Most industry insiders agree that revenues from investment sales and new leasing transactions—commercial brokers' bread and butter—will likely continue to fall through 2009. But while 2009 promises to be a tough year for commercial real estate brokerage firms, many in the sector view the current environment as fertile soil for growth in new areas of business.
Indeed, as flipping assets to make a profit has become impossible, property owners are turning back to fundamentals. Their goals today include stabilizing occupancy, improving rental streams and cutting operating costs. And they need an experienced management staff to do that. Corporate tenants also need help controlling real estate costs while holding on to key locations. And lenders, who as a result of rising loan defaults are being forced to foreclose on commercial properties, need brokers to help them assess the value of the assets.
As a result, over the next two years brokerage firms see opportunity for expansion in the management and financial analysis arenas, including asset management, lease renegotiation, valuation and global corporate services.
"When one door closes, which investment sales certainly have, there are other opportunities arising in the commercial real estate market," says Peter Morris, senior vice president with Colliers International, a Boston-based global real estate services provider. "Today, real estate still exists. Whether it's selling or not selling, the building still needs to be managed. Tenant relationships really need to be fostered more now than ever before. Management services is where we shine."
In anticipation of that shift, some brokerage firms are in the market for top talent to handle complicated leasing transactions and distressed asset sales.
For example, the Goldstein Group, a Paramus, N.J.–based boutique retail brokerage, recently added six people to its staff and plans to hire another eight to work in its leasing brokerage division, as well as on the investment sales side. Studley Inc., a New York City–based national brokerage that specializes in tenant representation, has been interviewing brokers in major U.S. cities to join its team. The firm is looking for seasoned professionals with experience in both tenant and landlord representation. Colliers International also is on the lookout for experienced brokers and property managers. Last month, Colliers hired Mehran Foroughi, formerly a top-producing investment sales broker with Sperry Van Ness, an Irvine, Calif.–based investment brokerage firm. In the past two and a half years, Foroughi closed transactions valued at more than $120 million.
The move to hire new people when leasing and investment sales are in flux seems counterintuitive. But as property management and lease renewals become increasingly complicated, brokers find that their negotiation and valuation skills remain in demand.
"I don't think anybody will ever be at the [revenue] levels of 2008," says Chuck Lanyard, president of the Goldstein Group, which recently moved into a larger headquarters to accommodate its expanded staff. But the downturn "has created some very good opportunities for our company's growth." Over the past year, the firm has seen an increase in property management and lease renegotiation assignments and expects to handle a large number of distressed asset sales later this year.
Lagging indicators
Today, brokers are only beginning to feel the full impact of the downturn. The brokerage industry might not have realized the scope of the damage until this winter, when several national retailers that were expected to emerge from Chapter 11 ended up opting for liquidation, notes Bill Bauman, executive vice president of the national retail services group at Studley.
"Some [brokers] thought they would have at least a chance to reorganize," he says of electronics seller Circuit City. "Now, I would say everybody is pretty realistic about the fact that we could easily see these market conditions go on for another 12 to 18 months."
As a result, brokerage firms across the country have started to rethink their strategies. Many, including CB Richard Ellis (CBRE), Jones Lang LaSalle (JLL) and Grubb & Ellis have launched or expanded distressed asset services groups, which will help lenders deal with commercial properties that have defaulted on loans.
But that line of business won't start paying off for another year or two, according to Anthony Buono, executive managing director for national retail brokerage services with CBRE. That's when the bulk of risky loans made in 2006 and 2007 will reach maturity. At present, brokerage professionals are concentrating on management, valuation and lease renegotiations.
Already, brokerages have felt the impact of slower leasing and sales activity.
CBRE, the international behemoth of the brokerage world, reported a 71 percent increase in net income from first quarter of 2007 to first quarter of 2008, from $12.0 million to $20.5 million. Net income measures a company's earnings minus taxes and other expenses. By the fourth quarter, however, year-over-year net income had fallen by 95 percent, to $6.5 million. CBRE, which breaks down its transaction results by geographic region, reported that leasing revenue in the Americas declined 11 percent in 2008 and sales revenue declined 49 percent.
At JLL, net income for 2008, at $84 million, came in 67 percent below the $256 million reported in 2007. The figure was impacted by $7 million in integration costs from the purchase of brokerage firm Staubach Co. and German retail property advisor Kemper's, as well as $30 million in restructuring charges and $23 million in severance charges related to staff reductions. Revenue from transaction services in the Americas rose 26 percent during the year, due to increased activity from the Staubach acquisition. On a global basis, transaction services revenue declined 8 percent because of slower capital markets activity.
Leasing fundamentals
New leasing activity may continue to be down—Anthony Paolone, an analyst with JPMorgan, expects CBRE's leasing revenue for 2009 to decrease 54 percent compared with last year. However, brokerage firms are seeing an increase in demand for lease renegotiation as tenants and landlords turn to them to handle renewals and requests for rent reductions.
