America's Heartland: Opportunities in
the Midwest
At the recent AFIRE Spring Conference
in Chicago, speakers discussed real estate investment opportunities
in that and three other urban centers -- Denver, Dallas-Fort
Worth and Minneapolis-St. Paul. Presenters, respectively,
were Bart Woloson , Senior Director of Cushman & Wakefield;
Peter Savoie, Executive Vice President of Cushman &
Wakefield; Frank M. Aldridge, III, President and CEO of
Circa Capital Corporation; and Frank J. Dutke, Senior Vice
President of United Properties.
The four speakers described markets with a variety of economic,
geographic and other factors influencing trends and opportunities,
and each began with a characterization of his subject city's
current overall economic situation. All noted some degree
of caution related to local and nationwide slowdowns in
economic activity, but the degree of such concern varied.
Not surprisingly, each also noted significant positive economic
trends in his city's economy over the past ten to 15 years.
On the subject of real estate markets, the most notable
similarity was that each mentioned differences between suburban
and downtown districts, and each of the cities had a distinct
downtown/suburban makeup. Peter Savoie talked extensively
about the market for office space, while the others addressed
the broad spectrum of real estate markets in their cities.
Describing Denver, Savoie started out with the prediction
that "Denver will see a significant increase in the
amount of institutional [investment] from foreign sources,"
due especially to what he described as a "dramatic
change in the dynamic in Denver's economy" from 1990
to 2000. In that time, he noted, the service sector has
grown significantly, the large government sector has remained
stable, and the extent and diversity of other industries
active in the city has increased. In 2001, he said, the
list of the city's largest office tenants includes few industries
and even fewer individual entities than were on the list
in 1990.
Frank Dutke described Minneapolis-St. Paul's as a stable,
diverse economy currently experiencing moderate growth.
This follows a period of more robust growth which was characterized
by prolonged increases in jobs and population. He described
a transition in the real estate cycle in the area also known
as the Twin Cities, but also noted that "our retail
market is stable and healthy and we have a very tight housing
market." Ongoing strengths of the local economy include
its diversity both across sectors and in the size of the
business entities.
Bart Woloson summarized Chicago's economy as a "moderately
performing mature economy," and he noted several phenomena
associated with that maturity. Chicago has a stable, strong,
diversified economy, he said, which typically grows a little
bit more slowly than the national average. Its diversity
across sectors (it is a center of finance, transportation
and manufacturing, and other sectors have a heavy presence
as well) contributes to this lag. Recent layoffs, he said,
have been "significant [in number] but not really in
the big picture" -- they've totaled about a quarter
of one percent. Chicago's per capita incomes are fairly
high, he said, and retail is always strong. As challenges,
Woloson mentioned the high cost of doing business arising
in particular from taxes, the city's net out-migration (20,000
people in each of the last several years), high exposure
to restructuring industries and the high cost of housing.
Opening on the subject of the Dallas area, Frank Aldridge
said "Texas is a big state with inhabitants who think
big." He went on to discuss the big job growth and
population growth that characterized the area's economy
over the last decade and a half, noting that in the 1990s,
750,000 single-family homes were authorized. He also noted
some big challenges and big opportunities. "With growth
like this comes risk," he said, and mentioned that
areas in the state that are dependent on a single industry
may face slower economic growth for several years. Nevertheless,
Aldridge described the Dallas-Fort Worth (DFW) economy specifically
as "one of the healthiest and most diversified in the
country," and said that Dallas is ranked as the eighth
best market for suburban office investment.
Real Estate Markets in the Four Areas
Office Space
Each of the speakers talked about the influences on the
various real estate segments in his subject city: office,
industrial, housing, retail and hotel. Office space was,
not surprisingly, the most extensively discussed of these.
In almost all cases the recent economic slowdown has manifested
itself in the form of increased availability of direct-lease
and sub-lease space.
In Denver, the overall trend in the last
fifteen years might be described as one of robust recovery:
in both downtown and suburban office markets absorption
was significant and sustained, but Savioe also reported
that for long periods there was also absolutely no new construction.
Nothing at all was built in the suburbs from 1985 to 1996
and downtown from 1985 to 2000. Savoie revealed new data
his firm had produced showing negative absorption of 940,000
square feet of suburban office space in the first half of
2001. He also said there will be more space becoming available
and there is a significant overhang of space available for
sub-lease. Nevertheless, he reported, leasing activity is
still going on, although often with significant concessions.
Class-A rents, he said, are about $21 in the Denver area
as a whole, but with concessions they are netting out to
about $14 or $15. The current vacancy, he said, has come
from surprising sources. Although the "tech wreck"
has contributed, he said it is not the main reason, nor
is overbuilding. The number one cause, he said, is the recent
move by Lucent Corporation to a new campus location (which
vacated its previous space). Several thousand layoffs in
the area by Qwest, the "tech wreck," and the supply
of sub-lease space share the remainder of the blame, according
to Savoie.
