Why the Office Market is Recovering Slowly

I recently participated in a commercial real estate symposium where I was a panelist.  My topic was the state of the office market in Metropolitan Baltimore.  I was the last presenter so I had plenty of time to absorb the preceeding presentations. 

 

The one that caught my attention, unexpectedly, was entitled “Government Leasing Trends,” presented by a member of the team that provides real estate brokerage services to the State of Maryland.  Initially, I thought, how exciting can this topic be?  But, I was very surprised.  First I learned the state is driving the commercial markets with adoption of green building technology, which keeps occupancy costs low.  Next, I learned the state’s office space standard had decreased from 125 usable square feet (“usf”) per person to 75 usf.  A usable square foot is generally defined as one square foot of office floor space that can be occupied by a person, a desk, a file cabinet, etc.  The state’s new standard equates to floor space approximately the size of a rectangle drawn on the floor with dimensions of 10 feet x 7.5 feet.

 

I soon drifted off into deep thought pondering how my office space needs had changed over the ten years I have been in business.  I have moved twice.  First, I departed the central business district for Charles Village, a neighborhood just north of mid-town.  Paid parking in the former, free parking in the latter.  Second, I moved within my building, downsizing from an 855 usf suite featuring a reception area, two large private offices and a large conference room, to a 457 usf suite with a file room and one large open area for two desks and a conference table.

 

I have also changed the way I work.  Today, I usually insist on meeting my clients in their offices.  Their office space, after all, is the main topic.  By visiting my clients, I can better understand exterior factors:  the quality and image of the building, traffic patterns, visibility, pedestrian access, parking, signage and neighborhood texture.  Inside the building and their space, I can better understand how they use office space:  cubicles, private offices, teaming areas, conference rooms, technology and storage.  I can also assess the quality of the work environment:  natural light, fresh air, “flow” of the floor plan, ergonomics of the furniture and fixtures, filing standards and efficacy of mechanical, electrical and lighting systems.

 

I have discovered I need less office space due to my spending the majority of each day in the field.  I now use my office for the occasional meeting, for receiving mail and packages, for preparing reports, and for production activities such as printing, scanning, and shredding.  Finally, I use my office less and less for storing paper documents.  Increasingly, I store documents, communications and brochures in the cloud and on an external hard drive.

 

Returning to the decreased Maryland space standards and the stagnant Baltimore office market, I theorized that many businesses had changed their spaces needs as had I.  Technology, which had spelled doom for manufacturers of rolling file cabinets in the 1990’s, was now wreaking havoc among office building owners.  Multiple-terabyte capacity hard drives, scanners, email and cloud storage were all conspiring to reduce the number and size of offices, desks, file cabinets, fax and copying machines.  This unruly gang was even chasing employees away from the office party.  File clerks, secretaries, receptionists and administrative assistants were fading in number and value.  Now, I often pass an empty receptionist desk when entering a client’s suite.  Increasingly, my clients are turning to web-based phone answering systems that can answer and forward calls, or record a voice message - with or without transcription.  Fax machines are now virtual and send output directly to email. And with respect to multi-line desk phones and desktop computers, most of my clients use untethered smartphones and laptops with a Wi-Fi or cellular broadband connection.  That’s how I operate.

 

Just as my colleague was ending his presentation, I realized the current office market malaise would probably linger a bit longer as office users evolve, recalibrate and adjust to this new age of recession-induced, technology-enabled productivity.  Low-cost technology is the current alternative to real estate and employees.

A Meal or a Mess

Baltimore and New York City.  Two great American cities.

Two rival cities, as well.  I am not referring to the sports rivalries between the Orioles and Yankees.  Rather, I am referring to the intensifying rivalry for creative talent and thus a stake in the economy of the future.

