The Ground Floor

Top Four Markets for Real Estate

This post was written by Trisha Riggs, vice president of communications for ULI.

Washington, D.C. ranks as the top market in the United States for real estate investment and development, which, in the current economic environment, means it is the least troubled. So says the 2010 version of Emerging Trends in Real Estate®, released this week at ULI’s Annual Fall Meeting in San Francisco.

The widely anticipated annual industry overview, copublished by ULI and PricewaterhouseCoopers, was based this year on a record number of surveys and interviews with more than 900 developers, investors, brokers, analysts, researchers, appraisers, and academics. The overriding sentiment: No one is bullish on any particular market--even the perennial favorites such as Washington. Still, despite the faint enthusiasm, the report notes that "markets performing well before the crash will perform better coming out of it, while those lagging before will continue to lag."

The top four markets--all of which are gateway, 24-hour cities heavy on brain power with significant geographic barriers to entry:
• Washington: "Always the top market during recessions, buffered by the federal government;"
• San Francisco: "Highly volatile, but bounces back quickly;"
• Boston: "All those universities help buffer the market;" and
• New York: "Wall Street is down, but not out and always reinvents itself"

The number five market, Houston, is not a gateway city, but is an energy capital with a talented workforce, says the report.

Out of favor: manufacturing centers (mainly in the Midwest); secondary or tertiary cities requiring a flight connection to go overseas; formerly high-growth markets now suffering from overdevelopment and a bubble burst; and places where most development has been concentrated on the fringe.

Emerging Trends predicts that investment and development will start to pick up steam in a couple of years. In the meantime, those who are in a position to do so should buy or hold multifamily; buy hotels; buy distressed condos and second homes; buy land; buy or hold industrial; hold office; and apply a "triage" approach to retail.

Looking past the recession, "The future is about green development, infill, and transit-oriented development."

Demographics of the Next Decade Will Transform New Housing and Retail

This post was written for The Ground Floor by Robert Krueger, communications associate with the Urban Land Institute.

SAN FRANCISCO -- There is no doubt that the big question at this year’s ULI Fall Meeting is what the U.S. and international markets will look like once the recession is over. For those in the industry, they realize that this economic downturn is uncharted territory and uncertainty for the future leads to many unanswered questions. A session panel focused specifically on the next decade and the implications that changing demographics will have on commercial real estate and land use patterns. Specifically, the panel answered the question of how people of the next decade will live, play, and shop.

The panel discussed two main demographic groups that will drive the next decade’s housing market: Generation Y and their parents (the aging baby boomers). As one panelist, Deborah L. Brett, president of Deborah L. Brett & Associates, stated that the demand from these two generations will determine the location of housing and heavily influence the success of retail and office space. 

James H. Johnson, director of the Urban Investment Strategies Center at the University of North Carolina, got more specific by addressing what he called 'disruptive demographics."”  With this, Johnson referred to changing demographics that are seriously altering real estate development and needs that have been in place for over a generation.

"The browning and graying America will transform all of our political and economic institutions, but especially real estate," said Johnson. "Increased minorities, immigrants, and seniors make up this package."

Brett pointed to the implications of these two generations as well as other statistics that are changing the market.  These include:

• Little or no growth in purchasing power due to the expectation of continued stagnation of household income over the next decade.

• Changes in the work place, such as delayed retirement, working from home, and computer based virtual meetings instead in-person less business travel.

• Greater diversity in housing since there are more single households, nontraditional households comprised of multiple roommates, and more minority and immigrant groups.

Will commercial real estate be in a position to handle these changes? In a publication released at the Fall Meeting, Five ULI Fellows Present Ideas for the Next Years, ULI senior resident fellow John McIlwain, said that these two groups and other changing demographics "will bring long-term growth to cities and help redevelop town centers. The bad news is that it is unlikely that enough new housing can be built in urban areas to meet this growing demand.  The result is likely to be rising urban housing costs--good for developers and owners and bad for homebuyers and renters with limited funds."

New Models for Resort Development

This post was written for The Ground Floor by Robert Krueger, communications associate at the Urban Land Institute.

