-quality assets that yield double-digit returns. The company intends to remain a diversified developer and would like to increase its presence in Washington, D.C. Cousins also hopes to expand into the Miami and San Diego markets.
Cousins remains committed to a business model that has proven successful for decades. “We recycle our capital, we produce high-quality assets and we try to maintain very strong relationships with our clients,” Bell says, “so that we can do more business with them over time.”
Talent Search Intensifies as Brokers Grow Restless
Insignia/ESG's CEO is taking advantage of the downturn to recruit top producers as well as add new lines of business.
By Parke Chapman
Stephen Siegel recalls when just “showing up” meant doing deals. It was during the late 1990s boom when the surging economy drove heavy demand for office space. Leasing volume soared, the office market was as tight as a fist and brokers gorged on commissions.
“I was a genius in 2000. I couldn't make a mistake,” says the 57-year-old Siegel, who has been president and CEO of Insignia/ESG since 1992. “I really thought I could use my 2000 style for at least another five years,” he adds, laughing.
Siegel, to be sure, wasn't the only brokerage “genius” back then. But in this post-boom economy, Siegel says he has adopted what he calls his “down-market mode.” The biggest challenge at a time when commercial vacancy nationwide has risen to more than 16% is to keep the best brokers and perhaps add some. “When people are raking in the bucks, they don't consider a change,” he says. Also, Siegel must do his best to keep broker morale high in the middle of a bleak market.
On the recruiting front, Insignia wound up on the defense last summer when its star office broker, Mary Ann Tighe, jumped ship to join rival CB Richard Ellis. Tighe was one of a dozen or so high-level brokers to switch teams in 2002. After Tighe left, for example, Insignia hired Woody Heller — one of Jones Lang LaSalle's top brokers. That, Siegel says, turned out to be a good move because Heller's strength is investment sales, which is much stronger right now than the leasing sphere.
Attracting top brokers and keeping them happy is essential to the company's success, especially with shareholders watching. Insignia/ESG is part of Insignia Financial Group (NYSE: IFS) which was founded in 1991 as a real estate opportunity fund. The firm went public in 1993, just in time to ride the office boom. A strong market that began in the mid-1990s meant high returns for the firm, now flush with commissions and new management assignments. In 2000, the firm posted a 60% growth in net earnings before interest, taxes, depreciation and amortization (EBITDA). Shares of IFS peaked at over $17 per share during the winter of 2000.
But the overall economic slump and sharp cuts by the financial services, technology and media companies that drove demand for Manhattan office space in the 1990s, have taken their toll. In New York City, where Siegel works, commercial vacancy is hovering around 11%, well above the vacancy rate of 6% in 2000.
And IFS shares were trading at $7 a share in mid December, more than 40% off their 52-week high of around $12 last March. Siegel says that the firm is now working harder for less business. And tenants, not landlords, are calling the shots.
A Little Perspective
This isn't the first sour real estate market that Siegel has endured. Prior to joining Insignia more than 10 years ago, Siegel worked for archrival Cushman & Wakefield for 25 years. He remembers the early 1990s as a far bleaker time for the real estate industry, when office vacancies hit nearly 20% across the country. “In some markets right now we are 10% vacant. Back in the early 1990s that was Nirvana! The thinking was, ‘if we get to 10%, we build!’” says Siegel.
According to real estate data provider CoStar Group, the national vacancy rate for Class-A office properties rose from 12% at the end of the third quarter of 2001 to 16.3% at the end of the third quarter of 2002.
The Talent Search
Siegel says he is using the slowdown as an opportunity to bulk up on staffing. “This is a great time to recruit. We are focusing on recruitment at the highest levels,” he says. Signing bonuses for new staff, along with retention bonuses for in-house talent, can become very expensive, he acknowledges. But it's a cost that the brokerages can't afford not to pay.
Another priority for Siegel is maintaining broker morale. Many brokers have seen their commissions all but vanish. Unlike firms that routinely trim the weakest 10% of their brokerage staff, Siegel shies away from this by-the-numbers approach. Such measures, he says, could lead the firm to fire an employee who will later become a star at a rival firm. Nonetheless, he's been forced to trim his head count lately. “It's a last resort,” he says.
Siegel's other great challenge is to continue pushing Insignia/ESG's global strategy. Siegel remembers when being a New York City powerhouse was an all-consuming mission for the company. But it didn't last long before the company realized that it must expand geographically and into new areas of service to compete for top corporate tenants and to grow the business. “We couldn't just stay in New York City,” he says. “Your clients won't allow you to do this.”
So, Insignia has gone global. Five years ago, the firm bought the London-based Richard Ellis group. Three years later, the firm crossed the channel to buy French real estate services firm Groupe Bourdais. The firm has also focused on Central European markets, opening a total of 24 branches.