What made me think of the rivalry between New York City and Baltimore was an announcement on Monday, December 19, by New York City Mayor Michael Bloomberg.  Cornell University, in partnership with Technion-Israel Institute of Technology, was selected the winner of a global competition for the right to develop an engineering campus in New York City on Governor’s Island.  Seven proposals were submitted by seventeen institutions.  Stanford University, the presumptive front runner, pulled out of the competition last Friday.   The winner of the competition were offered the right, at no land cost, to develop an engineering campus on Governor’s Island in the East River plus a $100 million contribution towards the cost of building infrastructure.  The total cost of the venture is projected to be $2 billion, of which $350 million was sourced from Charles F. Feeney, the billionaire Cornell alumnus who founded Duty Free Shops.  The package includes a $150 million venture fund expected to spawn 600 new firms that will create 30,000 new jobs and generate $1.4 billion in new tax revenue.  Cornell also committed to training 200 teachers annually and annually supporting 10,000 students.  Finally, constructing this new, 2 million square foot urban campus will create 20,000 construction jobs.[1]

Amazing!  New York City, the largest city in the country and the financial capital of the world, pivots on a dime in the middle of a deep recession to make a large wager on the economy of the future.  New York City leverages vacant land plus a $100 million investment into a $2 billion initial investment in human capital.    

Looking south towards Baltimore, what do I see? Another large municipality making a similar size wager on the economy of the future.   I see the State Center project.  This is a planned $1.5 billion mixed-use development project that will offer 2,000,000 square feet of office space, 25,000 square feet of retail space and 1,400 housing units.  This project is slated to replace the 932,000 square feet of existing office space owned and occupied by various agencies of the State of Maryland.[2]  We will not discuss the pending lawsuits.

I ask the citizens of Baltimore City and the State of Maryland to compare the Cornell/Technion engineering campus project in New York City to the State Center project in Baltimore.  First, compare the public resources each jurisdiction has wagered:  New York City - $100 million plus some vacant land; State of Maryland/Baltimore City – up to $200 million plus some vacant land.[3]  Second, compare the goals of each project:  New York City – human capital development, economic development, and a new source of tax revenue for generations to come; State Center – a depreciating office building asset, housing units that may only be built if they are heavily subsidized for low income/Section 8 tenants, waived real property tax revenue for 25 years, up-front developer profits, and a free parking garage for state employees.

Is this the best Maryland can do?  Why aren’t we investing our scarce resources to secure a commanding role in the future economy?  Why are we not investing in human capital, the benefits of which are described by Edward L. Glaeser in his book, “Triumph of the City?”  Wasn’t Mr. Glaeser a guest lecturer at a recent meeting of the Downtown Partnership of Baltimore?

When I think of the proposed State Center project as compared to the Cornell/Technion project, Thanksgiving comes to mind.  Growing up, I always marveled at my mother’s cooking.  She was the best cook in a family of seven girls and four boys.  She could transform readily available ingredients into a spectacular meal using her superb culinary skills and vast experience.  As a single adult living on my own, I once tried to replicate my mother’s Thanksgiving dinner.  I stocked my pantry, cabinets and refrigerator with everything my mother used.  I bought similar pots, pans and utensils.  I even used her recipes.  My efforts resulted in a big mess, wasted ingredients and wasted time.  I realized that my mother’s skills and experience made the difference between my big mess and her exquisite meal.

Returning to my comparison of the State Center project to the New York City project, I am concerned that twenty years from now, the State Center project will a be pile of bricks and mortar at the end of its useful life, while the Cornell/Technion engineeering campus will have become Silicon Valley East, training world-class engineers, conducting research with global partners, spawning start-ups, producing creative products, and attracting the brightest minds from around the world.

New York City and the State of Maryland are both staring into a pantry looking at the same ingredients.  Who will make a meal?  Who will make a mess?  I believe we have New York City’s answer.

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[1] The New York Times.  “Cornell Alumnus Is Behind $350 Million Gift to Build Science Schil in City.”  Richard Perez-Pena.  December 20, 2011.

[2] Maryland Daily Record.  “Md. moves forward on $1.5 billion State Center project.”  Andy Rosen. June 3, 2009.

[3] Ibid.

Sick and Tired of Being Sick and Tired

We are beginning to see a slow thaw in the commercial real estate markets.  This thaw is being driven by (1) institutions, (2) health care providers, and (3) small businesses.  While not enough to drastically reduce the high vacancy levels in retail and office properties, meaningful reductions in real estate could be apparent in the first quarter of 2012.