"Historically, we've helped retailers with the strategic planning of their rollout plans, we would help them identify new locations and negotiate leases for new locations," says Bauman. "We have not generally been asked to assist in the renegotiation of existing leases or options. Now, we are asked to evaluate existing leases and assist them in value engineering."
The change is due to the fact that as market conditions have turned, leasing transactions have become riskier, notes Morris. Landlords worry they are giving rent breaks to and losing cash flow on tenants destined for extinction. Tenants are concerned their real estate holdings are too large to maintain in a deep recession. As a result, a renewal negotiation that would have taken a few weeks in 2006 now takes two months because every item in the lease has to be weighed for long-term viability.
"People are thinking, ‘If I enter a lease today, is this position going to be good for me several years down the road?'" says Morris. Plus, parties that in the past would not participate in renewals—accountants, insurers, lenders—now want to weigh in because their livelihood is at stake as well.
As bankruptcies in the retail sector have accelerated, it also has become more important for landlords to retain existing tenants, adds Morris. Today, as lenders estimate future cash flows, they are taking a very conservative stance on vacant spaces. Lenders are projecting that it will take months, if not years, to find replacement tenants. In addition, the rent on the new leases will likely be significantly below rents paid by retailers already at the center. Brokers can help keep current tenants by negotiating concessions agreements that work for them and the landlord.
Focus on management
More and more, owners have also been turning to full-service brokerage firms for property management. During the boom years, the expertise required to operate retail properties wasn't that important, as hunger for new space kept occupancy levels above 90 percent. And many owners weren't interested in property management anyway because they didn't plan to hold on to their centers, notes Morris.
"If you think back just a couple of years ago, when a person could buy a building in March and sell it in May and make a few million dollars, management really was not that important," he says. "No one expected to hold a portfolio long enough to really make an impact on real estate value."
Back then, the bigger landlords handled property management in house, while smaller investors outsourced management to the cheapest third-party provider. Today, having experienced property managers has become crucial for containing operating costs and retaining tenants. In some cases, owners have been willing to spend more on management fees than they did during the boom years to hire highly experienced professionals who can help them maintain current occupancy levels, says Morris.
For example, the amount of retail space under management in CBRE's U.S. portfolio jumped 10 percent from December 2007 to December 2008, to approximately 71 million square feet. JLL's U.S. assets under management grew by 5.4 percent, to 58 million square feet. Even smaller firms are getting a boost. The Goldstein Group saw its 7-million-square-foot management portfolio grow by about 15 percent, or one million square feet, in 2008.
"Landlords have been turning to us at a tremendous rate to handle the properties that in the past they've been handling themselves," says Lanyard of the Goldstein Group.
Global solutions
In an effort to cut costs, many retailers also have been cutting in-house real estate staff and outsourcing leasing and property management to brokerage firms. Outsourcing to a third-party provider can be cheaper because all the services associated with real estate—construction, management, leasing, sales—come bundled in one package.
For instance, CBRE's global corporate services division accounted for 34 percent of revenue in 2008—up 9 percentage points from 23 percent in 2007.
"It's everything from turning the doorknob of the building to cleaning the building to the speed with which you get rid of the building," says Buono. "The whole business is built around key performance indicators—how efficiently, how wisely can you use human resources to optimize business? We are saving them human resources, saving them time, saving them money."
In addition, there are still some retailers out there in expansion mode. The Goldstein Group, for example, has been working with convenience store operator 7-Eleven on an aggressive expansion campaign throughout New Jersey. The firm also has been representing a number of local and regional concepts such as health clubs and children's party places in securing new locations.
"A lot of these tenants are now being given opportunities that they've never had before, namely spaces that landlords would traditionally only want [to fill with] nationally rated tenants," says Lanyard.
Taking these trends into account, many brokers have a rather optimistic outlook for the future, even in a severely strained environment. JP Morgan's Paolone forecasts that CBRE sales revenue will be down 22 percent in 2009 compared with last year and leasing revenue will be down 54 percent.
By 2010, however, national retailers will likely start expanding again, capital markets will begin to benefit from discount sales and all those groups launched to handle distressed real estate will see business skyrocket, says Bauman.
Real Capital Analytics, a New York–based real estate research firm, estimates there are 3,736 commercial properties in the U.S. showing potential for distress, with a value of approximately $80.9 billion. And that's not counting the 1,043 properties, worth $25.7 billion, that are already in various states of distress, including loan delinquencies, defaults and foreclosures.
Retail makes up $23.5 billion of assets currently identified as showing potential for distress, a dollar volume greater than any other sector of commercial real estate. Approximately $4.7 billion of retail assets are currently identified as distressed.
"I think 2010 will actually be a very solid year for the retail business," Bauman notes.