“Our European operations are performing very well. Still, much of our international business is grown domestically,” says Siegel. In other words, the broker often helps its U.S. clients find space overseas. Insignia, which owns local operators in 44 world cities, generates approximately 25% of its revenues from offshore business.
“To do this successfully takes time, patience and a lot of energy,” he says. “There are a lot of trials and tribulations involved in doing this.”
Deeper Bench of Services
In addition to expanding internationally, another of Siegel's goals is to build Insignia's financial services arm, along with the firm's debt and equity placement business. Last summer, Insignia created a Washington, D.C.-based finance and capital markets group.
The capital markets division is charged with raising capital for clients through joint ventures and private offerings. The new division specializes in the sale of office, multifamily, retail, hotel and industrial properties. Insignia/ESG was already offering these financial services in major markets like New York and Washington, D.C.
So, when does Siegel figure he can revert to his “2000 style?” He predicts that the national market will rebound by the third quarter of 2003, but that New York City will lag, mainly because of continued layoffs in the financial services sector.
“I tell my people, ‘This is what you've got — deal with it, make the best of it, work a little harder and bang on some doors longer.’”
Arthur Mirante Faces ‘Global Stagnation’
In pursuit of an international empire, Cushman & Wakefield encounters the ripple effects of a recession.
By Parke Chapman
Ten years ago, Arthur Mirante, president and CEO of privately held Cushman & Wakefield, set the firm on a global course. When he launched the strategy, a base assumption was that a portfolio of far-flung operations would be a hedge against a decline in domestic activity. The idea was, when things were slow in the U.S., Europe would take up the slack. But in this downturn, Cushman is seeing a falloff in leasing activity at home and abroad.
“The world changed very quickly,” Mirante says. “The diversity is still working, but not the way it used to work or was supposed to work. I'd have to strain myself to tell you that Seoul and Barcelona are improving.
“It used to be that when the Asian market was up, the U.S. market was down and it all evened out. Not anymore,” he continues. “Tenant demand and transaction volume are down throughout the world, and we're left with global stagnation.”
Still, Cushman & Wakefield is not retreating. The brokerage generates 25% of its revenues from offshore business, and Mirante expects that to rise to 50% within the next five years. The most profitable corner of the globe for the firm — outside of the U.S. — is Europe, says Mirante. One of Mirante's first offshore acquisitions was U.K.-based real estate services firm Healey & Baker, purchased in 1991. In Brazil, the firm manages 20 million sq. ft. of office space and has maintained an office in Mexico City for the past 10 years.
Bulking Up for a Down Market
Heading into 2003, Mirante's biggest challenges are domestic. Market conditions remain depressed and a flurry of economic reports released at the close of 2002 offered little reason for near-term optimism.
“For almost eight consecutive quarters, tenants in the U.S have put more space back onto the [office] market than is being leased. There's negative absorption and very little economic growth right now,” says Mirante.
In his view, the single most important catalyst in 2003 will be business growth and job creation. He says that he will be very disappointed if New York City doesn't see job growth resume by June.
Until then, Mirante believes that the firm can still grow stronger, even if the market remains flat or weakens further. Case in point: The firm is stepping up efforts to recruit top broker talent. Due to the slump in the office market, top brokers at competing firms are willing to consider their options. “This is a great time to hire talent so that when the turnaround comes, you can explode out of the blocks,” Mirante says.
In the summer of 2002, the firm snagged Scott Latham and Jonathan Caplan, two well-respected building sales brokers from CB Richard Ellis. Earlier, however, Cushman had lost two of its own top sales brokers — Darcy Stacom and Bill Shanahan — to CB Richard Ellis.
For Mirante, a weak market is no excuse for flat returns. “We have to be profitable regardless of the climate. You've got to make tough decisions, but you know that it will get better,” he says. The company declined to disclose any financial information, however.
Given the slow market, Mirante must make some difficult personnel decisions — to get costs in line and weed out poor performers. Cushman & Wakefield reviews the brokerage staff every year, but lately “the bar has been set higher” due to the soft market, he says.
“A lot of these people are young, just getting their start in the business. Maybe they are just not good salesmen, or need to be with a smaller firm,” he says.
Up from Legal
Mirante's professional background sets him apart from many of his C-suite peers. He heads one of the biggest real estate brokerage firms in the world, but was never a broker. Mirante began working for Cushman in the early 1970s as a corporate attorney.
Mirante's legal experience comes in handy as the company spins an ever more complicated web of alliances to pursue its global strategy. “I'm a details maniac,” he says. “That's the lawyer in me.”
