The new millennium is nearly here and for the real estate industry, the year 2000 will offer new challenges - not only opportunities and possibilities, but risks and uncertainties as well.
There will be major transformations in some real estate sectors, while other areas will remain unchanged. Consolidation is expected in certain fields, while expansion is the watchword in others. Some of the nation's hottest regions may boast some cold submarkets. And continued demand for certain product may produce too much supply; overbuilding is expected in some sectors but it won't resemble the littered landscape of the 1980s.
High-tech revolution And then there is the information superhighway. Only a few years ago, some thought the Internet was a final line of defense against mosquitoes. Today, the Internet has become a major concern to those in the real estate industry - not only from a retail perspective - and it will continue to be a worry well into the next century.
"Electronic commerce is expected to dramatically change the real estate industry in the new millennium," says Michael A. Pollack, president of Michael A. Pollack Real Estate Investments, a privately held shopping center developer in Arizona. "E-commerce is already affecting two real estate sectors in a major way - retail and industrial, and it is expected to impact other areas as well, including office, hotel and multifamily."
Michael Brennan, president, CEO and director of Chicago-based First Industrial Realty Trust, agrees. He sees 2000 as a strong year for industrial for a number of reasons, including e-commerce. "Demand will be significantly accelerated by a number of factors including traditional retailers and born-on-the-Web retailers coming into the market for additional industrial space," says Brennan.
Retail, of course, is being impacted by e-commerce, and there will be even more reverberations in the year 2000. Internet sales are causing some concern among retailers and developers/owners alike, acknowledges Martin Debrovner of Weingarten Realty Investors (WRI), a real estate investment trust with some 3,000 different tenants in 185 neighborhood and community shopping centers in 13 states, primarily in the Southwest.
"As an owner of shopping centers, I think it is best to be prepared to deal with whatever changes are going to occur because of the Internet," Debrovner explains. "But I personally believe that most people are still going to want to shop, to interact, to browse at a store, while some will choose to shop over the Internet because of hectic schedules and less time."
E-commerce is expected to impact other sectors in different ways, ranging from hotels that now have a new marketing tool, to office development, which is dealing with fewer employees at the office and more workers at home, to the multifamily market, which now offers telecommunications packages along with basic utilities.
But the Internet isn't the only concern facing real estate in the year 2000. Others include a scarcity of capital, a concern that a decade-long economic expansion may be getting long in the tooth, and an oversupply of buildings.
Look for a good year 2000 will be a good year for a number of reasons says Stephen B. Siegel, chairman and CEO of New York- based Insignia/ESG. "While the economy may not be booming quite as much, we're seeing economic growth in telecommunications, e-commerce, entertainment and other areas," he explains. "The country is not dependent on any small cadre or industry for growth."
With a few exceptions, he adds, there is no real threat of oversupply, "and that may be as much a factor of leasing velocity as well as the capital crunch. There might have been the potential for more speculative development, but the awakening last summer of lenders dried up capital and increased equity requirements."
Michael J. Alter, president of The Alter Group, Lincolnwood, Ill., says he is optimistic that the economy will continue to do well next year. "The supply throughout the country is very much in check. Although we're continuing to see pockets of overdevelopment, nowhere are we seeing an oversupply creating an imbalance in the market," he says. "In many areas where there are new buildings coming along, they should be leased fairly quickly. From the capital markets point of view, there's a lot of money, but people are cautious about doing spec development, so it's very healthy for office development and leasing."
Next year will bring a continued supply-and-demand equilibrium, agrees Steven E. Pumper, executive vice president/owner advisory services in the Dallas office of Transwestern Commercial Services.
"The CMBS meltdown last year slowed development," Pumper says. "There is much better information because of the public market. It's not going to prevent overbuilding, but will limit the level of overbuilding."
Still, there are some signs of a softening in the market. Office vacancy is creeping upwards, says Ray Torto, principal of Torto Wheaton Research based in Boston, a division of CB Richard Ellis. He notes that nationally the vacancy rate is breaking through 10% and will creep toward 11% in2000.
Some 106 million sq. ft. in new office is expected this year, he says, compared to 14 million sq. ft. in 1996. By contrast, in 1986, there was about 172 million sq. ft. built. "One way to look at it is in the year 2000 we will have more supply than we've had really for most of the 1990s," he says. "But the early part of the decade had very little office space being built."
Overstating e-commerce? E-commerce is definitely on the minds of those in the retail industry. But after several years of uncertainty, many in the industry now feel its impact may be overstated. "I don't think we're going to eliminate in any way, shape, or form the grocery store nor service retailers like the barber shop, the hair salon, the shoe repair shop or the dog-grooming boutique," says Arizona developer Pollack. "There will continue to be a need for service-oriented retailers. It's hard to have your dog groomed over the Internet."
Perhaps a more disturbing trend for many retail merchants in 2000 and beyond is the continuing dominance of major retailers such as Wal-Mart, which are zeroing in on secondary and tertiary markets as well as small towns - and could have the potential to economically effect a large percentage of local retailers.