SAN FRANCISCO -- What will resort development look like in a post-recession economy?  As investors experience the worse market collapse in a generation, the best and most talented professionals in the resort development industry have taken advantage of the current economic climate by researching and reinventing themselves so that they are better prepared for when people start buying again. During a session at the Urban Land Institute’s 2009 Fall Meeting in San Francisco, a few of these developers spoke about what innovative solutions are paying off and the industry transformation that they are experiencing.

The consensus of the panel appeared to be: The future of the resort will emphasize social and environmental responsibility. According to one panelist, Brian De Lowe of Viceroy Hotel Group of Los Angeles, California, the "resort development model of the past is dead." Lowe said that there needs to be a revised model for the industry that makes projects more adaptable to the market. There needs to be a diverse combination of brands instead of the "traditional resort." The old method of stamping out traditional-style resorts will not work in the future. He presented a "Triple Bottom-Line Thinking," which weaves the need to make profit with a wider balance of social and environmental responsibilities for the local community. While sustainable development is not a new concept, Lowe emphasized how this approach is attractive local governments. Particularly in tough economic times, partnering with government can help relieve some of the costs.

"Governments like being involved with such developments," Lowe said.  "They feel that they are helping to protecting the area's human heritage and natural landscape . . . such measures are attractive to buyers since it adds to an authentic experience that is unique."

Rebecca Zimmerman, president of Design Workshop, later spoke of what it means to be simple, in regards to amenities. She highlighted the need to create experiences and going back to nature." Social connection is truly important," she said. "Now, people need people, and people find social nourishment by engaging with others."

She emphasized that when people begin buying again, what they will look for is places that show social and environmental awareness. In addition, Zimmerman stated that simple, natural amenities are critical to attracting knowledge-based workers.

She pointed out the fact that 82 percent of the U.S. population walk outdoors for either fun or exercise and that such numbers show the growing trend of the future: a desire for simple amenities that do not cost $50 million each.

"It is about being simple and bringing people back to the places that are already built," Zimmerman added. "More is no longer better. The key is simple…but connected. What are needed are such things as easy acquisition to airports with daily flights to major cities. Economic growth is a combination of amenities, telecommunications, and availability to air travel. This brings a whole new obligation to sustainable development."

Paranoid Optimism: The Best Attitude Toward Economic Recovery

This post was written by Trisha Riggs, vice president of communications for ULI.

"Paranoid" optimism--a belief in the ability to overcome the negatives that could be coming--may be the best attitude to take regarding the economy’s recovery, according to renowned economist Bill Emmott. The former editor-in-chief of The Economist provided a global economic outlook during yesterday’s opening session of ULI’s Annual Fall Meeting in San Francisco.

Borrowing an analogy from former U.S. Department of Defense Secretary Donald Rumsfeld, Emmott said that moving from recession to recovery might best be analyzed by considering the "known knowns" versus the "known unknowns."

Among Emmott’s known knowns: 

• An economic recovery is underway to some extent in most countries, with the rebound in the U.S. and Western Europe being more gradual while China and India will be more immediate.
• Economic globalization and openness to cross-border trade has remained intact. "We are seeing some sense of global sharing of the rebound," Emmott said.
• A continuation of the fiscal stimulus in the U.S. and Western Europe helps to keep the momentum going.
• An acknowledgement that consumers remain cautious and that consumer spending will not lead the recovery.
• The likelihood that more government-funded programs will be created in the U.S., China, and Japan.
• The likelihood of tighter financial regulation in the U.S. and the U.K.

Among the "known unknowns":

• The extent to which consumers and corporations will pay down debt.
• How quickly eliminated jobs will be recreated.
• How quickly the value of Chinese currency will be re-evaluated in relation to the dollar. Quicker re-valuation so the currency is not artificially low would benefit world trade and revive U.S. exports, Emmott noted.
• The future of oil prices, which as yet have not reflected the global recession.

The known unknowns, Emmott said, have created a course of "uncharted waters" that could change the character of the economic recovery. His reasons for optimism: a belief that job growth will occur sooner rather than later; faith in the flexibility of the economy, particularly that of the U.S.; and encouraging prospects for U.S. exports.

"Be realistic but positive," he advised ULI fall meeting attendees. "There is much we do not know, but new situations bring as many positive possibilities for growth and change as negative ones. Paranoid optimism is the right feeling to have as we move forward."  