Arguably, institutions such as Johns Hopkins University, University of Maryland, Baltimore and University of Baltimore never slowed for the Great Recession.  With diverse funding commitments from large endowments, the National Institutes of Health (NIH) and wealthy benefactors, these three educational institutions continued their multi-billion building campaigns on their respective campuses.  Johns Hopkins Medical Institutions is nearing occupancy of Sheikh Zayed Tower and the Charlotte R. Bloomberg Children’s Center, a combined investment of $1.1 billion.  University of Maryland, Baltimore is constructing its $157 million expansion to the Shock Trauma Center, with its BioPark Building 3, a $40 million life science building, getting started.  Meanwhile, Mercy Medical last year completed its $400 million Mary Catherine Bunting Center.  In Mid-town, the John and Frances Angelos Law Center is being constructed at a cost of $107 million.  The growth of these institutional players will continue to anchor Baltimore’s economy and having a positive effect on surrounding real estate markets.

Primary health care providers, despite being unsure about the wild political climate in Washington, D.C. (remember “repeal and replace”?) find themselves no longer able to sit on the sidelines.  The U.S. Supreme Court announced this morning that it will hear the law suit challenging the Patient Protection and Affordable Care Act (Dept. of H&HS, et al. v. Florida, et al.) in mid-March, with a decision by early June.  Notwithstanding the pending U.S. Supreme Court case, many primary health care providers are proceeding with expansion plans, and have begun to commit to expanding clinical space and buying private practices to expand their networks.  It appears that the health care industry is betting on most of the Affordable Care Act being affirmed, thus creating more insured patients in 2014. 

Working on behalf of Total Health Care, Inc., our firm negotiated a lease for a new clinic at 700 Washington Blvd, in Washington Village.  This 4,000 square foot clinic opened on October 1, 2011.  Total Health Care continues to consider additional locations.  We are aware of three small physical therapy practices searching the Metro Baltimore region for new locations.  Our firm is also representing a physician in the acquisition of a building to be converted from retail space to medical office space.  As one more example, the former Bradford Federal bank branch located at the corner of York Road and Homeland Avenue was recently purchased by York Road Health Care, LLC and is being converted into medical office space.

Finally, small businesses, including our firm, are moving, renewing leases, downsizing and beginning to shake off the Great Recession with the blind faith that enough is enough.  Our firm is representing small (less than 3,000 square feet) tenants in the purchase of buildings and leasing of office space.  We recently negotiated leases on behalf of an insurance agent, a construction company and a non-profit.  Everyone is now sick and tired of being sick and tired.  May that attitude continue into the New Year!

Reality Case Study - Ripped from the Marketplace

Have you ever wondered, "What ever became of XYZ project?"

As a commercial real estate broker who either participates in or observes others participating in the hunt for real estate deals, I often wonder. Over time, every deal reaches its conclusion. Project A is sold to Investor B for $C. Asset D is withdrawn from the market because Lender E overpriced it and needed time to come to grips with reality. Project F dragged Developer G into bankruptcy, resulting in the unfinished project being sold to Investor H who plans to reposition it. Portfolio I sold quickly for a record high of $J. There is an ending to every story.

As an intellectual exercise and to have some fun, I have decided to select a current deal or project to follow. I will gather the facts and figures, offer my up-front analysis of the project and make predictions as to how it will conclude. I will rely on public records as much as possible. Where I cannot, I will make educated guesses based upon then current market conditions. Time will be the arbiter of my predictions.

Stay tuned while I cast around for an eligible deal for what will hopefully be an ongoing feature of my blog. Of course, I am always open to reasonable suggestions.

Move Over BRAC

At a luncheon for commercial real estate brokers hosted on May 25, by Corporate Office Properties Trust (COPT) at its newly acquired Canton Crossing Tower, COPT CEO Randall Griffin observed that while BRAC (the Base Realignment and Closure Act of 2005) may be heavily promoted as a big economic engine in the Baltimore-Washington, D.C. region, work being done by Federal government agencies and their contractors in cyber security may prove to be a far greater economic engine and anchor for our region. He further opined that with the construction pipeline for Class A office buildings near empty, 2011-2012 could see a spike in office occupancy levels along with a corresponding spike in Class A office rents. His friendly advice to the commercial brokers in attendance was to begin focusing more on office users who are involved in cyber security.


That is news we can use!