The outlook, he said, is somewhat better
in the central business district (CBD), where there is unlikely
to be much increase in inventory. Nevertheless, vacancy
has risen in the first half of this year from 6.5 percent
to 9.8 percent. Rents here average $24-$25. Downtown, he
said, "never got as good as the suburbs, but it clearly
isn't going to get as bad either."
Sales prices also differ between the suburbs
and downtown, Savoie said. Suburban sales are primarily
new construction selling above replacement cost with long-term
leases. Because of the lack of construction downtown (even
what little has been built is going to be held by the developers,
he said) downtown sales will likely be buildings "built
in the last cycle, acquired for 50 to 75 percent of replacement
cost, with initial yields in the 8 to 9.5 percent range
and overall IRRs leveraged in the 12.5 to 13 percent range."
Suburban core properties, he said, are generally underwritten
at 12 to 12.5 percent IRR, with yields at 9 to 10 percent
on a ten-year hold.
Savoie also anticipated "polarization"
between downtown Denver and the southwestern suburban commercial
area, due to the renovation of the I-25 highway, expected
to be a seven-year project. The throughfare will be all
but closed to achieve the renovation, he said, which will
essentially preclude travel between downtown and the suburbs.
Savioe said he sees this as potentially "a real boon"
to downtown.
He described Denver as on its way to being
"mentioned in the same breath as San Francisco, Boston
and New York - America's 24-hour cities." To support
this forecast Savoie cited 9,000 new housing units downtown,
real vitalization of the western-most lower section of downtown
("LoDo") with dining and entertainment centers,
and the city's highly educated workforce.
Nevertheless, Savioe noted, one of the
reasons Boeing didn't move to Denver was that there wasn't
enough contiguous space available downtown, and the company
definitely sought a vibrant downtown area.
In Minneapolis-St. Paul, the market for
office space has recently shown signs of the slowdown. Dutke
reported that this follows a period of growth in the service
sector, which had benefited the office market. Construction
and absorption were generally in equilibrium but in 2001,
including space available for sub-lease, absorption is about
zero. He does not currently foresee any new construction,
and predicted that it would take about a year to absorb
the overhang of sub-lease space. He also mentioned the likelihood
of concessions and the possibility of an overall decline
in rents.
In downtown and suburban Chicago, by contrast,
rents have increased, although not as much as in some cities.
Absorption last year was good, Woloson said, but he expects
new supply in the next two years to increase vacancy from
the current 10 percent to about 12.5 percent. Space currently
under construction totals 4.5 million square feet downtown
and 6 million in the suburbs. In reporting this, Woloson
noted his concern about the likelihood of its absorption:
"That's a danger point in my mind, that the 6.2 percent
increase [the six million square feet in the suburbs] can
be absorbed in the next year or two," he said. Comparing
downtown and the suburbs, Woloson said that occupancy rates
in downtown are always better than in the suburbs. Buildings
are easier to permit and construct in the suburbs, he said,
and there is often oversupply in the outer areas.
Going into the details behind the Dallas
area's high ranking as a destination for investment in office
space, Aldridge described a disparity between downtown Dallas
and the suburban areas. The CBD in Dallas, he said, has
the highest vacancy rate in office space in any major city
in the country - 16 percent. Prime space is going for $16.
The city, Aldridge and others have said, "lacks a vibrant
central business district." A variety of redevelopment
projects are underway or have been proposed, although he
did not describe revitalization as a certainty.
Some of the Dallas suburbs, on the other
hand, sport among the country's lowest office vacancy rates,
he said. Las Colinas, "the 114 Corridor," the
Legacy development in Plano, and Dallas North were offered
as among those suburban areas experiencing success and rapid
growth. One note of caution in this discussion was the potential
impact of difficulties in the high-tech sector of the economy.
Industrial Space
In the Twin Cities, Dutke reported a slowdown in industrial
space akin to what the area is experiencing in office space.
Much of the industrial space in the cities is higher-finish
office warehouse and office showroom space and its construction
and absorption have been well balanced in recent years.
In early 2001, however, vacancy has risen from 10 percent
to about 14 percent. Nevertheless, rents remain stable in
most submarkets, he said. He did note that the more heavily
industrial uses, such as distribution, have been squeezed
farther out of the cities as the price of close-in land
for industrial use has increased in recent years.
Chicago, Woloson reported, is the largest
industrial market in the world, with about 1 billion square
feet of space. He reported overall vacancy at 7.4 percent,
up slightly but still good in his view. He also noted the
massive ongoing absorption of about a million square feet
a month.
Like the Twin Cities, the DFW area is
experiencing a slowing in leasing of industrial space, Aldridge
reported, and development is slowing down as well.
Retail Space
The retail sector, a significant one in Minneapolis-St.