24th European Photovoltaic Solar Energy Conference & Exhibition

This post was written for The Ground Floor by Rick Abelson, ULI Council Member, and director at Online Land Planning in Redondo Beach, California.

The world’s largest solar PV conference was held September 21-25, 2009 in Hamburg, Germany. Online Land Planning had a chance to attend and used the event as an opportunity to understand the key players, learn about new technology, latest trends and assess the current state of the industry. Here are a few impressions of what I heard and saw:

1. The solar PV industry appears quite mature and poised to launch in dramatic fashion once global capital markets rebound and cash becomes available.  Japan, Germany and the U.S. remain the technology leaders. But now, there is overcapacity. So the goal is to maintain margins as prices get cut based on competition.

2. Solar PV manufacturers are being cautious about expansion and instead are focused on building market share. They are strategically looking for new opportunities in the 50-100 MW range.

3. To offset this concern and meet the pressing demand, a special ‘solar economic zone’ where a public – private partnership offers a business park setting, shared resources, tax and trade credits, green jobs, training and no government interference throughout the entire value chain - was proposed by India.

4. Governments trying to lure solar PV business into their regions have plenty to choose from as new competition enters the industry. As a result, third-party industry experts are now being asked to make independent evaluations on business plans to determine which companies will get government incentives. 

5. Grid parity is still considered a nearly a decade away.  But when it occurs, the solar PV industry is considered boundless in terms of financial potential, thus the continued investments to reach this milestone.

6. Solar PV farms, consisting of different applications including condensers, modules and reflective mirrors are the most ubiquitous large-scale applications. In populated areas and small countries, they take up a large amount of land, require constant maintenance and have poor visual quality.

7. Solar PV makes the most sense to alleviate 'brown outs' in many parts of the world where the demand for electricity is highest during the day and correlates to when the sun is shining.

8. Solar PV manufacturers are beginning to include vertical integration into their business models such as developing utility size power plants to capitalize on their output as they predict the future of the energy market and how power will be distributed.

9. The biggest technology drawback to solar PV is that the power produced must be used right away. It cannot be stored efficiently and affordably.

10. Uncertainty of the market has made leading solar PV companies unwilling to share lessons learned and competitive data with the industry.

Real Estate Outlook: the Good, Bad, Ugly

The extraordinary level of job losses in the United States, currently at about 700,000 a month, is creating a black hole of uncertainty that is having a ripple effect worldwide on productivity, business investments and consumer spending, according to market analysts at ULI’s recent Spring Council Forum.

The high unemployment is fueled by the fact that relatively few new jobs were created during the recovery following the dot-com bust and the mild recession of 2001-2002, explained Hessen Nadji, managing director of research services at Marcus & Millichap in Walnut Creek, Calif.

The overwhelming number of white-collar and blue-collar workers now laid off is affecting and will continue to affect all segments of real estate, with improvements likely coming later rather than sooner, he noted.  Nadji pointed to a spending pullback by consumers who are still employed, as well as those who have lost jobs. (The national savings rate has risen to 5 percent from zero in 2007.) Those who need to borrow money have “nowhere to run,” and they are “tapped out and paying the price,” he said. 

A key factor in restoring consumer confidence: a housing market rally, which is not expected in the months ahead. In a market overview, Nadji noted that while home sales seem to have bottomed out, pricing has not, with prices down nearly 20 percent overall from their peak more than two years ago. Currently, Marcus & Millichap is predicting that home prices will continue to slip into 2010, before starting to trend back upward. Regarding sales, Nadji said the recent higher numbers reflect more foreclosure sales, rather than an uptick in sales by homeowners. On a national basis, the inventory of homes on the market -- currently a nine-month supply -- needs to shrink to a four- to five-month supply before a lasting rally will occur, he said. The firm’s top five housing markets: Austin, Texas; San Antonio; Oklahoma City; Houston; and Washington,D.C.The bottom five: Phoenix; Detroit; Inland Empire, Calif.; Charlotte, N.C.; and Orlando.

In terms of commercial real estate, while vacancies are up in all market sectors, relatively little overbuilding has occurred, with the exception of the retail market, Nadji said. As a result, while the office market has been affected by high job losses, vacancies are not as severe as they would have been had an excess of space been built prior to the recession. There are lucrative purchasing opportunities in the office market for those who are in a position to buy, he noted. Despite the layoffs in the financial sector, New York City, with a vacancy rate of about 10 percent, tops Marcus and Millichap’s list of healthy office markets. Detroit, with an office vacancy rate exceeding 25 percent, ranks as the worst.