COPT's commercial real estate broker luncheon at Canton Crossing Tower was set in a former penthouse residence on the top floor of this 17-story, 474,000 square foot office building. The luncheon provided a unique opportunity for my fellow brokers and me to enjoy the exquisite culinary offerings of the Blue Hill Tavern. We dined while peering through the floor-to-ceiling windows at Baltimore's Inner Harbor, Fort McHenry, Harbor East and the working waterfront.


Landlords use broker events as marketing vehicles to let brokers experience a property that is being offered for lease. Landlords capitalize on the fact that brokers, being brokers, can seldom turn down free food, chances to win door prizes and the convenient opportunity to talk deals and market scoop with colleagues.

Rand Griffin wisely seized the opportunity to offer his thoughts on the big picture. He guessed correctly that his audience would be more interested in learning his perspective on the economy, financial markets and office markets than hearing a recitation of project details. After all, we had been mixing and mingling with the listing brokers and COPT's in-house leasing team throughout the luncheon.

Rand's expertise in the Class A office market is derived from his experiences developing and operating a large, high quality portfolio. COPT is one of Maryland's largest private office landlord, owning and operating 197 building with 13.6 million square feet. COPT owns 268 properties in six states (AL, CO, MD, NJ, PA and VA) containing over 20 million square feet. COPT's business model is to offer Class A office space to Federal government agencies having an alphabet-soup of names such as NRO, NSA, NGA, DoD, GSA, DISA and CIA. COPT derives 56% of its revenue from government agencies, 30% from government contractors and the balance from first class businesses such as CareFirst BlueCross BlueShield.

Thanks Rand Griffin for your insight. Your optimism is encouraging during these challenging, uncertain times.

Is Microsoft Becoming Irrelevent?

Say it isn't so!



Microsoft (MS) is becoming irrelevant - calcified to accelerating change in the tech market, reacting to yesterday's news, not actively participating in defining or divining markets for tomorrow's services and products. I have even read reports of the best and brightest college graduates spurning MS for Google and facebook.



How did that happen? Perhaps I am over reacting to just a slight lull in the marketing prowess of a tech giant. Or maybe not. In this era of the 24 hour news cycle, a BlackBerry tethered United States President, on-air correspondents Tweeting while cameras roll, and facebook eclipsing Google as the most popular web site, something is different.



I just read an interesting article on CNNMoney.com (a co-sponsored feature with Fortune) describing the state of the mobile computing world. (See the link.)

MS, while tarnishing the upgrade of Windows XP with the ill-fated Vista, ceded market leadership in search to Google, and then began ceding market leadership in mobile computing to Apple. Windows 7 has rescued the MS brand in desktop computing. Bing is making inroads in search. Will Windows Phone 7 be the next Vista or Windows 7? Windows Phone 7 is scheduled to be released, according to PC Magazine, during the 2010 holiday season. MS is promising a new experience, Hubs and Apps. Apple, meanwhile, is 75 million iPhones and 4 billion apps down the road. Android is gaining share. Palm had to seek shelter in the arms of HP. And Nokia's Symbian, what is the new release date, again? As of today, the stock market capitalization of Apple is $241 Billion, versus Microsoft's $270 billion and ExxonMobil's $325 billion. Something has changed.

What does this have to do with commercial real estate?

Has the cataclysmic shock experienced by commercial real estate in the Great Recession changed the course of business as usual? If so, how? Many suspect things have changed. We hear the terms "deleveraged," "falling valuations," "distressed assets," "workouts," "record high vacancies," and "bank failures." How has your commercial real estate business adapted to this new reality? What is the new reality? Who will be the next generation of winners, loosers, or has-beens? Has your service delivery platform migrated from desktop to mobile and then into the cloud?

Stay tuned.

Live within your means

One of my relatives recently admitted that for last six months, she had been afraid to open her monthly 401(k) investment account statements for fear of the certain very bad news. Ignoring them would make the bad news go away. When she finally opened the statements, she realized her fears and just cried. For many American workers who have worked hard, lived within their means, and saved religiously, the recent meltdown in the economy is almost a repudiation of the American dream. The worst is yet to come, in some instances. Decisions such as when to retire, whether or not one can afford to retire, and the life-style that will be enjoyed during retirement have all been pre-empted. Bigger issues such as job loss, loss of medical benefits, eviction and car repossession are more pressing.