"When Wal-Mart comes into an area, there is a significant impact on the retailers," says Pollack, who currently has 150,000 sq. ft. of retail in escrow and is building 100,000 sq. ft. of new space. "Some such category killers are running into resistance in many areas."
Already, retailers are using both their physical bricks-and-mortar stores as well as cyberspace to generate sales, says WRI's Debrovner He notes that Wal-Mart has just announced a massive expansion of new stores for the year 2000 and believes that Wal-Mart management still feels most people are going to want the traditional shopping experience of touching, feeling and "trying on" before buying. However, Debrovner says developers/owners could see sales drop to perhaps $250 per sq. ft. from stores that have a history of reporting around $350 per sq. ft.
Stephen D. Lebovitz, president of CBL & Associates Properties Inc., a shopping center owner and developer headquartered in Chattanooga, Tenn., agrees, saying he thinks the sentiment has changed about the Internet.
Before, Lebovitz explains, experts were saying the Internet would put conventional retailers out of business. Now the feeling is there are benefits to having conventional retailing and Internet retailing because it gives customers more choices. "Retailers are not going to close stores and sell everything on line," he adds, "and that change in the market mindset is going to help us."
In fact, retailers will continue to grow in 2000, reports Paul H. McDowell, senior vice president at Capital Lease Funding LP, a specialty net-lease lender, based in New York. "The larger retailers will continue to increase their top-line revenue growth by growing their business and creating more and more stores," says McDowell. "When retailers don't create them, they buy them, and the result is the same."
John Konarski, senior vice president of the International Council of Shopping Centers (ICSC) in New York, the trade association of the shopping center industry, agrees. "If the economy continues at its present rate, continued growth is expected in the retail sector."
At the same time, Mark A. Pasquerilla, chairman of Johnstown, Pa.-based Crown American Realty Trust, says his company continues to search for creative ways to position itself with institutional and retail investors.
"We will continue to focus on the operating side of our business in order to grow existing assets," he says.
"Regional shopping malls within the middle-Atlantic remain the core business of this company. We will continue to monitor the economies of states within this area and are excited about such high-growth areas as Onslow County, N.C., [among others]."
Changes afoot for industrial While the industrial market seems to be close to equilibrium in major markets, changes will occur in the sector, ranging from mergersand consolidations to some companies even leaving the business, says W. Blake Baird, CIO at San Francisco-based AMB Property Corp.
Baird adds that private companies that went public during the capital frenzy of the early-1990s may now experience some problems because they have not adapted to the changing marketplace.
"Many of them have not developed a public operating model," says Baird. "They are operating the same way they did when they were private companies. The classic private operating model is, basically, if you can finance it, then buy it or build it. It's not a model that ultimately makes money for shareholders, so many companies are going to experience capital problems, and some will be forced to sell assets or merge."
Demand for functional, well-located industrial space is still outstanding in major areas of the Midwest, says Paul T. Ahern, CIO at CenterPoint Properties based in Chicago.
CenterPoint invests in Milwaukee, Chicago and Northwest Indiana, he adds, and for the past two years, "we've had pretty steady high demand overall for industrial space, absorbing 35 million sq. ft. a year in Chicago."
The industrial sector is expected to be very good for the foreseeable future, he continues. "It's almost as though we always try to over build, but we just can't do it," says Ahern, "because not a lot of brand new space sits vacant long."
Brennan of First Industrial notes that new tenants coming into the marketplace will be performing fulfillment work for existing retailers who are now selling via cyberspace. "For instance, Fingerhut is performing fulfillment distribution for Wal-Mart's e-commerce operation," he says. "There are a number of firms that help traditional retailers who have never done direct commerce sales off the Internet."
Hotels yield a mixed bag Next year will be a good one for the hotel industry, says Paul Whetsell, CEO of Washington, D. C.-based MeriStar Hospitality, one of the country's largest owners of upscale, full-service hotels. Whetsell also is CEO of MeriStar Hotels & Resorts, the fourth-largest hotel real estate investment trust (REIT) in the United States.
"I don't think growth is going to be as dramatic in the year ahead. Certainly we will not see the type of growth we've seen in the latter half of the 1990s," Whetsell says. "We're entering a period of stable, steady growth, and that's healthy for the industry. The only reason we reported double-digit ReVPAR [revenue per available room] and growth was that the industry went down so far, and bounced so far back."
2000 will also be another year of consolidation, says Michael A. Leven, president & CEO of Atlanta-based U.S. Franchise Systems, which has 1,101 properties open or in development.
"Companies that now can't show similar kinds of growth rates they had in previous years are looking to improve profitability by consolidating expenses and overhead," says Leven. "We'll also see less money in capital rehabilitation because people aren't going to get the same type of room rate boosts they've gotten over the years. So more hotels are going to go longer without refurbishing."
There are other concerns in the industry. Bjorn Hanson, New York-based chairman of PricewaterhouseCoopers' lodging and gaming group, notes that average hotel occupancy, which was 63.5% in 1999, will fall further to 63.1% in 2000, and remain flat for 2001.