Cuts in consumer spending have severely hurt the retail sector, with store closings this year expected to nearly triple the 2008 level of 7,000 closings, said Bernard Haddigan, managing director, national retail group at Marcus Millichap in Atlanta. The retail operations most likely to remain stable are the necessity based stores such as grocery stores and pharmacies, as well as discounters, he noted.
San Francisco ranks as Marcus and Millichap’s most successful retail market, with a vacancy rate of about 4 percent; while Cincinnati ranks at the bottom, with a vacancy rate exceeding 13 percent.

In the commercial market, the apartment sector shows the most promise in terms of a rally, with as many as five million echo boomers entering the housing market starting in 2011, the panelists said. With apartment construction at a standstill and few new projects planned, demand will outstrip supply when the economy improves, and echo boomers start getting jobs and “stop living with their parents,” Nadji said. New York City currently top’s Marcus and Millichap’s list for apartment markets, with a vacancy rate of under 4 percent, while Jacksonville ranks as the worst apartment market, with a vacancy rate of nearly 13 percent. 

Repositioning Your Company to Weather Difficult Times

Outlasting the economic recession requires a thoughtful business strategy that includes acting quickly and decisively to adjust staff; staying within core competencies; conserving as much cash as possible; avoiding any unnecessary expansions; and communicating frequently with employees, investors and other stakeholders. According to two land use industry veterans and longtime ULI leaders, implementing such a plan can help real estate companies survive the slump and be better positioned to thrive when the upswing begins.

Peter Rummell, chief executive officer of the Nicklaus Companies in Jacksonville, Fla., and J. Ronald Terwilliger, chairman of Dallas-based Trammell Crow Residential, recently shared their insights company repositioning during a ULI webinar moderated by Gadi Kaufmann, managing director and chief executive officer of RCLCO/Robert Charles Lesser & Co. in Bethesda, Md.  The webinar was part of an ongoing online series sponsored by ULI on topics related to the economy and the outlook for the industry.

Rummell and Terwilliger, both developers, based their advice on experience gained from weathering recessions during the past three decades, with Rummell applying lessons learned while at the St. Joe Company and Disney, and Terwilliger at Trammell Crow Residential. While none of the previous recessions, including the last major real estate recession in 1991-92, were as severe as the current one, the actions taken then provide a solid framework for battening down in today’s environment. Having a clear, actionable plan, said Rummell and Terwilliger, is the key to moving a company forward – even slowly – in a down market.  “Hope,” noted Rummell, “is not a strategy.” 

“Defining the problem is the first step,” Terwilliger said. In the case of real estate development, he said determining the right course of action requires using the best information available to 1) weigh demand versus supply, factoring in long-term projections for both; and 2) calculate the probable timing of a turnaround. Defining the problem also entails determining the impact of the current situation on cash flow, and which actions a company can take to improve projected cash flow, such as cutting overhead.
 
According to Rummell, it is critical to remember that “time is your enemy,” meaning that when the need for staff cuts becomes apparent, the decision for reductions must be made quickly. “It is a human tendency, particularly if you are in real estate, to be an optimist, to assume that things will get better. These are tough decisions, and we want to put them off, because you never think that you have to do what you really have to do.”  However, he said, dragging out cutbacks not only hurts morale, but adds overhead during a time when the company can least afford it.

Both Rummell and Terwilliger advised carefully sizing up who should be retained, avoiding the desire to base such decisions solely on seniority. “That (seniority) cannot be the most important determinant,” Terwilliger said. “Keep the people you want to be with you going into the next up cycle. Look for cross-over opportunities to place people in new roles. Keep your best players, because you will not be able to hire them back.”

“The criteria for best may not be the smartest, or toughest, or the biggest producer. In an organizational culture, you have to think about who best compliments the organization, who brings the best chemistry, who makes things happen.” Rummell said.