I expect the current near-depression recession will leave its scar on the and “millennial” generation similar to the way the Great Depression scarred the generation of my 86 year old parents. Growing up during the Great Depression forced my mother and father to be extremely conservative with financial and physical resources. When I was growing up we rarely splurged on restaurants, except for the occasional McDonald’s. We ate well but my parents believed in buying in bulk, buying on sale and growing many types of vegetables in our large backyard garden. My parents drove the cheapest cars offered, all without air conditioning until the 1980’s. We wore the most practical clothes and enjoyed simple vacations. Once we splurged to see the World’s Fair in Toronto – what a treat, I can remember. The one area with relaxed spending limits was education - they placed very few estarints on books, magazines, educational experiences and college tuition.

So what’s this got to do with real estate? I believe the current near-recession depression will leave a lasting imprint on the real estate industry.

Some may say, “But have we been through down cycles before.” True, even recently: the high inflation of the early 1980’s, the savings and loan disaster of the late 1980’s, and the dot-com boom and bust of 2001- 2003. They were all pretty bad, but the damage they inflicted was localized.

The recession of the early 1980's resulted in high inflation and interest rates for cars and home loans in the upper teens. Didn’t work for or have money in a failed savings and loan? That’s ok. Your savings account, retirement, job and home were all safe. The greedy unskilled bankers and the greedy, crazy, real estate developers took the direct hits. Never heard of the dot-com boom until after it was over? That’s ok. Only venture capitalists and other investors in dot-coms took the direct hits. Oops, I almost forgot about the thousands of unskilled, inexperienced, naïve, young geniuses who got fired from made-up positions at shouldn’t-have-been-started companies.

As for average Americans, we still had our jobs, our houses, our savings accounts and our health benefits.

This time is very, very different, though.

Who hasn’t been impacted by the current recession? Those who were never directly involved have been equally decimated along with those who were very involved. Stock markets: off 40% [based on DJIA close of 8,473.29 on 5-26-09]. Home housing prices: off 25 – 50% [Case-Shiller Index, National Association of REALTORS®]. New home construction starts at their lowest levels since 1945. [Bloomberg.com] Domestic auto industry: 2 of the Detroit 3 producers in or near Chapter 11 bankruptcy. Banking industry: alive, but on a $1+ trillion lifeline from the U.S. Treasury. Retailers: sales have declined in 13 of the first 16 months in 2009 [National Retail Sales Estimate, ShopperTrak RCT Corporation] Dozens of retailers such as Circuit City, Linens ’n Things and Mervyn’s have closed. Commercial real estate: Nationally, sales volumes are down 80% and sales prices are down 17% year-over-year as of February 2009 [Real Capital Analytics]. Unemployment: 8.9% and rising. Jobs: 5.7 million lost since recession began in December 2007 [Bureau of Labor Statistics]. Job losses have been so large that the April job loss of 590,000 was celebrated as a positive sign. Bank failures: 36 to date, more than the last five years combined [FDIC].

In other downturns, we as a society learned crisp lessons writ large in the headlines of the day:

Savings & Loan Crisis: Speculative development is bad. Don’t start a project without at least 50% of the project pre-leased to financially solid tenants.

Dot-com Bust: Real sales, real earnings and real products are the only reality. Dreams are what you experience while sleeping. Adults must still be in charge.

What is the lesson this time?

A consensus appears to be growing in the popular press and among my clients, friends and family: Live within your means and save for a rainy day. More and more people are beginning to admit that we, average adults in the United States, were not living prudently within our means. We spent money we had not yet earned using credit card cards and home equity lines. We drove cars that cost too much and were too inefficient. We saved too little. We lived in houses that were too large. Corporations borrowed up to their eyeballs on unrealistic expectations for future earnings and confidence in the ability to refinance debt. Businesses assumed that an economy fueled by extravagant consumer spending would endure for the ages. Commercial real estate owners, developers and investors assumed that prices, values, rents and demand for real estate would continue their upward spiral. So now we know.

Going forward, I predict that commercial real estate decisions will be driven by one simple question: does this decision support a society living within its means?