"Interestingly enough, profits will grow about 10% in 2000, which is more than the rate of inflation and room rate growth," Hanson explains. "There will continue to be many different kinds of revenue enhancements and expense reductions, ranging from increases in menu prices to charges for meeting rooms, and so forth."
Multifamily: The Law of averages The multifamily sector always has a good, solid year - typically batting over 300 - and 2000 will be no different, says Jonathan Kempner, president of the National Multi Housing Council based in Washington, D. C.
"The multifamily sector usually makes the playoffs annually, but it may not win the Super Bowl or World Series," he explains. "Construction has remained at a consistent pace, consistent with long term demand, and there are no signs that this consistency has changed."
Kempner notes that multifamily has been one of the favored REIT sectors, a trend he expects to continue in the new millennium - barring some economic catastrophe.
Ric Campo, CEO of Houston-based Camden Property Trust, one of the nation's top multifamily REITs, agrees.
"One of the big concerns in 1999 was overbuilding, and we've seen a significant drop in construction permits in most markets," he says. "I think the slowdown is going to be felt in 2000. We won't have as much competition as this year, and that's good if you're trying to raise rents."
He notes that, in Las Vegas, starts are down 29%, on a 12-month trailing basis ending August 1999. In Houston, starts are down 30% and have declined 35% in Fort Worth.
Most of the nation's multifamily markets are in equilibrium, says Douglas Crocker II, president and CEO of Chicago-based Equity Residential Properties Trust based. Crocker expects to see rents grow by around 3% next year.
"If you own assets in New England, New York and its collar counties, San Francisco, Los Angeles and Orange County, you're going to be real happy," he adds. "Financing and equity will be difficult to obtain, and I think we'll see continued consolidation in the industry, whether it'll be public-to-public mergers or public companies taken private by large venture funds."
Ron Witten, president of M/PF Research of Dallas and a nationally known residential expert, says next year will bring a wider disparity in local multifamily markets.
"The stronger markets, generally Southern California, and the Northeast, plus some of the Midwest markets like Chicago where it is difficult to produce product to accommodate demand, will continue to be strong," says Witten. "But I think in we're going to see a small number of markets struggling through a large volume of new units being delivered."
Witten notes that Houston, Dallas, Phoenix and possibly Orlando are among the areas that may be struggling with too many new units. "They still have an excellent economy, and it's not a lack of demand," he explains. "It's a simple over response on the supply side."
As for the supply of funds, the capital outlook for private and public companies will become more pronounced in the coming year, says Dick Michaux, president and CEO of AvalonBay Communities based in Alexandria, Va.
"The private companies will continue to have pretty good access to equity and more discipline on the debt side," says Michaux. "They will continue to develop and acquire as they have in 1999 because fundamentals are strong in almost all markets they are active in. The public side will continue to have difficulty with access to capital, particularly equity."
Shekar Narasimhan, chairman and CEO of WMF Group, Ltd. of Vienna, Va., agrees that the capital market is changing.
"We're in a different part of the credit cycle, and lenders are going to have to be more cautious in lending next year," Narasimhan says. "They'll be looking for signs of weakness on management and marketing sides."
At the same time, GSEs (Government-Sponsored Enterprises such as Fannie Mae and Freddie Mac) will continue to play a larger role in multifamily financing. "Fannie and Freddie combined will probably do over 50% of the total multifamily financing this year, and I would predict they will do even more in the next few years," he adds. "That's going to be quite a test of the survivability of CMBS (commercial mortgage-backed securities) issuance markets as the percentage of multifamily available for conduit securitization declines."
Seniors sector to turn up? David S. Schless, executive director the American Seniors Housing Association, a trade group that represents the interests of seniors housing developers, operators and financiers, notes that 1999 was a difficult year for many public seniors-housing companies - but predicts 2000 will be different.
"Next year will be one of focus," he says. "Many people within the industry expect to see some activity taking place to reduce the number of publicly traded seniors housing/assisted living companies. There is definitely some possibility of merger or consolidation."
There is no question consolidation in the industry is on the horizon, adds William B. Kaplan, chairman and CEO of Chicago-based Senior Lifestyle Corp., a privately held firm with more than 10,000 units in operation or development around the United States.
Kaplan says some of the private companies probably regret having gone public and as a result of their aggressive growth programs are now cutting back, particularly in development. "As a result, we'll probably see a slowdown in growth," he adds.
Mel Gamzon, president of Senior Housing Investment Advisors, a Newton, Ma.-based national investment real estate brokerage firm specializing in the seniors housing industry, says the sector is looking quite bullish in terms of real estate transactions for the new millennium.
"The good news is that capital has been more difficult to procure, and as such, only the Triple-A ventures are being financed, for new development as well as acquisitions," he says.
So after all of this never-ending millennium hype, how to describe real estate in the year 2000? In a word: evolving.
"That means real estate developers must change with the times, and not blindly follow fads or trends," says entrepreneur Pollack of Arizona.
"Remember the power centers of a few years ago? Some have already closed down. Real estate is no longer a 'Field of Dreams.' ... It has become an aggressive business, not only with competitors but other mediums as well. 2000 will definitely be a year of change."