Another key survival tool is to stick with operations that have a proven track record for the company, according to Rummell and Terwilliger. “Remember what business you are in,” Rummell said. “We all forward-integrate into new opportunities in good times, but when things slow down, it is hard to let them go. This doesn’t mean there aren’t opportunities to consider, but make sure they are time-tested and stress-tested, so you can do them for the long run. Don’t kid yourself about overhead allocations and long-term values.” 

Using Trammell Crow Residential as an example, Terwilliger noted that the company’s core business is the development and sale of market-rate, multifamily rental housing. Although the company had entered into other operations in previous years, it has reverted to its core business. “(During up cycles) many of us tend to get stretched a little thin and forget what our core strength is,” he said. Consider the near-term and intermediate-term outlook for the primary business, Terwilliger advised, noting that is it highly risky to delve outside core operations if there is no apparent competitive advantage.

A fourth component of a survival strategy is to conserve as much cash as possible to stay afloat during the credit crisis, said Rummell and Terwilliger. “Liquidity is essential to paying the bills and staying in business,” Terwilliger said. “If you run out of cash, you run out of business.” He advised testing the duration of revenue by preparing different scenarios that allow for sufficient cash reserves under the worst case conditions, and for sharing such a plan with investors, lenders and other stakeholders. In addition, Terwilliger said is it important to minimize or eliminate non-essential outlays, including new pursuits or expansions. “Defer new development when financing is uncertain. Be realistic,” he said.

“If they don’t conserve cash or make cash, those (ventures) are the enemy,” Rummell said. “Cash is king, and there is no queen. If you remember that in the good times, you don’t have to re-learn that in the bad times.”

During a time of such unprecedented economic uncertainty and market volatility, it is critical to communicate well to those “who will lead you into the future,” Terwilliger said. “Be honest. Don’t be Pollyannaish. But, share your vision and keep your team informed.”

Rummell pointed to the wisdom of seeking the advice of a trusted female – specifically, he advised men who are married to follow the intuition of their wives. “Listen to your wife,” he counseled. “Women have a sense about people and situations that men don’t. It is an amazing tool and it should not be ignored.”

Transit’s up, driving’s down: Have we reached the tipping point?

This post was written for The Ground Floor by Robert Dunphy, senior resident fellow Transportation at the Urban Land Institute.

Transit is up, and driving is down--have we reached a tipping point where Americans finally renounce their love affair with the car and adopt more sustainable transportation? The latest national travel data shows transit ridership, spiked in part earlier this year by the runup in gas prices, continued to grow despite the collapse of prices at the pump. Transit ridership reached 2.8 billion trips in the third quarter, a 6.5 percent jump from the same period last year. During the same period, driving continued to decline, not quite as much as during the summer, but a still significant 4.5 percent.

New Ridership Record Shows U.S. Still Lured to Mass Transit

So both driving and transit are headed in the right direction from a sustainability perspective, how do they compare in absolutes? Not very close, unfortunately. The number of transit trips increased 174 million in the quarter, so the total miles traveled by those riders, using a standard 5 miles for the average trip distance, comes to an increase of 876 million - just under a billion passenger miles. The Vehicle Miles of Travel (VMT) for the same period, for all types of vehicles, including trucks, declined by 35.5 billion. That would put transit’s share of the decline in driving at a mere 2.5 percent. No surprise, really. As New York Times journalist Paul Krugman wrote, “as of 2005, only 4.7 percent of American workers took mass transit to work. Paul Krugman: Conscience of a Liberal, NYT Blog, May 10, 2008, Sick transit and all that. “So even a 10 percent surge in mass transit ridership would take only around half a percent of drivers off the road”. So the trends are helpful in reducing driving, but hardly transformational. What’s going on?

A July survey by NuStats in found that, indeed, two out of three respondents reported driving less, but largely by combining trips, eliminating trips altogether, and working from home. The use of public transit as a replacement for driving ranked behind combining and eliminating trips, using a more fuel efficient car, working from home, using toll roads to save gas, and car pooling. Even walking instead of driving was more common than public transit. The outlook for transit was more positive. If gas prices stayed at the same level in the future, respondents said that transit was the most preferable option to driving among all other travel options except for choosing a more fuel efficient vehicle.

The survey suggests that the greatest potential for reduced driving lies not in expanding public transit to serve new riders, but to focus growth in areas where it supports established transit, where residents have options for shorter trips, combining trips, and walking, as well as public transit. In New York, for example, the Metropolitan Transportation Authority calls for land use strategies that will capture two-thirds of new VMTs in the region.