Cushman & Wakefield has established beachheads by signing up local affiliates in Singapore, Seoul, Latin America, India and Tokyo. Mirante calls this a courting process. “This is how we get to know these people before deciding if we want to buy them,” he says.
So far, no affiliate in Asia has made it to the altar. In Bangkok, an affiliation was severed due to a low volume of business.
Africa and the Middle East have proved to be the biggest challenge thus far in Cushman & Wakefield's global expansion efforts. “We've had three offices in the Middle East, and of those three we've closed two of them,” he says, citing geo-political reasons.
Leading the Way
Mirante is often credited with anticipating the need for overseas expansion long before most brokers. But he modestly shrugs off such a label.
“Jones Lang LaSalle used to be Jones Lang Wooten,” he notes. “They were a powerhouse in Asia and London. They were the firm that captured Hong Kong.”
CB Richard Ellis had what Mirante calls a “global vision,” although in his opinion they were dogged by a series of false starts in executing it.
And last but certainly not least, there's his archrival, Insignia/ESG. “Insignia clearly watched what we did and followed,” says Mirante. “They've bought some very good companies, particularly Groupe Bourdais [in France],” he says.
Where does Cushman go from here? Mirante plays it close to the vest — one privilege of being a privately held firm. “We're doing a lot of unconventional things right now,” he says, laughing. “I just don't think I can tell you about them.”
West Coast Shopping Spree
After gobbling up Center Trust for $600 million, Pan Pacific focuses on digesting its newest acquisition — and it's still hungry.
By Joe Gose
While several real estate investment trusts (REITs) have slimmed down during this economic downturn by being net sellers of assets, Pan Pacific Retail Properties is bulking up. Case in point: The company in November acquired Manhattan Beach, Calif.-based Center Trust Inc. in a deal valued at $600 million. With the purchase, the Vista, Calif.-based REIT solidified its standing as the dominant owner of grocery-anchored shopping centers on the West Coast.
So, what's next? More acquisitions, of course. “We operate in what is probably one of the most fragmented markets in the country,” says 43-year-old Stuart Tanz, CEO of Pan Pacific Properties. “So in terms of further consolidation on the West Coast, we're in great shape to do that.” Pan Pacific will continue to scour the West Coast for single deals and privately owned portfolios, adds Tanz.
To finance further acquisitions, over the next 12 to 18 months Tanz intends to sell about $178 million worth of Center Trust properties that don't fit into Pan Pacific's core of community-based centers. Among the candidates for disposition, two malls are a certainty: the 1.2 million sq. ft. Media City Center in Burbank, Calif., and the 820,000 sq. ft. Baldwin Hills Crenshaw Plaza in Los Angeles.
Pan Pacific's planned dispositions are in line with a maturing REIT industry that emphasizes buying and selling assets compared with the prevailing buy-and-hold paradigm a decade ago, but Tanz also is keenly aware it's a strong seller's market. “When you have a marketplace where the fundamentals are very strong, where cap rates have been suppressed downwards — or pricing has increased — you should take advantage of selling those assets that no longer have strong internal growth,” Tanz says. “You should deploy that capital into assets with strong net operating income (NOI) growth.”
Richard Moore, a retail REIT analyst at McDonald Investments in Cleveland, notes that Pan Pacific has developed a track record for improving properties once they've been added to its portfolio. That has earned the company a favorable reputation among mom-and-pop sellers of grocery-anchored centers who can become emotionally attached to their centers and want to make sure their properties are well-maintained after they're sold.
But Tanz's immediate concern is executing the details of the merger struck between Pan Pacific and Center Trust. Cultures need to be blended as well as portfolios. Tanz emphasizes that because the two companies own neighborhood centers in the same general vicinity and share similar operating systems, he expects the merger to proceed smoothly.
Company Vital Signs
Mergers are not a new experience for Pan Pacific. In 2000, the company acquired Western Property Trust, which at the time increased Pan Pacific's holdings on the West Coast from 9 million sq. ft. to more than 14 million sq. ft. The Center Trust deal, which was expected to be approved by Center Trust shareholders early this month, increases Pan Pacific's portfolio by 37%, from 108 shopping centers to 138, and from 14.2 million sq. ft. to 19.4 million sq. ft.
The merger is expected to boost funds from operations (FFO) by 10% and increase shareholder value. From early November, when the deal was announced, through mid-December, Pan Pacific's stock price rose from $34 a share to $36.25 a share.
For the third quarter ended Sept. 30, 2002, Pan Pacific reported FFO of $25.8 million, or 75 cents a share, compared with $23.2 million, or 68 cents a share, in 2001. Net income for third-quarter 2002 was $20.4 million, or 60 cents a share, compared with $16.5 million, or 50 cents a share, in the third quarter of 2001.
Beyond NOI and FFO growth, the Center