Paul, was reported to be in stable and healthy condition
there. Average incomes in the region are relatively high,
and the cities are a shopping destination in the area, Dutke
said -- although ranked 14th in size by population, retail
sales for the area rank 11th. He said that absorption, construction,
rents and vacancy levels are fairly stable: vacancy is a
little over 5 percent and rental rates are trending slightly
up. Recent negative absorption in some areas is attributable
to temporary causes, Dutke said, and he predicted both positive
absorption and some new construction of retail space by
the end of the year.
Demand for retail space in Chicago has
been on the increase, especially with the growth of high-end
luxury housing in the city. Offsetting this, site availability
is not good and traffic and restrictive zoning provide challenges.
Still, there have been developments in several downtown
areas (sometimes on land made available by the removal of
old industrial buildings) and several more are contemplated,
Woloson said. Rents in several prime retail areas have reached
new highs recently.
The retail market is not a high point
in Dallas-Fort Worth, however, and Aldridge's only comment
on the subject was that there is little interest in retail
because of concerns about the financial strength of tenants.
Housing
Dutke described the housing market in the Twin Cities as
one of the tightest in the country, owing largely to high
local real estate taxes and civic activism against development.
Vacancies are 2 percent and less in both owner-occupied
and rental housing. High real estate taxes have suppressed
development. A tax of 3 percent of value on apartments translates
into about 20 percent of gross income on a project, he said.
In addition, suburban communities are so opposed to apartment
development that "there's a shortage of buildable land."
Reductions in the tax rates are expected (for residential
as well as office and industrial properties), however, which
could be the basis of future opportunity in the Twin Cities,
Dutke said.
In Chicago, Woloson reported, the tax
structure significantly favors home ownership and the rental
housing market is small. Consequently, investors have been
involved in conversions, he said, and in construction of
new condominiums. The rental market is actually a little
soft at the moment, a condition he ascribed to the popularity
of ownership. The resulting boom in condominiums has increased
land values so much that the medium of choice is luxury
condos, and other uses are being squeezed out.
In DFW, according to Aldridge, the situation
in the housing market is mixed. Apartment occupancy and
rents are both increasing with continued job growth and
a slowdown in apartment starts "get[ting] the credit,"
he said. Sales of existing homes have slowed, but housing
starts are still on the rise.
Hotel
Woloson and Aldridge both discussed the state of the hotel
market in their cities, perhaps because in both cases the
news was quite good.
In Chicago, the average daily rate has
risen in five years from $119 to $169, making the hotel
business quite solidly profitable, Woloson said. In that
time the supply of rooms has increased little. In the next
three years, however, the supply of new rooms is likely
to exceed demand, he said, and "occupancy has to give."
Even at what he guesses will be about 69 percent occupancy,
however, the business will remain strong and most downtown
hotels will be worth "north of $200,000 per room,"
a mark he said has already been exceeded in some sales.
In the DFW area, hotel occupancy has remained at about 65
percent in the past two years, and the average daily rate
has increased from just over $91 to almost $94. The increase
suggests underlying strength, Aldridge said, considering
that in the past five years 20,000 new rooms have been delivered.
Telecommunications
Space
Finally, Bart Woloson brought up a new kind of market --
the use of centrally located space to house telecommunications
equipment in what is sometimes called telecommunications
carrier "hotel space." In the past two years about
3.3 million square feet of space has been converted in this
way in Chicago, and tenants have absorbed 2.6 million of
it, he said. Although trends in the technology market have
meant that this market is "kind of dead right now,"
Woloson sees this as a temporary condition, and predicted
that the market would eventually come back to absorb up
to 8 million square feet.
While each of the speakers reported
measurable effects of the national economic slowdown (the
most common being declining absorption of office space overall
and increasing availability of sub-lease space), each also
noted specific opportunities, especially in the long run,
in his appointed city. Many of these had to do with circumstances
particular to the market in question and apart from general
economic trends. In the Twin Cities and Chicago, for example,
demand for housing exceeds supply because of legal and tax
structures and community concerns, but both cities provide
opportunity for developers in this area, speakers said.
Aside from the current slowdown, Frank Dutke predicted long-term
strength in the office market as well. He and Peter Savioe
both said they see their cities on the way to being among
the country's 24-hour centers. Savoie also predicted two
new 5,000-person corporate campuses in the Denver area.
In Dallas, and more broadly in Texas, Frank Aldridge described
an overall pattern of continuing economic growth and market
expansion, with short-term challenges and some pockets of
vulnerability. Success there will be based on "inevitable
growth and diversity of industries," he said. In Denver,
construction work on a major highway is likely to weaken
temporarily the connection between the suburbs and downtown.
Peter Savoie sees this as presenting particular opportunities
in downtown Denver. And in Chicago, a large and mature market,
Bart Woloson anticipated continuing economic strength and
mentioned many opportunities for development, involving
both expansion and rededication of properties.