As Krugman points out in his blog, “The point isn’t that nothing can be done--it’s just that serious reductions in driving would require a lot of long-term rearrangement of the way we live. It will come--but not quickly."

Thoughts on Property Tax

This post was written for The Ground Floor by Bill Hudnut, senior resident fellow/Joseph C. Canizaro Chair Public Policy at the Urban Land Institute.

How about restructuring the property tax across America to install a two-tiered system? More tax on those horizontal pieces of empty land and asphalt, less on the buildings. That is, reduce the tax rate on homes and other improvements, and substantially increase the rate on the site value. I think such a system would induce more compact development and more infill work. 

Pittsburgh has used the system for years until problems arose with the way assessments worked out, as my colleague and former Pittsburgh Mayor Tom Murphy has told me. Nonetheless, if assessments are fair, the higher land tax would bring vacant or woefully under-used central sites into use, giving new life to inner cities and reducing sprawl. It would also stem land speculation, which is the big engine behind house price escalation, thus stabilizing neighborhoods and keeping sale prices and rents more affordable. The land tax returns to government--the values it creates with bridges, roads, and other infrastructure--helping to pay for maintenance and necessary improvements.

Years ago, in 1972, ULI issued a Research Monograph (No. 19) by R.W. Archer, discussing the Australian States' use of the site value system of taxation. It quoted an American land economist, Professor M. Mason Gaffney: "If the real estate tax as it continues to grow (in America) is not to scorch the earth, it must be modified to exempt improvements. That can be done by focusing it on the base of land value or site capability, which not only permits improvement but positively prompts it." In short, a two-tiered property tax system taxes land and building values separately. Higher taxes on the land, lower taxes on the building, discourages a land holder from leaving his land fallow and speculating on its increased value, and conversely, encourages improvements on the land and redevelopment. The monograph used Sydney Australia as a case study, but its general point, that a site value tax system puts "pressure on owners to sell their property for redevelopment if they cannot or will not redevelop it themselves."

1972 was over a quarter of a century ago; but could there be here an idea whose time has come?

Green Building Still Strong

The U.S. green building market is accelerating at a dramatic rate, according to two surveys released this week. According to McGraw-Hill Construction's Green Outlook 2009: Trends Driving Change report, the value of green building construction starts was up five-fold from 2005 to 2008 (from $10 billion to $36-$49 billion), and could triple by 2013, reaching $96-$140 billion.

Autodesk, Inc. and the American Institute of Architects (AIA) noted an increase in the implementation of sustainable design practices from architects and building owners in the 2008 Autodesk/AIA Green Index. In addition, it shows that architects' clients have experienced a doubling in the market demand for green buildings over the past year as well as positive shifts in architects' attitudes toward their ability to impact climate change.

A major finding of the 2008 Green Index was that 42 percent of architects report clients asking for green building elements on a majority of their projects, with 47 percent of clients actually implementing green building elements on their projects, an increase of 15 percent from 2007. Sixty-six percent of surveyed architects citing client demand as the primary influence on their practice of green building.

Architects believe that the primary reasons their clients are asking for green buildings are reduced operating costs (60 percent), marketing (52 percent) and market demand (21 percent, up from 10 percent in the 2007 survey). 

McGraw-Hill Construction attributes green building's rapid expansion to growing public awareness, an increase in government regulations, and recognition of bottom-line advantages. In response to the rising client demand for green buildings, architects are increasing their use of certain sustainable design practices.

According to AIA’s survey, 34 percent of architects are now implementing green or vegetated roof coverings on more than half of their new projects, compared with 7 percent of architects in 2007. Also, 39 percent are using renewable, on-site energy sources, such as solar, wind, geothermal, low-impact hydro, biomass or bio-gas on over half of new building designs, compared with just 6 percent last year.

Green building is the bright spot in an otherwise tough economy. U.S. Green Building Council members report green building to be less affected by the down market compared to nongreen building, and homebuyers are willing to pay more for a green home.

Perceived economic benefits are driving green building, including higher revenues, lower lifecycle costs, and lower operating costs, but builders and buyers are also motivated by health benefits, new government regulation, and pressure from global competition.